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Showing posts with label Joseph E. Stiglitz. Show all posts
Showing posts with label Joseph E. Stiglitz. Show all posts
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“A nation that continues year after year to spend more money on military defense than on programs of social uplift is approaching spiritual death.” – Martin Luther King, Jr.
"The selfish spirit of commerce knows no country, and feels no passion or principle but that of gain" - Thomas Jefferson, 1809
"Capitalism and altruism are incompatible; they are philosophical opposites; they cannot coexist in the same man or in the same society" - Ayn Rand, 1961
"The chief business of America is business" - President Calvin Coolidge, 1925
"The glory of the United States is business" - Wendell L. Willkie, 1936
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Globalization Marches On: Growing popular outrage has not challenged corporate power
Shifts in global power, ongoing or potential, are a lively topic among policy makers and observers. One question is whether (or when) China will displace the United States as the dominant global player, perhaps along with India.Such a shift would return the global system to something like it was before the European conquests. Economic growth in China and India has been rapid, and because they rejected the West's policies of financial deregulation, they survived the recession better than most. Nonetheless, questions arise.
One standard measure of social health is theU.N. Human Development Index. As of 2008, India ranks 134th, slightly above Cambodia and below Laos and Tajikistan, about where it has been for many years. China ranks 92nd -- tied with Belize, a bit above Jordan, below the Dominican Republic and Iran.
India and China also have very high inequality, so more than a billion of their inhabitants fall far lower on the scale.
Another concern is the U.S. debt. Some fear it places the U.S. in thrall to China. But apart from a brief interlude ending in December, Japan has long been the biggest international holder of U.S. government debt.Creditor leverage, furthermore, is overrated.
In one dimension -- military power -- the United States stands alone. And Obama is setting new records with his 2011 military budget. Almost half the U.S. deficit is due to military spending, which is untouchable in the political system.
When considering the U.S. economy's other sectors,Nobel laureateJoseph Stiglitzand other economists warn that we should beware of"deficit fetishism."A deficit is a stimulus to recovery, and it can be overcome with a growing economy, as after World War II, when the deficit was far worse. And the deficit is expected to grow, largely because of the hopelessly inefficient privatized health care system -- also virtually untouchable, thanks tobusiness's ability to overpower the public will.
However,the framework of these discussions is misleading.The global system is not only an interaction among states, each pursuing some "national interest" abstracted from distribution of domestic power. That has long been understood.
Adam Smithconcluded that the "principal architects" of policy in England were"merchants and manufacturers,"who ensured that their own interests are "most peculiarly attended to," however "grievous" the effects on others, including the people of England.
Smith's maxim still holds, though today the "principal architects" are multinational corporations and particularly the financial institutionswhose share in the economy has exploded since the 1970s.
In the United States we have recently seen a dramaticillustration of the power of the financial institutions. In the last presidential election they provided the core of President Obama's funding. Naturally they expected to be rewarded. And they were -- with the TARP bailouts, and a great deal more. Take Goldman Sachs, the top dog in both the economy and the political system. The firm made a mint by selling mortgage-backed securities and more complex financial instruments.
Aware of the flimsiness of the packages they were peddling, the firm also took out bets with the insurance giant American International Group (AIG) that the offerings would fail. When the financial system collapsed, AIG went down with it. Goldman's architects of policy not only parlayed a bailout for Goldman itself but also arranged for taxpayers to save AIG from bankruptcy, thus rescuing Goldman.
Now Goldman is making record profits and paying out fat bonuses. It, and a handful of other banks, are bigger and more powerful than ever. The public is furious. People can see that the banks that were primary agents of the crisis are making out like bandits, while the population that rescued them is facing an official unemployment rate of nearly 10 percent, as of February. The rate rises to nearly 17 percent when all Americans who wish to be fully employed are counted.
Bringing Obama to heel
Popular anger finally evoked a rhetorical shift from the administration, which responded with charges about greedy bankers."I did not run for office to be helping out a bunch of fat-cat bankers on Wall Street,"Obama told60 Minutes in December. This kind of rhetoric was accompanied with some policy suggestions that the financial industry doesn't like (e.g., theVolcker Rule, which would bar banks receiving government support from engaging in speculative activity unrelated to basic bank activities) and proposals to set up an independent regulatory agency to protect consumers.
Since Obama was supposed to be their man in Washington, the principal architects of government policy wasted little time delivering their instructions: Unless Obama fell back into line, they would shift funds to the political opposition."If the president doesn't become a little more balanced and centrist in his approach, then he will likely lose"the support of Wall Street,Kelly S. King,a board member of the lobbying groupFinancial Services Roundtable, told the New York Times in early February. Securities and investment businesses gave the Democratic Party a record $89 million during the 2008 campaign.
Three days later, Obama informed the press that bankers are fine "guys," singling out the chairmen of the two biggest players, JP Morgan Chase and Goldman Sachs:"I, like most of the American people, don't begrudge people success or wealth. That's part of the free-market system,"the president said. (Or at least "free markets" as interpreted by state capitalist doctrine.) That turnabout is a revealing snapshot of Smith's maxim in action.
The architects of policy are also at work on a real shift of power: from the global work force to transnational capital. Economist and China specialistMartin Hart-Landsbergexplores the dynamic in a recent Monthly Reviewarticle. China has become an assembly plant for a regional production system. Japan, Taiwan and other advanced Asian economies export high-tech parts and components to China, which assembles and exports the finished products.
The spoils of power
The growing U.S. trade deficit with China has aroused concern. Less noticed is that the U.S. trade deficit with Japan and the rest of Asia has sharply declined as this new regional production system takes shape. U.S. manufacturers are following the same course, providing parts and components for China to assemble and export, mostly back to the United States.For the financial institutions, retail giants, and the owners and managers of manufacturing industries closely related to this nexus of power, these developments are heaven sent.
And well understood. In 2007,Ralph Gomory,head of theAlfred P. Sloan Foundation, testified before Congress,"In this new era of globalization, the interests of companies and countries have diverged. In contrast with the past, what is good for America's global corporations isno longernecessarily good for the American people." Consider IBM. According to Business Week, by the end of 2008, more than 70 percent of IBM's work force of 400,000 was abroad. In 2009 IBM reduced its U.S. employment by another 8 percent.
For the work force, the outcome may be "grievous," in accordance with Smith's maxim, but it is fine for the principal architects of policy.Current research indicates that about one-fourth of U.S. jobs will be "offshorable" within two decades, and for those jobs that remain, security and decent pay will decline because of the increased competition from replaced workers.
This pattern follows 30 years of stagnation or decline for the majority as wealth poured into few pockets, leading to what has probably becomethe greatest inequality between the haves and the have-nots since the end of American slavery.
While China is becoming the world's assembly plant and export platform, Chinese workers are suffering along with the rest of the global work force.This is an unsurprising outcome of a system designed to concentrate wealth and power and to set working people in competition with one another worldwide. Globally, workers' share in national income has declined in many countries -- dramatically so in China, leading to growing unrest in that highly inegalitarian society.
So we have another significant shift in global power: from the general population to the principal architects of the global system, a process aided bythe undermining of functioning democracyin the United States and other of the Earth's most powerful states.
The future depends on how much the great majority is willing to endure, and whether that great majority will collectively offer a constructive response to confront the problems at the coreof the state capitalist system of domination and control.
If not, the results might be grim, as history more than amply reveals.
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Globalist Interview >Global EconomyThe Vindication of Joe Stiglitz
By Prakash Loungani | Friday, March 19, 2010
In this Globalist Interview, conducted by the IMF’s Prakash Loungani, Joseph Stiglitz warns there is a reasonable risk of another financial crisis "within five to ten years." As the Nobel Prize-winning economist argues, this is because policies, though better than those following the Asian crisis, are still being driven through the "lens of the big banks."
Joseph Stiglitz “remains a professor, not a player... And yet, somehow, the issues he cares about most always make it onto the agenda.” The New Republic's Jonathan Chait wrote these words about the Nobel Prize-winning economist a decade ago.
The financial crisis of 2007-09 put the issues Stiglitz cares about back on the agenda. During the Asian crisis of 1997-99, Stiglitz said the crisis should be seen as a broad failure to tame the powers of financial markets.
We will look back at the time from the 1980s to 2008 as one of market fundamentalism, where we lost the balance.
And he said the macroeconomic policy remedies being followed were wrong. There should be stimulus, not austerity, and countries should be allowed to use capital controls as one of their tools.
While his words were not heeded then, the recent crisis has seen the Columbia University-based Stiglitz vindicated. Financial markets have come in for criticism, even from many on the right. Many countries provided unprecedented monetary and fiscal stimulus, often at the urging of the IMF — and capital controls are no longer a taboo subject.
Wall Street vs. Main Street
LOUNGANI: What do you think of the financial rescue of banks during the crisis?
STIGLITZ: People in the financial markets were facing a near-death experience — Lehman Brothers was like a financial 9/11 — and they were obviously driven by self-interest. And policymakers who were sympathetic to them had an incentive or were naturally inclined to buy into the fear story that the world would collapse unless the banks were bailed out.
They wanted to give away money, because they bought into that particular view. What’s so remarkable is that people on both the left and the right were agreeing that this was not the right way of doing things. So it’s only a small and narrow group of people who see things through the lens of the big banks.
LOUNGANI: Given your views, doesn’t that make you a little pessimistic or angry?
I haven’t lost my Midwestern optimism that things will improve over the long run.
STIGLITZ: Yeah. It is upsetting. We face a reasonable risk of another financial crisis within five or ten years. If that happens, the likelihood that the banks will get their way again in the second round is much smaller. There will be greater impetus for genuine democratic reforms, because people will realize we failed in the first round.
LOUNGANI: Some people say it might have been better to get a few more things right after this first round …
STIGLITZ: Of course. From society’s point of view, if you had gotten more returns for the money we gave the banks, and, therefore, in the long run lower fiscal deficits, would we be in better shape? Absolutely, yes. I don’t think anybody can question that.
But you had a policy driven by financial markets. And you know, the financial markets didn't talk about the risk of fiscal deficits until they got all the money that they could get, and then, all of a sudden, they're back to talking about [the dangers of] fiscal deficits.
LOUNGANI: There’s also criticism that some of the people who caused the problems have been brought in to fix it.
STIGLITZ: Yes, I’ve been very critical on that score. Ironically, some of the people who favor markets haven't understood incentives. If you have incentives that are short-sighted and encourage excessive risk-taking on the part of bank managers, why should you be surprised that you get bad behavior?
In the second round, there will be greater impetus for genuine democratic reforms, because people will realize we failed in the first round.
The remarkable thing is that some of the market advocates do not seem to understand that well-functioning markets don't arise by themselves. You have to have rules. Unlike other U.S. administrations, this one knows what I’ve written [on this topic]. Still, I do think they would gain from having a broader set of views in the decision-making process.
There is a tendency of anybody in a political situation to try to focus on the short-run, saying, "Can’t I just get over the next six weeks?" and not think about the risks that that might pose for the long run.
Across the pond: Is Europe better?
LOUNGANI: We’ve been talking about the United States. Some think that the importance given to financial markets here is part of the elevation of Wall Street over Main Street concerns like jobs, the quality of life, the environment. Do you think it’s different elsewhere? Do you find Europe different?
STIGLITZ: I would say most leaders in Europe, on the left and the right, are very sensitive about issues of quality of life and the environment.
LOUNGANI: When you travel between here and Europe, do you feel that they balance work and leisure better, balance work and other aspects of life better?
STIGLITZ: Well, that’s obviously difficult to say, but what is very true is the following: There’s been a productivity dividend [in both the United States and Europe], improvements in technology. That meant that an increasingly smaller fraction of our time had to be devoted to meeting the necessities of life. And the question is: What did we do with the surplus?
Developing countries will be facing a higher price of carbon. And that will change their patterns of living.
Europe and America have gone different routes. While Europe has decided to consume a larger fraction of the surplus in leisure, we’ve decided to not only take all the surplus in material goods, but actually to work more. If you look at the average amount of work that an American does vis-Ã -vis a European, Americans are working more. In 1970, there was much less difference between the two.
It's obviously a judgmental question if one is better than the other. But I think in terms of the sustainability of the world, environment and material goods, the U.S. model obviously can't work for the world as a whole. So there’s a problem.
The Middle Kingdoms: China and India
LOUNGANI: The United States and Europe are still so much more richer than the Chinas and the Indias. Is it really fair to tell China and India to start already thinking about these issues of sustainability?
STIGLITZ: There are increasingly large groups within these societies that do have to think about this — these are both very large societies with an increasing middle class by almost any standard. Decisions that are being made today will affect many aspects of their lifestyle 50 years from now. You know, time goes very quickly.
When we built our interstate highway system in the 1950s, we didn't think through the implications that it would have for the design of our cities, urban usage, land usage and the growth of suburbia and exurbia.
After this financial crisis, we are going to see a China — and an Asia — that is much more influential.
China and India have to begin thinking about where their economy is going. Even though the kinds of constraints on the emission of carbon will be different for the developing countries, implicitly or explicitly they will be facing a higher price of carbon. And that will change the way they consume and will change patterns of living.
LOUNGANI: How do you think China is positioned after this financial crisis?
STIGLITZ: What I’ve seen already is sort of renewed confidence in China. Now that doesn’t mean that they might not have some bumps ahead, but I think one is likely to see a China — and an Asia — that is much more influential, both economically but also in political discourse.
The movement from the G8 to the G20 represented, in a sense, a big step. When I was in the White House over 15 years ago, there was [already] a recognition that you could not have global discussions in which you didn't have China and India.
LOUNGANI: How do you see China’s institutions evolving?
STIGLITZ: We’ve already had a significant opening up economically in China, and in some ways you might say even politically. In terms of broad access to information, access to global knowledge, access to what is going on in the rest of the world, China is not an insular society. It’s not like we thought of Albania and Romania [in the Cold War days].
The financial markets didn't talk about the risk of fiscal deficits until they got all the money that they could get.
China is much more open to the world and to what's going on. The Internet has fundamentally changed the ways in which both economies and polities work. It’s pretty much impossible to run a functioning globally integrated economy without access to the world's knowledge. It’s hard to predict exactly how that will impact the evolution of political institutions, but that it will have some impact seems to be pretty clear.
LOUNGANI: I know you talk at universities in China …
STIGLITZ: Yeah. I am — quite honestly — constantly amazed at some of the questions that I get asked.
LOUNGANI: Better than Columbia [University]?
STIGLITZ: You know, no different from Columbia. No different. And, you know, by Chinese students, not foreign students. The Chinese students raise very deep, difficult questions about politics and political processes.
The Commanding Heights: Markets & the State
LOUNGANI: Your critics to the left say that you always talk about the market failures, but you are not really working to bring about fundamental change. Your discussion is always, "What can we do to fix markets?" — rather than, "Can we think beyond markets?"
STIGLITZ: I don’t agree with them. It may sound conservative, but I mean markets do have certain powers. They may not work as perfectly as the market fundamentalists assert, but it would be wrong to say that markets have not been a part of every big success, but then so has government.
There's been a productivity dividend, but Europe and America have gone different routes on consuming the surplus.
And then from an analytical point of view, one has to try to understand which assumptions are critical, because if we think the markets don’t work in a particular way, we want to say, "What can we do to make either markets work or something else work?"
LOUNGANI: How do you see the world 20 years from now? Resurgent capitalism? Back to socialism?
STIGLITZ: We will look back at the time from the 1980s to 2008 as one of market fundamentalism, where we lost the balance [between markets and the state], in some countries at least. That was preceded by a period of the socialist-communist experiment, as the other extreme, where again we lost the balance. We are working at getting a new balance. Twenty years from now, we will be in a mixed market economy with the government playing an important role, and there may be also an important role for the third sector, the NGOs.
And we’ll need a different kind of capitalism. Nineteenth century capitalism was driven by the wealthy people who managed their own firms, using their own savings. Twenty-first century capitalism is in some ways more democratic. Lots of people have savings, for example through pension funds. But they don’t manage it for themselves.
It’s managed for them by others and in ways that often doesn't reflect their interests, and in ways that often exhibit a kind of shortsightedness. So how we make this kind of capitalism work better is going to be one of the big issues.
Markets have been a part of every big success, but then so has government.
LOUNGANI: Some of what you say reminds me of what Michael Moore says in his movie, “Capitalism: A Love Story.” But you seem much less frustrated and angry than him.
STIGLITZ: (Laughs.) I think Moore is very effective. But frustration doesn’t do any good. I guess I haven’t lost my Midwestern optimism that things will improve over the long run.
WHAT WE FILIPINOS SHOULD KNOW: Note: Bold and/or Underlined words are HTML links. Click on them to see the linked postings/articles. Forwarding the postings to relatives and friends, especially in the homeland, is greatly appreciated. To write or read a comment, please go to http://www.thefilipinomind.blogspot.com/ and scroll down to the bottom of the current post (or another post you read and may want to respond) and click on "Comments."
"The selfish spirit of commerce knows no country, and feels no passion or principle but that of gain" - Thomas Jefferson, 1809
"People who are greedy have extraordinary capacities for waste - they must, they take in too much" - Norman Mailer, 1968
"You show me a capitalist, I'll show you a bloodsucker" - Malcolm X, 1965
"Capitalism and altruism are incompatible; they are philosophical opposites; they cannot coexist in the same man or in the same society" - Ayn Rand, 1961
"The chief business of America is business" - President Calvin Coolidge, 1925
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Capitalist Fools
Behind the debate over remaking U.S. financial policy will be a debate over who’s to blame. It’s crucial to get the history right, writes a Nobel-laureate economist, identifying five key mistakes—under Reagan, Clinton, and Bush II—and one national delusion.
Treasury Secretary Henry Paulson and former Federal Reserve Board chairman Alan Greenspan bookend two decades of economic missteps. Photo illustration by Darrow.
There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.
What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.
No. 1: Firing the Chairman
In 1987 the Reagan administration decided to removePaul Volckeras chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation—or “liar”—loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn’t have the tools, he could have gone to Congress and asked for them.
Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen—for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk—but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else—or even of one’s own position. Not surprisingly, the credit markets froze.
Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn’t put it as memorably as Warren Buffett—who saw derivatives as “financial weapons of mass destruction”—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with “innovation” in the financial system. But innovation, like “change,” has no inherent value. It can be bad (the “liar” loans are a good example) as well as good.
No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn’t its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”
The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.
As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission,Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers and Greenspan were adamant—and successful—in their opposition. Nothing was done.
No. 3: Applying the Leeches
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.
The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.
No. 4: Faking the Numbers
Meanwhile, on July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are “incentive pay” in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention.
No. 5: Letting It Bleed
The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.
The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.
Was there any single decision which, had it been reversed, would have changed the course of history? Every decision—including decisions not to do something, as many of our bad economic decisions have been—is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself—such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.
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.
Joseph E. Stiglitz, a Nobel Prize–winning economist, is a professor at Columbia University.
The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that 
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