Stiglitz: The Fall of Wall Street Is to Market Fundamentalism What the Fall of the Berlin Wall Was to Communism
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".
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GOOD WRITE UP... NOTICE a lack of those rt wing mac backers are mia in sneaking on to sidetrack!!! This is a disaster in kaing,,,,, I hope real reforms are put in place and many more things are donw to being about a fair,equitable econ system for all people!! Higher wages to keep up with inflation be put in place for all under say 40 k,,,,, HEALTH CARE asap for all---This would save biz's money in long and short run......Have system in place that sends people of all ages up to mid 60's to college to either get a degree aft high school or to be retrained aft layoffs or other types of job loss......HAVE a tax rate that puts back in place the rates of the late 1960's!!!! IN 1967 WE HAD A SURPLUS FED BUDGET AND STRONG ECON....LOW INFLATION.. VERY LOW COLLEGE TUITION, ETC......IF VIET NAM AND PENTAGON spending could have been taken out we perhaps could have avoided the big inflation mess of the early 70's.....We must cut defense spending,,,regulate more of the hedge funds, mtg houses, oil corps,insurance corps,,, etc.... A great statesman, economist, man of ideas to study is the late JOHN KENNETH GALBRAITH............GO O' BIDEN '08!!!
There is no such thing as a fair and equitable system. It is either fair, or it is equitable, never both.
and who is that from OD?
The country lost the impassionate compass that holds society together - the rule of law. The current administration does not believed in the Constitution, Geneva Conventions, habeas corpus, accountability on all levels, and such. The greatest danger to the republic comes from weakeness of the judicial system. The Wall Street saga is just a derivative of a larger problem: the believe that those with money and power are above regulations. Notice how the lawless Bushies do stand for the unlimited control over others, hence the various forms of surveillance. Today the US is at the disposal of the weaponry producers and distributors who use the country at their pleasure.
When Joseph Stiglitz speaks we had better listen.
And Stiglitz is the sort of man you can bet that Obama will bring into his administration to advise.
"Bank" on it!
So long as your bank is still open.
Unfettered Free Market Capitalism is an
unmitigated failure.
Again.
Put back the regulations we installed after the depression. And more.
Where have you ever seen unfettered free market capitalism in the history of the world?
Seems like the criminals are getting away with it now, doesn't?
Obsession: redoubling your efforts in the direction that has failed.
Good point. Deregulation happened during the last democratic administration. Clinton. he also opened up China. Good job guys.
The GOP has lead the fight for deregulation forever. Some dems went along with some of it.
Question: How many staunch Republicans support the federal financial assistance given to AIG? Of those, how many realize that it's an example of Socialism?
The AIG folks gave the GOP money, that's how.
I think you're mistaken.
Socialism is when the government does something for the little guy - something like health care, unemployment compensation, public school education and other things too horrible to mention in a family forum like HuffPo. In its less virulent form, it's known as welfare and handouts. These are very bad things to do because they distort the "free market" and undermine peoples' incentive to work.
On the other hand when government takes actions to bolster our economy and way of life - something like unneeded tax cuts for already too wealthy, no bid billion dollar contracts for big corporations, and let's the market "regulate" (wink wink) itself - that is 100% pure Americanism.
And because everyone knows (or should) that making our country stronger is pure "Americanism" then these steps are not and never can be socialism.
The logic is simple (quite simple).
It's like family values - your family not mine.
Socialism turns everybody except politicians into the "little guy".
Events of the last weeks have truly demonstrated that this system is not capitalism, it is a form of corporate socialism where profits are privatized and losses are socialized. WELCOME TO THE WORLD OF CORPORATE WELFARE BUMS!!!!
Amen
I strongly feel the time has come to rethink every aspect of the society, as the global community.
Have anyone noticed that so called market theory and Marxist theory have very similar notion?
For example, we say gas price must be kept higher because that is the only thing that forces us to really seek alternative energy. Not to mention that many environmentally conscious people have long been seeking alternatives without being forced to the edge for their personal wallets, if that is logically true, can we also say: the government must be kept reckless because that is the only thing that forces us to really seek reasonable government? How absurd and stupid, like we have to chose McCain/Palin in order to get the end of "real" necessity of change! You know, this end would be "End of Time" and "Rupture" after nuclear (or "new clear" in Palin's term?) Armageddon.
Marx must have said something like this: "It is not conscious that makes change happens (in his case "change" meant revolutionary change) but social infrastructure that is forced to the threshold where it can no longer take the pressure..." (I'm quoting from old, old days of my memory.)
"Market fundamentalists" have been pushing this absurd theory. If they have been doing that without knowing, their brains are equally absurd. If knowingly, their thoughts are monstrously sinister.
Only our conscious acts can make change happens; market also will change accordingly.
So you are an enemy of freedom. At least you've clarified it for us.
In your Orwellian world, maybe.
Oh if your basiliscus brain could appreciate the irony of your own statements OD.
This is the man who should be our next Secretary of the Treasury to harness the FED and temper hyper-globalization. He's been on the money for years. It is not rational to destroy massive creative economic sectors of any nation to serve the ideology of globalization. We have been doing trade for thousands of years. Technology has always been a double edged sword. We need regulation not only of the finanical markets but also long term national programs and investment to bring back the vocational-technical high schools to support educational-national security enterprises in energy, infrastructure, retooling, and transportation. We also need to get our population under control. Not to digress, but if we begin bombing Iran our nation will go to hell. Very possibly, nothing will save us.
The model that our free-enterprising-right wing Republicans used was the primitive, traditional model of the law of the jungle with the strong always winning against all the others. It was a stacked system. Always the goal was the fast return on ever more borrowed money. The result was the buying and dismantling of assets for the sake of finance. The end saw ineffective monopolies, international conglomerates and concentrated banking that corrupted the political process and destroyed the universially esteemed dollar.
The model evolved by FDR and fully created and operated under the Truman Administration (extended through the Eisenhower and Kennedy Administrations in weakened forms) was the best economic model devised in modern times, possibly in all time. It is now seen as the American Golden Age of democracy.
The next President would be wise to visit the economic, monetary policies ot the Truman Administration and take to heart the lessons of extraordinary administration. President Truman is one of the top 3 or 4 leaders in the history of mankind. In a hundred years enlightened societies will make the study of his leadership and achievement compulsory for all young people.
A very rare valuable commentary.
Good analogy.
One was a physical wall.
One is a virtual wall.
All ones and zeros.
As simple as that.
*Poof!
Thank you.
K.I.S.S. needs to get back in vogue.
"Our country has thus suffered from the consequences of choosing as regulator-in-chief of the economy someone who didn't believe in regulation."
That would be rather like choosing a chief of police who doesn't believe in law enforcement.
Excellent column. Good regulations and enforcement results in a level playing field for participants. It is unfortunate that government went to the extreme of little to no regulation in the name of "democracy".
Regulation..you chant this like it is some kind of holy mantra...what specfically could regulation have done to avoid this mess?? The only thing I can think of is restricting the IBanks to operate with significantly less leverage. I know we are all trying to blame deregulation for these problems so we can have a talking point vs. the Republicans, but get real - deregulation did not get us here, and re regulation certainly won't get us out. Look at the damage Sarbanes Oxely has done to our competiveness in financial markets - lost market share to London and elsewhere, no emerging growth IPO's or secondary financing. Be careful, you really don't want them driving the car. And if you are going to disagree - please be very specfici about what your suggestion is, and try not to mention Phil Gramm....
Without getting to specific and technical, I think Stiglitz lays out re-regulation quite clearly. I suspect he could write a 500 page book on specifics:
We need to put in place a new system that can cope with the expansion of finance and financial instruments beyond traditional banks.
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.
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.
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.
i think for an interview of this type, Stiglitz lays out some rather good ideas that need to be fleshed out and expanded.
"new system" -uhhh, can you be slightly more specfic?
"regulate incentives" - the wholly grail of regulation - lets fight the war of 1812 over again. Stock option accounting..this was a relevant comment five years ago.
asset expansion - well, if you know what will be the source of the next bubble, go right ahead and regulate the dickens out of it - but I guarantee it won't be real estate, credit default swaps or technology stocks. Want to re-regulate tulip bulbs???
Regulation absolutely could've prevented this meltdown problem nobody was watching what Wall Street was doing. A money and banking class will explain to you what regulation would've done to prevent this.Those guys on Wall Street were coming with anything they could to selll as a security and ethics were out the window as far as lending to people that couldn't afford expensive homes. Fine, London is ahead but they have been for a very long time and now all of Europe is doing better than us regarding the dollar and the Euro. You really need to take a class about how all the regulation came about in the first place and it was due to similar tactics that we have now. You say regulation doesn't work and re-regulation wouldn't work either but you give no evidence to back it up. This meltdown was due to deregulation, period. Oh and a bunch of greedy white guys.
Lets be clear, I didn't say we don't need regulation, I said we can't blame a lack of regulation for the current mess. "Wall Street" didn't lie about incomes in order to get a mortgage that couldn't be afforded. Someone out there has yet to tell me what specifically could have been "regulated" to avoid this crises....still waiting...maybe I will take a class..
Two big culprits involved here. The federal reserve bank that holds our economy hostage and the de-regulation dating back to reagan. As noted in the interview, greenspan was appointed by reagan replacing Volcker, reagan wanted a de-regulation guy. He got one who now is wringing his hands over how bad things are but still not man enough to step up and take responsibility. The de-regulation of virtually every safeguard and oversight of Americas industry, including markets and trading, has gutted this country. The players are counting their money and we are holding the empty bag.
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