Joseph Stiglitz was awarded the Nobel Prize for Economics in 2001. I spoke with him Tuesday about the Wall Street meltdown.
Nathan Gardels: Barack Obama has said the Wall Street meltdown is the greatest financial crisis since the Great Depression. John McCain says the economy is threatened, but fundamentally strong. Which is it?
Joseph Stiglitz: Obama is much closer to the mark. Yes, America has talented people, great universities and a good hi-tech sector. But the financial markets have played a very important role, accounting for 30 percent of corporate profits in the last few years.
Those who run the financial markets have garnered those profits on the argument they were helping manage risk and efficiently allocating capital, which is why, they said, they "deserved" those high returns.
That's been shown to be not true. They've managed it all badly. Now it has come back to bite them and now the rest of the economy will pay as the wheels of commerce slow because of the credit crunch. No modern economy can function well without a vibrant financial sector.
So, Obama's diagnosis that our financial sector is in desperate shape is correct. And if it is in desperate shape, that means our economy is in desperate shape.
Even if we weren't looking at the financial turmoil, but at the level of household, national and federal debt there is a major problem. We are drowning. If we look at inequality, which is the greatest since the Great Depression, there is a major problem. If we look at stagnating wages, there is a major problem.
Most of the economic growth we've had in the past five years was based on the housing bubble, which has now burst. And the fruits of that growth have not been shared widely. In short, the fundamentals are not strong.
Gardels: What ought to be the policy response to the Wall Street meltdown?
Stiglitz: Clearly, we need not only re-regulation, but a redesign of the regulatory system. During his reign as head of the Federal Reserve in which this mortgage and financial bubble grew, Alan Greenspan had plenty of instruments to use to curb it, but failed. He was chosen by Ronald Reagan, after all, because of his anti-regulation attitudes.
Paul Volcker, the previous Fed Chairman known for keeping inflation under control, was fired because the Reagan administration didn't believe he was an adequate de-regulator. Our country has thus suffered from the consequences of choosing as regulator-in-chief of the economy someone who didn't believe in regulation.
So, first, to correct the problem we need political leaders and policymakers who believe in regulation. Beyond that, we need to put in place a new system that can cope with the expansion of finance and financial instruments beyond traditional banks.
For example, we need to regulate incentives. Bonuses need to be paid on multiyear performance instead of one year, which is an encouragement to gambling. Stock options encourage dishonest accounting and need to be curbed. In short, we built incentives for bad behavior in the system, and we got it.
We also need "speed bumps." Every financial crisis historically has been associated with the very rapid expansion of particular kinds of assets, from tulips to mortgages. If you dampen that, you can stop the bubbles from getting out of control. The world wouldn't disappear if we expanded mortgages at 10 percent a year instead of 25 percent a year. We know the pattern so well we ought to be able to do something to curtail it.
Above all, we need a financial product safety commission just like we have for consumer goods. The financiers were inventing products not intended to manage risk but to create risk.
Of course, I believe strongly in greater transparency. Yet, in terms of regulatory standards, these products were transparent in a technical sense. They were just so complex no one could understand them. If every provision in these contracts were made public, it wouldn't have added any useful information about the risk to any mortal person.
Too much information is no information. In this sense, those calling for more disclosure as the solution to the problem don't understand information.
If you are buying a product, you want to know the risk, pure and simple. That is the issue.
Gardels: The mortgage-backed securities behind the meltdown are held across the world by banks or sovereign funds in China, Japan, Europe and the Gulf. What impact will this crisis have on them?
Stiglitz: That is true. The losses of European financial institutions over sub-prime mortgages have been greater than in the U.S.
The fact that the U.S. diversified these mortgage-backed securities to holders around the world -- thanks to globalization of markets -- has actually softened the impact on the U.S. itself. If we hadn't spread the risk around the whole world, the downturn in the U.S. would be much worse.
One thing that is now being understood as a result of this crisis is the information asymmetries of globalization. In Europe, for example, it was little understood that U.S. mortgages are non-recourse mortgages -- if the value of the house becomes less than the value of the mortgage, you can turn the key over to the bank and walk away. In Europe, the house is collateral, but the borrower remains on the hook for the amount he borrowed no matter what.
This is a danger of globalization: Knowledge is local because you know far more about your own society than others.
Gardels: What, then, is the ultimate impact of the Wall Street meltdown of market-driven globalization?
Stiglitz: The globalization agenda has been closely linked with the market fundamentalists -- the ideology of free markets and financial liberalization. In this crisis, we see the most market-oriented institutions in the most market-oriented economy failing and running to the government for help. Everyone in the world will say now that this is the end of market fundamentalism.
In this sense, the fall of Wall Street is for market fundamentalism what the fall of the Berlin Wall was for communism -- it tells the world that this way of economic organization turns out not to be sustainable. In the end, everyone says, that model doesn't work. This moment is a marker that the claims of financial market liberalization were bogus.
The hypocrisy between the way the U.S. Treasury, the IMF and the World Bank handled the Asian crisis of 1997 and the way this is being handled has heightened this intellectual reaction. The Asians now say, "Wait a minute, you told us to imitate you in the U.S. You are the model. Had we followed your example we would be in the same mess. You may be able to afford it. We can't".
Loading comments… 
The American Society a not a Completely Free Society but it is a FAIR Society with Certain Freedoms. A Completely free Society without LAWS to GOVERN would be CRIME RIDDEN, ruining our standard of living.
If American Markets were Completely Free Markets Corruption would RUN WILD. For most of our history AMERICA PRIDED ITSELF IN FAIR MARKETS. But in the last 8 YEARS we have SEEN AN EXPERIMENT WITH FREE MARKETS and AMERICA IS IN CRISIS.
Therefore, like Society, our Markets need a Robust set of Rules and Regulation
America is GREAT because of "FAIR MARKETS" people TRUST--NOT
The Economic Consequenc
The next president will have to deal with yet another crippling legacy of George W. Bush: the economy.
" . . . The economic effects of Bush’s presidency are more insidious than those of Hoover, harder to reverse, and likely to be longer-las
and the final paragraph
In short, there’s a momentum here that will require a generation to reverse. Decades hence we should take stock, and revisit the convention
http://www
You just stay home and do nothing while the big gest hei st ever attem pted is carried out right under you nose.
I am asha med to be a gu tle ss Am eri can.
We saw this coming in 1980. Well guess what. Dare I say it. In the words of a recently smeared Reverend: America's chicken's have come home to roost!
They created it. Let it all meltdown right into their lap come Nov. 4th. John McCain, the king of deregulati
Who in their right mind would consider giving the Presidency to a bald faced liar as he obviously is. Bill Maher is absolutely correct: America has a stupid electorate
When the feds became involved in illegal regulation
The feds do not have the required knowledge or expertise to do this stuff. They depend on special interests to tell them what they should do. It's like asking a wolf to guard the hen house.
http://ewe
If so you haven't got a clue.
PS Communism failed for MANY reasons,
Your simplicity in logic belies your simplicity in thinking.
Mergers and consolidat
Is there a rush to get it done before the Democrats take power? It just seems to me that Mergers are happening in a big hurry and are be abetted by the Federal Reserve, Treasury Secretary and the Bush Administra
Are things really that bad in the financial sector or are the markets being manipulate
All before the election……
Hmmmmm! Are we getting screwed? Sure feels like it…..
Fannie is government control, government
Deflation is just bringing price back to value. Or in other words. To many people paid more for their house then it was worth. The sign--110% mortgages-
Free enterprize adjusts quicker and more often, government is less often with bigger disasters and prolonged affects.
Take your choice of medicine. I prefer free enterprise with more often and smaller affects. Also, I do not trust other people to handle my affairs. Especially government people.
The question you've got to ask yourself is whether you want to be in the hands a cadre of profession
Regulation will always be needed. Those who think that the market will take care of itself & that people will do what's right without regulation have been living in fantasy land.
The answer isn't socialism, we've had some great periods in American history. We've just got to put it back together and the best place to start is with Obama.