Michael E. Lewitt’s Death of Capital: How Creative Policy Can Restore Stability is a remarkably entertaining and thought-provoking book. At its core, it is another entry in the popular genre of postmortems on the Great Crash of 2008. But unlike its peers, The Death of Capital analyzes both the theoretical underpinnings of the crash and the business practices that caused it.
Lewitt’s thesis is that the crash was triggered by the death of capital (in late 2008), which temporarily shut down the entire global economy and inflicted billions of dollars of permanent losses. It is a complicated thesis based on sophisticated arguments, so Lewitt wisely begins with a review of the basic facts. He spends Chapter 1 defining capital, making sure that his audience understands that capital is a process rather than an object and is thus inherently unstable.
Once Lewitt establishes this truth about capital, he devotes Chapter 2 to explaining why, according to the theory of capital (and capitalism more generally), the Great Crash of 2008 was essentially preordained. To make his point, he relies on the insights of three of history’s most famous economists—Adam Smith, Karl Marx, and John Maynard Keynes—plus the lesser-known Hyman Minsky.
The following four passages encapsulate Lewitt’s argument. The first is an interpretation of Smith’s writings:
The unfortunate truth is that financial crises, which are occurring with increasing, not decreasing, frequency, are the result of deeply embedded traits of human nature and recurring failures to regulate our worst instincts. Two-and-a-half centuries after Adam Smith, mankind is still in need of protection from itself. (p. 59)
Lewitt points out that Keynes felt similarly about the role that human nature plays in market dynamics (the following is a quote from Keynes, not Lewitt):
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on mathematical expectations. Most, probably, of our decisions to do something positive…can only be taken as a result of animal spirits. (p. 74)
A related observation, from Marx, is that value is inherently unstable. And Lewitt argues that modern financial engineering has made this problem substantially worse since Marx’s time.
In a world where financial instruments are almost ridiculously complex and increasingly divorced from their underlying economic referents, the concept of what a financial instrument is worth is thrown into question to a greater degree than ever before. (p. 70)
Finally, Lewitt writes about Minsky’s “financial-instability hypothesis”:
[Minsky] taught that stability breeds instability. When the economy and the financial markets appear to be stable, it is perfectly rational for investors to feel that it is prudent to take more risk. The problem lies in the fact that everybody tends to increase their risk appetite at the same time, which raises overall systematic risk to dangerous levels. (p. 62)
Each economist delivers the same basic message: Free-market capitalism is a flawed system ruled by emotion, not reason, and is thus inherently unstable. And the Great Crash of 2008 is a textbook example of such instability.
Following his discussion of the theory of capital, Lewitt turns his attention to the specific practices that led to the crash. He writes competently about the usual suspects—securitization, credit default swaps, and the rating agencies. But he also introduces two causes that have received comparatively little attention: the rise of financialization and the growth of private equity firms.
Financialization is “the process of money begetting money, or more broadly, capital begetting capital” (p. 104). Lewitt argues that the rise of financialization marked a profound shift in the economy that became a major contributor to the crash. As recently as 30 years ago, the finance industry existed primarily to provide capital to industrial companies that would use it to fund their productive projects. Lewitt argues that today’s finance industry exists to expand itself and to provide investors with clever ways to invest in ever more opaque and complex instruments. As huge sums of capital flowed into these securities in the years before the crash, it was only natural that large losses would ensue. Moreover, the flow of money into these speculative instruments effectively took capital out of the real economy (factories, equipment, etc.), thus reducing the productive capacity needed for the economy to earn its way back to profitability.
The other group that Lewitt writes about—the private equity industry—is not typically associated with the crash. He offers a scathing critique of the firms’ business practices and explains their role in the crash.
Private equity is a form of financial vampirism, sucking the blood out of corporate corpses and leaving them empty.... The substitution of debt for equity was one of the leading contributors to the 2008 financial crisis due to the fact that it increased the volume of financial commitments that companies were facing as the financial markets ceased to function and the economy came to a grinding halt in the final quarter of 2008. (p. 125)
Completing his criticism of the industry, Lewitt argues that private equity firms charge excessive fees and receive unfairly preferential tax treatment.
Finally, in the book’s last chapter, Lewitt makes some policy recommendations. His suggestions are sound but not terribly groundbreaking. For example, he urges policymakers to address the “too big to fail” doctrine and to improve the capital adequacy of banks. Of course, these ideas are two major themes of the Dodd–Frank financial regulation law that recently went into effect.
Overall, The Death of Capital is a fascinating book that provides a fresh perspective on the Great Crash of 2008. Except for the author’s slightly mundane policy recommendations, it is certainly worth reading.