Tuesday, February 24, 2009

Joseph Stiglitz lays the smackdown on the financial crisis

Joseph Stiglitz gave a talk at the United Nations today, and hammered the US approach to the financial crises, both the one in 1997-98 (from which the roots of this one originated, he said) and the one today. I found this talk really, really illuminating, so the highlights of his lecture have been posted below, with some explanation so you don't have to wade through the whole thing blind. It's all pretty simple, when you get down to it.

1. There are two crises. The first is the US housing and financial bubble that has burst, but the second and deeper problem is a global insufficiency of aggregate demand. Quoth Stiglitz:
Why is it that the central banks all over the world, particularly in the US, in UK, and in some other countries, let loose a flood of liquidity, lax regulations, let there be this kind of bubble? The reason was relatively simple. There was an insufficiency of aggregate demand, and they took on a responsibility to try to keep aggregate demand going. It worked. It worked in a relatively shortsighted way. We had a few years of prosperity, or seeming prosperity.

2. Our financial system stunk. Stiglitz:
We had a really bad financial system. When you think about what is it that a financial system is supposed to do? It's supposed to mobilize savings. It's supposed to allocate capital. And it's supposed to manage risk. It didn't mobilize savings. Savings in the US was zero. It didn't allocate capital well. It allocated capital to houses beyond peoples ability to afford in places where it wasn't needed. And it didn't manage risk: it created risk. It didn't innovate in ways that were meaningful to helping our economy perform well. It innovated in ways that led to temporarily high profits but it didn't innovate in ways that enabled average Americans to manage the risks that they faced. The most important risk is a very simple one: how do you stay in your house without losing it? And not only did they not innovate ... they actually resisted innovations that would have helped effective risk management. ... Did they do it at a low cost? The financial sector is a means to an end, not an end to itself. You don't eat transactions. You don't enjoy them. A good financial system is one with low transaction costs. But yet, in America, and in some other countries, the financial sector was garnering more than 30% of all corporate profits. That should have been a symptom that something was deeply wrong. A means to an end have become an end to itself and it distorted our whole economic system.

3. To fix the financial crisis, we most obviously need "much better financial regulation." And if bankers tell us that's not necessary, we shouldn't listen to them, because they've benefited enormously from the old system. We need to stop rewarding risk-taking and shortsighted behavior.

4. But that's only the beginning. The fundamental underlying problem was caused by the last financial crisis of 1997-98 that devastated Asian economies. From here, I'll let Stiglitz explain, because he's way smarter than I am:
Once we fix the financial system, will we recover to robust growth, or will we still have the problem that gave rise to the problems that we're seeing? There are good reasons to believe that while it is necessary that we fix the financial system, it won't be sufficient to restore robust growth.
So, for instance, the head of America's central bank, Bernanke, today said yes, the economy's going to be weak not only through 2009 but also 2010, but forecast that we'll return to robust growth in 2011. But I think that's excessively optimistic, and that unless deeper reforms are made, there is a substantial risk that we will emerge from this downturn into -- without meaning any offense to anybody -- what is called a Japanese-style malaise, slow growth instead of robust growth. ...
One has to look at all these problems from a global perspective. Yes, there's an American problem. This crisis has a Made In USA label on it. We exported our deregulatory philosophy, we exported our toxic mortgages, and we thanked the rest of the world for buying all our toxic garbage, because if they hadn't, our downturn would be much worse, and now we're exporting our recession. But that simply highlights the fact that we have to look at these problems from a global perspective. There are 2 problems. One is the problem of global imbalances. ... Everybody worried about the disorderly unwinding of these global imbalances and in some ways [that's what we're seeing]. Part of the story ... is the fact that many emerging markets, developing countries, have felt a need to have a buildup of large amounts of reserves. And the reserve buildup in the last 8 years, 9 years, has been enormous. We're talking about trillions of dollars of savings in countries in Asia, in the Middle East particularly. But it's totally understandable why this happened. We mismanaged the last global financial crisis of 1997-98. I talked to several prime ministers who were involved, and they said "never again will we expose ourselves to the loss of our economic sovereignty" and the kind of policies that were imposed on them by the IMF, the pro-cyclical policies that turned downturns into recessions, recessions into depressions. They said, "that's not acceptable to our people and we have to protect ourselves." There's no global system of insurance. So each country is building up these mega-reserves. But this system of mega-reserves is-- one way of thinking about it is, this is income that people are earning that they're not spending, and they're not spending it because they have to build up this buffer in case things go bad. And they were right to do that, because things have gone bad, and the countries that built it up are in better shape than the countries that didn't. In that sense, it's individually rational for countries to do it, but from the system point of view, it leads to a global insufficiency of aggregate demand. The way the global system responded to this was that there was one country that acted as the consumer of last resort, and that was the United States. It was criticized and the Secretary of the Treasury once said, "you should be thankful to us because of what we are doing to global aggregate demand. We're keeping it going." But what kind of a global system is it when it's the richest country in the world that has to live beyond its means to keep the economic system going? It's clearly a very flawed economic system. But that's the economic system that we had. And what worries me is, if we don't do anything about this, things will get even worse. If we don't do better in how we respond to this crisis, and we don't fix the underlying problems, countries will have an incentive to build up even more reserves to protect them from the next crisis, contributing even more to global imbalances and an insufficiency of aggregate demand.

5. To fix this, we need a global reserve system.

6. We need policies that won't increase global inequality. Why does this matter in the financial crisis? Stiglitz:
It's very simple. What we've been doing is, in effect, transferring income from those who expend it because they need to to those who are not spending it, and that is contributing to the insufficiency of aggregate demand. Now in the US we thought we got around that in a very clever way: we told the poor people whose income has been falling for years now, we told them, don't worry, you can continue to spend even though you don't have any income. It was a brilliant idea, to completely disengage income from spending. And the way we did it was to say, borrow borrow borrow. But it should have been obvious that this was not sustainable. ... One of the innovations of our financial markets was to find ways to allow people to spend incredibly beyond their income, but it was a recipe for disaster, and it was only a matter of time before that disaster occurred.

7. This is going to be really hard to fix, and if we're not careful many of the policies the developed countries are undertaking right now will exacerbate inequality, which will make the problem worse. As Stiglitz points out:
We are bailing out American banks. More accurately, we are bailing out American bankers, and their shareholders, and their bonuses. And what are talking about having to cut back on? America's social security system. It's a straight transfer in effect from average and poor Americans to our bankers.

Stiglitz then points out that the amount we spent on TARP, which accomplished, in his words, "nothing," was way more than the gap in the social security system for the next century. So instead of getting nothing, we could have guaranteed the retirement of every American for the rets of all of our lifetimes. Meanwhile, on the global front, we're in effect subsidizing our banks and auto industries, etc., while the developing countries don't have the money to do that, so not only are rich people getting rich and poor people getting poorer, but rich countries' industries are getting richer while poor countries' industries are getting screwed.

Ticked off yet?

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