Reply to Comments--June 5 to June 19, 2009

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There were a number of interesting comments. I cannot discuss them all and my failure to discuss a comment should not be construed as criticism. I pick out a few to discuss where I think a restatement or response may be useful, and I shall discuss these in the order in which they were posted, rather than grouping them by subject matter. I would like to note at the outset, however, my policy on approval of comments, in light of a comment in this batch criticizing other economic bloggers for disapproving comments. My policy is that I will approve any comment that does not contain threats, obscenities, or other unlawful matter (I have yet to receive such a comment). The fact that a comment is critical, or that I disagree with it, would be the worst possible reason for refusing to approve it.

The first comment I wish to mention is on a statement in my book that it is lucky that social security was not privatized, as, had that happened, the savings of people who were retired or were approaching retirement would have been depleted by the fall in stock prices, which would have produced an even greater fall in personal consumption expenditures than we have experienced. The comment points out that, assuming (properly) that social savings accounts in a privatized regime would resemble 401(k)s, as people approached retirement they would tend to shift from stocks to bonds and so would not have taken as great a hit as my statement in the book might have implied. The commenter further points out that because the value of social security benefits grows very slowly, the net value of a privatized social security account might well exceed that of the governmental account, depending, however, on when one had started investing in stocks in the privatized account. I add that it was never intended that one's entire social security account be privatized, so there was no danger of being left with no social security benefits no matter how badly the market crashed.

The next comment points to Erving Goffman's theory that all a regulator should attempt to do is, after the fact, remind the public of the mistakes that gave rise to the fraud or excessive risk taking that the regulator had not detected (had perhaps not even tried to detect) in advance. I don't think this is adequate when one is talking about the kind of economic crisis that has engulfed the nation. Nor indeed is there evidence that people "learn their lesson" and so need only be reminded of the lesson from time to time. The housing bubble followed fast on the heels of the dot-com bubble, the bursting of which had little effect on people's tendency (which I argue in my book is rational) to treat rising prices as a signal for further buying.

A comment about my blog entry on unemployment points out that the circumstances in which a person becomes unemployed (as inferred by prospective employers) may affect his chances of finding a new job. They may be dim if prospective employers infer that he lost his job because the economic downturn caused his employer to cull his least productive workers. A further problem is that he will find himself in a job-seeking competition with young workers who have been laid off plus more young workers entering the work force for the first time as they graduate from school, and employers may prefer young workers for a variety of reasons, including lower expectations of pay. Hence for many older workers who become unemployed, unemployment may mean involuntary early retirement from the work force.

Another comment points out (if I understand it correctly) that if the unemployed are pessimistic about their future employment prospects, this will reduce the amount of effort they put into looking for a new job--which in turn will further reduce those prospects.

Another comment, noting my emphasis on regulatory failure (including the deregulation movement, unsound monetary policy, and lax enforcement of remaining regulations) as the main cause of the current depression, points out correctly that the financial industry is politically powerful and pushed for deregulation, and so is deeply implicated in the regulatory failure. That is certainly true and it is also true that the proximate cause of the financial crisis that precipitated the depression was the conscious (I believe) taking of high risks by bankers, other investors, and consumers. So they cannot escape responsibility for the macroeconomic consequences. But it is government (albeit heavily influenced by the private sector) that creates the economic environment that in turn shapes the utility-maximizing behavior of private individuals. If risk-taking is utility-maximizing, the risk takers should not be criticized too harshly for refusing to sacrifice their personal utility for the greater social good.

A comment on risk managers states, first, that they often are hired from the ranks of the traders and may therefore have above-average tolerance for risk taking. Second, "to the extent they are essentially compliance officers, they have little pull in their institutions because the profits come from the traders and [the risk managers] cannot prove any real level of risk exists." And third, they use the same models as the traders, and these models, as I point out in my book, are of limited value because they necessarily are based on past data (the future is too uncertain), and the future does not always repeat the past.

A comment criticizes the as yet inoperative, and perhaps dead-on-arrival, program of subsidizing the purchase by hedge funds and other investors (including banks) of the securitized debt owned by banks (the debt referred to as "toxic assets," meaning however merely that they are difficult to value accurately). The comment points out that as time passes and the economic picture clarifies, the market should be increasingly able to value these assets correctly, and there is now sufficient liquidity to enable an unsubsidized market in these assets to function effectively. The only excuse for the program is as a device for increasing bank capital (by inducing overpayment for the assets) without a direct grant by the Treasury, though politically "toxic." That excuse is losing force as the financial industry revives, and this may be why the program is, it seems, being allowed by the government to die.

One comment asks whether I agree with Professor Krugman that it would be premature to scale back the government's economic rescue efforts, such as the $787 billion stimulus program. I do agree. The analogy to 1936-1937, when the government raised taxes, reduced the money supply, and reduced deficit spending--and as a result precipitated a very sharp recession before the economy had recovered from the Great Depression of 1929-1933--seems to me compelling. As long as unemployment is increasing, credit is restricted, consumer prices are below what they were a year ago (deflation), personal and business bankruptcies are soaring, and most foreign economies are severely depressed, the nascent economic recovery here in the United States is too fragile to withstand the kind of hit that conservative critics of the recovery program advocate. Still, it's a pretty close call, given the growing worry about the federal deficit--a worry that is likely to slow recovery by causing consumers and businesses to hold back from consumption and investment, respectively. Scrapping the stimulus program--not that there is any chance of that happening--would somewhat alleviate that worry; but I think it would be more likely to cause a further drop in consumption and a surge in unemployment.

A comment asks whether improved data collection and processing could reduce the form of uncertainty that consists of economists' inability to explain the business cycle, and hence the current depression and how to recover from it. I am not optimistic. There are plenty of data and they are exploited by economists in their unending efforts to explain the business cycle, yet without achieving a consensus on such issues as what caused (or caused the severity of) the Great Depression. The problem is that when many forces are acting on an economy simultaneously, the causal effect of each one can't be isolated from that of the others.

A comment expresses doubt that risky mortgage practices during the housing bubble were actually rational, given that there was widespread publicity given to the possibility that the rapid run-up in housing prices in the early 2000s was indeed a bubble phenomenon. Indeed there was such publicity--I gave some examples in my book. The commenter goes on to point out correctly the "musical chairs" character of bubble behavior. You want to ride a bubble until just before it bursts, because that is when the bubble is biggest (i.e., prices are highest); if you get off sooner, you leave a lot of money on the table. But I don't consider efforts to ride a bubble until just before it bursts irrational. It is not irrational to have a high tolerance for risk--it's simply risky! I think that where an irrational element may creep in, however, is in the phenomenon of regret. If you jump off the bubble too soon (or if it turns out not to be a bubble), you are likely to feel like a fool, even though you had made a sensible ex ante choice. And knowing you are likely to feel like a fool if you jump off too soon, you may stay on and lose everything.

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Richard A. Posner

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. More

Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.
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