Transactions: Oct. 18, 2010

Is finance too mighty? Is finance a leech upon the real economy or a Keynesian magneto? Did finance balloon after the '70s for good reasons, like the need to drive an advanced, post-industrial, capital-intensive economy? Or was it all about greed? Were there other, practical options beside steroidal finance to generate that growth? Three years after the crisis began with a burp in the subprime subbasement, these questions elicit scant consensus. Instead, sides have formed, trenches dug, mortar rounds flung at each other, followed by name-calling. Of course, Wall Street is excessively large. Of course, Fat-Cat City sucked the life from Main Street. Look how we prospered in the '50s and '60s without securitization, derivatives, firms the size of planets. Contemplate the speculatin' rich! Bailout babies! Then, of course, chest-high in mud, huddle the we-can't-break-up-the-banks-and-shrink-Wall-Street rump. They fire back: Only a large, complex, innovative financial sector can provide the liquidity to drive a mature economy in a take-no-prisoners world. The '80s and '90s were swell. Ponder the rise of China and India. Got any better ideas to generate growth?
The big vs. small finance debate feeds other matters, like who's to blame. Alas, think deeply about it and you end up with a mash-up of free will and determinism. How much human agency went into designing the system that blew up so spectacularly? What were the articles of faith in the '70s and '80s? (What, in fact, does "wrong" mean -- over short term or long?) Policymakers clearly believed big was better than small, deep markets better than thin, free better than constrained, complexity better than simplicity. Were they wrong? Regulatory decisions to liberalize markets were justified by competitiveness, efficiency, productivity. Heavily regulated commercial banks struggled in an increasingly market-dominated world, so the Federal Reserve freed them, loophole by loophole, to compete. Conventional wisdom saw size as a necessity. And so barriers fell, creating a purportedly more efficient banking system (and many believed right up to 2008, a safer one). Did many profit from those decisions? Did the structure of finance grow simpler as institutions became more complex? Did decisions spawn unintended consequences and trigger further lockstep change?

Say you were in charge in 1975. What would you have done differently? It's a tribute to the relative paucity of alternative economic ideas, particularly in America, that it's hard to imagine a different outcome. The '70s were a grim decade, arguably as bleak as today. Market liberalization was a path to reviving prosperity; the competitiveness debate was about combating decline. Meanwhile, down in the basement, something was happening, and it wasn't just rising oil prices and Islamic agitators. Industrial profits were shrinking. As trade barriers fell, lower-cost nations, beginning with Japan, proved more efficient at producing manufactured goods; others, in waves, followed. Should we have turned inward? Could we have preserved the postwar boom in amber, like '50s-era Chevys in Havana? The Cold War still rumbled. The economy was being rewired with digital technology. Services (like finance) were booming. Women went to work -- by choice and necessity. Job mobility soared, corporate loyalty fell. Companies, suddenly interested in shareholders, dumped retirement planning onto workers. Credit fueled consumer spending. Could anyone be elected in America who promised, in the slogan of that era, "limits to growth?"

In the early '90s, Paul Krugman still despaired of American debility, rooted in lousy productivity. Mistakes were subsequently made, regulatory capture occurred and self-interest deepened. But we rose from the slough of '70s despond. True, by the '90s complexity fueled greater complexity; bureaucracy spawned more bureaucracy; ideas went from fresh to dogmatic to imprisoning. The efficient-market hypothesis was once a fertile idea, only to morph into policy, then ideology. Necessity ruled. The gospel of consumption, competitiveness and opportunity was, and is, powerful. Growth was a winning issue for Ronald Reagan and Bill Clinton. In the late '80s, as fears over Japan raged, Larry Summers proposed a Tobin tax to reduce financial transactions -- an idea that went nowhere and one he dropped. That was the last time a Tobin tax got any play (it wasn't much) until U.K. financial regulator Adair Turner revived it last year. In 2007, even a liberal critic such as Robert Reich could write admiringly in "Supercapitalism" about our economic machine; he worried that it was so successful at feeding consumer desires that democracy was threatened. Inequality was troublesome, but who could foresee breakdown? All this is not to argue for passivity in the face of perceived necessity. It is an attempt to understand how our wise men proved so fallible and to wonder what ideas we're becoming enslaved to today.
See the complete archives of the Editor's Note

Robert Teitelman is Editor In Chief of The Deal