Larry Kotlikoff on The Big Con

The Big Con
The Usual Suspects
Unsafe at Any Speed
Looking for Solutions
Maine and Montana

I have a special treat for you. I’m at Camp Kotok, the annual economics/fishing retreat in Maine. Knowing internet connectivity would be scarce here, I asked good friend Larry Kotlikoff to be your guest writer this week.

For those who don’t know, Larry is a Boston University economist whose work spans an amazing breadth of fields. You’ve probably seen some of his retirement planning research or maybe used MaxiFiPlanner, the software tool his company offers.

Today, though, Larry will share some provocative ideas on what caused the Great Recession. As you’ll read, he demolishes the explanations Wall Street and Pennsylvania Avenue want us to believe. Instead, he argues that our financial system was built to fail, failed spectacularly, and was then rebuilt to die another day.

If, as Larry claims, another financial collapse is a matter of when, not if, we need to pay close attention to the animal spirits—the group psychology—that Larry, like Keynes, claims can flip the economy on a dime. We should also heed Larry’s call for Limited Purpose Banking, which, as described in his book, Jimmy Stewart Is Dead, eliminates, as he puts it, “banking’s twin O rings.”

For most of you, the idea of no- or low-leverage banking is quite new. It is not what we have now. It has been around since Irving Fisher proposed a version of it in the 1930s, as he blamed bank leverage for the Great Depression. Milton Friedman had a similar idea.

It is hard to imagine in today’s world, but limiting bank leverage has a growing number of high-profile supporters, including me, but will probably happen only after another Great Depression-like event. Kind of like shutting the barn door after the horse is already in the north 40. But read with an open mind.

This is important because you need to understand why what seems like no big deal (subprime is contained) becomes a crisis of confidence and then panic. It will be the same in the next crisis. But that is why we always get through it. Because it is a confidence issue. Just make sure you are hedged and ready.

Now to Larry. I’ll be back afterward with a few brief comments.