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Harsh lessons we may need to learn again
The best that can be said for 2009 is that it could have been worse, that we pulled back from the precipice on which we seemed to be perched in late 2008, and that 2010 will almost surely be better for most countries around the world. The world has also learned some valuable lessons, though at great cost both to current and future prosperity - costs that were unnecessarily high given that we should already have learned them.
The first lesson is that markets are not self-correcting. Indeed, without adequate regulation, they are prone to excess. In 2009, we again saw why Adam Smith's invisible hand often appeared invisible: it is not there. The bankers' pursuit of self-interest (greed) did not lead to the well-being of society; it did not even serve their shareholders and bondholders well. It certainly did not serve homeowners who are losing their homes, workers who have lost their jobs, retirees who have seen their retirement funds vanish, or taxpayers who paid hundreds of billions of dollars to bail out the banks.
Under the threat of a collapse of the entire system, the safety net - intended to help unfortunate individuals meet the exigencies of life - was generously extended to commercial banks, then to investment banks, insurance firms, auto companies, even car-loan companies. Never has so much money been transferred from so many to so few.
We are accustomed to thinking of government transferring money from the well off to the poor. Here it was the poor and average transferring money to the rich. Already heavily burdened taxpayers saw their money - intended to help banks lend so that the economy could be revived - go to pay outsized bonuses and dividends. Dividends are supposed to be a share of profits; here it was simply a share of government largesse.
The justification was that bailing out the banks, however messily, would enable a resumption of lending. That has not happened. All that happened was that average taxpayers gave money to the very institutions that had been gouging them for years - through predatory lending, usurious credit-card interest rates, and non-transparent fees.
The bailout exposed deep hypocrisy all around. Those who had preached fiscal restraint when it came to small welfare programs for the poor now clamored for the world's largest welfare program. Those who had argued for free market's virtue of "transparency" ended up creating financial systems so opaque that banks could not make sense of their own balance sheets. And then the government, too, was induced to engage in decreasingly transparent forms of bailout to cover up its largesse to the banks. Those who had argued for "accountability" and "responsibility" now sought debt forgiveness for the financial sector.
The second important lesson involves understanding why markets often do not work the way they are meant to. There are many reasons for market failures. In this case, too-big-to-fail financial institutions had perverse incentives: if they gambled and succeeded, they walked off with the profits; if they lost, the taxpayer would pay. Moreover, when information is imperfect, markets often do not work well - and information imperfections are central in finance. Externalities are pervasive: the failure of one bank imposed costs on others, and failures in the financial system imposed costs on taxpayers and workers all over the world.
The first lesson is that markets are not self-correcting. Indeed, without adequate regulation, they are prone to excess. In 2009, we again saw why Adam Smith's invisible hand often appeared invisible: it is not there. The bankers' pursuit of self-interest (greed) did not lead to the well-being of society; it did not even serve their shareholders and bondholders well. It certainly did not serve homeowners who are losing their homes, workers who have lost their jobs, retirees who have seen their retirement funds vanish, or taxpayers who paid hundreds of billions of dollars to bail out the banks.
Under the threat of a collapse of the entire system, the safety net - intended to help unfortunate individuals meet the exigencies of life - was generously extended to commercial banks, then to investment banks, insurance firms, auto companies, even car-loan companies. Never has so much money been transferred from so many to so few.
We are accustomed to thinking of government transferring money from the well off to the poor. Here it was the poor and average transferring money to the rich. Already heavily burdened taxpayers saw their money - intended to help banks lend so that the economy could be revived - go to pay outsized bonuses and dividends. Dividends are supposed to be a share of profits; here it was simply a share of government largesse.
The justification was that bailing out the banks, however messily, would enable a resumption of lending. That has not happened. All that happened was that average taxpayers gave money to the very institutions that had been gouging them for years - through predatory lending, usurious credit-card interest rates, and non-transparent fees.
The bailout exposed deep hypocrisy all around. Those who had preached fiscal restraint when it came to small welfare programs for the poor now clamored for the world's largest welfare program. Those who had argued for free market's virtue of "transparency" ended up creating financial systems so opaque that banks could not make sense of their own balance sheets. And then the government, too, was induced to engage in decreasingly transparent forms of bailout to cover up its largesse to the banks. Those who had argued for "accountability" and "responsibility" now sought debt forgiveness for the financial sector.
The second important lesson involves understanding why markets often do not work the way they are meant to. There are many reasons for market failures. In this case, too-big-to-fail financial institutions had perverse incentives: if they gambled and succeeded, they walked off with the profits; if they lost, the taxpayer would pay. Moreover, when information is imperfect, markets often do not work well - and information imperfections are central in finance. Externalities are pervasive: the failure of one bank imposed costs on others, and failures in the financial system imposed costs on taxpayers and workers all over the world.
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