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Judge Richard Posner Questions His Free-Market Faith In "A Failure Of Capitalism"

First Posted: 05/21/09 06:12 AM ET Updated: 05/25/11 02:15 PM ET

Richard Posner

"If you're worried that lions are eating too many zebras, you don't say to the lions, 'You're eating too many zebras.' You have to build a fence around the lions. They're not going to build it."
- Judge Richard A. Posner

One of the most prominent proponents of free-market capitalism is having second thoughts.

Judge Richard A. Posner, a federal appeals court judge who has been called the most cited legal scholar of all time, discussed his doubts and his analysis of the current financial crisis in a wide-ranging interview with the Huffington Post.

A longtime proponent of deregulation, the idea that business works best in a free market without burdensome government regulations, Posner began to change his mind when he realized the enormity of the crisis. This change of heart inspired him to write his upcoming book, "A Failure Of Capitalism."

Though still a believer in the virtues of capitalism, Posner now emphasizes the importance of government regulations; the need to strengthen the regulatory structure by directly funding authorities rather than the current fee-based model; the dangers of excessive executive compensation, and even expressed support for the idea of changing bankruptcy law to make it easier for homeowners who face foreclosure.

"I wouldn't have thought the economy was as vulnerable," he explains. "I wouldn't have thought that banking deregulation was dangerous."

Posner says he grew "complacent" about the risks of deregulation since economists "said they had solved the problem of depression and knew how to control inflation without causing recession." His relaxed attitude was also due to the fact that the economy had been running fairly smoothly since the early 1980s.

Now, he realizes that more regulation of our financial markets is needed, employing a typically entertaining analogy to illustrate his point:

"If you're worried that lions are eating too many zebras, you don't say to the lions, 'You're eating too many zebras.' You have to build a fence around the lions. They're not going to build it."

Posner emphasizes that he doesn't blame the bankers for not sensing earlier the damage that their risky behavior had on the larger economy. "If you say to a banker, 'If all the banks go broke, the economy will take a hit.' They'll say, 'What can I do. If I decide to play it safe, my competitors will take all my business.'

Since our free-market system encourages businessmen to be self-interested profit maximizers, Posner says it doesn't make sense to also ask them to be conscious of their impact on the wider economy.

"You can't expect [an] individual firm to be worrying about what his collapse will do to the rest of economy. That's why you need government regulation of banking... Coal-burning utilities in the Midwest don't worry about acid rain because that's going to be in the east. That's why you need regulation."

Posner is critical of the government bailout because it doesn't seem to have served its purpose: banks are not lending, but rather hoarding the billions they have received of TARP funds.

"What government has been trying to do is give them enough money to feel safer. But it doesn't work too well because if making loans is risky... and there's not much demand for loans... they'll find other things to do with the money. You can lead a bank to money but you can't make it lend."

Posner is careful to emphasize that while the bailout may be wrong, it may have prevented an even greater crisis: "You don't know how much worse things would be if government hadn't done this. Without all those hundreds of billions, maybe the banks would have collapsed."

Overall, he doesn't have much confidence in the government's approach. "What I criticize them for is the failure to have had any contingency plan. So it's now 6 months since the September crash of the banking industry... my sense is that the government is still feeling its way. It improvises, doesn't have any real long-term plan."

And he warns that the crisis's aftershock may be worse. "The danger here is that the Fed is pumping several trillion dollars into the economy, on top of the Bush deficits... the danger is that in a couple of years, we have very severe inflation."

Posner even seems amenable to an idea suggested recently by Yale professors John Geanakoplos and Richard Levin to reduce the mortgage principal and not just the interest rate of homeowners facing foreclosure. That would probably involve a change in bankruptcy law:
"It's not a bad idea... If you reduce the principal, you're going to reduce foreclosures... It might be possible to have a law that does that - that would be really radical... if it could be done legally."

Posner was also critical of the current regulatory structure, in which the numerous federal agencies are funded by fees from the banks and institutions they regulate. That creates a "cozy" relationship which can lead to lax regulation. "There's a kind of shopping involved. Countrywide was originally under the Federal Reserve because it had a bank connected to it... and decided that the Fed was too rough on it, got rid of its bank and as a result was regulated by the Office of Thrift Supervision."

Instead, he suggests, regulatory agencies should be "supported by general tax revenues."

Posner's other non-traditional free market suggestions: Putting a ceiling on credit card interest rates and payday loans and possibly capping the salaries of bank executives (though he prefers disclosing the full compensation of all senior executives and requiring that a substantial share of compensation be tied to a company's future performance) and even increasing the marginal income tax rate of high-income individuals.

In his book, Posner takes aim at the Republican Party, explaining that thoughtful conservatives were "appalled at the intellectual vacuity" of the McCain campaign. Echoing Stephen Colbert's mock-conservative take, he derides how the party flaunted the 'anti-intellectualism of its supporters', concluding that "The economic crisis in which the nation finds itself cannot be solved in the gut." And he makes sure to include the failures of liberalism in his rant, condemning how they are "trapped in fantasies of equality."

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