The book analyses the causes underlying the recent credit crisis in the global financial markets. Dr Barbera is a follower of Hyman Minsky, the economist, who argued that:
- A long period of healthy growth convinces people to take bigger and bigger risks.
- When a great many people have made risky bets, small disappointments can have devastating consequences.
(The point of time at which the tide turns is often described as the Minsky moment in business media.)
Dr Barbera argues that free market ideology evolved into a mis-guided notion that the outcomes are always perfect; that the “invisible hand” is also the “infallible hand”. Such belief was partly the result of mathematical models built on the questionable assumption that participants are rational. (The fact of course is that, in financial markets in particular, people often act on fear, on greed, on the herd instinct — rather than rationally. And, mathematics is powerless to factor in human emotions.) A corollary of this argument is that “there was no theoretical justification for the visible hand of government to come to the rescue of banks and other financial institutions.” Dr Barbera concludes that “we all need to think differently about free market capitalism if we want to preserve it.”
Such free market fundamentalism has become the accepted dogma for the last 25/30 years — since the coming to power of Prime Minister Thatcher in the UK and President Reagan in the US. The period has also seen a number of crises:
- The stock market crash of 1987 thanks to portfolio insurance based on dynamic delta hedging concepts (in my view Dr Barbera’s analysis of this crash is less than complete or logical);
- The crisis in the savings and loan industry in the US thanks to deregulation of interest rates;
- The crisis in Japanese banking in the 1990s;
- The series of balance of payments crises in east Asia in 1997-98, caused at least partially, in your reviewer’s opinion, by premature recourse to a liberal capital account;
- The dotcom bubble in stock prices in the US, in the late 1990s; and
- The credit crisis in 2007-08 which has led to a global recession.
Dr Barbera correctly argues that one of the reasons underlying some of the crises was that monetary policy considered only wage and price inflation, ignoring inflation in asset prices (Japanese equities and real estate; US stock market prices in the late 1990s; the housing prices in 2005-06). One cannot take exception to his conclusion that, “from 1945 to 1985 there was no recession caused by the instability of investment prompted by financial speculation — and since 1985 there has been no recession that has not been caused by these factors.”
While one agrees with the major conclusions in the book, some of the other arguments are more questionable. For example, at one place, Dr Barbera gives too much credit to the wisdom of financial markets: “This immediate processing of news, to constantly reshape our vision of the future, provides spectacular benefits to capitalist economies. As the news shapes opinion, it rewards success and punished failure. In particular, money pours into areas where innovative approaches revolutionise effort. Wall Street, on a real-time basis, shines a spotlight on such successes. And, success, for a long while, breeds imitation and more success. In that fashion, capital markets channel funds toward innovation and therefore lucrative endeavors, and deny funds to antiquated enterprises.” A couple of pages further down, he concedes that Wall Street’s “feedback process is largely backward-looking.” To my mind, the latter statement is far more realistic than the former eulogistic one; too often, participants in financial markets invent causes from results rather than the other way round! And, a backward-looking process is hardly the most efficient way of channelling capital where it will produce the maximum output. The fact is that finance capital has become far more oriented towards speculative activity than investment objectives: in the former case, assets are bought or sold in the hope of profiting from price movements, and not for the returns which the investment will fetch, a point which Dr Barbera does not really touch upon.
There are also a couple of obvious errors: in figure 10.5, the y-axis should read “Times” and not “Share (percent)”. Again, on page 155, Dr Barbera confuses CDOs with Credit Default Swaps, an error one does not expect from a Wall Street economist.
THE COST OF CAPITALISM
Robert J Barbera
McGraw-Hill
240 pages; $27.95
