Radical Economics

Bruce Greenwald, professor of investing at Columbia, has analyzed the current crisis and developed conclusions which contradict those of just about every known economist. His contrarian streak alone is a joy to my rebellious, defiant and profit-seeking heart.

Since most economists describe the innovative, but untested financing of subprime housing as the cause of the current crisis, the logical approach to fixing the crisis is twofold: re-regulate so that such "nonsense" never occurs again and use monetary tools (i.e., get interest rates down to zero) to revive the economy so that banks are allowed to make high spreads between the borrowing costs (now zero) and lending income.

Greenwald essentially debunks the use of monetary tools as the solution. He argues that dropping interest rates to zero did not work in Japan, did not work in the Asian crisis and did not work in the German crisis. Rather, he argues that building the equity capital of the banking system is the only solid approach. He demonstrates that Malaysia and Sweden used recapitalization of banking as the basis for a rapid recovery.

He theorizes that the deregulation of the banking industry removed an effective means of recapitalizing banks from the economic system. Prior to deregulation, monetary tools were effective because the increase in zero interest demand deposits created a de facto equity class for the banks. Since deregulation, raising equity, at the time needed, has become extraordinarily difficult for banks.

He posits that the availability of such de facto equity prior to deregulation was responsible for the effectiveness of monetary tools, demonstrating the closeness of monetary impulses and economic outcomes. After deregulation, monetary policy and economic outcomes have little correlation.

All of this is news to us, because, as Professor Greenwald says, "Chairman Greenspan is given credit for steering the economy, but, in reality, the steering wheel was disconnected from the economy and moved of its own accord." If Professor Greenwald is correct, re-regulation and monetary tools will not produce the rapid recovery that all would like to see.

Greenwald's World

Over the past couple of years, I have added a name to my list of cochamim: Bruce Greenwald. He teaches at Columbia in the same program where Benjamin Graham taught Warren Buffett - a strong cultural legacy. This video captures the essence of his teaching and is worth watching:

http://www.youtube.com/watch?v=pgE6i8JHbUs

Recently, he has dedicated some of his instruction time to a discussion of what has caused the current crisis. Despite the common consensus of politicians and media, he submits that the economic crisis is not based in poorly developed financial structures, but in real fundamental economic ones. If he is correct (and I think he is), then much of the re-regulation going on is misguided and will not help avoid future crises.