Nobel-prize-winning economist Joseph Stiglitz‘s take on the 2008 financial crisis is simple: Free markets are bad; government is good; we need more government. This is, essentially, a reiteration of what is known as the Greenwald-Stiglitz theorem, which states that markets are imperfect, so “government could potentially almost always improve upon the market’s resource allocation.”
A flaw common to both the Greenwald-Stiglitz theorem and Freefall is that, while Stiglitz goes to great efforts to show that markets are imperfect, he makes no effort at all to show that government will do better. His theorem says government could potentially do better, and another one of his theorems says an “ideal government” could do better, but the real question, which he never addresses, is whether a real, not ideal, imperfect government will actually do any better than an imperfect market.
Freefall makes no genuine effort to analyze the causes of the 2008 financial meltdown. Instead, Stiglitz merely uses it as another example in his case for bigger government. The crisis resulted from the failure of American capitalism, he says, and he dismisses any other explanation (if he mentions it at all) as “sheer nonsense” (p. 10).
Before reviewing Stiglitz’s arguments in detail, I have to say this is one of the most poorly written books about the crisis I’ve read. The publisher must have rushed it into print, because it didn’t bother to include an index, which seems essential for an economics book as technical as this one ought to be.
The strange organization of the book makes me suspect that Stiglitz merely took a number of papers he had written and strung them together in one semi-cohesive whole. The first two chapters describe how Stiglitz thinks we got to the crisis. Chapter 3 critiques the Obama stimulus plan. Chapter 4 turns back with more detail about the causes of the crisis. Chapter 5 critiques the Bush and Obama administrations’ response to the crisis (making it clear that Stiglitz doesn’t see much difference between the two administrations). Though you wouldn’t know it from its title, “Avarice Triumphs over Prudence,” chapter 6 presents his recommendations for preventing future crises. Then chapters 7 through 10 wander off onto other topics that have little to do with the crisis, instead making arguments for his New Keynesian school of economics.
The three chapters (1, 2, and 4) describing the causes of the crisis provide little more than factoids that could be found in a few New York Times articles (and far less than would be found in various articles in Vanity Fair, which had some of the best coverage of the crisis). The crisis began, says Stiglitz, with a housing bubble (p. 1). What caused the bubble to start to grow? Stiglitz never says, but he argues it was “fed” by “low interest rates and lax regulation” (2). Stiglitz takes it for granted that the bubble was nationwide, never acknowledging that, in fact, less than half of all American housing was affected by the bubble.
The main problems, Stiglitz suggests, were: first, mortgage companies encouraged too many people to get adjustable-rate mortgages when fixed-rate mortgages were better (85); second, bankers had incentives to engage in “excessive risk-taking” (10) and “didn’t want to know” about the real risks of their actions (14); third, the ratings agencies failed to tell them about those risks because they had flawed models and merely wanted to earn money for giving AAA ratings to high-risk bonds (92–94); and finally, government regulators were so taken by free-market ideals that they ignored the problems.
Critical to Stiglitz’s case against markets is the claim that “all of the banks behave similarly. . . given their herd mentality.” This was far from true. J.P. Morgan did not plunge heavily into mortgage bonds. Wells Fargo did not make huge numbers of risky loans to subprime homebuyers. Lots of small banks ended up smelling like roses after the crisis. Some of the institutions that did make mistakes (notably AIG) proved to be “too interconnected to fail,” but that’s a different problem from the herd mentality that Stiglitz erroneously credits to the banking industry.
As it presents a summary of the problems Stiglitz perceives and his proposed solutions, chapter 6 deserves closest scrutiny. The problems and solutions are:
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1. Problem: The banks faced flaws incentives. Stiglitz’s solution: “Reform corporate governance” by giving shareholders “more say in determining compensation” (155). That’s it? Give shareholders more say in pay? That’s going to solve the problem of perverse incentives? Apparently, Stiglitz isn’t aware that, of the banks the failed, the main shareholders were the executives who ran the companies, and they in turn were some of the biggest losers from the bankruptcies. Shortly before Lehman’s bankruptcy, its CEO’s share in the company were worth roughly a billion dollars. He ended up getting $65,000 for the 2 million shares of stock he owned in the company. To make sure employees didn’t just focus on short-term profits, Lehman gave out most bonuses in the form of stock that employees weren’t allowed to sell for many years. So how will changing pay structure improve incentives?
2. Problem: Lack of transparency. Stiglitz’s solution: Insist on mark-to-market accounting and close “dark” capital markets such as those in the Cayman Islands (159-160). Both of these ideas make sense, but banks already practiced mark-to-market accounting before and during the crisis, so this isn’t much of a reform.
3. Problem: Unbridled Risk-Taking. Stiglitz’s solution: Require banks engaging in high-risk activities to put up more capital, limit leverage, restrict particularly risky products such as credit default swaps, and reinstate Glass-Steagall limits on commercial banking (164). These sound good, but who is to decide what is a “high-risk activity” or a “risky product”? The whole problem with the mortgage market was that almost everyone, including all government regulators, agreed that it was a low-risk market. Credit default swaps were not risky products; they were ways to reduce risk (or at least spread it around). It is easy to say that government should regulate risk, but if you can only see that something was risky in hindsight, then government can’t do any better than the market.
4. Problem: Too big to fail. Stiglitz’s solution: “Preventive action. The government needs to be able to stop the too-big-to-fail, too-big-to-be-resolved, and too-intertwined-to-be-resolved situations from arising” (168). Well, duh. But just how is government supposed to do that? Place a limit on the size of banks? Place a limit on the number of financial institutions each bank can be “intertwined” with? Stiglitz doesn’t say, and any way I can imagine government might try would be actually counterproductive.
5. Problem: Risky innovations such as derivatives. Stiglitz’s solution: “Derivatives should be limited to exchange-traded transactions” (no “over-the-counter” transactions), and “exchanges have to be adequately capitalized.” The problem here is that every major financial crisis involves some new instrument that didn’t exist before. As the Antiplanner has noted before, bureaucrats regulate to prevent the last crisis, but don’t have a clue what to do about new financial tools that were created since then.
6. Problem: Predatory lending. Stiglitz’s solution: A “Financial Products Safety Commission [that would] identify which financial products are safe enough to be held by ordinary individuals” (176). In other words, some government agency will tell you whether you can get a fixed-rate or adjustable-rate mortgage. Other than the fact that it is not likely that some government bureaucrat knows my needs better than I do, this proposal is going to stifle financial innovation, which is ironic considering Stiglitz’s next problem, namely:
7. Problem: Inadequate competition suppressing innovation. Stiglitz’s solution isn’t really clear. He argues that “much of the innovation of the financial system has been designed to circumvent accounting standards” (181), but “a better-regulated financial system would actually be more innovative in ways that mattered” (182), presumably because that innovation would be done by altruistic government bureaucrats, not greedy bankers.
In short, the remedies in Stiglitz’s chapter 6 all have one thing in common: a childlike faith that mommy and daddy will always know best. This is in sharp contrast to chapter 5, which is a diatribe against the evil, ignorant, and greedy government officials in both the Republican and Democratic administrations of 2008-2009.
Having used the first 6 chapters to show how the crisis proves we need bigger government, Stiglitz turns in chapter 7 to all of the other wonderful things bigger government could do for us, such as reducing income inequality, promoting innovation, and preventing exploitation of downtrodden workers. Stiglitz presumes his readers are fully aware that all these problems are due solely to unbridled free-market capitalism. Chapter 8 looks at globalism, arguing we need both global regulation and a global reserve currency. Chapter 9 is a diatribe against free-market economists, whose ideas should be suppressed so people never make the mistake of deregulating the economy again. The final chapter has lots of pretty words about sustainability, community, and incorporating carbon emissions and happiness into our measures of GDP.
Stiglitz is no exception to the rule that everyone views the crisis through the lens of their preconceived notions. The Antiplanner has made no secret of the fact that I am guilty of this as well. But at least I am trying to get as many views as possible before I form my final conclusions about the crisis. I’ll share those conclusions with you soon.
Did it have anything on how we need fractional reserve banking to prevent economic bubbles and prevent the hastening of “transfer of wealth upward” as Dan apparently believes?
Apart from that, it seems to be a virtual encyclopedia on shilling for big-government “solutions”, attacking the actual free-market solutions, and how planning and regulation are the answer to all our ills.
Now Highwayman can come in and tell us about all those missing railroads, Dan can tell us about “hand waiving” and maybe lecture us little people on how close-minded and stupid we are for not wanting “gubmint” looking over our shoulder all the time.
The biggest advantage of capitalism is that it assumes most people are greedy. Other systems assume you can find non-greedy people to regulate and govern the greedy people.
Obvious and transparent stalker sockpuppets spewing thoughts-by-misdosage aside, We know from centuries of history that bankers need to be controlled; few things are better known. Fallacious assumptions about markets forget that much of our information is controlled, and asymmetrical information is becoming more asymmetric across several key scales [notwithstanding Jasmine revolutions being a notable and happy exception, but this was a low bar]. That is: wishing for something to be real isn’t a policy prescription.
We also know that simply disagreeing with something (as in 4. Too big to fail) isn’t a rebuttal, despite our fervent wish for it to be true. Of course monopoly power should be limited if we want opportunity and equity. Simply asking a dumb question arising from forgetting how it was done to mount some sort of objection tips your hand, Randal. When bankers are controlled, they don’t screw things up on wide scales. When they are left to collude to grab money, we have both fresh memories and history to tell us what happens. Not hard. Not hard to grasp at all, even through the fog of ideological agnotology.
And please, no blatant lies about wanting sozhulist control. That cheap, tawdry ploy is a waste of Randal’s bytes.
DS
I have to say I have thoroughly enjoyed these informative book reports. For an additional perspective of a liberal elite and the case for “big government,” see:
http://dyn.politico.com/printstory.cfm?uuid=72E27C29-A59A-46BC-B271-896AEB7925FE
Metrosucks asks, “Did it have anything on how we need fractional reserve banking?” The answer is yes; Stiglitz’s solution 3 (as numbered above), “put up more capital, limit leverage” was aimed in that direction.
Dan says, “We know from centuries of history that bankers need to be controlled.” Actually, what we have had for the last 70 years or so is a mixed system: On one hand are FDIC insured deposit banks that accept regulation requiring fractional reserves (i.e., that they keep roughly 10 percent of their deposits in cash rather than loaning them all out). On the other hand are other financial institutions (investment banks, insurance companies, etc.) that are not FDIC insured and not as heavily regulated. In general, the market does pretty well at making sure these institutions also have enough capital on hand.
The market failed in this instance because everyone, including the regulators, underestimated the riskiness of mortgage securities. So the question is, if the regulators failed too, how would more regulation have prevented the crisis?
By the way, I much appreciate how everyone has kept discussions civil in the past week or so. I find the comments from people on all sides to be enlightening and I look forward to more.
Randal, capital reserves are just one thing to ensure banks don’t get over-risky. The repeal of Glass-stegall was another thing. Once they started crossing the lines, they got more and more risky in their behavior and creating more paper to hide their bad investments. I’m not sure how to get their tentacles out of everything without limiting their power and scope, as they certainly were creating new shells for their game faster than people could figure out where was the pea – I suppose ensuring they stay small is a good first step and limiting the sectors in which they can operate. Surely some or even most of them should have been allowed to fail, but hindsight is 20/20.
And bennett has a good point about deficit reduction memes and the failure of such policies overseas – I daresay that the Shock Doctrine may be enacted here for a short time until folks come to their senses.
I also agree that the tone is more civil. Some of the sockpuppets are not peppering their blatant falsehoods with as much bile and foul language. The blatant falsehoods are still there, but they’re nicer.
DS
Dan’s initial reply on this post was nothing but gibberish. Really. Great way to say a lot without actually saying anything. And can Dan point out my “blatant falsehoods”, please, thanks.
Thank you for admitting you are a sockpuppet. Your blatant falsehood was this crock. And @8 ‘gibberish’ is what one expects from someone with nothing to go on but making it up. But everyone knows that already.
DS
The advantage of markets is that they police themselves by removing failing market actors. The problem in the recent and continuing crisis with the banks is that market regulators, i.e. government, are doing everything in their power to preventt the removal of failed and failing market actors from the market.
Dear Antiplanner,
I have come to this discussion board for some intelligent discussion about some issues that I care about and have some knowledge of. Unfortunately many potentially interesting discussions are ruined by the mean-spirited postings of “Dan.”
You intervened in this discussion board last week for the benefit of “Dan”. Unfortutely, “Dan” has become emboldened by your support and is even more deliberately trying to suppress intelligent conversation. I think I remember reading that “Dan” boasted that he had met you, so I can see you know him and clearly support his postings.
Therefore, this is my last posting on “The Antiplanner”.
Borealis
Sorry to see you go, Borealis. I agree that Dan is a highly inflammatory individual whose only purpose on this blog is to post spiteful and antagonistic messages. As another poster noted, he clearly hates this blog, its message, and most of the posters, so why visit it so often?
Take my post that he linked to, above. I was asking a valid question in that post (given Dan’s long-standing behavior), and instead of replying to my question, I had venomous invectives thrown my way.
While Highwayman can often simply be ignored or even be found humorous, Dan has displayed nothing but naked contempt for opposing views. His over the top posts incites similar behavior from other contributors. Banning Dan would immediately raise the civility of discourse here by a great deal. And I agree that by refusing to reign in Dan, the Antiplanner is, in effect, condoning his behavior.
Oh Gawd!
1. Dan may be mean-spirited, but he is almost always on topic.
2. It’s pretty clear that Mr. O’Toole and Dan are ideological opponents.
3. This is a great forum for ideological opponents to duke it out.
and most importantly…
4. If Dan ruins discussions, then the reaction to Dan is equally culpable.
Don’t give up, man up and take the high road. This blog is better with your presence.
This is a great forum for ideological opponents to duke it out.
Not when the opposition has no intention of listening to opposing arguments, and is here mainly to portray the other side as stupid or in need of an adjustment in their medications (both are arguments that have been used by Dan).
It takes two to dance. There is a tendency for some commenters to respond to Dan, ad hominem and Dan gives back as good as he gets. As I tell my three school age kids, everyone needs to lay off each other.
Metrosucks,
Pot and kettle, stones in a glass house, two faces, two standards. You have absolutely no credibility in this argument as you are as guilty as anyone in the tactics you describe.
While it pains those who actually discuss the day’s topic to loose the contributions of borealis, I would bet that no commenter here would think twice if you never posted again. If there was no Dan or Hwyman you would have nothing to say.
And yet this blog is called “The Antiplanner, Dedicated to the sunset of government planning”. It is not called, “The Antiplanner, a place where planners can heap abuse on their ideological opponents without fear of public exposure”. Though clearly Dan thinks that the latter is the purpose of this venue, and the owner of said venue has unfortunately empowered him with recent actions.
I would have plenty to say on the topics discussed here if there wasn’t the constant, corrosive presence of people like Dan to contend with. He brings nothing of value to the table. His sole purpose here is to belittle and dehumanize opponents. It has a negative influence on everyone.
If you review the record, you will note that if no one attacks Dan in the morning, he will make controversial statements just draw attacks and keep the attention on him.
“The Antiplanner, Dedicated to the sunset of government planning.”
Is this somehow NOT supposed to elicit a visceral and combative response from professional planners? I’m not sure what you do for a living, but I would bet you would have a zealous response or two on a blog dedicated to the demise of your profession.
I’ve been coming to this blog for 4+ years now. I used to respond in the same manner as Dan, until being thoughtfully called out by another commenter, but I often want to resort to angry, personal comments.
Planners who comment here continually read hyperbolic (Often the stage is set by Mr. O’Toole himself) nonsensical, and even personal attacks on their profession. Why would any rational person think that the response to this, in a forum such as this, would be cordial, diplomatic or friendly?
At the risk of letting this post spiral further all I can say is, cry me a river, suck it up and if you’re going to dish it out to Dan, buckle up, ’cause he’s bringin’ the lumber.
he will make controversial statements just draw attacks and keep the attention on him.
Horsepucky. You are projecting.
—————
And my, look at the spin out of control when transparent sockpuppets are mentioned! My.
But look what it has accomplished: we aren’t talking about the utter failure of Greenspan and the deregulation doctrine.
Randal raises an excellent point about new financial instruments that no one has seen before. Shrink the scope pre-Glass-Stegall repeal to get FIRE back in their box, reduce monopolies and the size of banks. Make banks like BofA pay for their cr*ppy loans. That will pretty much take care of all the low-hanging fruit and 85% of the problem. Where are these discussions in DC? Nowhere. FIRE has their tentacles everywhere.
And the party of The Wrecking Crew and Shock Doctrine make money off of the hinky system, in addition to basing their philosophy on the failed doctrine. And the weak opposition party can’t do without FIRE’s money either.
So until major reforms are enacted that refudiate the failed philosophy, we will continue our decline.
DS
Sorry to hurt your feelings, Bennett. You are right that Dan is as intelligent as a 2×4, and some of us take delight in just making him look like a total idiot with just a splinter.
I almost think Dan is really the Antiplanner working to drive up angry traffic to his website. After all, Dan makes planners look much worse than even the Antiplanner can accomplish.
“…reduce monopolies and the size of banks.”
So would you recommended ending the Federal Reserve? It is after all a HUGE cartel of banks. Would you recommend reducing government’s and the Fed’s money monopoly (Monopoly money) so that other monies (especially gold and silver) can compete on an even playing field?
No Frank, Dan wouldn’t support ending the Fed. After all, he believes that institution is necessary, and I quote:
…..”Ending government deposit insurance and fractional reserve banking, which is essentially fraud, would go a long way to end the business cycle.
This will actually cause more bubbles and more pain to the individual on lost deposits (like the 1930s). The exact opposite is true.
But it will hasten the current transfer of wealth upward, which of course some people are all for and are acting now to ensure. So if you see the italicized happen, Banana Republic status is just around the corner and you’ll want to get your passport in order.”…..
By the way, just in case he attempts to say I am “lying”, his comment can be found here:
http://ti.org/antiplanner/?p=4782&cpage=1#comment-121258
Speaking of 2x4s, fractional reserve banking and the Federal Reserve are different things.
Nonetheless, the current minority fetish for shrinking government by eliminating the Fed and implementing reality-refuted solutions – replacing with gold standard – will fade away. It will die an ignominious death once the public realizes this wave of Shock Doctrine rich people is ruining the country at an accelerating rate. Hopefully. Florida, for one, isn’t sure and he thinks it will get worse before it gets better. The Fed isn’t at fault, its the humans directing it – Greenspan and Bernanke in particular – that have screwed things up. Is there a major economy without a central bank? Srsly?
DS
This is so cool to have Dan screaming like a lunatic.
Could Dan post the following?
1. Proof that central banking is required for advanced/prosperous economies to flourish?
2. The reasoning behind why a gold standard is somehow a “reality-refuted” solution?
3. How eliminating the Federal Reserve will somehow instantly cause the entire country to slide into the ocean?
Oh, and please use small words that we ignorants can understand. We are completely unworthy to be in your presence Dan; You are the True Source of wisdom and all that is good. We tremble in supplication and beg for your enlightenment to lift us out of the dark pit of conservatism.
1. That was not my assertion.
2. That was not my assertion.
3. That was not my assertion.
Wow. Shocking, surely. I’m going back to ignoring the sockpuppet.
DS
Heh heh heh. Dan is watching Glen Beck on Fox News.
Glen Beck talked about Stiglitz’s arguments on his show, and Dan is just mouthing the same thing. Or maybe he was watching MSNBC’s 24-hour coverage of Glenn Beck, and that Dan is being a transcriber. You can’t really tell with Dan.
Substantively, we know from centuries of history that planners need to be controlled; few things are better known. Fallacious assumptions about markets forget that much of our information is controlled, and asymmetrical information is becoming more asymmetric across several key scales [notwithstanding Jasmine revolutions being a notable and happy exception, but this was a low bar]. That is: wishing for something to be real isn’t a policy prescription.
I’m not surprised. Dan wants to have his cake and eat it too. He wants to make a claim, and then a day later, say he never claimed so.
Hey Andy, Dan probably watches Fox News all day long and can give us a minute by minute replay, complete with his sarcastic, hick-style commentary. It’s well known that liberals actually watch Fox a lot more than conservatives do.
Also very important stuff:
We also know that simply disagreeing with something isn’t a rebuttal, despite our fervent wish for it to be true. Of course monopoly power should be limited if we want opportunity and equity. Simply asking a dumb question arising from forgetting how it was done to mount some sort of objection tips your hand, Dan. When bankers are controlled, they don’t screw things up on wide scales.
3. How eliminating the Federal Reserve will somehow instantly cause the entire country to slide into the ocean?
The gravitas of Federal Reserve Board members is what keeps the country balanced against the weight of all the fruits and nuts on the west coast. Without this gravitas, the fruits and nuts would quickly tip the country over and it would slide away into the Pacific.
2. The reasoning behind why a gold standard is somehow a “reality-refuted†solution?
Well, the international gold standard only lasted from about 1873 to 1914.
Throughout most of human history, money has been defined by its weight in silver, not gold, and humanity has used a silver standard with a base unit of a pound of silver (Pound Sterling, French Livre, Italian Lira, the Babylonian and Hebrew and Greek Mina. Gold coins were used by way of a derivative weight ratio of silver to gold, most recently 15.5 to 1, which was relatively stable for 300+ years up to the 1870’s and Germany’s ending of the minting of Silver Thalers.
A US Dollar is 371.25 grains of fine silver alloyed 10:1 with copper for a total coinage weight of 412.5 grains. @ 35 FRN per troy ounce, 1 real US Dollar = 27 FRN in phoney baloney Federal Reverse Note paper money.
I don’t bother to read Stiglitz anymore. He’s basically a broken record, and he’s competing with Krugman to see who can go farther in terms of ignoring their training and making fatuous, ideological statements. Every one of his publications in popular outlets ends with the same prescriptions to increase the size and scope of government.
Nobel laureates do tend to write to the reality-based community. So some audiences don’t have the socializing to grok the message.
DS
Yeah free-marketeers, stick that in your pipe and smoke it!
On a more serious note, Dan doesn’t have a Nobel prize, and Krugman’s Nobel prize in economics is about as valid as Obama’s peace prize.