Realizing that it is somewhat unadventurous to merely review and regurgitate other reviews of quality work, I decided to purchase, read, and review David A. Westbrook’s Out of Crisis: Rethinking Financial Markets. In that spirit, I also urge you to read the book for yourself and draw your own conclusions. This, I believe, is an important book for our times. Here are my (somewhat long) thoughts:
In one sense, this book is very modest in its aims. In the introduction, Westbrook admits that, “it is sociologically and psychologically implausible that our administrative agencies will rethink our financial markets at all well and except under extraordinary circumstances.” However, as the title implies, in order to get out of the crisis, we must move ourselves from the limited framework of thought that has dominated policy for decades. And, of course, we are in extraordinary circumstances. Even so, introducing a new paradigm of thought, even while acknowledging that it may fall on deaf or corrupted ears, is an ambitious undertaking.
Against the current backdrop, Westbrook’s rethinking seems quite necessary. Indeed, he argues that the crisis represents the birth pains of a transition to a new era of financial capitalism (replacing the era of portfolio management, which spanned three decades). Entering this era with anything less than a new framework of thought will leave policymakers two or three steps behind. As Westbrook argues, even our grammar and language for markets needs to be reshaped.
So, what are the assumptions with which we move forward in this bold rethinking? First, Westbrook seeks to dispel the somewhat irrelevant bifurcation between governments and markets. This key move is related to another predisposition, the idea the financial markets are intensely social entities. Third, related to this, Westbrook want us to understand finance from a legal perspective as a series of contracts, rather than a set of property rights. Finally, Westbrook seeks to reemphasize the importance of uncertainty (sharply distinguished from risk) in how our financial markets operate.
Early on, he dispels with what he terms “melodramatic narratives” of the crisis, ranging from securitization to monetary policy, all of which are intellectually conservative because they operate within the same structure of thought that led to the crisis. Not among their number is the exploitation-inequality-uneven demand explanation that is common in Marxian and institutionalist circles, and that I’ve trumpeted on this blog on many occasions. In many ways, Westbrook’s argument is tangential to this narrative, as he is primarily probing the financial crisis, which is one (albeit major) part of the economic crisis. As a law professor, it doesn’t seem to strike him as to whether his narrative of the broken framework is sufficient for a broad economic crisis; however, this wrinkle doesn’t make his argument any less relevant.
The path that the financial sector has taken in recent decades is broadly indicative of an attempt to move from uncertainty to risk, inserting knowledge as the previously missing link. As Westbrook argues, however, the contractual nature of financial instruments weakens the ability to execute knowledge in a way that constructs the more simple risk. The failure to see this disconnect has led to the false allure of diversification, in which risk is managed by spreading resources over a number of purportedly independent investments. Again, going back to contracts, Westbrook argues that diversification, or “portfolio management,” necessarily reduces transparency. This story echoes the mainstream account of subprime-based CDOs, but builds on it by arguing that a whole range of securities and derivatives can fall prey, and the underlying causes run deeper than a shock to housing prices or the like.
So where has the government been in all of this? Westbrook argues that the zero-sum conception of the government-market relationship has “legitimated” bureaucratic irresponsibility. He faults the free-market ideologues for insisting that market priorities supersede societal goals or human ramifications. However, he also cautions that much is unknowable for regulators, who thus should seek performance over design, so as to stay ahead of the curve. Markets must be approached as they are: existing in a social space.
It is at this point that Westbrook makes one of his most important contributions, urging a reshaping of our metaphors and grammar for markets, so that they don’t replicate the false dichotomy between government and markets. His most useful metaphor, I think, is “tensegrity”: a structure in which elements pull against each other, but the structure remains as long as the link are tight- the structure is “integrated by tension.” The tension, in this metaphor, is credit, underscoring the notion that credit is the lifeblood of the modern financial system. He also uses ecology as a metaphor, and says that we should think about markets not as a jungle but as a garden, a place “of both planning and necessity.”
Where does these intellectual move lead us? First of all, we shift our focus to systemic risk, as Westbrook argues, acknowledging that diversification is pretty much meaningless for our situation. His hope is that systemic risk “become a concept…that broadly organizes thought.” There will always be structural weaknesses in a regulatory regime; however, basically misguided policy puts us in a far more precarious position. Confronting uncertainty as a certain reality is a difficult-financially and politically-but necessary consequence of acknowledging systemic risk. Thus, while systemic risk appears to be moving to the forefront in intellectual discussions- I say this mainly on the basis of VoxEU articles in the last year- the discourse is not occurring in the radical (i.e. to the roots) way that Westbrook encourages.
We also must carefully consider the risk of constructing what Westbrook calls a “courtier economy,” in which the powerful use their money and influence to capture the (de)regulatory process. He sees the construction of this class as one of the first steps toward a protectionist and militarized world, as a courtier class inevitably will push national policies that engender international tension.
At first glance, Westbrook’s argument seems to push for a “balanced” approach to the economy in which more socially-embedded markets gain more influence. However, there is no blueprint for what a socially-embedded market looks like. We certainly know what it doesn’t look like; a Polanyian view of the last few decades easily exposes the failures of the market-utopian drive. However, there are no assurances that the markets of the future will actually be regulated as if they are socially constituted. Are we to trust that this rethinking will help us get things right next time, or that reconceived markets are even the right way forward?
Should it be the case that they are, I hope they are conceived from Westbrook’s framework: that class tensions, uncertainty, and complexity are confronted head-on; that bureaucrats acknowledge their role and consider systemic issues in their designs; that we have more garden and less jungle. In an e-mail, Westbrook points out that he hopes this book serves as a political intervention in our society. The measure of its success as such will inevitably be whether we begin to hear the words “social” and “markets” in the same sentence from regulators, and whether we observe a change in our metaphors and an acknowledgement of contradictions. Understanding this book requires that we make the leap in accepting the constitutive role that discourse has. This pill is easier to swallow for intellectuals than for the quants and paper-pushers, whose language has been handed to them, their jargon ingrained. Westbrook is aware of these difficulties, yet one cannot blame him for seeking something of a revolution in thought.