Richard Posner's Animal Spirits

Matt Welch | May 7, 2009

Richard Posner, the one-man content robot who has been writing of late on "The Failure of Capitalism," makes the Market Psyche 101 case in favor of the auto bailouts:

The bailout worked. At a relatively modest, though by ordinary standards very large ($17 billion), cost to the government, the auto companies were kept out of bankruptcy until the acute psychological phase of the economic crisis had passed. Last December, and indeed until sometime in March, government officials, the media, and the public were understandably fearful that the economy was in free fall and might land somewhere near where the economy had landed in March 1933 (25 percent unemployment, output 34 percent below the GDP trend line, 18 percent deflation). Such a fear can constitute a self-fulfilling prophecy, because by causing consumers and producers to hoard cash rather than to spend, it can push the economy into a very deep downward spiral. That fear has now abated. Moreover, General Motors and Chrysler (and Ford as well) have in fact partially liquidated since December, closing many plants and laying off (for good, probably) many hourly and salaried employees, and terminating many dealerships. As a result of these drastic measures (but spread out over months, which reduced their psychological impact), the incremental shock effect of the auto companies' declaring bankruptcy has diminished greatly. And government promises to back any bankrupt automaker's warranties have begun to sink in and reassure consumers. Chrysler has just declared bankruptcy and GM may follow suit in a matter of weeks, yet the perturbation caused by the bankruptcy of the one company and the prospect of the bankruptcy of the other has been slight.

It's an interesting argument, perhaps even a correct one, and certainly something I've heard from more than one self-described libertarian over the past half-year. But I'm not convinced. Partly out of a suspicion for what Reason contributor Will Wilkinson has called "macroeconomics as mind control" (see more of Wilkinson's argument on same here, here, and here). In other words, that there is something quite a bit less than scientific and quite a bit more than mildly propagandistic about basing public policy on acute psychological phases, self-fulfilling prophecies, mass perturbations, and the like. What's more the argument ignores or glosses over the not-insubstantial role that the past two presidents of the United States have played in fomenting that fear to begin with, particularly whenever their latest piece of legislation is up for a vote (when, that is, they even bother with such separation-of-powers niceties). The self-fulfilling prophecy has much more to do with presidents warning hyperbolically of a new Great Depression, and changing the rules and conditions of the finance market almost daily, than it does with the market sentiment of car buyers.

When you start down that rabbit hole of managing public fear and reassurance, you quickly end up in that bad place, as Henry Farrell did in a Bloggingheads.tv debate with me, in which it's OK for a president to lie as long as it's in the service of making us all calm down. Put another way, just because Detroit bankruptcy was off Obama's table in November, yet administration policy by April, doesn't mean us proles should be expected to alter own views accordingly. In order for Posner to be right, I think, it has to be true that bankruptcy proceedings launched late last year would have created substantial spillover effects into the economy, enough to prevent anything like normal bankruptcy events (such as renegotiations with creditors, or the sale of some divisions to competitors) from taking place. That, and not the animal spirits of psychology, is the argument that needs to be won before I'm willing to even consider having the president suspend the rules of capitalism and law. Your mileage may vary.

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JP|5.7.09 @ 11:13AM|#

Interested in Posner's book? Want to learn more? I've posted chapter summaries on my blog.

Thank you for your support.

mark|5.7.09 @ 11:21AM|#

Posner has an editorial this morning in the WSJ. It's a long-winded mess filled with contradictions and contradictory policy prescriptions, IMHO.

Fluffy|5.7.09 @ 11:23AM|#

The other problem with this argument is it will also be applied to episodes such as the blatant illegality involved in the Fed and Treasury Department's deliberate deception in the Bank of America - Merrill Lynch takeover.

"We had to lie, in order to make it through the acute psychological phase."

In other words, honesty and fair dealing is only to be expected of peons, while government officials can freely lie, expropriate, throw money at bailouts that end in bankruptcy anyway a few months later, etc. After all, our heroic government officials have to deal with acute psychological phenomena.

mark|5.7.09 @ 11:28AM|#

I thought I liked Posner.

For even if declarations of bankruptcy would not have resulted in the immediate liquidation of the businesses and thus the sale of their assets at distressed prices and the laying off of almost all their employees, the effect on consumer morale and willingness to buy cars from bankrupt companies might well have been profound. It was not worth taking that risk. The government bailout moneys thus purchased a kind of insurance policy against macroeconomic calamity.

WTF? GM sales were down 33% in April. If the companies reorganized in bankruptcy, where would car sales be? 50% down? And now Chrysler is going bankrupt, so why did they need money in the first place?

|5.7.09 @ 11:52AM|#

The bailout worked.

Fatal error.

"I painted myself blue and danced naked on the mountain top, clacking chicken bones together. The world did not end. Therefor, my dancing saved the world."

Fuck off, Posner.

|5.7.09 @ 11:53AM|#

Yeah, Posner is usually better than this. I don't see how Detroit can be viable long-term without tearing up the UAW contracts. I'm not thinking of the pay and benefits so much as the hugely inefficient and byzantine work rules: a line worker can't just replace a light bulb because an electrician must be called, etc. Imagine trying to make cars while having to conform to about 1,000 pages of that sort of thing.

|5.7.09 @ 11:56AM|#

Bush lies, and these guys can't stop screaming. Obama and Co. lie like rugs, and it's all justified.

I hate partisans so fucking much that I'm literally angry with rage.

|5.7.09 @ 11:57AM|#

Panics are real, and the market does through acute phases of irrational thought. And in terms of a run on bank, panics can criple healthy companies. For the autos however, the argument is BS.

Warty|5.7.09 @ 11:58AM|#

I'm literally angry with rage.

It's beautiful.

JP|5.7.09 @ 11:58AM|#

One thing that should go in the plus column for Judge Posner is a point he makes in the book, that failure to head off a depression is likely to result in a still larger and more oppressive central government, because so many voters will clamor for assistance. He gives the New Deal as an example.

|5.7.09 @ 11:59AM|#

"I'm a rageaholic. I'm addicted to rageahol."

Mad Max|5.7.09 @ 12:00PM|#

If the problem is psychological, all the President has to do is say that there is no serious crisis, and that recovery is just around the corner. I mean, it worked for Herbert Hoover, didn't it?

|5.7.09 @ 12:03PM|#

Rage pisses me off, too.

|5.7.09 @ 12:04PM|#

Oh, please. Posner knows better. The keep-everyone-from-freaking-out argument to protect the economy is silly. What would've happened, a bad week on the market? Which we'd bounce back from once everyone had some knowledge about what was going to happen (i.e., bankruptcy)?

If the government had sat around, wringing its hands, saying "There's nothing we can do", we'd have taken our lumps and would be in the midst of an early recovery. While the recovery will happen despite the government's best efforts to screw it up, a lot of damage has been done by its incessant meddling. What lessons did investors and creditors learn from all of this? What did executives learn about taking risks? Hmmmm?

Egad.

|5.7.09 @ 12:05PM|#

WELSHY!!!

|5.7.09 @ 12:10PM|#

At a relatively modest, though by ordinary standards very large ($17 billion), cost to the government, the auto companies were kept out of bankruptcy until the acute psychological phase of the economic crisis had passed.

Doesn't this entire argument if the auto companies go into bankruptcy anyway? WTF difference does it make on a macro scale if the bankruptcy was postponed a few months?

Who says the acute phase has passed, anyway? This little bear rally? Spare me. The dominos are still lined up to the horizon, as far as I can tell, and all the systemic problems that got us into this mess are still there, completely unresolved, with a thick slathering of moral hazard and uncertainty caused by massive and arbitrary government interference larded on.

The Angry Optimist|5.7.09 @ 12:18PM|#

Guys, Posner doesn't actually know better, or at least, as long as I've been reading him, he doesn't. Posner (if I may be so bold) rarely considers the long-range, philosophical implications of a thing in favor of utility.

|5.7.09 @ 12:29PM|#

Oh, wait, maybe he's just trying to get that elusive Supreme Court appointment.

db|5.7.09 @ 12:40PM|#

acute psychological phases, self-fulfilling prophecies, mass perturbations, and the like.

"Of course, you forget, Peter, I was present at an undersea mass sponge migration!"

EdK|5.7.09 @ 12:55PM|#

|5.7.09 @ 12:57PM|#

All this demonstrates is that a person can justify anything if they really, really, want to. Nothing new there.

I wonder if Freudians blame the current economy on their mothers...

mark|5.7.09 @ 1:02PM|#

Judging (pun intended) from the Becker-Posner Blog, this guy is not willing to make any fundamental changes to the Fed, other than to give it more control ("independence" in Posner's language) over the money supply.

Posner believes that the interest-rate-lowering regime of the early 2000's was a period of less political independence at the Fed:

... Congress could eliminate or reduce the Federal Reserve's independence from the normal political process at any time. Its independence is therefore legally precarious.

That is part of the reason why the modern Federal Reserve has focused on controlling inflation, and, specifically, why it did not prick the housing bubble of the early 2000s, as it could have done at any time by pushing up interest rates, until the bubble got completely out of hand in 2006 and 2007. Had it pricked the bubble earlier, precipitating a fall in housing prices with consequent defaults and foreclosures, at a time when it was unclear that the run up in housing prices was a bubble, it would have been blamed for causing a recession, because proof of a bubble is difficult.

Instead of worrying about the merits of concentrating economic power in a single institution, he's much more specifically worried about politics affecting the Fed, even though he admits that the Fed's actions were the main cause of the economic bubble!

If the Fed's actions precipitate inflation or have other untoward consequences, there is likely to be a political backlash against the Fed. We live at present in a blame culture, and really the Fed is lucky that so far most of the public's and the Congress's and the media's ire has been directed at the bankers rather than at Greenspan or Bernanke.

Hey says all this, despite Greenspan's own pronouncement that the bubble was caused by his own hubris (basically, he said his ideology was flawed, but that just means he fucked up) and thus not by politics.

|5.7.09 @ 1:03PM|#

Fuck that noise. Obama has done serious, long lasting (possibly irreparable) harm to the US economy by re-writing on the fly our system of property and markets.

Ron Paul|5.7.09 @ 1:12PM|#

Panics are real, and the market does through acute phases of irrational thought.

Or perhaps acute phases of rational thought.

And in terms of a run on bank, panics can criple healthy companies.

Not really. I imagine that by this you mean that even a healthy bank can be destroyed by a bank run. That's true, but not necessarily evidence of market irrationality. If the banks actually fail, then the bank run wasn't irrational. A belief that banks can't fail, or that there is such a thing as a totally safe bank, is the part that's irrational.

|5.7.09 @ 1:15PM|#

Robert Prechter has an interesting idea called the "potent directors fallacy." Basically, the assumption that politicians, regulators, and central bankers can successfully manipulate or bolster public confidence is a false one. The market is much bigger than any weaponry these officials can bring to bear. But a 25 year bull market like the one we just finished convinced everyone that the "directors" really do have that power.

Hence, writing like Posner's.

|5.7.09 @ 1:16PM|#

We actually need to bring back the bank run, so depositors will quit putting their money in whatever P.O.S. institution (e.g. GMAC) is offering the highest interest rates.

http://mises.org/story/3350

|5.7.09 @ 3:06PM|#

Yup, this is the beauty of the bailout policy, it can't be disproved. If the economy turns around the can claim it "worked". If the economy stagnates, they will say "can you imagine how much worse it would have been if we did nothing?"

This goes the other way too. If the economy stagnates, they'll blame Obama and the stimulus spending of course (no matter how much worse it would have gotten otherwise--something that can't be proved). If the economy turns around, they'll say it wasn't as bad a crisis as was claimed.

Paul|5.7.09 @ 4:21PM|#

This goes the other way too. If the economy stagnates, they'll blame Obama and the stimulus spending of course (no matter how much worse it would have gotten otherwise--something that can't be proved). If the economy turns around, they'll say it wasn't as bad a crisis as was claimed.

Obama's being presidential. He has to govern.

Shit, that never gets old!

|5.7.09 @ 7:31PM|#

This goes the other way too. If the economy stagnates, they'll blame Obama and the stimulus spending of course (no matter how much worse it would have gotten otherwise--something that can't be proved). If the economy turns around, they'll say it wasn't as bad a crisis as was claimed.

Which is why tracking the stimulus spending is so important. So we can do some factual analysis of it's effects on the economy.

Granted, we must also include some analysis of the effects of all that debt too. Of course, that won't happen until the Chinese come knocking in a few years.

|5.7.09 @ 8:36PM|#

Watch how the psychology of pro-bailout citizens change when they are asked to finally pay for all the bailouts. Then we can make some decent assessment of the effects of government intervention into failing parts of the economy. When it's not you, but your children or their children paying for all this garbage, people have a much different different assessment of how much they want the fed telling us what companies should stay in business.

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