A Financial Treatise that Provokes Much Thought:

Richard Posner’s The Crisis of Capitalist Democracy

Dwight D. Murphey

Wichita State University, retired


                       A silver lining that can be found in the financial crisis of 2008-2009 is that it has produced a substantial literature that provokes much thought.  Richard Posner’s The Crisis of Capitalist Democracy is such a work.  A discussion of it has carried us into so many matters of intellectual and practical importance that an article, not just a review, is in order.  Among other things, we will consider the role of ethics in the marketplace, the global financial community’s ever-present brinkmanship, the crises in macroeconomic theory and in the U.S. political system, the difference in values between those who follow completely the logic of economic globalism and those who don’t, and whether there needs to be a radical rethinking of the role of banking.  In addition, we will see Posner’s assessment of the Obama Administration’s responses to the crisis, and the reforms he favors.


         Key Words: Richard Posner, financial crisis of 2008-2009, ethics in the marketplace, global financial brinkmanship, crisis in macroeconomic theory, crisis in American political system, logic of economic globalism, role of banking, Obama Administration’s financial crisis responses, financial reforms.


          Richard A. Posner, author of The Crisis of Capitalist Democracy,[1] is a remarkable man.  He is a judge on the United States Court of Appeals, Seventh Circuit, a level of court just one step below the United States Supreme Court, and is a senior lecturer at the University of Chicago Law School.  One would think from this that he would be absorbed in the law to the virtual exclusion of everything else.  We find, instead, that he is an economic thinker of the first rank.  He is a master at what we call “economic hydraulics,” the following of the ripple effect as one thing affects another, and that another and then another.  Accordingly, this book provides, among other things, a much more detailed explanation of the bank seize-up in 2008 than we have found in the other excellent books we have reviewed on the financial crisis; he describes in vivid detail the blighted condition the financial firms got themselves into; he relates the many specifics of the long-developing process of financial deregulation; and he gives a lucid explanation of “credit default swaps.”  Even though Posner is stoutly pro-capitalist, he joins a number of other prominent commentators who perceive a “crisis” for the current form of capitalism and from the predicament the United States, in particular, finds itself in politically and economically.  That a crisis of such a kind is seen by so many prominent thinkers indicates an intellectual turning-point of major import.

          Our interest in this article will not be with revisiting the details of the financial crisis so much as with examining several provocative points Posner’s discussion brings to mind:

          1.   The gradations that have become evident within free-market ideology.  Posner strikes a position that is in the second of at least three variations within the contemporary stew that makes up the prevailing thinking among the supporters of a market economy.  (While each variation is identifiable in itself, it is worth noting that the differences are matters of degree, positions on a continuum.)

          One of these variations (we will arbitrarily call it the first) sees a free market as well-nigh perfect in itself, highly productive and with “rational expectations” and self-adjustments that keep in on an even keel.  To this view, the main need is for “government to stay out of the way” of the market.  The move in recent years toward this pole has been the ideological underpinning of the “deregulation” that has occurred since the mid-1970s. Few regulatory demands are made, and little is expected by way of acculturated ethical constraints in the marketplace.

          The second position is the one taken by Posner.  He accepts much that the market does, so much so that he welcomes economic globalization, the hurricane-like “creative destruction” of industries, firms and jobs, and the deindustrialization of the United States.  And yet, he believes a strong web of laws and regulations is essential.  “I believe in capitalism.  But capitalism is not a synonym for free markets.”  He calls for “a system of laws… institutions for enforcing those laws, and regulations.”  Ethics, he says, “can’t take the place of regulation.”

          The third position is one that classical liberal philosophy has long considered vital to the overall framework of a free society (of which a market economy is a major part).  This is that the society’s primary reliance must be on a pervasive community of ethics, family, personal responsibility, civic obligation, professional duty and the like.  “Only a virtuous people can be free” is an old saw from the Founding Fathers’ generation.  To this view, government can only be “limited” if the civil society is largely self-maintaining because the people are responsible and can mainly take care of themselves, needing relatively little policing.

          One might think that this third position is compatible with the first two.  It would be if it weren’t for the fact that the “market is near-perfect” view has, in its “do your own thing” libertarianism that is in part traceable back to the 1960s and in other part to the libertarian philosopher Ayn Rand, lost sight of the need for the social cement of civic virtue.  The reality, in this reviewer’s mind, is that, for a sound classical liberalism, all three positions have to be combined into one, with a vigorous market, adequate regulation and a solid ethical foundation.  The philosophy has become unhinged when enthusiasms arise that carry one part off on its own.

          When Posner says that “ethics can’t take the place of regulation,” he is not by that statement alone saying that regulation can stand by itself.  The statement can be taken simply to say that regulation is nevertheless needed even if ethics are present.  But Posner’s position on several things regarding the financial crisis points beyond that to his eagerness to blame government (and its lack of regulation) and to exculpate the actors in the private sector.  (And this, we should observe, is consistent with the reductionism within recent thinking that has never budged from the notion that virtually all problems come from “government.”)  A lack of virtue, he argues, wouldn’t have been a problem if regulation had done its job.   “It is a mistake to blame the bankers and the home buyers (or home-equity borrowers),” since, he says, the risks they took “seemed optimal” when they took them.  It is a mistake, too, to blame “greedy bankers” or to put fault on the credit rating agencies with their rampant conflicts of interest, since their “limitations were well known to professional investors.”   He acknowledges that there was “egregious compensation” at Goldman-Sachs, but he again puts the problem in the lap of government, saying that “the government should have demanded a big chunk of Goldman’s future profits.”

          This condonation of the myopic self-aggrandizement that was so prevalent in the lead-up to the financial crisis should not be understood as simply an aberration in Posner’s thinking.  We recall that there is a prominent school of libertarian thought that actually denounces a pervasive culture of socially-expected ethical responsibility.  Nathaniel Branden, the protégé of Ayn Rand, has belittled what he calls a “conventional social metaphysician.”  Such a person, he says scornfully, centers his life “among the standard values of his culture: respectability, financial success, marriage, family, professional competence, prestige, etc.”  Branden writes of “an abstraction called ‘morality’” that is “a residue of an older, religious way of thinking….”[2]  The Rand-Branden philosophy of “objectivism” champions its own ethical system, but it is only superficially that of classical liberalism.

          Posner opposes caps on the compensation given to financial executives, saying that limits will inhibit firms from attracting “desperately needed talent.”  Here, again, we see a conflict separating the notion of a purely profit-maximizing economic process and the broader philosophy of classical liberalism.  Even if insider cronyism is left out of account to explain the phenomenal compensation packages, the idea that competition for talent makes necessary and justifies astronomical remuneration runs counter to any ethic of trusteeship.  When executives sit at or near the top of banks, investment companies, mutual funds, universities, charities or large corporations, they are almost entirely handling “other people’s money.”  The many investors, lenders, taxpayers and contributors count on the executives to serve them conscientiously, figuring they are put into office for that purpose.  For the executives then to treat their positions as sinecures and to consider it acceptable to skim millions of dollars off the top of the fund for themselves is for them to violate their fiduciary duty – or in fact to fail to perceive any fiduciary responsibility at all.  A broader philosophy of a free society would say to their boards of directors: “For any executive to want an enormous compensation, even if others elsewhere are receiving one, should itself be considered a definitive disqualification, since it shows that he doesn’t understand his job.”

          Even this does not exhaust the thoughts that come to mind from Posner’s stance vis-ŕ-vis ethical obligation in a commercial setting.  As we have seen, he largely holds the actors blameless, thinking that they were just playing within the game allowed by regulatory agencies.  It isn’t enough for us simply to say we disagree with him on this.  There are subtleties to the issue of personal responsibility.  Most people within an organizational context act according to a “common denominator.”  They won’t allow their own behavior to fall noticeably lower than that denominator calls for, but for reasons of “being practical” they won’t act much above it, either, mostly especially if to do so will incur costs to themselves or their organization. 

          Most people absorb as a matter of course the ethos (the “common denominator”) of their group, but there are conscientious souls who perceive the ethical problems inherent in a too-low denominator.  These people, if they express their scruples, come to experience considerable “crunch” from their peers and superiors, which in addition to merely social pressures may take the form of loss of their jobs or other preferment.  This is illustrated by recent Congressional testimony in which an employee of one of the major credit rating agencies told how he had perceived an ethical problem and about the reaction that occurred when he brought it up: “My manager declined to do anything about the potential fraud, so I raised the issue to a more senior manager… Because of the culture, I knew what I did would possibly jeopardize my role.”  The article telling about his testimony said “He was right.  Less than two months after challenging the integrity of the ratings, [he] was removed from his post and given a lower-paying job elsewhere….”[3]

          The punitive “crunch” that is applied to those who seek to act above the level of the common denominator is not necessarily because those applying the pressure are worse than others, but because they have in a variety of ways rationalized their group ethos to themselves.  “Everybody’s doing it,” is a typical rationale.

          What is essential, if the behavior is to be better, is that the common denominator be raised.  Posner would count on government regulation as his primary, perhaps his only, instrument for this.  No doubt the legal parameters are important in setting a level of behavior.  But it is reductionist to think that is all there is.  Most crimes, say, are not unacceptable only because the law says they are; there is a much more pervasive ethical sensibility, too, that declares them unacceptable.  (This distinction is of long standing in the law, which classifies crimes as either malum in se or malum prohibitum.)  There are many factors in a society that come to bear on the height and content of the society’s ethical culture.  We will leave it to the reader to think about what they are, since a review of them would carry us too far afield here.

          2.  Posner’s views about the brinkmanship within the global economy.  We have noted in earlier reviews that the respective authors generally point out how the world’s economy, especially its mega-trillion-dollar financial market, is at all times walking on the edge of calamity for a variety of reasons.  At the same time, as a seeming contradiction, the authors stress how important and indispensable the whole thing is. 

          Posner is the same.  He observes that “the U.S. economy is deeply entangled with foreign economies” and that “these entanglements limit the ability of the United States either to prevent or to mitigate economic crises.”  But he gives little attention to what to do about it.  While he suggests many reforms, he keeps his focus on the domestic American economy, not the hundreds of trillions of dollars “sloshing around” (to use a common description) in the global financial scene.  His posture is mainly defensive: “We mustn’t let the financial collapse of 2008 give risk a bad name”; and, again, “we must begin by noting that a modern economy lives on credit.”  This shows little sense on his part that it is intolerable for the world economy to be so perpetually threatened.

          He makes two suggestions that, if expanded upon, could help overcome this seeming obliviousness.  He says “an international treaty for regulating the global financial system… is necessary”; and includes a “financial transactions tax” among his “radical measures… to close the fiscal gap” in the United States. Each cries out for much further explication.  A transactions tax, applied in an international context, might be a valuable part of restraining the global financial tidal waves.   

          3.  His awareness of monetary theory’s current dead-end.  Nothing is more apparent than that monetary theory has reached a cul-de-sac.  The gold standard was dropped years ago, and the monetarists’ concern over the quantity and velocity of money was then abandoned, to be replaced by what we might call “the spigot system” of incremental turning off and on of the money-faucet by raising or lowering interest rates.  Now the events of 2008 show that the spigot system is incredibly vulnerable.  Since the monetary system is so central to a market economy, this constitutes a “radical crisis” both intellectually and practically.  The authors we have reviewed, including Posner, seem only dimly aware of what a challenge this poses.

          Posner doesn’t offer a new paradigm, but he does include a chapter “The Crisis of Macroeconomics” which is important in this context.  He tells us how warped out of shape the thinking has become: contemporary macroeconomic thinking is “ideological” in the pejorative sense, indulging in little self-criticism and often engaging more in advocacy than in reflection; it has allowed itself to become a virtual branch of applied mathematics, with little “synthetic vision”; it adheres to simplistic models; and it ignores important economic factors when they aren’t quantifiable.  Posner writes, for example, of “the new Keynesians,” who have “jettisoned the most important parts of Keynes’s theory because those parts do not lend themselves to the mathematization beloved by modern economists.”  These observations note an extra dimension, of course, to the intellectual crisis.

          4.  The crisis he sees in the U.S. political system.  The book’s title The Crisis of Capitalist Democracy is rooted in Posner’s doubt about “whether America is [any longer] governable.”  The two large political parties have converged, he says, into what is in effect one big “party of profligacy.”  The parties agree on deregulation, hostility to taxes, and eagerness to spend.  It is a system of pandering to voting groups; and “campaign contributions [without effective limitation]… make the legislative system one of quasi-bribery.”

          He has no pretensions about having a solution: “What could solve our problems of political culture, I have no idea.”

          5.  Posner’s full acceptance of international free trade theory, abjuring concern about issues of American national well-being.  He fully embraces global free trade thinking, and this means abandoning any identification with the economic outcome for a particular people, including his own.  He considers it “a ridiculous goal” to make “a national commitment to the United States’ remaining a major manufacturer of motor vehicles,” adding that “nowhere is it written that the United States shall produce motor vehicles, any more than it shall produce television sets, which it no longer does.”  From this perspective, “Chrysler is an unimportant company in a highly competitive global industry,” and its demise would “have no greater consequence for the economy as a whole.”

          We see in this the deracination that is central to free trade ideology when it is carried to the limit of its logic.  There is little concern for nations, or any given nation, per se.  Although the theory claims to be based on science rather than value-judgments, the difference between it and those who are concerned about, say, America’s having deindustrialized is essentially one of values.  It is interesting to speculate on how earlier generations of Americans would characterize a generation of thinkers and of businessmen whose ratiocination has carried them so far from attachment to their roots.

          6.  His acceptance of the centrality of banking.  Posner would have to stray quite far from what people take for granted if he were to question whether radical changes should be made in how enterprise and consumption are funded.  Banking as the world has known it, not simply as holders of deposits but also as extenders of credit, has long been central to market systems.  “The lending of borrowed capital is the essence of banking… Banking is both inherently risky and critical to economic stability.”  He writes of “the centrality of banking to the economy of a modern commercial society.”

          Given the vacuum that currently exists within macroeconomic thought and the recurrent threats of world economic collapse, now is perhaps the best time for minds of the caliber of Posner’s to “think outside the box” about the whole system of banking and finance.


His assessment of the Obama Administration’s responses to the crisis

          In our series of reviews of books on the financial crisis, it has seemed worthwhile to report how such major economic thinkers are assessing the responses that have been made to what Posner prefers to call the current “depression.”   We know that President Obama’s political and ideological opponents have condemned the buyouts and the stimulus packages.  Is that condemnation mostly political smoke, or is it backed up by what the most thoughtful commentators have to say?

          For his part, Posner positions himself among the critics, although his reasons for doing so may or may not be the same as others’.  He was “startled” that “Obama did not assume office with a comprehensive plan of economic recovery in hand.”  The stimulus was too protracted and not sufficiently targeted to job creation; the mortgage-relief program was too small and slow; the “cash for clunkers” effort was “miniscule,” and made only a “very small” contribution to economic recovery.  There was no realistic plan to raise revenue or cut spending; and there were “ambitious unfunded spending programs.”

          Perhaps more than anything else, Posner finds fault with the soaring deficits.  “On the ground that a crisis should not be wasted – in other words, that the depression should be treated as a pretext for the launch of expensive social programs that might be politically infeasible in calmer times… the administration is piling trillions of dollars of proposals for long-term social reform on top of the trillions of dollars of emergency spending… and the trillions of dollars of ‘normal’ federal budget deficits….”  With regard to health-care reform, he says “it soon became evident that… the Administration had no workable, politically feasible plans for funding the $1 trillion in projected cost.  The estimate of economies could not be taken seriously….” 

          His criticism goes so far as to see considerable venality in the Administration’s actions:  “The Administration, in another futile effort at quantification, offered statistics riddled with fraud, error, and implausible assumptions on the number of jobs saved by the stimulus.” 


Reforms that Posner favors

          Posner wants to “roll back financial deregulation,” and has a number of specific regulations to suggest, but mainly says that existing regulatory institutions, and not new ones, should be able to handle it.   The Federal Reserve, he says, should keep its attention on “managing the money supply,” and thus should not be assigned the job of being the “systemic risk regulator” (although he does say that the Fed would do well to set “margin requirements for mortgage lending”).    It is the Securities and Exchange Commission that should take on the regulation of systemic risk – and it can do it under its existing statutory authority.  (The SEC under the Obama Administration, he tells us, has already taken steps in that direction.)  So far as consumer protection is concerned, there is no need to create a Consumer Financial Protection Agency, since there are already “plenty of remedies against financial fraud.”

          He makes a suggestion that has long seemed to this reviewer to be a good one for many aspects of the consumer marketplace.  He favors what he calls “plain vanilla financial products” that will be “offered to prospective borrowers along with the lender’s own product.”  This is a suggestion that could have broad application: consumers in many areas are presented with contracts containing lots of small print that they just sign off on, counting on the good faith of the merchant.  In law, these are called “contracts of adhesion,” since the weaker or less organized party is expected, and almost always does, just “adhere” to them.  In financial transactions, automobile sales, home construction contracts, commercial and residential leases, and many other settings, impartially drawn paradigm-contracts that would seek to address the legitimate interests of both parties, not just one, would greatly facilitate equitable trade.  The parties could still agree to different terms, but would in effect be put on notice to consider the changes carefully.  Although a widespread market reform of this sort would seem to be in the best interests of all honest dealers, it is typical of the myopia that often constrains the acting man that, as Posner tells us, the financial industry “mobilized its resources to [successfully] oppose enactment.”

          What are some of the specific regulations (mentioned passingly above) that Posner recommends?  They include the Federal Reserve and Treasury’s formulating a plan, heretofore lacking, “to deal with the possibility of a catastrophic failure of our financial system”; regulating off-balance-sheet contingent liabilities, such as “credit default swaps”; addressing the conflict-of-interest problem with the credit rating agencies (although Posner says this is “probably unnecessary,” since investors, once stung, now know better); “return to the Glass-Steagall Act” so that commercial banking will again be separated from “proprietary trading and other high-risk financial activities”; and taking “radical measures” to “close the fiscal gap.”   The latter measures to be considered would include a federal Value Added Tax (VAT), a financial transactions tax, an online sales tax, and “means testing” for Medicare and Social Security benefits.  (Obviously, he is not part of the “no new taxes” movement that is so much a part of the “tea party” phenomenon in the United States in 2010.)

          We recall that Pat Choate, in his book Saving Capitalism: Keeping America Strong which I reviewed in the Spring 2010 issue of The Journal of Social, Political and Economic Studies, discussed the VAT in detail and favored it as a way at least partially to match the protection of their home markets that 153 other nations employ with their VATs.  He explains that most other nations that use VAT also use it to protect their home markets, rebating VAT on exports but imposing it on imports, and mentions that the World Trade Organization rules allow that particular form of protectionism, and that only the United States desists from using it.     





[1]  Richard A. Posner, The Crisis of Capitalist Democracy (Cambridge: Harvard University Press, 2010).

[2]  Nathaniel Branden, The Psychology of Self-Esteem (Los Angeles: Nash Publishing Corporation, 1969), pp. 176, 228.

[3]   McClatchy Newspapers article, “Rating agency leaders take no blame,” The Wichita Eagle, April 24, 2010.