THE RAPID PLUNGE OF THE GLOBAL ECONOMY INTO a seemingly bottomless pit has caused extreme insecurity worldwide. In Canada, where two years ago you were considered a foot if you were not in on the stock market and housing boom, many are now facing economic ruin for not getting out early enough and taking on too much debt. Either way, people can be plagued with self-doubt: if only they were smarter, if only they understood this complex financial stuff better, they could have made the right bets at the right time.
The recent confession by Alan Greenspan to a U.S. congressional committee that the behaviour of banks had left him in a "state of shocked disbelief" should help people cut themselves some slack about their lack of financial foresight. Greenspan is the former chairman of the U.S. Federal Reserve, and used to command such confidence in his financial acumen that he was called "The Oracle."
Not any more. Greenspan is being criticized for being one of the architects of the current catastrophe. His fierce opposition in the late 1990s to regulation of risky financial products, voiced with his characteristic arrogance, intimidated the U.S. government from taking steps that might have prevented financial markets from blowing up.
Greenspan conceded in his testimony he may have been "partially" wrong in his belief that financial institutions' self-interest (Greenspan is a fan of libertarian Ayn Rand) would keep them from acting recklessly. This half-hearted apology seems particularly callous with 6.5 million American families facing foreclosure over the next five years, and so many people across the globe losing their jobs.
It is important, though, to understand what the current crisis is not about. Contrary to Republican Party claims, it is not about giving poor Americans access to housing by allowing those with few assets to qualify for mortgages. Most of the people inveigled to take out subprime mortgages in the U.S. were already homeowners. If the only government response to this fiasco is tighter mortgage standards, bank bailouts and the few modest regulatory reforms people like Greenspan are suggesting, the world really is in for very deep trouble.
The U.S. Model: Creating Demand, Suppressing Wages
The economic model that led the U.S., and now the rest of the world, into this mess has two fundamental aspects. One we are familiar with. It is the face of people losing their homes as "innovations" in mortgage lending set them up for foreclosure when the housing market declined.
The other facet is more obscure. It is the world of shadow banking, where financial products are exchanged in unregulated markets, with no-one knowing for certain how many trillions of dollars are involved. There is the potential for both eye-popping gains and spectacular losses, creating huge systemic risks.
You can find some ironic statements about the virtues of this system from the era when Bush Administration officials used to swan around the world telling other countries to follow its model. For example, in 2002 Deputy Treasury Secretary Kenneth Dam was in South Korea as part of an administration campaign called "Engines of Growth." This campaign was an effort to get other countries to restructure their financial sectors along American lines.
Dam touted the benefits as follows:
"Just look at the United States. Our financial sector is the backbone of our economy. During last year's U.S. economic slowdown, for example, it was innovations in our financial sector ... that helped fuel the economic recovery we are currently experiencing. It was access to new mortgage products that kept U.S. consumers spending and sophisticated debt instruments that kept businesses investing."
A combination of policies has contributed to suppressing wages in the U.S. so that "new mortgage products" were needed to keep average Americans spending. These …