Nobel Prize Winning Economist Joseph Stiglitz Tells Us Who Caused This Mess

[haha]

Capitalist Fools | CommonDreams.org

 

[dex]

"The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, "I have found a flaw." Congressman Henry Waxman pushed him, responding, "In other words, you found that your view of the world, your ideology, was not right; it was not working." "Absolutely, precisely," Greenspan said. The embrace by America-and much of the rest of the world-of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today."

This is the crux of the issue. I think we need another point of view that makes the case that markets have not been allowed to be self adjusting. The case that since FDR the government has been attempting to eliminate the "adjusting". And in attempting to do so brought us to where we are today.

 

[Gone4Good]

This is the crux of the issue. I think we need another point of view that makes the case that markets have not been allowed to be self adjusting. The case that since FDR the government has been attempting to eliminate the "adjusting". And in attempting to do so brought us to where we are today.

Maybe because before FDR the "adjusting" lead to a Depression . . . and because left to their own devices the "adjusting" would have lead to a depression this time too.

Markets can't fix their own shortcomings. Left to its own devices the market won't prevent a company from polluting the water until the "price signal" of enough dead customers hurts business. Similarly, the market won't prevent people from spinning 9% junk mortgages into 5% Aaa gold until the fraud blows up in everyone's face. For these reasons we need rules. Those rules are commonly called "regulations".

 

[dex]

Maybe because before FDR the "adjusting" lead to a Depression . . . and because left to their own devices the "adjusting" would have lead to a depression this time too.

You missed a few intervening years.

FDR's policies prolonged the depression.

1930s
Government establishes the secondary mortgage market - Creation of Fannie Mae
Government begins the consumer credit market explanation with permitting 30 year market

1960s
privatizes Fannie Mae to get it off the government's books

1970s
Freddie Mac established to expand the secondary mortgage market
Carter enacts laws to expand lending in an attempt to help the deteriorating inner cities

1990s
-The executive & board compensation for Freddie and Frannie changed to primarily an increase in assets/loans

-Clinton press F&F to ease up on lending rules

2000
Increase in the different types of loans
Low interest allowed for more people qualifying for loans
Low interest rates - banks willing to take higher risks to get a higher yield.

Banks made risky loans because they didn't have to keep them. They packaged them and sold them - go back to 1938.

So if we are looking for the causes of today's problems we need to look towards the past and be open to various opinions and viewpoints.

+++++
If banks kept the loans they made; they would not have made loans to people who could not pay them - would they? Of course not.
That is the "adjustment" that was taken out of the market by the government. Make a bad loan and you lose money. Simple no.

 

[dex]

Similarly, the market won't prevent people from spinning 9% junk mortgages into 5% Aaa gold until the fraud blows up in everyone's face. For these reasons we need rules. Those rules are commonly called "regulations".

No one is saying we don't need rule or regulation. You are missing the point. Government did not regulate - they attempted to manage the markets - see above.

Regulating the markets would have been telling banks that they would have minimal lending standards and would be responsible for the loans they made.

The "spinning" you talk about was started by the government - see above.

 

[Gone4Good]

Banks made risky loans because they didn't have to keep them. They packaged them and sold them - go back to 1938.

That's a nice argument expect it ignores the giant pink elephant of banks writing down hundreds of billions of dollars worth of loans and mortgage related securities. The truth is that banks held lots of this toxic crap so they could keep the origination game going. They even created off balance sheet vehicles so they could warehouse more of the risk than would have been allowed under existing capital adequacy requirements. And when they ran out of junk loans to bundle (even with zero lending standards) they duplicated existing loans synthetically and bundled those (no reason in the world Fannie & Freddie would have any reason to be part of that nonsense).

In your little history of I didn't see anything about the creation of the CDS market, or CDO squareds, or synthetic mortgage backed securities, or SIVs, or the leveraging of investment banks 30+:1, etc. etc.

I know there is a political death match going on with free market conservatives pitted against big government liberals to try to assign blame. But this seems pretty obviously to be a market failure at its heart.

 

[OAG]

Does not make any difference now! No one will be punished. Banks are not going to be forced to "restructure" can continue to do what they like. Some banks will be folded but the breathing culprits will surface at other banks or new banks (or maybe ER with the fruits of this debacle). Sad, sad, situation - too much of a "good" thing leads to disaster, eventually.

 

[ziggy29]

Does not make any difference now! No one will be punished.

Not really. Responsible taxpayers are all getting punished. Other people get the buzz, we get the hangover.

 

[dex]

That's a nice argument expect it ignores the giant pink elephant of banks writing down hundreds of billions of dollars worth of loans and mortgage related securities. The truth is that banks held lots of this toxic crap so they could keep the origination game going. They even created off balance sheet vehicles so they could warehouse more of the risk than would have been allowed under existing capital adequacy requirements. And when they ran out of junk loans to bundle (even with zero lending standards) they duplicated existing loans synthetically and bundled those (no reason in the world Fannie & Freddie would have any reason to be part of that nonsense).

In your little history of I didn't see anything about the creation of the CDS market, or CDO squareds, or synthetic mortgage backed securities, or SIVs, or the leveraging of investment banks 30+:1, etc. etc.

I know there is a political death match going on with free market conservatives pitted against big government liberals to try to assign blame. But this seems pretty obviously to be a market failure at its heart.

You can go to post #10 in this thread to see what I you are looking for:
http://www.early-retirement.org/forums/f50/free-market-under-attack-40024.html

It isn't a giant pink elephant; it is a sequence of events that that led to the current situation - including some of the items you mention.

Also, it isn't "a political death match going on with free market conservatives pitted against big government liberals to try to assign blame." That attempt at dichotomy misses the point. There was not a free market in the banking industry and it wasn't regulated by the government adequately.

Understanding history so that it isn't repeated is what is important.

Simply stated from the history - the government did not regulate the mortgage and CDS market (it specifically declined to regulate it in 2000). The government attempted to use the lending industry for its political goals.

So the discussion is not one of a free market Vs regulation. The key issues are:

1. Should the government attempted to manage the mortgage market for its political objectives? - my opinion - no

2. Did the government's attempted management and lack of regulation in the mortgage industry going back to 1938 sow the seeds for the current financial crisis? my opinion - yes

The items (Toxic etc) you mention are a result of the lack of regulation. They could have been regulated by requiring lending (this might have come in conflict with the government's political objectives) standards an various balance sheet quality regulations.

 

[Gone4Good]

There was not a free market in the banking industry and it wasn't regulated by the government adequately.

It was, and is, a very free market. True the government attempted to subsidize mortgage rates through Fannie & Freddie. But those subsidies didn't cause the problem any more than the mortgage interest deduction did. And those subsidies didn't cause the market not be free and are really only a small part of the problem.

The much larger problem, in a nutshell, is that the market badly misjudged risk. It did so at several points in the process and for different reasons in each case (at loan origination, during bond structuring, during the ratings process, during the risk management process at financial institutions, during the strategic planning process at those same institutions, etc.). Correct the risk assessment at one of these levels and the crisis never happens. Remove Fannie & Freddie and it still does.

 

[dex]

It was, and is, a very free market. True the government attempted to subsidize mortgage rates through Fannie & Freddie. But those subsidies didn't cause the problem any more than the mortgage interest deduction did. And those subsidies didn't cause the market not be free and are really only a small part of the problem.

These are examples of how the market is not free and in reduction and declining regulation:

1970s
Freddie Mac established to expand the secondary mortgage market
Carter enacts laws to expand lending in an attempt to help the deteriorating inner cities

1990s
-The executive & board compensation for Freddie and Frannie changed to primarily an increase in assets/loans
-Glass-Steagall Act of 1933 - interstate lending and separation of banking/investing/insurance eliminated.
-Clinton press F&F to ease up on lending rules

2000
CDS specifically exempted by regulation by the Senat

The much larger problem, in a nutshell, is that the market badly misjudged risk. It did so at several points in the process and for different reasons in each case (at loan origination, during bond structuring, during the ratings process, during the risk management process at financial institutions, during the strategic planning process at those same institutions, etc.). Correct the risk assessment at one of these levels and the crisis never happens. Remove Fannie & Freddie and it still does.

That the market misjudged risk is a result of the government setting up a secondary market for mortgages. If the banks that made the loans were required by regulation to hold them and have reserves on their books for defaults; risk would have been addressed. That the government set up the secondary mortgage market and allowed banks to make riskier loans. No secondary market; no mortgage crisis today.

 

[samclem]

I think most people agree that markets work fabulously well when risks and rewards are transparent, and when those who stand to gain from taking risk will also lose if things go poorly. That was apparently not the case here. Saying "the free market didn't work" is like saying "automobiles don't work" after you get a flat tire. The market works fine if we just have regulations in place that set the conditions for transparency and assuring that the results (good or bad) from taking risks accrue to the proper parties.
I do wonder exactly how the current bailout orgy is helping us re-align risk and reward in our financial system. It does precisely the opposite.

 

[OAG]

Not really. Responsible taxpayers are all getting punished. Other people get the buzz, we get the hangover.

I meant the perpetrators would not be punished. Of course the Taxpayer will pay - they always do.

 

[Independent]

Capitalist Fools | CommonDreams.org

Good piece, thanks for posting it. From what I've read about Stiglitz, he really was pitching the "markets don't self-regulate" view back when it would have made a difference.

 

[Independent]

Looking for the "one cause" of our financial problems is hopeless. Any storm this bad has to have multiple causes. A nice feature of the Stiglitz piece is that it lists quite a number.

I tend to see three steps, or places where people think we should "do something".
1) The federal gov't has been promoting home ownership by subsidizing borrowing for a long time. Worse, it hasn't been carrying the cost of the subsidy on its books clearly, so we can't debate how much we're spending.
2) The housing bubble was accelerated by lenders who made amazingly (at least to Greenspan) bad bets.
3) When the bubble popped, experts believed that we were on the brink of "a complete meltdown of the financial system" which would lead to depression in the real economy.

I think that (1) is poor public policy, but it's a very small part of our current problem.

(2) is a real problem, we've seen that financial markets don't self-regulate enough.

But, (3) is the huge problem. Note that the tech stock bubble didn't threaten a depression, but the experts were extremely concerned when one hedge fund (LTCM) failed in the late 90's.

Certain types of financial firms seem to have the ability to do a surprising amount of collateral damage when they fail.

It's like having a lot of factories in your city. All of them are capable of doing good and bad things for your population. But the one that produces large quantities of a toxic gas is uniquely able to cause huge problems. The market isn't going to do a good job limiting the risk from that one company. The gov't (for all it's faults) is still our best option for dealing with it.

We don't need to fall all over ourselves building new regulations here. We've known the general rules since the 30's. We simply need to update them for some new twists.

 

[Abreutime]

I think most people agree that markets work fabulously well when risks and rewards are transparent, and when those who stand to gain from taking risk will also lose if things go poorly. That was apparently not the case here. Saying "the free market didn't work" is like saying "automobiles don't work" after you get a flat tire. The market works fine if we just have regulations in place that set the conditions for transparency and assuring that the results (good or bad) from taking risks accrue to the proper parties.
I do wonder exactly how the current bailout orgy is helping us re-align risk and reward in our financial system. It does precisely the opposite.

Right on.

I will add another point that anti-free marketers tend to get wrong. They often assert that the free market fails when a poorly run company fails. NO! The free market succeeds when a poorly run company fails, and the value of the company is wiped out. Freedom to succeed (and be rewarded for success) and freedom to fail (and be punished for failure). Without the latter, you don't really have the former.

 

[dex]

Right on.

I will add another point that anti-free marketers tend to get wrong. They often assert that the free market fails when a poorly run company fails. NO! The free market succeeds when a poorly run company fails, and the value of the company is wiped out. Freedom to succeed (and be rewarded for success) and freedom to fail (and be punished for failure). Without the latter, you don't really have the former.

Right on, Right on

 

[bssc]

Right on.

I will add another point that anti-free marketers tend to get wrong. They often assert that the free market fails when a poorly run company fails. NO! The free market succeeds when a poorly run company fails, and the value of the company is wiped out. Freedom to succeed (and be rewarded for success) and freedom to fail (and be punished for failure). Without the latter, you don't really have the former.

I think that the big issue is that there is no freedom to fail if you are too big to fail. The discussion seems to be do the Detroit 3 qualify as too big to fail. The profits are shared privately but the losses are shared publically.

 

[ziggy29]

I think that the big issue is that there is no freedom to fail if you are too big to fail. The discussion seems to be do the Detroit 3 qualify as too big to fail. The profits are shared privately but the losses are shared publically.

Agreed. Another way to put it is, if you're treated as "too big to fail" by the federal government, you don't have much incentive to pursue a business model that promotes success. And those competing businesses which *are* built for success aren't given the competitive advantage they've earned.

 

[eridanus]

I hate to break up this circle...

The "too big to fail" philosophy is a realization that a failure of a large and important company - like, say, Lehman Brothers (or LTCM or AIG or MBIA) - would cause further pain in the economy. If propping up a company slows down or prevents a spiral, then it might benefit the economy even though "free market" ideologies are bruised.

The market serves us. We do not serve the market.

 

[ziggy29]

I hate to break up this circle...

The "too big to fail" philosophy is a realization that a failure of a large and important company - like, say, Lehman Brothers (or LTCM or AIG or MBIA) - would cause further pain in the economy. If propping up a company slows down or prevents a spiral, then it might benefit the economy even though "free market" ideologies are bruised.

Sure. But that begs a couple of questions in and of itself:

1. If becoming "too big to fail" means the taxpayers have to subsidize your failure, maybe we need to consider whether it's wise to allow a business to become so large?

2. Propping up a failing "too big to fail" business or industry takes multiple forms. When the reason for the failure is largely because of the business model and cost structure, propping them up with taxpayer money with little or no demands toward fixing said business model and cost structure is just throwing good money after bad.

 

[eridanus]

2. Propping up a failing "too big to fail" business or industry takes multiple forms. When the reason for the failure is largely because of the business model and cost structure, propping them up with taxpayer money with little or no demands toward fixing said business model and cost structure is just throwing good money after bad.

This is true. More transparency would work, at least in the financial world.

Saying "See ya" might leave us feeling all warm and fuzzy as we curl up with Adam Smith but it may not be the wisest choice. It's hard to get an economy moving again if credit is constipated or even non-existent.

 

[ERD50]

I think most people agree that markets work fabulously well when risks and rewards are transparent, and when those who stand to gain from taking risk will also lose if things go poorly. That was apparently not the case here. Saying "the free market didn't work" is like saying "automobiles don't work" after you get a flat tire. The market works fine if we just have regulations in place that set the conditions for transparency and assuring that the results (good or bad) from taking risks accrue to the proper parties.

I do wonder exactly how the current bailout orgy is helping us re-align risk and reward in our financial system. It does precisely the opposite.

Very well said. And I am of the opinion that we will not secure our future until 90% of the High School graduating class understands that simple bit of information. It is hazardous when an electorate is free to wail to their representatives that we need this, or need that, w/o understanding the implications.


RE: "too big to fail"

Saying "See ya" might leave us feeling all warm and fuzzy as we curl up with Adam Smith but it may not be the wisest choice. It's hard to get an economy moving again if credit is constipated or even non-existent.

In the short term maybe. But you are ignoring the long-term consequences of breaking the risk/reward link. The next "too big to fail" company takes on too much risk (maybe wiping out smaller companies that cannot be so aggressive), and maybe has to get bailed out ( after destroying truly competitive companies), and on, and on, and on.

However, I do wonder if there may be a point in regulating companies so that they cannot get so large as to cause a meltdown if they make an error. But, if you broke them up, would the industry just still be as large, and still be as dangerous? I dunno.

-ERD50

 

[Independent]

Right on.

I will add another point that anti-free marketers tend to get wrong. They often assert that the free market fails when a poorly run company fails. NO! The free market succeeds when a poorly run company fails, and the value of the company is wiped out. Freedom to succeed (and be rewarded for success) and freedom to fail (and be punished for failure). Without the latter, you don't really have the former.

I'm not sure who the "anti-free marketers" are. Are some of them posting here?

The problem is that this:

Originally Posted by samclem
I think most people agree that markets work fabulously well when risks and rewards are transparent, and when those who stand to gain from taking risk will also lose if things go poorly.

doesn't always happen automatically. Suppose I put up a building on my farm, cut corners on the electrical work, and the building burns down. I'm the sole loser when my gamble doesn't work out well.

If I do the same thing while remodling my downtown store, and the entire block burns down, then I've generated a much bigger loss. If I don't have enough assets to reimburse my neighbors for my failed gamble, or if my assets are protected because I made sure that the building was owned by a limited liability corporation, then neither my neighbors nor I have recieved the rewards and losses arising from our own actions.

In the case of certain financial institutions, the claim is that their risky behavior would have led to a depression - which would involve trillions of real losses (not just market values or loan guarantees). This is a case where the people generating the loss won't and can't pick up the tab for the losses they created. So it seems to me that Sam's necessary condition for successful markets isn't satisfied.

 

[Texarkandy]

...
Suppose I put up a building on my farm, cut corners on the electrical work, and the building burns down. I'm the sole loser when my gamble doesn't work out well.

If I do the same thing while remodling my downtown store, and the entire block burns down, then I've generated a much bigger loss. If I don't have enough assets to reimburse my neighbors for my failed gamble, or if my assets are protected because I made sure that the building was owned by a limited liability corporation, then neither my neighbors nor I have recieved the rewards and losses arising from our own actions.
....

To take your analogy a little further:

That's why to do work on your commercial building downtown you have to be a licensed electrician & your work subject to inspection by the government building inspector to make sure it's up to code - while just anybody is allowed to wire their own barn out in the country without oversight.

So - who was licensing the "electricians" and writing the the "code", & who/where were the "inspectors"?

And when the buildings burned down - was it the fault of the electricians, the code, or the inspectors?