Could it happen again?
To Hyman Minsky, a 20th-century economist as wise as he was overlooked, the answer was obvious: It could, and it would. According to Minsky’s “financial instability hypothesis,” financial systems — and the free-market economies that rest on them — are by their nature unstable, tending toward what he called “Ponzi finance.”
In boom times, companies take on too much debt, which gets them into trouble when profits fall, as they inevitably do, forcing them to sell assets to pay interest on those debts, causing asset prices to fall and triggering even more forced selling and market panic.
Although Minsky’s theory found little resonance during the benign markets of the 1950s and ’60s, it seemed to perfectly describe the 2008 financial meltdown, whose anniversary we mark this month. With corporate credit at an ominous all-time high and the stock market enjoying a record-breaking bull run, it’s a fair guess the United States is on the verge of another “Minsky moment.”
That’s not to say that steps taken by Congress, regulators or bankers themselves to prevent a replay of 2008 were in vain. Banks are better capitalized and less vulnerable to a sudden loss of short-term funding, while some of their more speculative activities have been eliminated or curbed. Consumer protections were strengthened, at least until the Trump crowd took over.
At a more fundamental level, however, the financial system and American economy remain uniquely vulnerable to booms and busts because Americans have chosen a kind of capitalism that invites them, based largely on a set of flawed ideas embraced in the 1980s that persist to this day.
The first of those flawed ideas is that “greed is good” — that the unbridled pursuit of wealth and commercial success by every worker, investor, consumer and firm is necessary to the success of a market economy. According to this morally vacuous logic, it is the lust for money and success that incentivizes hard work, innovation and risk-taking.
Or as the fictional corporate raider Gordon Gekko famously put it in Oliver Stone’s movie “Wall Street,” “Greed is right. Greed works. Greed cuts through, clarifies and captures the essence of the evolutionary spirit . . . [and] has marked the upward surge of mankind.”
It is this veneration and celebration of unrestrained selfishness that is at the core of just about everything that people now find repugnant about American capitalism, starting with the misguided nostrum that companies must be run solely for the benefit of shareholders.
Over the years, “maximizing shareholder value” has provided justification for the shabby treatment of loyal workers and consumers, the obscene compensation of corporate executives and fund managers, the thuggish demands of “activist investors” and the abusive and manipulative strategies of trading desks and hedge funds.
It has been used to rationalize the incredible lengths that companies will go — including renouncing of U.S. citizenship — to avoid paying their fair share of the taxes that are used to educate their workers, fund their basic research, protect their property and build the infrastructure that gets their goods to markets. In recent years, it has been used to justify an orgy of debt- and tax-cut-financed stock buybacks that have inflated stock prices and discouraged business investment.
It is no coincidence that these norms of business behavior have taken hold at the same time that the boom-and-bust cycle has reasserted itself in financial markets and in the economy, beginning with the S&L crisis of the 1980s and continuing through the Asian financial crisis of the 1990s, the tech and telecom bust of the early 2000s and the 2008 debacle.
They have resulted in a financial sector that has become too big, too rich and too powerful, one that distorts the behavior of businesses and investors and captures an excessive share of the national income. No longer content to efficiently allocate capital to the real economy, Wall Street has become the tail that wags the economic dog. Until it is cut back in size and put back in its place, the frequency and severity of financial crises will remain higher than they need to be.
The second flawed idea that animates American capitalism is that free markets are efficient and self-correcting. We can agree that markets are the best way to set prices, allocate scarce resources and spur the technological innovation that raises productivity and living standards.
But it is quite another thing to assert, as free market fundamentalists do, that asset bubbles don’t exist or that markets can be relied on to punish firms that try to defraud customers or abuse workers, or that the $800 million earned last year by the Blackstone Group’s Steve Schwarzman was an objective measure of his economic contribution. Those who experience American capitalism on a daily basis know that this is nonsense.
Yet it is on the basis of such nonsense that we have hamstrung antitrust enforcement and allowed a handful of giant companies to dominate industry after industry, squeezing workers, customers and suppliers and buying up any upstarts that might jeopardize their dominance.
It is on the basis of such nonsense that the business community has waged a decades-long crusade against every new regulation designed to protect society from its predations, mounting endless legal challenges, lavishing campaign cash on legislators who promise to nullify them and installing industry officials to top regulatory positions.
And it is on the basis of such nonsense that Congress and regulators have allowed the growth of an unregulated “shadow” banking system, with its opaque markets in asset-backed securities, collateralized debt obligations, credit derivatives and synthetic default swaps, that is now so much bigger and more economically significant than the old-fashioned banking system.
This shadow banking system has undermined the effectiveness of bank regulation, eroded lending standards, increased leverage in the economy and turbocharged market volatility. Even those who wrote and implemented the reforms following the 2008 financial crisis worry aloud that their efforts have done little to reduce the risks it still poses to the economy and the global financial system.
The third flawed idea is that a high level of inequality of wealth and income is necessary for economic growth and prosperity.
We all know the shortcomings of overly egalitarian economics. Communism failed in Russia, and China, Europe and India have retreated from socialism, and the kibbutzim are no longer a significant factor in an otherwise booming Israeli economy. Here at home, some of the most thriving companies and industries are those that offer significant rewards to hard work and innovation.
But if some inequality is necessary, more is not always better. There is a point at which the distribution of rewards becomes so unequal that it discourages individual hard work and innovation and undermines the trust and cooperation needed to grease the increasingly complex machinery of capitalism and the increasingly contentious machinery of democracy.
Economists have a name for this trust and cooperation — it’s called social capital — and for advanced economies like ours, it turns out to be as important as the better-known forms of human, physical and financial capital. Social capital gives us the confidence to take risks, make long-term investments and accept the inevitable dislocations caused by the gales of creative destruction.
Social capital provides the support not only for formal institutions of business and government but also the unwritten rules and norms of behavior that foster cooperation and compromise — between management and labor, between buyers and sellers, between business and government and among people of different races, creeds, classes and political beliefs. Societies with more social capital are happier, healthier and wealthier.
Decades of high and rising inequality have depleted our stock of social capital. The signs are everywhere — in declining levels of employee engagement and in the way we segregate ourselves in like-minded communities, residentially and virtually, and in the appalling lack of civility on the Internet. We see it in a politics that is increasingly polarized, partisan and paranoid, and in a government where consensus is elusive and compromise is equated with treason.
What does any of this have to do with financial crises? More than you might think.
For there is evidence that as the national income has been concentrated at the top, middle- and working-class households have had to borrow more and more just to maintain their standard of living, while upper-income households find themselves with more and more savings with which to lend and invest. The result has been a series of credit bubbles that, when they burst, leave the poor and middle class even further behind.
As a society, we are caught in a self-reinforcing dynamic in which rising inequality, economic insecurity, the erosion of social capital and political dysfunction are all feeding off one another, with more of one leading to more of the others.
This vicious cycle was not inevitable. Because of the laws and regulations we adopted and the business norms that we embraced, Americans have created a kind of capitalism that encourages the ruthless pursuit of self-interest, that over-relies on market competition to restrain anti-social behavior, that creates an oversize and overcompensated financial sector and generates world-beating levels of economic inequality. Because of these characteristics, it is also a kind of capitalism that tends more toward booms and bust.
Free market fundamentalists tell us that we should tolerate less economic stability and security because our kind of capitalism generates more innovation and higher productivity, and thus a higher standard of living.
That may have been true in the early 1980s, when the competitiveness of the American economy was in jeopardy. But there is now compelling evidence that American capitalism has evolved to the point that we no longer face a trade-off between economic fairness and stability on the one hand and economic growth on the other — that a bit more fairness and stability would actually result in higher growth and make the average American happier, healthier and richer.
As long as humans are motivated by fear and greed, market economies will have booms and bust — that was Minsky’s insight. The question for us is how frequent and how severe these booms and busts will be. Since 2008, we have done some small things to reduce the risks of a crisis like the last one. But in continuing to embrace our more ruthless, unregulated and unfair model of capitalism, we have left most of the big things unchanged.
Pearlstein, a Post business and economics columnist, won the Pulitzer Prize for columns in 2007 anticipating and explaining the ensuing financial crisis. He is also Robinson Professor of Public Affairs at George Mason University. This essay is drawn from his new book, “Can American Capitalism Survive?,” which will be published later this month by St. Martin’s Press.