January 15, 2010
Lyman Johnson on David A. Westbrook, Out of Crisis: Rethinking Our Financial Markets
Posted by Gordon Smith

Our second review of Bert Westbrook's new book, Out of Crisis: Rethinking Our Financial Markets comes from Lyman Johnson, who is the Robert O. Bentley Professor of Law at the Washington and Lee University School of Law and the Laurence and Jean LeJeune Distinguished Chair in Law at the University of St. Thomas School of Law.

David (“Bert”) Westbrook’s new book – Out of Crisis: Rethinking Our Financial Markets – is a challenging read, but one that pays a good return, and I recommend it to the non-faint of heart and mind.  The book is a challenging read, stylistically, because it contains numerous parentheticals that frequently hobble the flow.  Bert has a tendency to pack a great deal of additional information, references, or allusions into already-weighty sentences.

The book, more importantly, is substantively challenging, in the best sense.  It “challenges” emerging accounts of the recent financial crisis – what Bert calls the standard narratives – as evading a more fundamental examination of root causes, one not easily reducible to a clean storyline or obvious policy prescription.  Bert sees the crisis as an occasion of such colossal failure that it demands a bold rethinking of how we conceive finance, regulatory policy and modern capitalism itself.  It seeks to be a sophisticated and “inside” critique, but one launched at a very basic and ideological level.  Bert laments at length and with great insight, but he also offers a general way forward.

The book, early on, states that it seeks to revive and extend a “social understanding of markets” running back to Veblen, Weber, Durkheim and other social theorists though, in fact, Bert later seems to equate “social” with “political,” a point to which I will return.  He also early on makes the critical, often lost, distinction between “uncertainty” and “risk,” and he clearly states why he is extremely skeptical of self-regulation grounded on claims of market efficiency and human rationality.  Reminiscent of philosopher William Barrett’s The Illusion of Technique, he also decries excessive reliance on even greater technical savvy or information as the hallmarks of a path to reform.  He considers political (D.C.) Masters of the Universe to be as flawed as private (NY) Masters.  Too much hubris for Bert, though ultimately he makes a necessary peace with both.

The book carefully lays out how modern financial innovation has dramatically enhanced the liquidity of all sorts of property through the sophisticated use of contracts.  This permits leverage and necessarily entails widespread efforts at risk management via diversification, hedging, and insurance.  Risk (unlike uncertainty) can be successfully managed, Bert argues, under certain usual conditions, but not all.  Moreover, financial complexity often reduces transparency – a mainstay of our regulatory approach − thereby creating that dreaded uncertainty.  Furthermore, the remarkable degree of assumed liquidity in financial markets makes financial institutions − and the whole economy – highly vulnerable to a swift loss of liquidity.  This is due to the extraordinary interconnectedness and interdependence of modern financial markets and products.  And this brings Bert squarely to his thesis:  the social side of markets.

A contracting party is affected not just by its counterparty but by all of its counterparty’s counterparties.  And so on.  When uncertainty arises about ability to perform, risk management techniques do not help; in fact, they may exacerbate problems.  Caution sets in, and if sufficiently widespread, financial liquidity “freezes” throughout the entire system.  Financial fates in our country therefore are interconnected, whether one is virtuous or vice-driven.  For Bert, the recent crisis, above all, displays the extraordinary social danger attendant to the inevitably social nature of modern finance.  As a matter of political theory, then, Bert suggests we break out of the conventional analytical dichotomy between emphasizing one or the other of “the (free) market” and “the (regulating) government.”  Rather, markets themselves are one mode of shared governance and they should be deliberately and democratically constructed to achieve certain societal goals and avoid certain perils.

This is the greatest contribution of Bert’s book.  Although it goes on, especially in Chapter 9, to lay out broad policy ideas – I especially like his willingness to consider scale of operation as a problem and decentralization as a solution −  his chief goal is to overcome the customary ideological insularity of finance and economics and situate them squarely in political economy.  Here he uses delightful metaphors.  I have always liked the rules of basketball for seeing the constructedness of market rules, and the occasional need to change them, and Bert obliges here.  He also uses the splendid image of cultivating a garden.

I will end with one final observation.  Bert’s wonderful book would be even better had he not emphasized only the government as a “social” actor.  Our social terrain – and so our thinking about markets – can be more intentionally and beneficially shaped by other civic institutions:  schools of all sorts, but certainly business and law schools; religious institutions; and a host of non-government organizations that powerfully shape beliefs and customs.  Broadening the conversation Bert seeks will give more of us a voice in how to shape markets as well as heighten our own sense of responsibility.  This can aid in overcoming another disheartening attribute of modern finance:  most of us feel we are participants in a financial system we do not make but cannot leave (Bert – Sartre’s No Exit?).  To democratize capitalism requires, to be sure, renewed thinking about government’s role in finance but it also demands fresh thinking about finance in many other venues.  Bert’s provocative book invites that dialogue.

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