Help with discussing the \"Free Market Flaws Exposed\" article. THE world is in

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Help with discussing the "Free Market Flaws Exposed" article.

THE world is in the throes of an unprecedented economic crisis, and most mainstream economists and Washington policy makers didn’t see it coming. In a surprisingly readable new book, “The Cost of Capitalism: Understanding Market Mayhem and Stabilizing Our Economic Future” (McGraw-Hill, $27.95), Robert J. Barbera places the blame for this abject failure in economic forecasting and government policy on a “misguided confidence in the infallibility of free markets.”

“It is not that we put our faith in the wrong people, but that we embraced the wrong paradigm,” Mr. Barbera writes. “The events of 2008 revealed that using simple-minded free-market rhetoric as a policy guide is a recipe for disaster.”

Mr. Barbera is a veteran Wall Street economist with decidedly liberal leanings. A former staff economist for Paul E. Tsongas, the late Democratic senator from Massachusetts, Mr. Barbera is executive vice president and chief economist at the Investment Technology Group, a financial consulting firm, and an economics department fellow at Johns Hopkins University.

Although Mr. Barbera did not foresee the full dimensions of the crisis, he was wise enough to declare that the economy was in a recession back in January 2008, even as most mainstreamers were still predicting steady growth.

“The Cost of Capitalism” tries to identify root causes of the current global recession, the specific mistakes made and possible ways to avoid future financial catastrophe.

Lest he be mistaken for a radical, Mr. Barbera openly declares his abiding faith in capitalism.

“The ravages of the 2008 crisis do not justify a violent leftward lurch,” he writes. “Risk takers are the main drivers in the free-market machinery. Their efforts go a long way toward explaining the lofty growth rates capitalist economies have delivered in the postwar years.”

A proud member of the so-called post-Keynesian economics school, Mr. Barbera bases his thesis partly on the work of the late economist Hyman Minsky, summarizing it in two sentences: “A long period of healthy economic growth convinces people to take bigger and bigger risks. When a great many people have risky bets, small disappointments can have disastrous consequences.”

Mr. Barbera cites the plunge of the American housing market as a classic example of a “Minsky crisis.” From 1966 to 2002, he notes, housing prices maintained a continuous upward trend; that, in turn, prompted both mainstream economists and homeowners to assume that prices would never fall. In fact, as prices rose, people made ever larger bets on the housing market, in the form of subprime mortgages, mortgage refinancings and complex financial derivatives.

Mr. Barbera takes academics to task, saying they created the complex mathematical models on which those financial derivatives were based. “The constructs were underpinned by the assumption that people are well informed and act rationally,” he declares, adding, “They failed to acknowledge that financial markets periodically go haywire.”

Mr. Barbera is especially critical of Alan Greenspan, the former Federal Reserve chairman, and his successor, Ben S. Bernanke. He contends that they were lulled into complacency by the persistently moderate “Goldilocks” economic period from 1985 to 2002, after the success of their predecessor, Paul Volcker, in taming inflation.

As a result, they focused almost exclusively on moderating upward wage and price pressures. Although Mr. Greenspan worried aloud about “irrational exuberance” in the late 1990s stock market, he was ultimately convinced that the economy had entered a “brave new world” based on computer technology gains, Mr. Barbera asserts.

Last fall, Mr. Greenspan even insisted that the precipitating factor of the 2008 crisis was “the failure to properly price risky assets” — evidence, in Mr. Barbera’s view, of a misplaced belief that financial markets are rational and capable of policing themselves.

IF Mr. Barbera offers a concise analysis of what caused the current economic mess, he is a bit short on specific remedies for a long-term cure. Unlike Minsky, he does not advocate a move to socialized investment or total government control of the financial markets. Instead, he calls for “an enlightened synthesis” of mainstream and post-Keynesian economic approaches that “celebrates free-market risk-taking but establishes policies to rein in inevitable excesses.”

For starters, Mr. Barbera says, government policy makers must respond to rapidly rising markets with the same urgency they muster in responding to rapidly falling markets. He also sees a need for regulations that provide “safety margins for the myriad nonbank financiers” that arose outside 1930s-era banking industry reforms.

But he cautions that policy makers must recognize that “innovation on Wall Street, over time, dulls the applicability of a given set of regulations,” thereby mandating constant vigilance and regular updating of the rules.

In the end, Mr. Barbera acknowledges that “there is simply no elixir to be had that will ensure a Goldilocks backdrop” completely free of boom-and-bust economic cycles.

But heeding the lessons of the last few years, as documented in this book, may help both financiers and government policy makers find ways to reduce some future costs of capitalism without sacrificing all the potential rewards.

Explanation / Answer

The main reason for the financial crisis is the complex products that have been launched by mortgage companies, These companies were risk takers and the clients of these companies were also betting on the property market.

The result was the boom that was very huge, This boom was taken happily by the policy makers who did not take any action.

The author says that there need to be action on the excesses that financial system creates, Rapid rise of economy must also be looked carefully, Actions must be taken to avoid excess price rises, If policy makers have looked more carefully at the products launched by these institutions then disaster could have been avoided.

The risk in the market is also very high and capitalism is the game of risk takers, but policy makers must have policy to curb inevitable excesses that are created by such people.

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