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Nobel Prize Winning Economist Joseph Stiglitz Tells Us Who Caused This Mess
Old 12-15-2008, 08:07 PM   #1
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Nobel Prize Winning Economist Joseph Stiglitz Tells Us Who Caused This Mess

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Old 12-15-2008, 08:24 PM   #2
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"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.
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Old 12-15-2008, 08:34 PM   #3
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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".
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Old 12-15-2008, 08:46 PM   #4
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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.
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Old 12-15-2008, 08:58 PM   #5
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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.
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Old 12-16-2008, 06:13 PM   #6
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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.
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Old 12-16-2008, 06:21 PM   #7
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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.
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Old 12-16-2008, 06:23 PM   #8
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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.
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Old 12-16-2008, 07:09 PM   #9
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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/foru...ack-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.
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Old 12-16-2008, 09:02 PM   #10
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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.
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Old 12-16-2008, 09:19 PM   #11
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Originally Posted by . . . Yrs to Go View Post
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



Quote:
Originally Posted by . . . Yrs to Go View Post
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.
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Old 12-16-2008, 09:22 PM   #12
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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.
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Old 12-17-2008, 09:28 AM   #13
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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.
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Old 12-17-2008, 09:41 AM   #14
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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.
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Old 12-17-2008, 10:08 AM   #15
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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.
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Old 12-17-2008, 12:56 PM   #16
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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.
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Old 12-17-2008, 01:40 PM   #17
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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
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Old 12-17-2008, 02:13 PM   #18
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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.
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Old 12-17-2008, 02:44 PM   #19
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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.
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Old 12-17-2008, 03:42 PM   #20
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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.
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