During the economic turmoil of the last few years, Nobel Prize-winning economist and Columbia University professor Joseph Stiglitz has been one of the most strident and incisive critics of the historic bailout of the banking sector.
Never one to mince words, Stiglitz, who served as the Chief Economist at the World Bank and on President Clinton's Council of Economic Advisers, has said the meltdown has resulted in a kind of "ersatz capitalism" in America. He has also repeatedly called for a second round of fiscal stimulus to support struggling Americans.
We recently sat down with Professor Stiglitz to discuss his new book "Freefall: America, Free Markets And The Sinking of The World Economy", and how the Obama administration should go about reshaping our economy.
With so much talk of a recovery, where is our economy right now?
The way I put it is that, if you look back before the crisis, the American economy was basically supported by a housing bubble, which supported a consumption boom. In one year, we had $950 billion in mortgage equity withdrawals. That got reflected in the statistics and our savings rate went to zero.
The implication is that post-crisis, even if we have our banking system work, it is not likely that we will go back to a zero savings rate in the U.S. If we don't go back to a zero savings rate, it's going to be hard to have a robust recovery unless you find something else to fill in the gap.
A recovery is predicated on the financial sector working, but obviously the sector isn't working. And there is another set of problems: Small businesses can't get loans. We are in that dynamic process now, where some of the things that we did [to steady the economy] have the characteristics of stretching out our economy's adjustments. These steps buoyed the economy in the short run, but may be more likely to extend the length of the downturn.
Our response to the crisis was party based on a fundamentally flawed theory. The theory was that we were having a psychological problem, and that if we could only restore confidence then the economy would go back to normal. Of course, we had a psychological problem, which was the bubble, but we're back to reality now.
This approach is having profound implications that are likely to last. In 2010, the projections say that there will be between 2.5 to 3.5 million foreclosures, more than the 2 million that occurred in 2009. So, that's an example of the dynamics going the wrong way, probably because we put in place the wrong policies.
In your book "Freefall", you suggest that the U.S. economy needs structural changes, rather than just cosmetic changes. Do you get the sense that the Obama administration shares that sensibility?
I think there are differences of view among those in the administration, as in any administration. But I think that one can read the proposal last week of a tax imposed on large banks on the basis of leverage to be a recognition that there is need to do more than a cosmetic change.
I think most people would say the tax has enhanced the equity of the bailout. But it's also an efficiency measure in two ways: first NOT to have the banks pay is subsidizing the financial sector, and that leads to a bloated financial sector. Second, the fact that the tax focuses on liabilities means that the Obama administration recognizes that part of the problem is excess leverage.
Does it go far enough?
No, it doesn't go far enough in several respects. First, as I point out in my book, this is not the first bailout that's come at the expense of American taxpayers or at the expense of taxpayers abroad. The banks have had an impressive record of bad lending all around the world. So, it is clear that the sector has been subsidized and is over-bloated. But, secondly, it's also clear that the sector proposes large externalities on the economy and the incentives structures at the organizational and individual level are such as to exacerbate the problem.
The tax is backward looking and is just attempting to recover [the costs] of this particular crisis. It doesn't look at all the other crisis, past crises and it doesn't create a fund for future crises. And it doesn't stop other forms of excessive risk-taking, like over-the-counter derivatives.
You mention in your book that, before the crisis, as much as two-thirds of our GDP in America was housing-related. If the housing market is going to continue to languish, how do we replace that in our economy? How do we move away from that concentration?
There is plenty of need for investment with high-yield returns. This is where the financial sector failed -- it didn't channel funds to areas with the strongest social return. I think most people would say that we need to retrofit our economy for global warming, and that we need to change our capital structure in those markets and change transportation and infrastructure.
Other examples of very high returns include education, technology and infrastructure -- many of these areas are in the public sector.
The third area is clearly stronger exports. We've been borrowing abroad and we've had a trade deficit as much as 5 percent of GDP. Some would say it's a reflection of exchange rate policy, but many people say it's caused by a lack of industrial policy. What I mean is a a set of economic policies that would promote research and technology that would make America competitive. And it is not a function of our wages -- Germany has a robust export economy and high wages.
We haven't had those kind of policies that would make American more competitive. We had a banking sector that was one of our leading sectors. Some people think that was part of the problem. We diverted people who would have been talented in other areas into banking. It's not just capital resources problem, it's our human resources that were misused.
In your book, you criticize the Obama administration for lacking a clear vision for how we could recover from the financial crisis and reshape our economy. Do you still feel that the Obama administration lacks a larger vision for our economy?
It's hard to say whether they have a vision. They haven't articulated a vision in a very clear manner. They've identified two problems, which I agree are very important: carbon and health care. And they've talked about the problem in our education system.
The lack of vision that I'm critical of is particularly evidenced in the financial sector. My approach is to say, "Lets have a view of what the financial sector is supposed to do, and lets see if they're doing it, and how they need to change."
Also, small businesses are having trouble getting credit. These type of companies tend to borrow on the basis of collateral. Collateral is usually the value of their mortgages. That's gone down, and now they can't borrow. That's an area where things seem to be keep getting worse.
What we should have done is identified the banking institutions that are lending, we should have given them more money and given them money on the condition that they lend.
When we had our welfare reform of 1996 [when Stiglitz was in the Clinton administration], we made welfare conditional. That is to say, you got welfare payments but you had to go to training and look for a job.
We put the banks on welfare, but we didn't put any conditions. We said, "You can spend the money you gave them on a Florida vacation." It's ironic that we were more "strict" with our poor than our banks.
Currently the top four banks control 40 percent of American deposits. Isn't this concentration in our banking system terribly dangerous for our economy? And do you get the sense that the Obama administration thinks it's dangerous, or plans to do anything about it?
It is bad for three reasons. First, the conventional economist's reason is that this degree of concentration gives you monopoly power, and this monopoly power leads to higher than efficient prices. Second, as Teddy Roosevelt realized when he was considering anti-trust actions against the banks, it was a political argument, not just an economic argument. [He knew] that economic power was going to be associated with political power. And today, you see this in the [banks'] opposition to financial reform legislation.
Third, these big institutions have become too big to fail. I think the Obama administration is a little bit aware of the last problem, but not at all attentive to the first two.
We saved the big banks because we were afraid of the what would happen if we let them fail. It wasn't that the government didn't have the economic powers to let them fail. It was a problem of political will. I think that they are beginning to see the political argument behind the danger of big banking monopolies. You're beginning to see a little of Obama's frustration.
In a recent piece in the New Yorker, John Cassidy wrote about the "death of the Chicago School" of economic thought, which was championed by Alan Greenspan and values free markets and very little regulation. Are economists who missed the crisis rethinking their views? Do you think that the field of economics is going through a radical upheaval?
I think that a surprisingly large number of those who had previously believed that markets work perfectly, and are self-correcting still believe that. And that there are a variety of formulas with which they can reconcile what happened to those beliefs.
They can believe for instance that their theories are sound, and that every 75 years there is an event their theories can't yet explain. So, many economists say, "Our theory works almost always," as opposed to the view that I take, that it's the pathologies that tell you about how things work normally. When things are working well, you don't see the failures that are about to happen.
At the same time, among younger people and probably disproportionately outside of the U.S., there has been a big change. I teach the graduate macro [economics] course at Columbia. The course is divided into four quarters. We believe the students should know all the strands of thought. I teach the last quarter, and it deals with Keynesian concerns, how to deal with unemployment and recessions. The first half the course is operating under the hypothesis that there's no such thing as unemployment, which is the dominant view held by the Chicago school.
The students come up at the end of my section and say, "Why did we have to waste our time with the first part [of the course]?" Young people have been very strongly affected by the crisis.
[The crisis] has bolstered more of the critique of the efficient markets theory. But it hasn't been the revelation and hasn't been the seismic change that one would have hoped.
What stories do you think the financial news media has missed since the crisis? Is there one big story that you'd like to see covered?
The market coverage of the recovery and meltdown has been very much driven by the market, Wall Street and the [Obama] administration, all of whom have the incentive to talk up the economy. Do you remember the "green shoots" Bernanke mentioned in March? [Larry] Summers recently said every one agrees the recession is over -- well, except for the one out of six Americans who can't get a job.