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No one can now know when the global economies will recover from recent turmoil

A CENTURY ago, the esteemed philosopher George Santayana warned: ‘Those who ignore history will be condemned to repeat it.’ One can add: ‘And those of us who do know history will be condemned to repeat it with them.’

Why did our top experienced experts fail to anticipate the worldwide financial turmoil brought on by the 2006 bursting of the real estate bubble?

No one can be a perfect forecaster. But leaders do differ in their long-run average of prediction accuracy. Alan Greenspan, during his decades of public service and private consulting, was definitely better than most.

Prior to 1997, he made only a few bad calls. But mostly, these were venial sins, not what theologians call mortal sins.

However, just before his January 2006 retirement as top Federal Reserve governor, he made the mortal error that will mar forever his reputation.

While just before his eyes the bursting of the sub-prime mortgage bubble was taking place, Mr Greenspan viewed it all through rose-coloured glasses.

New models of financial engineering, under rash deregulation, were exploding with dysfunctional finance. To him, they looked like clever risk-bearing by respected Wall Street activists.

What was dysfunctional before and after the fact looked rosy to Mr Greenspan. I suspect this traces to his gut remembrance of Ayn Rand’s extreme libertarianism.

Mr Greenspan has been in plentiful company. None of the CEOs of the biggest investment banks ever had the least understanding of the mathematics of derivatives nor of the hyper-leveraging that they were involving themselves in.

Now Wall Street Journal pundits tell us on Monday, Wednesday and Friday ‘the worst is behind us’. But on Tuesday, Thursday and Saturday, pundits tell us ‘the worst is yet to come’.

Who is right? What knowledge of past history could help answer that timing question? Actual economic history, almost by definition, is what mathematicians call a non-stationary time series.

Their past probabilities can be helpful, but only somewhat. And when new things happen, palaver about history can sometimes be materially harmful.

There can always be something new under the sun - even if you should not bet on it. The 1929-1939 Great Depression could not happen. But it did.

Hitler’s Germany almost won World War II. But it didn’t.

All of the above is a way of saying that no one can now know when the global economies will recover from recent serious turmoil.

This one can be known, however. The system cannot be counted on to heal itself. Fed chief Ben Bernanke did the right thing when he stretched the powers of our central bank to check the financial bleeding.

My guess is that after the Democratic Party victories in November 2008, new shifts in policy towards the centre will be needed:

(1) to improve sensible regulating; and maybe

(2) the US will have to rely in the end on myriad federal spending to clean up the financial engineering messes.

That was what had to be done in both the United States and Germany back in the 1933-1939 period of recovery from a depression that was brought on by massive deficit spending.

This, and not easier credit by central banks, is what mostly restored job opportunities to the one in three American and German workers who were suffering from long-term unemployment.

Searching for scapegoats is all too easy. The SEC monitors of speculative risk-takers were asleep at the switch. So were the central bankers in the US, the UK and the new EU central bank.

And where were the great, tried-and-true accounting firms? They were leading and abetting the charge into unknown abysses of leveraging and risk-taking, rather than controlling against them. The list goes on and on.

I stop at the abject failure of the three principal rating agencies.

They indiscriminately gave AAA ratings to good fish, foul fish, and stinking-foul foul fish. Why? Because, of course, they would otherwise lose the fat fees their customers paid only to messengers of good-sounding news.

To sum up, the financial system on President George Bush’s watch became systemically fragile and dangerous.

After all my bad news, it may come as cheerful when I say that the ills are not incurable. With time and good sense, after next November’s victory for centrist policies, each of them can be remedied.

However, because homes, offices and factories are such long-lived durable goods, the housing meltdown is likely to last for years, not months.

Furthermore, realists must expect the early kind of unwise actions by the Democratic victors: Such marred Franklin Roosevelt’s New Deal programmes during his first few years in office.

Also, the good economic deeds from former president Bill Clinton came mostly during his second term in the White House.

No democracy is perfect. One worrisome thing is the kind of promising to special groups that the victors had to make in order to become victors.

I will leave for another day the threat of extreme protectionism bred by how much the middle classes have suffered during Mr Bush’s eight years in office. — Tribune Media Services

The writer is considered one of the founders of modern neo-classical economics and was awarded the Nobel Prize for Economics in 1970

Source : Business Times - 23 May 2008