4 April, 2011Issue 15.6EconomicsPolitics & Society

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Bringing Down the House

John Feddersen

Faulks on FictionHans-Werner Sinn
Casino Capitalism
Oxford UP, 2010
304 Pages
£20.00
ISBN 978-0199588275

 


Books written about the financial crisis tend to ask the same set of questions: Why did the crisis occur? How much damage was caused? What should be done to avoid it in the future? While Hans-Werner Sinn’s Casino Capitalism is no exception to this trend, it stands out for its accessibility and for the precision of Sinn’s analysis. With a combination of intellectual rigour and hordes of data to support his conclusions,  Sinn answers the “why” and “how” more comprehensively than most books on the topic. Sinn’s proposed reform agenda is creative, in many respects controversial, and firmly grounded in his conjectures about the causes of the financial crisis.

The first half of the book focuses on explaining why the crisis happened. It is written with clarity, theoretical rigour, and attention to detail, and is well worth reading as a self-contained treatment of the subject.

In explaining the microeconomic causes of the crisisnamely, institutional deficiencies which created dangerous incentives both for individuals and firms—Casino Capitalism excels. According to Sinn, Wall Street in effect became a casino as a direct consequence of limited liability corporations and low bank equity requirements, which together encouraged banks to reduce their levels of equity in search of both high returns and socialised losses. Main Street gambled because of homebuyers’ access to non-recourse loans and the enactment of legislation which mandated lending to high-risk people.

Throughout the book Sinn advocates an ordoliberal approach, as espoused by Eucken, which suggests that “markets can only unfold their beneficial effects if the government sets the rules of the game.” While deploring the greed that led to the crisis, Sinn takes aim primarily at the rules and institutions governing capitalism.

A world-famous macroeconomist, Sinn also offers a careful analysis of the macroeconomic origins of the crisis. He dismisses the “savings glut” hypothesis espoused by US Federal Reserve Chairman Ben Bernanke, which suggests that foreign saving led to large inflows of credit to the United States which fuelled a consumption boom and caused current account deficits. Instead, Sinn favours an “institutional deficiency” or “glut of toxic assets” theory, which states that America was able to fund a consumption binge by selling the world financial assets of dubious quality.

Sinn speculates on the future of the world’s major economies and proposes his agenda for reform in the second half of the book, articulately treading a path between two popular and conflicting schools of economic thought. Highly critical of the Chicago School, which advocates self-regulating markets, Sinn suggests that it “has disgraced itself”. At the same time, the book eschews financial bailouts for non-financial firms (such as the US Government’s majority stake in General Motors) and urges restraint in the use of the Keynesian school’s prescribed fiscal stimulus“before Eucken arrives there, Keynes must save the banks and the economy.”

Given Sinn’s view that banks’ insufficient equity reserves played a major role in the crisis, it is not surprising that this area is viewed as fertile ground for reform. According to Sinn, the American Geithner plan for bank recapitalisation, which relies on “equity gifts” to banks, is flawed. These strategies provide too much taxpayer money to restore bank balance sheets, achieve their goals too slowly, and don’t encourage banks to reveal the extent of their bad debts.

Sinn proposes instead a system of “bank hospitals” in each jurisdiction. These would be funded by mandatory bank contributions and provide capital to banks when equity levels fall below a regulatory minimum, which Sinn argues should be higher than current levels. In return for a capital injection into a needy bank, the hospital would gain an equivalent equity stake in that bank.

While the virtues of this approach over nationalising banks or providing equity gifts is well argued, the process by which a bank hospital might be created is unclear. If, as Sinn suggests, a global regulatory race to the bottom is responsible for lax regulation and its disastrous consequences, the question arises as to what will compel governments to charge domestic banks to fund this hospital and to act against their natural tendency toward de-regulation. The notion of charging banks for all of the risks they take is not new, but rarely becomes legislation.

Sinn’s answer appears to be that “the crisis may help them to reach sufficiently strict international agreement to help reduce the risk of a repetition of the crisis.” Indeed, an assumption that strong international cooperation is possible is at the heart of many of Casino Capitalism’s proposed reforms, which cover accounting standards, bank capital requirements, and ratings agencies.

While this optimism may have been called for in May 2009, when the first edition of the book was published, it is not now. G20 attempts at international cooperation have largely failed and international financial centres continue to compete fiercely for footloose financial firms. For the English version, published in August 2010, an explanation of how cooperation might be achieved is notably absent.

Throughout, Casino Capitalism combines the clarity of an academic publication with a narrative likely to be enjoyable to anyone with an interest in the financial crisis. Key assumptions are enumerated and the analysis is free from much of the hand-waving argument which often appears in popular books on macroeconomics.

Sinn’s German roots as a macroeconomist are brought out in his analysis and make Casino Capitalism a refreshing alternative to the predominantly American perspective adopted by other authoritative accounts of the crisis (including those by a US Nobel Prize winner and a former US treasury secretary). Sinn’s proposals for change are detailed and ambitious; however, in the current climate, many appear unlikely to come to fruition.

John Feddersen is reading for a DPhil in Economics a Magdalen College, Oxford.

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