Heterodox Analysis of Financial Crisis and Reform: History, Politics and Economics.

Bracker, Kevin S.

Heterodox Analysis of Financial Crisis and Reform: History, Politics and Economics, edited by Joelle J. Leclaire, Tae-Hee Jo and Jane E. Knodell, Northampton, MA: Edward Elgar Publishing, Inc., 2011.

The 2008-09 financial crisis is a topic rich in potential for research, analysis and potential lessons. While there are already many books and articles, within both academics and the popular press, addressing the financial crisis, this book takes an alternative perspective. Heterodox economics refers to economic ideas that are outside the mainstream that includes such ideas as post-Keynesian, Marxism, institutionalism, etc. By looking at the financial crisis through this lens, the editors and authors strive to seek new insights and challenge some mainstream views. Robert Pollin states in his foreword: "There is certainly a wide range of thinking incorporated within heterodoxy itself, as the chapters in this book attest. But as regards the financial system, the heterodox tradition is unified in the conclusion developed through generations of research, debate and rethinking--that capitalist economies operating without significant regulations will inevitably produce instability and crisis." The book's genesis can be traced back to the 4th bi-annual Cross-Border Post Keynesian Conference at Buffalo State College, NY where over 50 scholars presented their work on the theme of Financial Crisis and Reform. From these presentations, twelve essays covering various aspects of the Financial Crisis were selected for inclusion in the book. The essays are grouped into three themes: (1) Financial Crisis and Reform (chapters 1-2), (2) History and Political Economy of Financial Crisis (chapters 3-6), and (3) Theoretical Analyses of Financial Crisis (chapters 7-12).

"Difficulties in reregulation of the financial system after the crisis" by Jan Kregel focuses on the regulatory environment that was in place leading to the financial crisis. Kregel argues that it was not the lack of regulation, but the failure of regulations to be applied and poorly designed regulations, that were responsible for much of the behavior that led to the crisis. This is an informative article that illustrates the difficulty of creating and applying effective regulations in a complex environment where the parties being regulated have the ability (and financial incentive) to work around the regulation. The one drawback of this article was that, while it identified the problems of the regulatory environment, it would have been nice to see more along the lines of recommendations or solutions for going forward.

"Public policy to support retirement: an alternative to financialization" by Yeva Nersisyan and L. Randall Wray examines the role pension funds in public policy. They note that from 1947 to the present, private pension funds have gone from being predominately invested in bonds to being predominately invested in equities. Public pension funds have followed a similar pattern. In addition, they highlight the fact that pension funds have increased in size relative to the economy, peaking at about 75 percent of GDP in the early-2000's. Judging by the provided graph, they fell to a little under 50 percent of GDP in 2008. Nersisyan and Wray argue that this increased financialization of pension assets leads to financial bubbles and that "managed money, taken as a whole, is too large to be supported by the nation's ability to produce output and income ..." Next they argue that investors, on average, will not be able to earn higher than risk-free returns and therefore all pension fund assets should go into Treasury debt. However, this is still not sufficient. They suggest that employer-based pension plans are not well-suited to "current and future realities" and that private savings plans are also problematic--"And even if individuals tried to do so, there is no reason to believe that they would not be duped out of their savings by unscrupulous financial institutions selling risky investments. There is also the aggregate paradox of thrift: trying to save more for retirement leads to lower income and employment and thus no increase of saving." Therefore, "the best solution would be to eliminate government support for pension plans and private savings and instead boost Social Security to ensure that anyone who works long enough to qualify will receive a comfortable retirement." Apparently funding for Social Security is not a problem as "Social Security is a federal government program, and as such it cannot become insolvent. All payments can be made as they come due, even if benefits become more generous." How private savings will lower income and employment, but funding for Social Security benefits escape this drawback is beyond this reviewer. The argument for pension plans investing solely in Treasury debt also seems inconsistent with my understanding of risk premiums and long-run returns of equities vs. Treasuries.

"Those who forget the past are condemned to repeat it: lessons learned from past financial crisis that were ignored by the deregulators of the past 15 years" by Robert W. Dimand and Robert H. Koehn examines the works of Veblin, Keynes and Fisher to provide historical context from past financial crisis to the recent financial crisis. By looking at past speculative bubbles and lessons learned by scholars who were active at those times, they argue that the 2008-09 crisis could have been averted. Deregulation, lack of transparency, and too much leverage led, predictably, down the path to speculative excess and the inevitable bust that followed. Whether you agree or disagree with the conclusion, the paper does a good job of providing historical context to the recent problems and makes a compelling argument.

"Panics and depressions: a historical analysis of 1907, 1929, and 2008" by William T. Ganley, like the previous chapter, explores the recent financial crisis in a historical context. While the presentation of each crisis is necessarily brief, they are done well and provide the reader with a chance to see the similarities and differences. One conclusion, that echoes an idea raised in the first chapter of the book, is that government responses (regulation) tend to be more responsive to what has happened and less effective for dealing with what will happen in the future. Another conclusion, which we are seeing play out, is that recovery from severe financial panics is a long-term process.

"The instability of financial markets: a critique of efficient markets theory" by Robert A. Prasch takes aim at one of the hallmarks of financial theory. The initial attack is based on a logical contradiction. Specifically, if markets are efficient, why do so many smart people spend so much time and effort trying to find opportunities? I would counter this by arguing that market efficiency need not be a binary variable where prices are 100 percent efficient or meaningless. While there can be some debate on the degree of market efficiency, the argument that "smart money" may not always lead to efficient and self-stabilizing prices is worth raising. The author also argues that it is not just uncertainty that may lead to inefficient pricing and thus market instability, but also systematic institutional pressures that lead to speculative excesses and instability.

"Sismondi, Marx and Veblen: precursors of Keynes" by John F. Henry examines the similarities of the works of Sismondi, Marx and Veblen to Keynes and argues that these authors may provide more insights in addressing potential problems of capitalism than Keynes. While this may be an informative article comparing the works of economists, it seems out of place in this text. While there is a connection in that the economists in question are known for their critiques of certain aspects of capitalism, I would like to see more discussion of the 2008-09 financial crisis in particular rather than capitalism in general.

"Money manager capitalism, financialization and structural forces" by Yan Liang covers similar territory to Nersisyan and Wray's article that comprised chapter two. The emphasis here is on the idea that intermediation from pension funds and mutual funds leads to increased complexity and financial power in the hands of these institutions. This in turn leads to economic instability. Liang notes that private pension fund assets have increased from $11 billion in 1952 to over $6 trillion in 2007. As in the Nersisyan and Wray paper, Liang notes the significantly lower emphasis on bonds and greater emphasis on equities and alternative investments over time. Liang also notes that the top 10 percent of families by income level have seen significant growth in both the mean and median levels of financial assets while the bottom 20 percent of families have seen no growth in median levels and much lower growth (relative to the top 10 percent) in mean levels of financial assets from 1989 to 2007. In addition, mutual funds have increased significantly as a share of household financial assets (from less than 1 percent in the 1980's to nearly 10 percent in 2008) while deposits have declined (from over 25 percent to around 16 percent) during the same time period. Further discussion is focused on the increased complexity of financial instruments and the lack of sufficient regulation. Liang states "The birth and growth of 'financial weapons of mass destruction' is a joint product of the 'innovative' financial engineers and the lenient financial regulators." This chapter provides an interesting critique on the role of finance, and particularly financial innovation, in an economy.

"Engineering pyramid Ponzi finance: the evolution of private finance from 1970 to 2008 and implications for regulation" by Eric Tymoigne furthers the discussion on the role of finance in the household and, in turn, the economy. Here, the purpose is to discuss the emergence of Ponzi finance and regulatory changes that would help reduce the inherent instability while encouraging economic growth. As with previous chapters, the role of growth in both size and complexity of financial institutions and instruments plays an important role in the thesis. The Ponzi finance system is defined as one where cash flows from operations are insufficient to cover expected debt services and instead rely on refinancing or increased asset prices. This was the nature of many real estate loans made leading up to the financial crisis. To reduce this problem, two regulatory changes are proposed. First, focus loans on the ability to repay from cash flows and relegate collateral to a secondary role. Second, have a government agency that must approve financial innovations and periodically check that it does not fall into Ponzi practices. The problem with both of these proposals is enforcement. They require regulatory bodies with enough information, foresight, technical expertise, political power, and resources to effectively regulate the institutions under their supervision. They also must not be too restrictive to prevent valid innovation, which can be a fine line to walk. As was suggested in chapters one and four of this text, having regulations is not sufficient. Being able to enforce the regulations and having the right regulations is easier said than done. Having said that, the issues raised in this article make a positive contribution to the discussion on the role of regulation of the financial system.

"A heterodox microfoundation of business cycles' by Tae-Hee Jo seeks to introduce more of a role for social relations into understanding of business cycles. Specifically, the author compares Schumpeter's Instability Thesis with Minsky's Financial Instability Hypothesis and then moves to a micro view of business cycles. While it may be due to my background being more in finance rather than economics, this chapter did little to enhance my understanding of the financial crisis.

"Business competition and the 2007-08 financial crisis: a Post Keynesian approach" by Tuna Baskoy examines the role of competition on the financial crisis. Baskoy sees a cycle in which firms try to maintain profit margins. However, as conditions change to reduce margins, competition increases which leads to higher risk and ultimately bankruptcy, withdrawals from the market and rising unemployment. The chapter does an excellent job of using news reports, banking industry data, and quotes from executives to illustrate how the banking environment at the time fit the model of competition that is introduced at the start. The author introduces a model, illustrates the model with a real world example that was one of the prime components of the financial crisis, and a well-written conclusion.

"The global crisis and the future of the dollar: toward Bretton Woods 3?" by Jorg Bibow discusses global currency markets in a framework of repeated Bretton Woods agreements. The author starts with the "Bretton Woods 2" hypothesis that "a quasi-permanent US current account deficit may be sustainable." From there, "Bretton Woods 3" is introduced where "US public debt replaces private debt" and fiscal policies of lower taxation and higher government spending kick-start the economy and deficit spending (although at lower rates than immediately following the financial crisis) are financed through high demand for US Treasuries. The discussion then moves to a potential "Bretton Woods 4." The key takeaway is the argument that fiscal deficits may be sustainable for the intermediate term.

The final chapter "Exchange rate regimes and the impact of the global crisis on emerging economies" by Alfredo Castillo Polanco and Ted P. Schmidt examines what types of exchange rate regimes (ERR) work best for developing economies in dealing with external shocks--such as the financial crisis originating in the US. The authors develop "a short run Post Keynesian macro model for developing countries with non-substitution between domestic production and imports." Their results indicate that "the more flexible the ERR, the more harmful the impact on the domestic economy" and that "the central bank should intervene to reduce the depreciation of the domestic currency."

As someone approaching this from the perspective of finance with an interest in looking at some non-mainstream (heterodox) discussion of the financial crisis, I found this book to be a bit hit-or-miss. Some chapters did an excellent job of presenting information regarding regulatory environments, history of previous financial crises, or the role of financialization which added to my understanding of the 2008-09 financial crisis. While I may not have always agreed with the conclusions, the authors raised valid concerns and criticisms. However, there were other chapters which I thought were not as well developed or did not directly address the financial crisis. There were also chapters, and this is no fault of the editors or authors, that were outside my area of expertise or interest as they tried to cover a wider range of topics. For those who want to look at the financial crisis from an alternative point of view, this book does offer some insightful chapters. However, unless you have a significant interest in the heterodox literature (either from a teaching or research perspective), there are other books on the financial crisis that are both more accessible and provide more insight into the specifics of the financial crisis.

KEVIN S. BRACKER

Kelce College of Business

Pittsburg State University