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".
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
Hey, why worry? "We" own the biggest insurance company in the world now, AIG. I can't wait for my dividend checks.
What I'm not understanding is how Paulsen and crew are using Federal dollars (= taxpayer dollars) to purchase equity interests in Fannie, AIG, whatever. In other words, instead of privatizing Social Security, they're investing public funds in the stock market gamble. And they're using public funds to buy up the toxic waste financial instruments that no one in the public sector will buy. Excuse me, but when you're in charge of public moneys, don't you have a fiduciary responsibility to invest prudently in safe assets? And what does it mean for the future to have, for example, 80% of AIG (still technically a for-profit company, managed by highly compensated private managers) owned by the U.S. government, as tonight's announcement says? (By what authority do they dilute the existing shareholders, without compensation, contrary to the 5th Amendment?)
I just don't understand. When Harry Truman tried to nationalize the steel plants, the Supreme Court told him he couldn't do it, he didn't have the authority, even in wartime. How do Paulsen and the Fed have authority to play all this, with our money? Do they not realize that the U.S. government isn't supposed to function as a hedge fund or investment bank?
Times have changed. Harry Truman was not above the law. George Bush IS the law. Henry Paulson can do whatever George Bush says he can do.
And the largely conservative SCOTUS will support Bush. End of story.
Looks like Bush and the Repubs did try to prevent this back in 2003:
http://que
"The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago. Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac"
"Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats"
''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts
What was proposed was essentially to place control of the two organizations directly under the Treasury Department, placing even more power in the president's hands. Basically, just what Paulson did without any legislative authority at all.
I'm outside my area of expertise, so correct if wrong, but...it seems to me that whenever anyone calls for serious regulation or economic reforms to protect us against excessive greed, power, incompetence, and unaccountability, the vested interests on the right cry "socialist" or use other cheap shots, as a decoy to divert attention away from the real problems. They're experts at that kind of spin, and they have abundant mdeia access, so they get the public to believe them, and to sort of worship unfettered free marketism as theology.
Like how "Obama is a Marxist"? As if a "Marxist" could get anywhere near the US Senate...
Tell them that crap isn't going to work anymore. Regulations are simply rules. Can you have a football game or any other contest without ground rules? How about a society without laws?
If they call you a socialist simply for calling for regulation of markets, ask in return if being a capitalist simply means not having to playing by the rules.
Europeans laugh at such nonsense. There has never been a serious Marxist or socialist political movement in the US and all such talk of socialism is scare talk cooked up during the Red Scare and the McCarthy era. But it makes for great sound bytes. The socialist movement in this country died before WWI in party to the Progrssive policies of Theodore Roosevelt who understood that we either began business regulation or permit socialism to take root. More than anything else, Progressivism ended the American socialist movement. The de facto outlawing of Syndicalism via the 1917 Espionage Act put the nail in the socialist coffin. The 1919 Red Scare eradicated what was left. There hasn't been any serious socialist efforts in America for 90 years.
I agree with Stiglitz's overview. More specifically, I think Commissioner Christopher Cox needs investigating, who was appointed by Bush and heads the SEC. In some respects, he bears some if not all of the responsibility for Black Monday II.
Cox plainly did not enforce the critical SEC rule with regard to short selling that traders, before they can sell a stock short must first locate shares for the transaction. By ignoring this rule, or being ignorant of it, Cox permitted what is termed "naked short selling" whereby huge Hedge Funds could literally destroy a large company by driving down the price of its stock (this is being done with AIG). After the dust settles, we may find out that these large institutions were destroyed by naked short selling--and Cox was asleep letting it happen.
Yep Christopher, ya did a heck of a job!
This is a fantastic, informative interview. Relatively short, but cuts right to the chase.
Keep buying your foreign products. The ripple effect has happened.
Wow! An article on substance. Thank you.
Liberalism is not Marxism
Conservatism is not Market Fundamentalism
Neither Liberalism nor Conservatism are good or bad economic theories. They are simply two sides of a single scale, the overweighting of either resulting in the economic chaos we see now. Both of these philosophical positions are failures in practice at the extremes precisely because they are extremes.
As Aristotle said, nearly 2400 years ago, what we need is balance.
Of course we need to allow for as free a market as possible in order to spur invention and innovation. But we also need to maintain regulations which protect the core of our economy (the fundamentals as Sen. McCain recently said) and support jobs like policemen and firemen, nurses and teachers, garbagemen and truckers, bricklayers and dockworkers, postmen and bus drivers.
Let's face facts: Some jobs won't ever make you rich. They just won't. The fire department isn't going to IPO and the letter carrier isn't going to make a fortune carrying a bag every day. Some people are going to have to work hard every single day of their lives at jobs which are not always intellectually stimulating and are NEVER going to result in a golden parachute. That is just the way it is.
But we NEED these jobs for our society to work at all. We need all those people to keep doing those jobs every day or our society falls apart. Furthermore, we need these jobs to provide adequate pay and benefits so that those people who hold them can own a house and raise a family and save enough to retire some day.
We all know what happens when the garbagemen strike...t
If you disagree, think about how your daily life would actually be affected if there weren't any stockbrokers. You would still get your mail, your kids would still go to school, your trash would get picked up...every
You see, these types of hard-work, low-reward jobs are the infrastructure of our economy...
I make more than 95% of all Americans as a software engineer. But I acknowledge that it is MY responsibility, and the responsibility of all of us who do jobs which are not a part of the NECESSARY backbone of the economy, to support those people I mentioned above through adequate tax structures and corporate regulation so that we may have the LUXURY of doing a completely non-infrastructure related job. I am an entrepreneur ONLY because someone else protects my streets and tends to the sick and picks up my trash.
So, here it is: I do not support social programs and increased taxation for the wealthy (myself included) because I am some bleeding heart liberal hippie idiot. Rather, I am a selfish capitalist who desperately wants to continue living my life of relative ease while others work their asses off to grow my food and drive through the night to get it to the grocery store and stock the shelves and work the checkout line FOR ME.
I had heard that Lehman was one of the largest players in oil futures in the country, and was actively manipulating the barrel price in the big run-up last winter. Now that they've tanked (pun intended) notice that the barrel price has dropped below $100 for the first time in a long time. It proves a point that I think Obama should hammer home: If the republicans really wanted to do something about the price of oil, they just needed to tighten up on the rampant speculation that has been going on and stop fighting the democrats attempt to close the so-called "Enron Loophole." This is a "teachable moment" that Obama should be jumping on.
Market fundamentalism is what they have at English racetracks. It's called letting the bookies handle the handle. And they also have it in southern Italy, around Naples. It's called the criminals being in charge.
"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."
Some people have been saying this for years. Decades, even. Meanwhile they were handing out Nobel Prizes to Milton Friedman.
I'll kick Stiglitz' assertion a little further down the road he's alluding to, and plainly put out there that market fundamentalism belongs along with communism on the scrapheap of history as an utterly failed idea, because maybe he's too "respectable" to say such a thing. Its time for a new progressive era where capital is regulated and the environment protected if this country and the planet are to survive. The longer we wait, the worse it will get. Wake up, America: the Reagan Revolution and its adherents who've held sway since the 80s have failed you miserably.
Well said. Thank you.
Central planning was proved false by the collapse of the Russian Empire (The Soviet Union). In the absence of imperial power the wall came down. Market fundamentalism has now been proven false by the collapse of Wall Street? If the market fundamentalists remain in power, will it matter that they are wrong? Does this mean that the American empire is about to collapse? I'm asking you Dr. Paul because you seem to know what you're talking about.
Who knows if it will collapse? Some say so. Some have been saying for a while now that this day would come, and they were roundly pooh poohed by the establishment. Google Michael Hudson, his articles of late have been illuminating, especially on the CounterPun
This much I know on an ideological level: market fundamentalism basically says that the market must have no obstructions to work -- and the claim is it will work for all. "Obstructions" are another word for democracy. Democracy means what the people decide to be the ground rules -- aka "regulation". Market fundamentalism seeks to subvert democracy by removing what democracy (the people) has decided to be the rules (regulation). The two are antithetical. We are seeing the fruits of market fundamentalism in the absence of regulation, in the absence of democracy. Check out the rich-poor gap since 1980, and lets hope this marks its turn toward a more egalitarian future.
All empires fail.
All dogmatic (fundamentalism) cults fail.
Pragmatism rules the day.
In economics the approach which has proven to work best is Keynesian.
Indeed. Contrary to Gordon Gekko (remember him?), greed is not good.
PS: I have three words for John McCain's supporters: S and L.
Any discussion of economics has to include the Federal Reserve (which is done in your article) any discussion of the Federal Reserve must include a discussion of the composition of the Board of Governors. Start with Kevin Warsh - Ron Lauder's son-in-law; Kevin is not an economist, he is a career civil servant; while very intelligent, he would be just another of the million or so smart people inside the beltway. Many of the Governors have the capability of dual citizenship - such a situation is a defacto conflict of interests. The Governors are not accountable. There are no whistle-blower protections with in the Federal Reserve - employees can be fired at any time for any reason - by Act, all employees are employed "at the peasure of the Board of Directors and Board of Governors.
Stepping back out to the presidents of the Federal Reserve Banks, roughly half have the capability of dual citizenship.
Within the Federal Reserve, there are approximately 500 economists - their jobs are similar to a college professor who does not have a teaching "load". Actually, the job of a Fed Economist is more cush - most receive around $100+K per year, most are eligible for "research abroad" programs (I know of one Fed economist who spent six months in Switzerland for "research"; he wrote no papers and was not held accountable for producing anything as a result of the $20K+ the Fed spent).
Since when are US mortgages non-recourse? They may effectively be non-recourse because defaulting borrowers have no other assets, but legally they are recourse!
THRSI - Not in the states with which I am familiar - residential mortgages are non-recourse.
Ever heard of "jingle mail" ?
That is when people realize that they are hopelessly upside down (i.e., the mortgage is more than the resale value) with their house, put the keys in an envelope, mail it to the bank and just walk away.
I can tell you that here in Massachusetts home mortgages are recourse. If you walk away from your house & mortgage in this state, the lender has the right to sue you personally for the deficiency.
I'm hoarse but I can't stop screaming. The free-market theory doesn't work, never has worked, and never will work without regulation and governmental oversight.
Your right of course, but the free-market theory was never really meant to "work". Right? It's a con. Right?
You must be logged in to comment. Log in or connect with
