Wednesday, December 24, 2008

RIP Chicago School of Economics

Economist Milton Friedman's Theories about unfettered markets dominated world governments' thinking for a loong time:

...For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley.

Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies.

In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies.

Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown ...

Friedman, who died in 2006 at age 94, defined the Chicago School in 1974 as he spoke to a board of trustees dinner:

“‘Chicago’ stands for a belief in the efficacy of the free market as a means of organizing resources, for skepticism about government intervention into economic affairs,” he said.

Well, maybe not so much anymore. We're all socialists now.

By the end of November, the government had committed $8.5 trillion, or more than half the value of everything produced in the country in 2007, to save the financial system.

The European Union had ponied up more than $3 trillion to guarantee bank loans and provide capital to lenders. And China had unveiled a $586 billion stimulus plan and its biggest interest-rate cut in 11 years ...

“When Friedman’s Platonic ideas of free-market virtues are put into practice, they have too often generated a systemic orgy of competitive greed -- whose remedies, ironically, entail countermeasures of nationalization,” [said] Marshall Sahlins, an emeritus professor of anthropology ...

Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

“The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001.

University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas.

“The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says ...

The problem, friends and neighbors, isn't market economies. The problem is unregulated market economies that get leveraged to the hilt and built on assets that are insanely inflated in value.

Nine years ago, I used to read financial commentary that said: "It's no problem that these new start up tech firms have a price-earnings ratio of two hundred or five hundred to to one. It's a new paradigm! Everything's different now!"

There were a lot of animation artists, flush with cash from the high-salaried nineties, who believed the commentators and invested accordingly. Which, of course, was ultimately a mistake. The dot-com mania and bubble of 1999 was a close cousin of the tulip bulb mania and bubble of 1637.

More recently, when Las Vegas real estate increased 100% in twelve months, I remember thinking: "This is unsustainable."

Human behavior ... and humans' capacity for self-delusion, doesn't really change a hell of a lot century to century, millennium to millennium.

Good rule of thumb: If it looks too good to be true, if it feels too good to be true, it is too good to be true.


Anonymous said...

What's your opinion on "Age of Turbulence" by Alan Greenspan?

I thought it was quite interesting.


Anonymous said...

Yeah, we gotta give this here socialism thing another try..

Anonymous said...

You mean "another try." bush reigned over the largest redistribution of wealth in U.S. History. The bush economic meltdown is the direct result.

Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers' ability to repay, making loans with deceptive "teaser" rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.

Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.

Predatory lending was widely understood to present a looming national crisis. This threat was so clear that as New York attorney general, I joined with colleagues in the other 49 states in attempting to fill the void left by the federal government. Individually, and together, state attorneys general of both parties brought litigation or entered into settlements with many subprime lenders that were engaged in predatory lending practices. Several state legislatures, including New York's, enacted laws aimed at curbing such practices.

What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.

Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.

Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government's actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.

But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.

Throughout our battles with the OCC and the banks, the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect. But the curbs we sought on predatory and unfair lending would have in no way jeopardized access to the legitimate credit market for appropriately priced loans. Instead, they would have stopped the scourge of predatory lending practices that have resulted in countless thousands of consumers losing their homes and put our economy in a precarious position.

When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.

Steve Hulett said...

There were other problems besides the administration protecting banks:

Chris Cox's disinterest in oversightof Wall Street in general, and Bernard Maddoff in particular, by the SEC.

The private ratings agencies' failure to honestly rate all the toxic loans, thereby allowing them to be bundled as AAA investments.

The SEC waiving of regulations for investment banks. The result was Goldman Sachs and others leveraging investment way up there -- over 40 to 1 -- and now all those investment banks are gone.

The removal of regulations over the last twenty years that has now undermined banks, Wall Street investment houses and hedge funds.

Oh yeah. And frozen up the financial markets, triggered bankruptices, and caused unemployment to soar.

It's been a queasy ride, and it's going to get queasier.

Anonymous said...

What this country needs IS socialism. We've had fat, corporate fascist taking too much of the workers blood and sweat for 200 years. If the new president is anykind of a "real" progressive then he'll start nationalizing industry and put all they greedy capitali$t where they should have been all along. On the assembly line with the rest of the workers.

Anonymous said...

The soviet union collapsed like almost 20 years ago now...

we're overtaxed as it is!


Anonymous said...

Well, you'd never know it from bush and dick's redistribution of wealth--the largest in U.S. history.

Anonymous said...

you haven't seen anything yet, here comes our Obama-nation.

Anonymous said...

Good to see that Rush still has listeners...

Anonymous said...

The middle class is stressed.

Here's what happens next:

1) BIG stimulus package ($800-$1 trillion).

2) 18-32 months of economic pain.

3) Deflation.

4) Followed by robust inflation.

It's gonna be similar to 1933-1945. Not same as, but similar to.

Anonymous said...

Praise GOD we have a Christian like Barack Obama in the White House. It'll be nice to have a President who believes in and follows the teachings of Jesus in charge. Maybe he'll be able to undo all the evil the current administration has wrought around the world and here at home.

Jaakko said...

See the newest challenge to modern economics in!

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