Monthly Archives: March 2010

The Clash of Ideologies – Economic Policy in Dismal Times

April 6, 2009

During the debate on the Senate floor on The American Recovery and Reinvestment Act of 2009, Senator McCain said, “This is not a stimulus bill; it is a spending bill.” Was he correct in making a distinction? By definition, a stimulus package is a spending package.  It is meant to add to the demand in the economy.  John Maynard Keynes, founder of the school of thought that prescribes aggressive government intervention to energize a slowing economy used an interesting metaphor to make his point – suppose the government would employ workers to dig ditches and subsequently fill these up, even though this would be unproductive use of labor, it will indeed benefit the economy through a process of secondary spending and re-spending – the multiplier effect – which will help create new incomes and productive jobs.

If the outcome of the Obama administration’s $787 billion Stimulus Package is a lasting improvement in the physical infrastructure, in the schools and bridges, in new energies, in the development of the first high speed train in the country, and the education of the young – this not only adds to demand in the short run but also creates conditions for a boost in productivity when the recovery gets underway.  These spending are not consumption or wasteful – they are investment in the future of the nation.  Over the years, both Democrat and Republican administrations have used the idea of fiscal stimulus to rescue a slowing economy.  In 1971, Richard Nixon, no liberal, famously remarked, “We are all Keynesians now.”

Yes, it is the entrepreneurs and the small businesses whose ingenuity and hard work create most of the jobs, but even the entrepreneurs need a framework to be successful.  This includes a healthy banking system, availability of credit, and customer confidence.  Both the House and the Senate versions of the Stimulus package include tax cuts that would result in higher disposable income for low income household to spend.

Tax cuts by themselves are seldom a cure-all for a slowing economy.  Consider the $168 billion Bush tax rebate introduced in February 2008 as part of the $300 billion Bush stimulus package. By most accounts, the impact was minimal. Most economists believe that tax cuts have a smaller bang for the buck due to our propensity to save a chunk of the tax check and the fact that some of the spending is on imported goods.  The supply side benefits of a tax cut popularized by A. Laffer have been found to be wanting.

Jesse H. Jones, the legendary Houston banker appointed as the Federal Loan Administrator by President Roosevelt, wrote, “Old and deliberate methods, dear to many, were necessarily brushed aside in order the people may have food, clothing and shelter, and that their homes and savings may not be taken from them. Fighting a depression is no different than from fighting a war.  In either case the entire resources of a nation must be used in necessary.”

If there was a time to set aside ideological differences, this is the time.  The Republicans should check save their mantra that free market does best when left alone for normal times. We are facing a crisis of historical proportions. A lot of factors cause and sustain an economic slowdown.  Not the least is the fear of failure.  Consumers and businesses pull back and the fear is infectious.  It will help dispel this fear, if the politicians act in a united manner to show their intent and determination to meet the challenge.  A house divided is a house weakened.

There is a clear and present danger that the nation’s economy could get much worse before eventually recovering.  By voting into law a bold stimulus package, the Congress has conveyed a strong message to the rest of the world that America is serious not only about defeating terrorism, but also in once again leading the world as the world’s largest and most dynamic economy.

As President Obama recently said China and other creditor worldwide should feel their investments in America is safe. The American economy is by far the largest in the world and has been a growth engine pulling the global economy.  It is incumbent on the politicians and policymakers to act decisively and responsibly to restore confidence at home and abroad so that America emerges from the recession stronger than before.

Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on the history of economic ideas. He can be reached at

email: muquddus@pvamu.edu.

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Why Government Intervention? The Promise and the Pitfalls

March 30, 2009

The American economy is in the middle of a ferocious retrenchment.  The statistics are not in dispute. The economy shed more than 651,000 jobs in February 2009, on top of more than 500,000 lost in January, bringing the total number of Americans looking for work unsuccessfully to a staggering 12.5 million. The national unemployment rate is a record 8.1%, a thirty year high.  Drilling down below the national averages the numbers are much worse for some groups. The unemployment rate last month was 13.4% for African Americans and a whopping 21.6% for teenage workers. A distressing 15 % of the unemployed have a college degree.  This is a huge waste of precious national resources, and a personal tragedy for those unemployed, and their families.

According to the most recent estimates from the Bureau of Economic Analysis, in the 4th quarter of 2008, the total economic pie or the Gross Domestic Product contracted a stunning 6.2% on annualized basis. The declines were deep and cut across all sectors of the economy.  The only sector where demand increased was government spending and net exports since imports were down. Warren Buffet, the world’s most famous investor and a shrewd student of the economy, appropriately described the situation as “an economic Pearl Harbor.”

It is not surprising that the average citizen is confused and scared.  There are many unanswered questions.  What happened? How did we get here? How could some of the world’s most profitable businesses make such bad decisions? Why were so many analysts wrong? How could politicians, government officials, and regulators create this mess?  Did institutions of democracy and capitalism fail the people of America?

There is plenty of blame to go around.  Clearly as some of those responsible have paid a price for poor judgment, many have not and will repeat these errors. According to most unbiased analysts, the current economic malaise originated in the growth and eventual collapse of a massive housing bubble; subsequent meltdown of several large firms in the bloated financial sector, that led to a freezing of the credit markets for important segments of the private economy.

The cumulative impact of greed, excesses, and hubris in Wall Street and Government’s halls of power was a catastrophic meltdown in the financial heart of the nation, and a collapse in the real economy that has cascaded to the rest of the world. In a blink of the eye, a staggering $8 trillion dollars in wealth has disappeared, mostly in equity markets and business bankruptcies.  Despite a massive $700 billion bailout of the rogue financial companies, and an equally big stimulus package, the economy is yet to stabilize from its downward spiral.

Thanks to globalization, the crisis in the US economy has rapidly spread throughout the global economy, infecting one nation after another. Historians have to go all the way back to the stock market collapse of 1929 and the ensuing Great Depression of 1930s to find a crisis of similar depth and proportions; the Great Depression was also caused by the collapse of an overly bloated economy and stock market from excessive destabilizing speculation that eventually spread to shutter down thousands of banks sending the economy into a tailspin.

The trillion dollar question is, should the Federal government wait for the economy to self-correct, or urgently intervene to prop up the economy? Consider some numbers.  If the economic decline continues at this pace, unemployment rate could be at double digits by summer of 2009.  For a $14.3 trillion economy, a one percent negative growth in the GDP results in the potential income loss of roughly $143 billion on an annualized basis. If the fiscal stimulus can be a catalyst for even a few points of GDP growth, it will pay for itself in greater incomes and output.

If nothing is done, no one knows how long it will take the economy to recover on its own.  Analysts point to almost ten lost years in Japan once it real estate bubble burst in the early 1990s.  Fortunately, we can learn from Japan’s experience and not repeat errors made by their policymakers.  It is unnecessary that American workers and businesses suffer through years of a painful recession which would erode the nation’s competitive position in the global economy.  Most economists agree on what ails the economy, and time tested remedies are available.  A sufficiently large stimulus in the form of a combination of direct government expenditure and tax cuts should jolt the economy back to path to full recovery.  Like a bitter medicine given to a sick patient, the stimulus may take time to work, and there would be some unpleasant side effects, but it eventually it would work.  It is a small down payment for more robust growth in the long run.

Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on the history of economic ideas. He can be reached at

e-mail: muquddus@pvamu.edu.

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The American Recovery and Reinvestment Act of 2009: An Exercise in Futility?

March 23, 2009

With an eye popping 333-0 vote, with none of the Republicans in Congress voting in favor, the American Recovery and Reinvestment Act, aka the Stimulus Package, designed to jumpstart the rapidly fading US economy, was signed by President Obama on February 17, 2009. Is this a good bill that will help create, as the new administration believes, millions of jobs and help re-energize the economy? Or is this the latest example of pork laden bill passed by politicians, on the back of the taxpayer, to achieve their narrow ambitions? A few lessons from economic history may help us answer these questions.

In the 1930s during the Great Depression as the average citizen on the Main Street suffered from the extreme hangover in Wall Street from the decade long speculative binge, economists were at a loss in explaining the cause of the crisis, and in offering solutions to officials.  In 1930s, economists did not understand the workings of the business cycle well enough.  The existing models of the economy predicted that a prolonged and deep recession from overproduction cannot happen.

The conventional wisdom based on a hundred year old theory called “Say’s Law,” preached that supply creates its own demand.  In other words, during the process of production, the economy creates enough income to support the necessary demand to buy the newly produced goods and services.  As a result, the economy would not experience a state of generalized overproduction from excessive savings – something that would lead to inventories to pile up and firms to cut back on production.  This view called the Classical model held that the economy may be derailed by temporary disruptions to demand, but the resilient economy eventually returns to a happy state of full-employment.  These widely used equilibrium models offered no real solutions for a moribund economy afflicted by a prolonged recession.  The model recommended no interventions since the economy is always expected to rebound on its own.

From across the Atlantic, the distinguished British economist, John Maynard Keynes, a Cambridge University professor and a high level government servant eventually solved the puzzle and presented breakthrough ideas on dealing with a recession in his 1936 book, The General Theory of Income, Employment and Money. Keynes persuasively made the case for immediate government intervention to reenergize the economy in a recession. He dismissed the mantra of an eventually self-correcting economy that needed no intervention. He wrote, “(The) Long run is a misleading guide to current affairs. In the long run we are all dead.”

The Keynesian model of the economy could explain economic slowdowns, and offered fresh solutions on how to recover from recessions.  According to Keynes, the slowdown is usually caused by insufficient demand in the economy from an external shock or consumers and producers stepping back from spending. Further, once derailed, the economy often fails to automatically return to full-employment due to inefficiencies such as sticky wages and prices that are built into the economy. Additionally, psychology (animal spirits) plays an important role in the decision of entrepreneurs and businesses to invest or not, he argued.  Keynes noted that insufficient demand often plagues the economy, and prescribed as solution, increased demand through a combination of expansionary monetary (credit, interest rate) and fiscal (tax and spending) policies.

Among the policy options, monetary policy has a few advantages. It can be implemented rapidly since interest rate decisions are made by the Federal Reserve Bank and not the Congress; second, changes in credit and liquidity work through the private economy. Unfortunately, at times monetary policy is not a good option.  For example, if interest rates are driven to very low levels, as is the case today, investors expect interest rates to rebound and bond prices to fall, and therefore they shun bonds. This scenario is aptly described as a “liquidity trap” since in this situation monetary policy loses its potency. With the Fed’s arsenal exhausted, the only effective policy option available to the state to deal with a recession is to stimulate demand by either cutting taxes or increasing spending, or use a combination.

The economy can be re-invigorated through increased government spending financed by borrowing from the public or the Central Bank, and/or a tax reduction that will also reduced revenues and result in a budget deficit.  Keynes showed that direct government spending was the most effective (fiscal) stimulus, since all of it is spent, whereas a tax cut increases disposable income a portion of which is used saved.  This “leakage” from the spending stream results in a smaller bang for the buck (tax multiplier is smaller than the spending multiplier).

With interest rates at historically low levels today, increasing liquidity and cutting interest rates will not be effective in lifting the economy.  The frozen credit markets make it even more difficult to depend on monetary policy as an anti-recessionary strategy.  This leaves a tax cut (favored by the Republicans) or an increase in spending as the only viable options.  President Obama’s advisors believed that the spending can be used more rapidly and targeted to achieve some of the goals on the President’s agenda.  However, nodding to the Republican attachment to tax cuts, a rather large tax cut for the low-income households in the Stimulus Package was included to the initial version.  Unfortunately, this failed to sway the Republicans.  Most of them argued for a tax cut only, largely ignoring that President Bush had implemented a hefty tax cut only stimulus in early 2008, without much success. Others argued, incorrectly, that doing nothing would be better than a flawed intervention.  However, most economists agree that even though there are some risks in government stimulus, given the fast deteriorating state of the economy, the positives far outweigh the negatives.

Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on economics and related subjects. He can be reached at

email: muquddus@pvamu.edu.

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“In The Long Run We Are All Dead.” Economic Policymaking in Times of Crisis

Munir Quddus

March 16, 2009

As politicians and pundits debate the role of government in helping the economy, they will do well to read up economic history, including the history of economic ideas. The quote in the title of this article is from John Maynard Keynes, the British Economist who died in 1939.  Keynes ideas presented in his 1936 magnum opus, The General Theory of Employment, Income and Money are largely credited with revolutionizing macroeconomic theory and economic policymaking during times of crisis.

To Combat Recession, Is an Economic Stimulus Necessary?

On February 17, 2009, President Obama signed the $787 billion The American Recovery and Reinvestment Act of 2009 designed to jumpstart the moribund economy passed.  The bill was enacted after a bruising tussle in the Congress where it gathered zero Republican votes.  Was the decision by the opposition to say no to the Stimulus Package based on good economics or on politics as usual?

A large number of economists in academia, business, and in government, prescribe increased government spending to cushion and reverse an economic slowdown.  They may quibble on the size of the funds to be borrowed, the method of financing, and how government funds should be spent, but fundamentally there is broad agreement that when the private economy hits the brakes and starts skidding, and the Federal Reserve has exhausted its arsenal to re-energize the economy, government spending or deficit financing is about the only game left in town.

Call it a Stimulus Package or Recovery Act, the basic concept is the same – since the problem is inadequate demand and private spending by business and consumers, government can step in to boast demand and create jobs in the immediate run and provide a cushion to the downward spiral of an economy that has temporarily spun out of control.

Are there negative side effects to this medicine for the ailing economy? Well, certainly.  Almost always there are winners and losers when a regulation is enacted, or a tax or spending policy changed. For starters, increased spending will result in an increase in budget deficits, national debt, some crowding out of private investments, possible waste, and inflation. All of this may come about in the future with varying degrees of certainty.  Why then support the stimulus? Why not let the economy reboot itself however long it takes?

Because managing the economy is not unlike managing a private sector organization or treating of a sick patient.  Using a medical analogy, almost every medication prescribed by the doctor has some negative side effects.  The exact prescription for treatment and recovery depends on the seriousness of the sickness, and the patient’s ability to withstand the negative side effects.  When the patient is seriously ill, doctors are willing to prescribe strong medicines and even surgery to save and eventually heal the patient.

Similarly, when the economy is buffeted by destructive winds of a category five economic hurricane, inaction by the government on the belief that in the long run winds will calm down, is hardly prudent economic management.  The economy and the society is far better off with an effective Stimulus Package as a crisis management tool to be followed by prudent policies to rebuild the foundations of long term recovery and a sound economy, once the emergency is over.
Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on economics and related subjects. He can be reached at

e-mail: muquddus@pvamu.edu.

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“In The Long Run We Are All Dead.” J. M. Keynes

Munir Quddus

February 11, 2009

As the nation debates – to stimulate or not – we can learn from economic history, and the history of economic ideas.

In the 1930s during the Great Depression as the average citizen on the Main Street suffered from the speculative excesses in Wall Street, the academic economists was at a loss in trying to explain the nature of the crisis, and offer solutions.  Economists did not understand the workings of the business cycle well enough.

The conventional wisdom based on a theory called “Say’s Law,” held that supply creates its own demand.  In other words, the economy should not experience overproduction, where inventories pile up because of insufficient demand.  This view sometimes called the Classical model held that temporary disruptions in demand may exist but eventually the economy returns to a state of full-employment, a happy state.  The existing model had no solution to offer in jumpstarting the moribund economy.

From across the Atlantic, the distinguished British economist, John Maynard Keynes, a Cambridge University professor, a high level government servant, and an author par excellence eventually came with a few breakthrough ideas on rebooting a sick economy.  In his book, The General Theory of Income, Employment and Money, published in 1936, Keynes persuasively made the case for immediate government intervention to reenergize the economy in a recession. He dismissed the mantra of an eventually self-correcting economy. “(The) Long run is a misleading guide to current affairs. In the long run we are all dead.”

Keynes built a new model of the economy that could explain economic slowdowns, and offered fresh solutions.  According to the new model, once derailed the economy often fails to return to a state of full-employment on its own due to the built in inefficiencies such as sticky wages and prices. Psychology plays an important role in the decision of entrepreneurs and businesses to invest or not, he argued.  Keynes argued that insufficient demand often plagues the economy, and the solution is to increase demand through a combination of expansionary monetary and fiscal policies.

Fiscal policies to stimulate the economy could be increased government spending financed by borrowing from the public or the Central Bank, and/or a tax reduction that will also result in a budget deficit.  Keynes believed that direct government spending was the most effective stimulus, since it is spent directly whereas a tax break can result in higher saving.  With interest rates at historically low levels, increasing liquidity and cutting interest rates typically are not effective during a deep recession.  He coined the term “liquidity trap” to describe the situation as we have today when monetary tools lose their potency. Derided as a socialist, Keynes believed that he was prescribing a solution to manage business cycles and strengthen capitalism.

Today, in America we face a ferocious economic retrenchment.  The statistics are not in dispute. The U.S. economy is in a free fall shedding 598,000 jobs in just one month, January 2009. The national unemployment rate is a record 7.6%, one of the highest in the past three decades.  Drilling down we find the unemployment rate to be 12% for African Americans, and a whopping 21% for the young people just entering the labor force. A distressing 15 % of the unemployed have a college degree.  What a waste of precious national resources, and what a tragedy for those impacted.

The total economic pie or the Gross Domestic Product contracted a stunning 3.8% in the 4th quarter of 2008. Warren Buffet, the world’s most famous investor recently described the situation as “an economic Pearl Harbor.”

What happened? How did we get here? This current economic malaise originated in the collapse of a massive housing bubble; the subsequent meltdown in the bloated financial sector, the resulting freezing of the credit markets. The cumulative impact of greed and excesses in Wall Street was a delayed deleterious impact on the Main Street.  Pretty soon, despite a massive bailout of the banks, the economy was fast spinning out of control.

The crisis in the US economy quickly spread throughout the global economy, infecting one nation after another. One has to go all the way back to 1930s to find a crisis of similar depth and dimensions; the Great Depression was also caused by the collapse of an overly extended economy and stock market from excessive destabilizing speculation that eventually spread to shutter down thousands of banks sending the economy into a tailspin.

The billion dollar question is, should we wait for the economy to self-correct, or should we urgently act prudently? If our economic decline continues at this pace, unemployment rate could be at double digits by summer of 2009.  For a $14.3 trillion economy, each month the economy is hemorrhaging, the potential income lost is roughly $46,000,000,000 and $550 billion annually.

Fortunately, this does not have to be the case.  It is unnecessary that the American workers and businesses suffer through years of a painful recession that will further erode our competitive position in the global economy.  Most economists agree on what ails the economy and time tested remedies are available.  A stimulus in the form of a combination of direct government expenditure and tax cuts should jolt the economy back to path to full recovery.  Like bitter medicine given to a sick patient, for the stimulus to work may take some time, and there may be some unpleasant side effects, but it should work.

Senator McCain said, “This is not a stimulus bill; it is a spending bill.” By definition, a stimulus package is also a spending package.  It is meant to be.  In a famous passage, Keynes used a metaphor to make a point – suppose the government would use its resources to have workers dig ditches and then fill these up, even though wasteful this stimulus would help the sagging economy through a process of spending and re-spending called the fiscal multiplier.  Just imagine if the end product is a lasting improvement in our physical and digital infrastructure and in our schools and the education of the young – these are not consumption or wasteful expenditures, they are an investment in the future of the nation.

Yes, it is the entrepreneurs and the small businesses whose ingenuity and hard work create most of the jobs, but even the entrepreneur needs help such as a healthy banking system, availability of credit, and customer confidence.  Both the House and the Senate versions of the Stimulus bill include payroll tax cuts for consumers to have higher disposable income to spend.

Tax cuts are seldom a cure-all for a slowing economy.  consider the $168 billion Bush tax rebate introduced in February 2008 as part of the $300 billion Bush stimulus package. Its impact was minimal. Most economists believe that tax cuts have a smaller bang for the buck due to our propensity to save a chunk of the tax check.  Further, the supply side benefits of a tax cut popularized by A. Laffer have been found to be wanting.

Jesse H. Jones, the legendary Houston banker appointed as the Federal Loan Administrator by President Roosevelt, wrote, “Old and deliberate methods, dear to many, were necessarily brushed aside in order the people may have food, clothing and shelter, and that their homes and savings may not be taken from them. Fighting a depression is no different than from fighting a war.  In either case the entire resources of a nation must be used in necessary.”

There is a clear and present danger that the nation’s economy could get much worse.  By supporting a bold stimulus package in a bipartisan way, our representatives in Washington have an opportunity to send a strong message to the rest of the world that America is united not only to defeat terrorism, but united also in bridging our ideological differences to rebuild a strong economy.

Munir Quddus is a Professor of Economics and Dean of the Business School at Prairie View A&M University, Texas. He writes on the history of economic ideas. He can be reached at e-mail: muquddus@pvamu.edu.

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Alan Greenspan’s Mea culpa – Too Little, Too Late

Munir Quddus
e-mail: muquddus@pvamu.edu

November 3, 2008

On October 23, Alan Greenspan, the nation’s most celebrated Central Banker, affectionately called the “maestro” for his skillful handling of the economy over 18 years as the Nation’s Chief Central Banker, finally faced the music.  One must give credit to Mr. Greenspan for showing up more than two years after his retirement as the Chairman of the Federal Reserve Bank.  Certainly, not showing up at the Congressional testimony would have been even more damaging to his carefully nurtured image as the nation’s foremost economic seer.

Mr. Greenspan, a Republican and self proclaimed admirer of Ayan Ryan’s somewhat extreme economic views that markets are always correct, has been a fixture in the Washington policy circles since the days of President Nixon.  During much of his tenure at the FED, Greenspan enjoyed a “large than life” persona, a celebrity who led a charmed life at the highest echelons of power.  The Chairman of the Fed is often called the most powerful man in the country, ahead of the President given the impact of monetary policy on the every day life of each American.

The questions from Congressman Henry Waxman, Chair of the House Banking Committee were direct and rough:  “You had the authority to prevent irresponsible lending practices that led to the sub-prime mortgage crisis. You were advised to do so by many others. Do you feel that your ideology pushed you to make decisions that you wish you had not made?” The Congressman reminded the former Fed chairman that he had been one of the nation’s leading defenders of deregulation, reading past statements in which Mr. Greenspan had argued forcefully that government regulators were no better than markets at imposing discipline.

What Congressmen Waxman and others should have asked was: How much did Mr. Greenspan personally benefit from his persistent opposition to regulations of the hedge funds and the derivatives? Why did the former Chairman of the FED, in his role as the regulator in chief of all financial markets, fail to take steps to stop the bubble when he was fully aware that one was growing? Why did he not adequately assess the risks to the financial system of the credit swaps and other derivatives and in banks getting ever larger? Why did Mr. Greenspan not learn from the real world crisis during his tenure – the collapse of the dot.com bubble, and the meltdown of the hedge fund Long Term Capital Management, when excessive leverage from the use of derivatives nearly brought down the financial system? Has he not read economic history to realize that time and again markets are disrupted by excessive greed and deceit leading to much misery? Why did he actively undermine the New Deal regulatory infrastructure put into place seventy years ago to prevent precisely this type of speculative excesses?

Mr. Greenspan, the high priest of unregulated capitalism, chastened by the unprecedented crisis was measured in his responses during his testimony: He said he was shocked that financial markets had failed to respond as anticipated. “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.”  Under intense questioning he conceded that he had “found a flaw” in his bedrock believe of “40 years or more” that markets tend to self-regulate. “I made a mistake” a somewhat contrite Greenspan explained. “It has been painful to realize that I had put too much faith in the ability of the markets to self-correct.” “My view is that same as that of many in the academic profession including Nobel prize winning professors.” Finally he confided that while in office he had no clue that a financial catastrophe was in the making.  Besides, the best computerized economic models in the country that are used by the FED, also failed to anticipate the financial tsunami.

Shocked and surprised?  This is incredulous.  Mr. Greenspan with a doctorate in economics is an expert on financial and economic history.  He should be fully aware of the long history of manias panics and speculative binges that have from time to time turned the financial markets into gambling casinos.  He has lived through and perhaps contributed to some of crises, from the 1987 stock market crash to the LTCM debacle; from the growth to the crash of the dot.com bubble.  These are enough to teach several lifetimes worth of lessons.

Mr. Greenspan’s Mea culpa is too little and too late.  First his statements do not sound like an apology.  He sounds as if he is still passing the buck instead of taking responsibility for his role in leading the nation into an economic debacle.  Second, the expression of regret is late.  As the economy spun out of control, he remained quiet.  In his recently published book for which he received an advance of $3 million, he failed to mention any of this. Finally, he cannot say that he did not have full information of the extent of the rot and the growing bubble.

The basic lessons are few: Do not put blind faith in the markets.  Prudent regulations are best for productive capitalism.  Look out for greed and excessive speculation.  Make sure the ability to leverage is constrained and transparency rules.  Keep an eye for any asset bubbles, and defuse these before they become “too big to fail.” As Adam Smith, the father of modern capitalism said, do not trust big business.  Power always corrupts.  Make sure the regulators identify and crush market power before it is too late.

For more than 18 years as the Chairman of the FED working with several administrations, Mr. Greenspan enjoyed vast powers. During this period, he was a fearless advocate of Laissez-faire capitalism and defender of deregulation.  He worked aggressively to block sensible regulations proposed to monitor and manage the derivative market, now considered a $65 trillion cloud casting a long shadow over the economy.

His intellectual and moral stature in the nation’s capital and on Wall Street was unique.  He was widely respected and admired, even feared.  He was considered the nation’s foremost authority over all things relating to the economy. He could have given a siren call for restrain and for regulating the secretive hedge funds. He could have single handedly called for new regulations.  He could have directed the Fed to use if vast powers to regulate to penalize some of the worst offenders of speculative excesses and send a clear message.

Clearly he was not an independent observer.  His politics has long been known.  He is a Republican, but as the chief of nation’s central bank, he was expected to serve as a unbiased public servant.  He did not do so.  He constantly opposed taxes. He always supported President Bush’s tax cuts when these cuts threatened to greatly explode the annual deficits and add to the national debt.  He is also much overrated as a economic forecaster.  In 2004, he said, “Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”

In the case of the LTCM, he successfully engineered a bailout.  He was in the room with the big bank CEOs and had information the rest of us did not.  He knew how close the system came to a meltdown. Did he not learn any lessons from this experience that the best and brightest can get caught in greed and indulge in irresponsible investments? Did he not learn how fragile and interdependent the system has grown? Was he not aware of the awful power of leverage from derivatives and the comments made by Warren Buffet that these were “(financial) weapons of mass destruction,” and must be monitored and controlled? Why did he used the full weight of his authority to unambiguously stop attempts to regulate the derivative markets? Why did he and his colleagues on the FDIC not seriously warnings from seasoned market participants like Warren Buffet who in 2004 called derivatives, “financial weapons of mass destruction.”

Unfortunately for America, Mr. Greenspan was overrated as an economic guru and as a sage.  He is an ideologue and not a moderate.  He is opposed to regulations, even good ones, as a core principle of his thinking. Is there a single regulation he has proposed, defended or strengthened? Can he point to any attempt on his part to restrain the excesses in the market (beside the lonely comment on irrational exuberance)? Can he claim in good faith that he and his colleagues did not have all the facts about the bubble in the nation’s housing market?

The real danger from this tragic episode is that Mr. Greenspan and other ideologues are far from convinced that markets are an imperfect device for creating wealth.  The blind faith in free markets – the mantra that markets are always efficient and right and never mistaken- are deeply embedded in the psyche of this nation.  Common sense and a cursory reading of financial history eloquently make the case for market imperfections and judicious regulations.  Yet ideology is powerful.  It can dazzle and spell bound the most analytical mind as well as the average citizen.  In this environment, Senator McCain’s attempt to raise the bogeyman of socialism makes perfect sense. The dreaded socialism – redistribution of wealth is as un-American as one can go.  Any attempt to reform or improve market performance is immediately labeled as an attempt to “regulate” the market, will increase inefficiencies, eliminate liberty and competition, and will be a step towards a complete control of markets – socialism.  According to this mindset, either you are for free unregulated markets or against it.  There is no middle ground in this debate.  Absurd as this view is, it has had considerable influence on the US economic policy and political arena.

The leaders of the unfettered or unregulated capitalism movement have invested too much in buying and selling the snake oil equivalent of the mantra that markets are the best mechanisms for self-discipline.  They refuse to learn from economic history and modern economic research that demonstrates that markets are never perfect, have lopsided information and participants often behave irrationally overcome by greed and hubris.  Just as in government, power corrupts.  Therefore, a system of checks and balances is good for the markets.  We need regulators to play cops in the financial streets just as we depend on cops to stop the criminals and protect the good citizens.  Just as we need fences for good neighbors, or the sprinkler for the remote possibility of a fire, we need regulations for all the parties to know the limits of what is allowed and what is not, and institutions that play that play the role of lender of the last resort.

Given this dismal conclusion, the cycle of boom and bust will continue in the future, and may even get worse.  This loss from the 2008 bust of $8 trillion may look like peanuts when ten years from now we run into the bursting of another bubble that may wipe out $20 trillion or more.  We must educate citizens, regulators, and politicians on the basics of capitalism.  We should make it mandatory that regulators read financial history to understand the power of human psychology in affecting markets to create as well as to destroy great wealth.

Market failure – economists call cases where markets fail to deliver the most efficient outcome as market failure.  This can happen if there is monopoly power in the hand of one large player preventing competition.  This can also happen if there are externalities so that the action of the buyer or seller has indirect implications for others.  For example, your education has positive implication for your neighbors since educated people are less likely to commit crimes.  If this is taken into consideration, the society or community should invest more into education (perhaps subsidize your college education) but it is often not.  A bubble will be yet another example of market failure since a bubble outcome – price or output – is far from optimal or efficient.  The aftermath is always wasteful and painful.  Whenever, possible a bubble must be prevented and controlled.  Some have hypothesized that the FED under Greenspan deliberately created the Housing bubble, or failed to prevent its growth, given they had other more important considerations (wanted to prevent a Japan style long recession).  From their perspective, the bubble would be the lesser evil.  Now we know how foolish this notion is.

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