In 2013, we are receiving the same banker and mass media propaganda that we heard in 2008. The stock markets are okay, economies are recovering, blah, blah, blah. However, do any of the facts support the propaganda? For example, this “bullish” US stock market has not even recovered to the levels of October, 2007. And even, if more QE, more HFT low-trading volume rigging can rig US and other western markets higher, do rising stock markets even matter if the growth of stock markets are less than the Central Bankers’ devaluation of the denominated fiat currencies? So, today, we should be asking the question, “Who sees another economic crisis coming and why?” In the meantime, my friend, journalist Lars Schall takes an investigative look back at 2008 and answers, the question, “Who saw the economic crisis coming and why?” Below, I present you his article. – JS Kim.
Who saw the economic crisis coming and why?
You have heard the widespread thesis that no one saw the current financial crisis coming. That thesis is simply wrong. However, it makes sure that those are not seen and heard, who a) did see it coming, who b) could have prevented it, and who c) have the knowledge of how we can get out of the mess we’re in.
By Lars Schall
The following article was originally published at Asia Times Online here [25].
Hans-Olaf Henkel is Professor of Business Economics at the University of Mannheim. Previously he was chairman of IBM Europe, Middle East and Africa and President of the Association of German Industries (1995-2000). He is a leading advocate of a split of the eurozone.
Henkel is also a leading figure in a new political group, “Alternative for Germany”, which is expected to be an official party in time to contest the September general election. Its main plank is the abolishment of the euro. (See here [26].) On March 4, Deutsche Bank Research published an analysis concerning its prospects. (See here [27].)
In the following article, Lars Schall revisits a debate over comments Henkel made in 2009 in which he attributed the cause of the sub-prime crisis and subsequent global financial crisis to political “do-gooders” ending the practice of banks in the US “redlining” specific areas, such as slums, often with a specific ethnic population, as no-go zone for home-loans.
You have heard the widespread thesis that no one saw the current financial crisis coming. That thesis is simply wrong. However, it makes sure that those are not seen and heard, who a) did see it coming, who b) could have prevented it, and who c) have the knowledge of how we can get out of the schemozzle we’re in.
A prime example for those contemporaries who say that no one saw the crisis coming is Hans-Olaf Henkel, the former head of the Federation of German Industries. Currently, he is, among other things, Bank of America’s senior advisor in Germany and a regular columnist for Das Handelsblatt, Germany’s most respected financial newspaper. Mr Henkel is in Germany a household name among people who follow economics and politics.
Thus, what Henkel says has some impact on the perception and thinking of the general public in Germany. Or, as he himself explained quite well during a 2009 interview with the German stock market commentator Michael Mross: ”If you don’t know the reason for the crisis, you automatically don’t know the right means to prevent the next one.”
For that reason I wanted to talk with US economist and book author James K Galbraith (The Predator State) in January 2010 about the underlying causes of the global financial crisis and in particular about the theses that Henkel voiced in that interview at the end of 2009 with Mr Mross. According to Henkel’s analysis – if you want to call it that – the trigger of the global financial crisis, ie the housing bubble in the United States, was predominantly caused by the ”starry-eyed idealism” respectively ”do-goodism” among politicians in Washington DC.
Not surprisingly, Prof Galbraith (as you can read here [28] in full length) did not agree with Mr Henkel’s public statement that the crisis had not been predicted by anybody. On the contrary, Prof Galbraith, who holds the Lloyd M. Bentsen, Jr. Chair of Government/Business Relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas in Austin, stated:
”Mr Henkel needs to read a little bit more. He needs to broaden his definition of what constitutes economic analysis, and needs to recognize that the problem is precisely a group of people who insist that nobody outside of their very narrow circle has any insight worth paying attention to. That’s a preposterous position. It’s a completely indefensible position. It reflects fundamental narrowed-mindedness and, as I may say, incompetence which is really on display for anybody to see. So I do not need to hammer the point too hard.”
As to ”do-goodism” among US politicians, Prof Galbraith said, inter alia: ”It is an amusing interpretation of the motives of someone like George W Bush, who represented one of the most aggressively predatory tendencies in American politics ever to reach the White House. … (T)o suggest that this was some naive altruism on the part of that extraordinarily reactionary Republican administration is, I must say, a view that no one who has actually lived through this period in the United States would recognize.”
Mr Henkel reacted to Prof Galbraith’s reflections promptly with a public statement, in which he wrote that Prof Galbraith ”deflected from the issue with an incredible degree of arrogance”. Moreover, Mr Henkel said that my interviewee ”should read a little bit more himself” – for instance, ”Mr Galbraith should familiarize himself Jimmy Carter’s ‘Housing and Community Development Act’ where in Section VIII Banks were prohibited the practice of ‘red lining’ which until then enabled them to distinguish ‘better living quarters’ and ‘slums’.” In addition, Mr Henkel asked at the end of his statement: ”If a so called ‘leading economist’ refuses to recognize the causes of an economic problem for obvious ideological reasons, how can he be taken serious in his analysis?”
It didn’t take long before another economist from the US became aware of Mr Henkel’s reaction to Prof Galbraith’s remarks. His name is William K Black, a former banking regulator, who’s nowadays an Associate Professor of Economics and Law at the University of Missouri, Kansas City (UMKC). Prof Black (who has written an important book about the Savings & Loan crisis, The Best Way To Rob A Bank Is To Own One) did his best in the following days to publicly counter Mr Henkel’s way of thinking. The climax was an open letter that Prof Black wrote to then-chairman of Bank of America, Dr Walter E Massey. In it, Prof Black wrote:
”Bank of America’s ‘senior advisor’ in Germany – the leader of a team of advisors that help set the bank’s policies – is bemoaning the end of redlining and claiming that American bank loans to black ‘slums’ caused the global financial crisis. I know that you understand exactly what redlining means – the deliberate exclusion of minority borrowers from credit on the basis of ethnicity. I also know that you understand that Mr Henkel’s effort to blame the global crisis on black Americans has no basis in fact and is the product of the vilest bigotry.”
At the end of the letter, Prof Black told Dr Massey:
”I offer the following recommendations for your board’s consideration. Mr Henkel should be terminated for cause. Immediately. Bank of America should review all policy advice it has received from him and his team and seek outside guidance from experts that (1) foresaw the crisis, and (2) are not bigots. Bank of America should review why its senior managers in Europe and the United States took no action while its ‘senior advisor’ spread his hate for months. Bank of America should announce a new $10 million scholarship program for college and graduate students of limited financial means. I suggest naming the program the Giannini awards.” [Amadeo Giannini, founder of Bank of America, noted for his willingness to lend in the immediate aftermath of the San Francisco earthquake.]
However, neither Dr Massey nor Mr Henkel responded to Prof Black in any way. The same was true after I conducted a few weeks later an interview with Prof Black to discuss the causes of the financial crisis and Mr Henkel’s indefensible claims (see here [29]). Instead, the whole issue was surrounded by a deafening ”sound of silence”.
A prize-winning economist
But then in early 2012 I had the opportunity to interview one of those economists who have predicted the current financial crisis: Steve Keen, an Associate Professor of Economics and Finance at the University of Western Sydney, Australia. A post-Keynesian himself, Prof Keen differs from the norm of critics of conventional economics by being highly mathematical in his own research, criticizing modern neo-classical economics as inconsistent, unscientific and empirically unsupported.
His main research interest is in developing mathematical models of Hyman Minsky’s Financial Instability Hypothesis. Aside from Minsky and John Maynard Keynes, the major influences on Keen’s thinking about economics include Irving Fischer, Joseph A Schumpeter, Piero Sraffa, and Francois Quesnay. In 2001, his book Debunking Economics: The Naked Emperor of the Social Sciences was published, and a new, expanded and extensively revised version was released in 2011 (see for more here [30]). I highly recommend that book.
Having the opportunity to interview an economist who has actually received the ”Revere Award for Economics” from the ”Real-World Economics Review” for predicting the financial crisis before it happened, I considered it worthwhile to ask Prof Keen about Mr Henkel’s theses as well. It was again not surprising to hear Prof Keen rejecting Mr Henkel’s way of thinking. Moreover, he pointed out that Mr Henkel had missed ”what turns out to be the most important thing in capitalism”. (You can listen to that interview here [31] at Steve Keen’s web site ”Debt Deflation”. The passage during which we talked about the ”no one saw this coming” topic and Mr Henkel starts at minute 24:19.)
However, I wasn’t really interested at that time to revive a rather one-sided discussion with Mr Henkel, and so I let it rest.
On the other hand, I have to admit that I am increasingly sick and tired of the status quo in financial / economic debates, and so I finally decided recently to confront Mr Henkel directly with Prof Keen’s arguments in an e-mail that I send to him on February 26, after I had arranged an extra transcript of the passage that I’ve mentioned.
My e-mail to Mr Henkel: Under the subject heading ”Media request re: Causes of the financial crisis” it said:
Dear Mr Henkel,
My name is Lars Schall, I am a freelance journalist for finance (for example, Asia Times Online). I copy this e-mail to Michael Mross, whom you gave this interview: Politik wrackt ab [32].
You may remember that there was a little, yet important controversy going on in early / mid-2010 related to Prof James K. Galbraith, Prof William K. Black and you regarding the causes of the current financial crisis – see here [28] and here [29]. If you want to read a German written summary about it, voila [33].
Since I think that the controversy was ultimately related to an essential aspect of the financial crisis (who saw it coming and why?), I want to come back to it one more time.
It might be interesting for you to know that during last year I’ve interviewed one of those economists / financial analysts who foresaw the current crisis and its causes without any shadow of a doubt, even though you want the public to believe in a myth: that there are no such economists / financial analysts. His name is Prof Steve Keen (who decided to talk about the upcoming disaster at the end of the year 2005 and started his blog ”Debt Deflation”).* More interestingly, I’ve made Prof Keen familiar with your statements and asked for his opinion related to them:
”As you are very well aware of, there is this study to a specific problem of the crisis: ‘No One Saw This Coming,’ written in 2009 by Dirk Bezemer (Dirk J. Bezemer: ‘No One Saw This Coming: Understanding Financial Crisis Through Accounting Models.’ MPRA Paper No. 15892, June 16, 2009). With regards to this, a very influential opinion-maker here in Germany, Hans-Olaf Henkel, stated exactly this in the past: that no one has foreseen the financial crisis, that he laughs himself to death whenever someone claims it was foreseen, and that it was caused by ‘starry-eyed idealism’ of politicians in Washington. What’s your reaction to this?
Prof Keen answered: “That is a classic statement of somebody who’s theoretical foundations mean he could never himself see this coming saying nobody else could either, and the only way that could be true would be if the crisis was caused by what you might call an exogenous shock, something outside the economy itself, something that economists don’t take account of in their models and therefore can’t be accused of missing it when it occurs and they don’t see it coming. So he’s saying it’s an exogenous shock and this particular nomination of this exogenous shock is the political behaviour of politicians in Washington.
“That points out the deficiency in that man’s thinking, the fact that he is saying we couldn’t have predicted it. What he is saying effectively also is there is no deterministic causal function behind this; it’s just something extraneous like what politicians do. That’s not true, there is something endogenous, it’s the level of private debt growing faster than income, and the reason it couldn’t be seen by people like himself was his economic framework told him to ignore what turns out to be the most important thing in capitalism.”
Moreover, I’ve asked Prof Keen: ”Isn’t it also if he says ‘No one saw this coming’ a smoke and mirror related to those who saw this coming?”
Prof Keen answered: “Yes, it’s a way of diverting responsibility from themselves saying, ‘oh, nobody could have seen this coming, therefore we can’t be accused of the fact that we didn’t see it coming’. I’m sorry, the form of economic analysis that neo-classical economists spent the last forty or fifty years suppressing, which approaches from the Austrian School from one extreme and the Marxists to the other and certainly Minsky in the middle, they spent their time suppressing this approach to economic thought, not publishing papers like people like myself in the leading journals, not accepting you unless you use neo-classical concepts and theory, driving those ideas out of academic discourse and certainly meaning that policy makers didn’t get a chance to listen to them.
“They’ve had a major responsibility for the fact that these views didn’t get heard in the public before the crisis actually occurred, and now they’re trying to excuse themselves by saying ‘well, nobody could have seen it anyway’. We were trying to publish articles on this basis, I’m talking in general about non-orthodox economists, and being refused by the neo-classical gatekeepers of these journals. So they definitely bear a responsibility, and you’re right, they’re trying to divert attention by saying ‘well, nobody could have seen it coming’.”
Furthermore, I’ve asked Prof Keen: ”But Mr Henkel knew someone to blame because he said that the crisis was caused because the ‘redlining’ practice in the US was abolished. Isn’t this a bit too much?”
Prof Keen answered: “It’s too simplistic, I mean certainly irresponsible borrowing, lending, got worse over time, but it was endemic in the American system anyway, and if you simply looked at the level of debt to GDP you could see that something very dangerous was going on, the only way you could not see it was by ignoring that particular indicator. So his argument is that all that really happened was the transition from slightly irresponsible lending to far more irresponsible lending and the legislators and politicians approving those changes, but the debt crisis is still there inherently because if you go back to 1987 for example, when we had the first stock market crash, the level of debt to GDP back then was already approaching levels of the Great Depression. By 1995/96 it had passed those levels and was still climbing.
“So any time in the last 15 years, we could have said ‘hang on, this level of debt’s too high, we have to stop this behaviour at this point now’. Even if we’d done it back then, we still would have had a mini-depression; the only difference is this crisis is far worse. Now, it is not so easy to rob a factory, you know, things can fall off the back of a truck so to speak, but it’s much, much easier to police that and much, much harder to make large amounts of money out of theft of commodities. The theft of money is very easy, and of course banks are put in a position of judiciary responsibility towards the rest of society when they’re given the capacity to create debt and therefore create money and that requires them to behave in the most responsible of fashions, but of course the way society develops over time, the most reckless of people get allowed to run banks and of course fraudulent behaviour is only a step away from that particular opportunity.
“So it then means that what happens ends up being worse than what I’d predict in my models, because on top of irresponsible behaviour you get fraudulent behaviour and money that’s supposed to be there is not there; financial assets that are supposed to be backed by real assets aren’t backed by those assets; multiple ownership claims exist; outright stealing occurs; and that of course means that the shock that the system feels is far worse and of course it’s allowed to continue because we don’t actually prosecute that behaviour.
“The thing which Bill Black can hold his head high is for the fantastic work he did when he was responsible for cleaning up the Savings & Loan mess, when he could send lots and lots of fraudulent people to jail. His successes these days have done absolutely nothing by comparison to what Bill did back then with a far less extreme instance of fraudulent behaviour than we’ve seen during the global financial crisis.”
LS: ”But it is deepening the crisis, that the criminal aspect of it isn’t punished.”
SK: ”That’s right, if some of these people spent their entire life behind bars rather than on the Cayman Islands, then we might finally get a strong barrier to this sort of behaviour, at least for a while, because that experience gets seeded into the minds of others who might consider indulging in a career of fraud later. But if you actually reward them by rescuing them as we’re beginning to do right now and punish the people who were innocent bystanders in the whole crisis thing, the people who are, you know, on public pensions or low paid jobs, depending upon state welfare, if they are in Greece and so on, you’re rewarding fraudulent behaviour. You’re being told being honest and being poor is not sensible, be dishonest and rich; that’s the last message we want to send to society, but that’s the one we are sending right now.”
LS: ”And this will have repercussions on the political landscape and societies.”
SK: ”Well, ultimately the debt does because a large part of why we had the horrors of the Second World War were those same attitudes towards the financiers who caused the crisis of the Great Depression. So if we continue down this path I have no doubt that at some stage there’ll be right wing, normally right wing, maybe in some cases left wing, but normally right wing political military coups in Europe, and politicians who express surprise about it will have nobody to blame than themselves because they punished the masses and the masses will then be quite willing to be led astray by a demagogue, and this is exactly how Hitler got into power, we’re letting it all happen again.”
I would like to ask you for a comment on Prof Keen’s observations, Mr Henkel. Or let me paraphrase your question at the end of your statement that addressed my interview with Prof Galbraith in a more challenging way: If a so called ”leading opinion-maker / expert” has not foreseen the crisis, isn’t familiar with the work of those economists / financial analysts who predicted the crisis, and refuses to recognize the causes of a financial / economic problem for obvious ideological reasons, how can he be taken seriously in his analysis?
Moreover, back in 2010 you did not respond to it, but what are your actual thoughts on the fact that Prof Black wrote an open letter to Dr Walter E. Massey, then-chairman of Bank of America, in which he called for your termination as Bank of America’s senior advisor in Germany?
Please be aware that Prof Keen, Prof Galbraith and Prof Black will be informed about this media request of mine.
Thank you very much for your attention!
Sincerely, Lars Schall.
* In 2009, Keen received the ”Revere Award for Economics” from the ”Real-World Economics Review” for predicting the financial crisis before it happened. For my interview with Keen go to: http://www.debtdeflation.com/blogs/2012/03/26/lars-schall-interview/ [31].
Denial of reality?
Until Monday of this week, Mr Henkel had not replied. (His latest Das Handelsblatt column, on the euro, was published on Monday; see here [34]). This from a man who demands quite often – you can’t make this stuff up – ”more courage” in public debates and wants to play a significant role in this year’s national elections in Germany (as a mouthpiece for the growing anti-euro movement).
And so I asked Prof Galbraith, Prof Black and Prof Keen this Monday for a final comment: ”Do we witness a kind of denial of reality on the part of Mr Henkel?”
Prof Galbraith (who published in the autumn of 2009 in ”Thought and Action” an article, “Who Are These Economists, Anyway?” [35], about some of those economists who did see the crisis coming, and who have not received the credit they deserve), answered: ”I see that Mr Henkel, a humble man, has accused me of arrogance. That is what defenders of the Vietnam War used to say, many years ago, about my father. I’m pleased, of course.” (James K Galbraith is the son of one of the most exceptional economists of the 20th century, John Kenneth Galbraith.)
Prof Black said: ”Since the time of my open letter to Dr Massey about Herr Henkel, it has become ever clearer that the most important development in the West has been crony capitalism led by the systemically dangerous institutions (SDIs) – the ‘too big to fail, manage, regulate, or prosecute’ banks. Henkel’s anti-regulatory lobbying helped create the international regulatory race to the bottom that created the most criminogenic environment for endemic ‘control fraud’ in history. A recent study by conservative finance scholars confirmed that control fraud was ‘pervasive’ at our ‘most reputable’ banks. Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market. Tomasz Piskorski, Amit Seru & James Witkin (February 2013) (‘PSW 2013?). See here [36].
"The key conclusion of the study is that control fraud was ‘pervasive’ (PSW 2013: 31)."
[A]lthough there is substantial heterogeneity across underwriters, a significant degree of misrepresentation exists across all underwriters, which includes the most reputable financial institutions’ (PSW 2013: 29).
”By 2006, 40% of the U.S. home mortgage loans made that year were ‘liar’s’ loans (the figure for the U.K. was 45%) – and they had a fraud incidence of 90%. Liar’s loans provide an ideal ‘natural experiment’ to test Henkel’s theory that the government caused the crisis by requiring banks to loan to blacks. No entity (and that includes Fannie and Freddie) was ever required to make or purchase liar’s loans and because investigations have shown that it was overwhelmingly lenders and their agents who put the lies in liar’s loans (and appraisals).
“Indeed, contemporaneous industry documents demonstrate that the government sought to discourage liar’s loans. Liar’s loans did not count toward Fannie and Freddie’s ‘affordable’ housing goals – and the same 2006 industry study (by MARI) that reported the 90% fraud incidence and the government’s efforts to discourage liar’s loans also reported that in 60% of the cases the borrower’s income was inflated by over 50%."
“To emphasize the obvious, this would have been a terrible strategy for meeting an affordable housing goal even if liar’s loans had been eligible for counting toward that goal. (Oh, and consistent with the Bush administration’s approach to affordable housing and financial regulation, nothing happened to Fannie and Freddie when they did not meet their affordable housing goals – see here [37].)”
Prof Keen stated: ”The ‘No one could have seen this coming’ mantra is almost the exact opposite of the truth: the only way that one could fail to see this crisis coming was to be seriously misled by a naive view of how banks operate. Unfortunately economic theory is dominated by precisely such a naive view, which led those who believe that theory to a denial of reality as profound as that of those who pretended they could see clothing on The Naked Emperor.
”Politicians who repeat this mantra help economics hide from its own weaknesses, when what we need is a revolution in economic theory and an overthrow of the bank-dominated politics of today.
”I am doing my bit for the revolution in economic theory by developing Minsky, a dynamic monetary modeling program – and you can help via my Kickstarter campaign here [38].”
In addition, I asked him: ”Can you elaborate for the readers of Asia Times Online a bit on what you’ve pointed out as ‘the most important thing in capitalism’, please?”
He answered: ”If I can interpret that question as ‘the most important thing about capitalism that most economists don’t understand’, it would be ‘that banks are not merely passive warehouses for storing money, but actively produce money, and can destabilize capitalism if they do this badly – which, left to their own devices, they always do.”
Lars Schall is a German financial journalist.
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