Friday, December 09, 2011

Analysis of the Financial Crisis, and a Small Sprout of Optimism

-- Posted by Neil H. Buchanan

Earlier this week, I attended an event in New York City, sponsored by GW Law's new Center for Law, Economics, and Finance (C-LEAF). C-LEAF is the brainchild of Larry Mitchell, a former GW Law professor who is now dean at Case Western in Cleveland. Now under the leadership of Professor Art Wilmarth, the center has been running a series of events designed to bring the business and policy communities together to discuss issues of common interest.

The New York event, "Headwinds in the Global Economy and Strategies for Regaining Traction," brought together a panel of three experts -- Corinne Ball (GW Law alumna and partner at Jones Day), Paul Roth (founding partner of Shulte Roth & Zabel), and former Secretary of the Treasury John Snow (also a GW Law alumnus) -- to discuss the aftermath of the global financial crisis and the possibility of a Euro Zone-led crisis going forward. All three panelists have serious expertise in these areas (Ball, for example, has been shuttling back and forth between the U.S. and Germany, consulting with German leaders as the situation has developed over the last few months), and their comments and answers to questions were candid and educational. (For an overall summary of the event, see here.)

As I listened to the panelists speak, I could not help but notice that their diagnosis and prescriptions for the financial system were very much in line with my understanding of what has been going on. Each speaker agreed that reduced financial regulatory oversight (fed, in large part, by regulators' fears of being slapped down by a series of Congresses and White Houses that have been very sympathetic to Wall Street) had been a major component of the 2008 meltdown. Within that context, they said, it was hardly surprising that people on the Street had gone overboard. This was, I think they were arguing, a completely avoidable crisis that was caused by bad policy, which was in turn caused by inappropriate political influence on the law-making and regulatory process.

Discussing the simmering crisis in Europe, all three panelists again agreed that the creation of the euro had been at best premature, with countries (understandably, given their histories) unwilling to cede sovereignty to make monetary union work. There seems very little doubt that something big is about to happen, with the only question being whether the euro will break up entirely, or perhaps the 17 countries in the euro zone will drop down to something like 7 "core" economies, with the periphery (Greece, Ireland, Portugal, and maybe even Italy (?!)) dropping out. The insistence of the Germans on enforcing Puritanical notions of fiscal propriety all but guarantees that the smaller countries will be forced out, with Secretary Snow noting that the "grinding" decline of those economies will make it politically impossible for national political leaders to withstand the backlash of their citizens.

During the question-and-answer period, I asked what the break-up would actually involve. That is, if the problem is that too many of these countries have too much euro-denominated debt, what happens when they drop out of the euro? Do we re-denominate the debt in the new currencies? The answer from all three panelists was, first, that nobody knows, and second, that (assuming that there is any euro left at all) the countries will simply impose a "haircut" on their lenders as part of the exit process, with the 10-50% of the pre-breakup debt that remains still payable in euros. This is a nice euphemism for debt repudiation. In other words, we are not just talking about changing currencies going forward, but about resetting the clock such that debt disappears. (Note that this means that as much as 90% of some countries' debt might simply be erased.) The panelists neither applauded nor deplored this result, saying that it was simply inevitable. It might, however, be fair to say that they applauded it a bit, at least by comparison to how bad things could otherwise become -- both economically and, in the scary ways that I have noted (for example, here and here), in terms of ugly domestic political extremism.

What is especially notable about the panel's discussion of the euro is how closely it resembled Paul Krugman's analysis of the problems and potential solutions to that crisis. Both in his twice-weekly NYT op-ed columns, and on his blog, Krugman has been excoriating the Germans and the European Central Bank for trying to punish other European countries for their imagined fiscal sins, rather than trying to deal with the real underlying problems. Similarly, Krugman has argued that the 2008 crisis was caused by a failure of policymakers to put adequate safeguards in place in the financial markets.

A few weeks ago, I referred in a Dorf on Law post to "leading economic thinkers on the left like Krugman and Stiglitz." One commenter wrote in response: "Any country in which Paul Krugman and Joseph Stiglitz count as the 'left' doesn't have a left." Quite so. John Snow, readers will recall, was the Secretary of the Treasury under George W. Bush, from early 2003 through mid-2006. Yet there he was in New York, saying things that were completely in line with Krugman's analysis of the two major crises that will define the early part of this century. Two high-powered corporate lawyers agreed.

As I noted in my post yesterday, what counts as "liberal" right now is truly bizarre. Elizabeth Warren wants nothing more than to make financial markets work more like pro-market economic theory says they should work, and she is called a socialist. I am clearly far to the left of center in U.S. political debates, but I write things like this: "If businesses are willing to compete honestly, and if they have a good product to sell at a fair price, then they will find customers, and they will prosper. That is capitalism. And when it works as Warren and I know it can work, it is a force for good."

I have recently argued (here and here) that there is precious little evidence of rationality on the right in U.S. politics these days. Occasionally, I see a hopeful sign, such as Rep. Darrell Issa (who is normally completely willing to engage in the new normal of name-calling and vilification) explaining recently that even the most radical plans to change governance in this country would have to be done carefully: "The federal government is not so desperate that we have to somehow pretend we’re in bankruptcy. But we are in need of reorganization, and for the good of the American people and the federal workforce, we should start acting like adults in our negotiations. But that has to originate from a president and from a Congress and then it has to respect the transition that would be appropriate." Of course, he could not resist claiming in the same interview that the federal government has been "hiring like crazy," which is plainly false, but at least he showed some sense that we cannot simply wish ourselves into his preferred small government Eden. That is a level of rationality that we see far too seldom from his party these days.

In any case, the C-LEAF event gave me some hope that there are people who are not political bedfellows who are still looking at evidence and are reaching reasoned consensus. In very recent times, it would not have been at all notable that Republican Snow and Democrat Krugman see some issues the same way. Now, such agreement might be the only basis for the tiny shred of optimism that we can still allow ourselves about the future. (That neither of those men holds public office should not be allowed to extinguish that optimism.)


Michael C. Dorf said...

On a side point: Ending the Euro is harder than many people think because it can lead to bank runs and other serious problems. English life peer Simon Wolfson has offered a £250,000 prize for anyone who can devise an orderly plan for unwinding the Euro. Wolfson is a Tory with policy views I don't share but I think he's right that an end-the-Euro scenario would need to be very carefully thought out. A recent Planet Money episode offered some cautions from the demise of the currency of the Austro-Hungarian Empire after WWI:

Neil H. Buchanan said...

I was trying to get at exactly that point in the Q&A. I was actually rather surprised that the answers to my "How would it really work?" question were so nonspecific. After the event, the other people at my table told me that they translated the panel's response as: "We really have no idea." That's not a criticism of the panelists, but an acknowledgement of how far we have ventured into uncharted territory -- and how much further we might yet need to go.

There is no way to describe the break-up of the euro as a desirable event, even if it is now obvious that it should not have been created in the first place. The problem is that holding it together could be even worse, which is really saying something.

Joline Rose said...

After the event, the other people at my table told me that they translated the panel's response as: "We really have no idea." That's not a criticism of the panelists, but an acknowledgement of how far we have ventured into uncharted territory -- and how much further we might yet need to go.Windows 7 ultimate product Key
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Linda Lolly said...

Unfortunately 3 years later we could still see little effectiveness of the attempts made by politicians at that time. The crises of consumer spending and consumer borrowing is only now being started to be overome and still the results are rather vague as for me.