Richard Posner is said to be the most cited legal scholar of the twentieth century.  A Failure of Capitalism, a book published toward the end of his distinguished career, is not among the most cited of his scholarly works – not even close – but probably the most read, judged by the number of ratings on Goodreads.  “The failure” of capitalism concerned herein is the financial crisis of 2008, which triggered the Great Recession, the worst recession the world had ever seen since the legendary depression of 1929.  The book attempts to explain the causes of that crisis, who should bear the blames and what lessons we may collectively draw from the event.

Posner believes the main cause of Great Recession is the confluence of lower interest rates in 2000s and the over-deregulation of financial industry that began much earlier.  On the one hand, cheap credit encouraged the expansion of homeownership, which pushed up home price because the supply in real estate market is usually slow to catch up with demand.  Rising price convinced people that houses are good investment, thereby inducing more to dive in with money borrowed beyond their means to pay back unless home price continued to rise.  On the other hand, deregulation made it harder for traditional commercial banks to raise equity capital from demand deposit accounts, owing to the competition from investment banks and hedge funds alike. To stay in the game, therefore, banks had to rely more on borrowed short-term credit, increase their leverage (the ratio of debt to equity) and make longer term (hence riskier) loans. With the huge demand for credit fueled by the low interests of 2000s, this business model was pushed to the limit, exposing the entire industry to the risk of default in the housing market should the price begin to fall.  To mitigate these risks, banks invented complex debt securitization devices, including the infamous credit-default swaps.   In hindsight, however, these tools were not so much about reducing the risks as hiding them, unconsciously or otherwise.

Given this analysis, it is hardly surprising Posner argues the leaders at Federal Reserve and other economic agencies – Alan Greenspan and, to lesser extent, Ben Bernanke, among others – are culpable for a misconceived monetary policy and the lack of foresight for the impending crisis.  He also points fingers at the US government for its deregulation of the financial industry – driven largely by market fundamentalism – and the failure to prepare a contingence plan that would have avoided the “bumbling improvisations” in the initial response.   Posner is also dismayed at the “failure of the economics profession to have grasped the dangers”.  Many, including Robert Lucas – the most distinguished macroeconomist at the time – seemed to have been completely blindsided by the disaster.    Lucas had gone so far as to downplay the imminence of a recession as late as September 19, 2008, four days after the collapse of Lehman Brothers.     However, Posner argues his fellow academics deserve lenience for missing the warning signs that they were supposedly best poised to spot.  For one thing, they were not well equipped to “empirically test rival theories of depression” and were increasingly isolated in their own silos by ever-greater specialization. More importantly, doomsaying is a tricky and unpopular craft. As Posner points out, “Cassandras rarely receive a fair hearing”, because “it is very difficult to receive praise, and indeed to avoid criticism, for preventing a bad thing from happening unless the probability of its happening is known”.

Posner pushes back forcefully against the claim that the crisis had much to do with the stupidity or greed of bank executives and hedge fund managers.  Nor does he believe they should be held responsible for not heeding the warning signs of a gigantic bubble while taking seemingly undue risks to “ride it”.     “Riding a bubble can be rational”, Posner explains, especially when money is cheap.  More importantly, nobody really knows when a bubble, unattainably large as it might seem, will burst, and until it does one could still be making much money riding it than climbing off.   Indeed, being rational could be a losing proposition when the majority is irrational, as summarized in Keynes’ famous aphorism,

“the market can stay irrational longer than you can stay solvent”.

Posner believes the duty of mitigating systematic risks resides elsewhere (i.e., government), because

“it would make no more sense for an individual businessman to worry that because of the instability of the banking industry his decisions and those of his competitors might trigger a depression than for a lion to spare a zebra out of concern that lions are eating zebras faster than the zebras can reproduce.”

Posner writes beautifully, with a combination of clarity, precision, and elegance that few authors could match.  If one wants to learn how to explain complex concepts to a layman in an accessible but still sophisticated manner, the book will make a great tutorial. I don’t know enough about macroeconomics or finance to comment on many an opinion expressed in the book.   Truth told, the book taught me a lot about those subjects – the difference between equity and security being a memorable example. However, I do question the wisdom of writing a book about an event that had not even run its course at the writing (early 2009).   If Posner had waited a few more years, perhaps he would not insist to label the crisis as a “depression”.  He might also reconsider his derision of Feds’ low-interest policy because that policy, in a much more aggressive form, had not only survived Great Recession, but also thrived for more than a decade since.