« We made a social deal to finance consumption by debt »

Marcellus Andrews’s speech at the conference « The Financial Crisis, the US Economy, and International Security in the New Administration », New York, 14th November 2008.

par Marcellus Andrews

As we know, we are in the middle of an economic crisis and facing a short-term problem. We need major stimulus and smart sti- mulus if we are to survive. But when I think about all that, I also think about what we see right now. We have a bailout that reminds me of nothing so much as a hostage situation, where the kidnapper grabs somebody and says, « My feelings are hurt because you didn’t pay me enough money. So if you don’t pay me enough money, I’m going to cry, and then I’m going to hurt this person, and then I’m going to snatch somebody else ». And see, the thing is, they’re doing this in the living room with police, and the police just give up more money. That seems crazy, doesn’t it?

I’m studying institutions, banks, financial markets. I’m trying to explain to my students things I barely understand myself. I’m trying to tell them that we have institutions that are supposed to price, manage and mitigate risk, but that what these institutions actually are doing is manufacturing and amplifying risk, and that they do it through hiding the risk from the regulators, from the markets, from the public. My students say to me: « we read the textbooks, aren’t financial markets supposed to allocate capital to its most efficient use? But haven’t all these foreclosures and bankruptcies, and these empty houses and people killing themselves because they lost their jobs and their houses, wouldn’t all this suggest that there’s been a massive misallocation? And now the people who massively misallocated capital are telling us what to do? »

I’ve been thinking about all that. And I arrived at some conclusions that I would like to share with you. If we go back and think about how all this started, then everything that has been said today seems to me absolutely right. But I also think about the political economy of this, political economy of low taxes and low regulation in a country where the majority - well, a minority at the time, but perhaps the majority now - couldn’t afford the American dream. We had made a social deal, which essentially was to finance consumption by debt and at the expense of people who had been abandoned by the elites of this country. And we asked Wall Street to find a way to lend money to, and to manage the risk of, people who really could not afford to borrow money. Steelworkers in Cleveland who don’t have jobs, poorly educated and suffering folks who work in bodegas in the Bronx, folks who want the big house, who want the TV, but who can’t really afford it, whose incomes will never allow them to afford it, folks who have to use their credit cards to pay their health insurance. And Wall Street did it. Because we ceded power to an instrument, a corporate form of financial management. And we asked markets to solve social problems. Somewhere along the line we seem to have forgotten that the corporation is not a part of the social infrastructure, and that its performance, particularly in risk management, is to be judged by whether or not our social needs are enhanced by the use of various of forms of financial instruments, by various forms of financial institutions.

« We made a social deal to finance consumption by debt, and we asked Wall Street to lend money to people who could not afford it."

Our automobile companies are now on the brink of bankruptcy. We are afraid of bankruptcy because of the long-term economic and financial consequences involved. We are afraid of bankruptcy with regard to Bear Stearns because we were afraid that if Bear Stearns went away, the plumbing of the financial system would collapse, and we would have to face an economic crisis. Is this not a hostage situation?

This drove me back to Charles Lindblom and even Karl Polanyi, and I asked myself: does the corporation fit anymore? In our current system, as we built it, the corporation is a device for accumulating capital, for managing our productive affairs; and we somehow let the financing of this entity dominate. And I keep wondering to myself: once we have dealt with the most urgent problems, maybe the most radical and important thing to do is to revisit the nature of the corporation, revisit it at its basic level? Who and what is it for? Who are its stakeholders? How do we finance this in such a way that we manage risks effectively and punish those whose risk-taking behavior threatens the entire system?

I’m sitting next to Joseph Stiglitz, author of so many articles and books about what prices can and cannot do, which risks can and which cannot be managed, about negative externalities and market failure associated with private management of risk. And we have a mechanism for the chartering and for the bare management of corporations charged with accumulating capital through financial markets and mana- ging, allocating, and mitigating risk; and yet we manage to pay no attention to what this man writes. Somehow we manage to pay no attention to the fact that we have organized our economy and our society in such a way that the management of risk is not an essential part of how we design our institutions. While those who managed these risks and failed still impose their views because of their political influence on the regulation system and the writing of the laws.

We design and use institutions that cannot possibly operate safely. We structure a social contract that deliberately ignores the needs of the majority of the people in circumstances with declining real incomes and growing inequality. We use debts to do something that cannot possibly be done. And then, when it all fails, we allow the same people to have a say in recovery and reconstruction. This seems insane. Once this urgent crisis is over, we need to revisit the nature of the productive enterprise, the way it is financed and why it should be silent - being just a tool and not a voice in politics or anything else.

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