Friday, December 26, 2008

Capitalist fools

Who is to blame for the current global financial mess? Joseph Stiglitz in this Vanity Fair classic identifies 5 key mistakes made by 3 US Presidents. 

(i) Appointing an anti-regulator (Alan Greenspan) to the position of Federal Reserve Chairman was a basic error - Greenspan did nothing to prick two asset market bubbles and refused to intervene to regulate derivative markets when many knew they were instruments of financial mass destruction.   Spiv economic culture was promoted.

(ii) Tearing down the walls and repealing the Glass-Steagall Act which separated commercial banks (which lend) from investment banks (which organise the sale of bonds and equities).  More spiv culture.

(iii) Applying the leeches - providing tax cuts to mainly upper income earners did little to stimulate the economy which was driven by a wash of liquidity and incentives which favoured capital gains over hard work.   Giving the spivs a chance in life.

(iv) Faking the numbers proceeded partly through gaps in the Sarbanes-Oxley Act which excluded executive options gave firms incentives to fiddle the books and partly through the operations of rating agencies who were paid by firms whom they were rating - financial overseering failed.  Spiv-related industry assistance.

(v) Letting it bleed - the bailout package is a confidence trick that forces ordinary Americans to bailout the rich but which will fail to restart lending - the core issue.  The spivs did well.

The issue to Stiglitz revolves around the need for regulation and for what I have elsewhere called the failure of free market fundamentalism:
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. (my bold)
HT to Sir Henry Casingbroke


JC said...


You're getting your economics from vanity Fair now?

ii) Tearing down the walls and repealing the Glass-Steagall Act which separated commercial banks (which lend) from investment banks (which organise the sale of bonds and equities).

Oh yea? I would have thought that the current crisis just put the final nail in the coffin of Glass, Steagall seeing there are only two firms left now, while the other three I banks disappeared.

it's the opposite of what this old socialist war horse is saying... Odd no?

Sinclair Davidson said...

Sorry, Harry that is just crap.

hc said...

If Joe Stiglitz a Nobel Prioze winner writes for Vanity Fair I'll cite him.

You guys are in a dreamworld. The worst financial crash in 80 years and you still have no doubts about the efficacy of deregulation.

This isan't socialism - its common sense.

jc said...


Please explain what new regulations you would like to see in the US.

Sinclair Davidson said...

Stiglitz didn't win the Nobel for his analysis of the crisis. But more specifically what deregulation? I don't know that this is the worst crisis in 80 years but I do see the dead visible hand of government everywhere.

Anonymous said...

Why does the myth of tax cuts mainly for the rich persist? I got a tax cut and I'm not rich. It's dishonest to pretend that only rich people got tax cuts.

observa said...

It is the worst crash in 80 years Harry but Spengler nails it much better than Stiglitz here-
It's always credit expansion that fuels the boom but real factors that inevitably constitute the bust, although every boom and bust is slightly different and for this one the unprecedented factor was that demographics.

As for more regulators and regulations(and we've never had so many), what can we learn from the SEC and Madoff in that regard? As always the regulator is there to help mourn the losses with the punter after they've both read about it all in the newspapers. Worse than the reality of caveat emptor, regulators like the SEC simply help fool investors to believe otherwise, at even greater cost as taxpayers. Creates some ethos for the public bailout I suppose.

observa said...

See Spengler's article 'Waking from Lever-Lever Land'( dec 25th) in the Asia Times

davidp said...

Hi Harry,

I had a look at the article and have a few concerns - it is not clear if some of the changes Stiglitz highlights created (or if not made would have avoided) the GFC:

1. As the crisis is a global crisis with severe financial problems in Europe (possibly elsewhere?) one must wonder about the importance of changes that happened only in the US. If changes like (i) -(iv) were key, why then problems elsewhere?

2. There may be other reasons to not like (iii) but the connection to the global financial crisis is dubious - unless there were tax cuts for higher income earners in other parts of the world at the same time. These sort of crises have happened in the past with various types of income distributions.

3. The first bubble Stiglitz refers to is the internet tech bubble - quite a different thing to the recent one as it is a not uncommon feature of markets with new technologies. Am not sure macro-policy should be regulating entry rates into markets...

4. Finally, the article is too quick to dismiss concerns about issues that were specific to the US like problems arising from the housing market. If there is a problem that occurs only in the US then it is probably more likely due to US conditions/regulatory settings.

Of course if my facts are wrong, am happy to be corrected.

In general, am keener on more specific discussions of the problems (like Rabee's on this blog and elsewhere) - that being said point (iv) is probably the strongest (in terms there was a failure of ratings agencies and regulators to recognize risks - this is more of a global issue) and regulatory fixes aimed at the specific market failure (which take account that regulators have imperfect information, their own motivations etc.).

Am not a finance person so don't want to go too far into issues on derivatives - but this may also be more of a global issue - is this an issue for the Central Bank - or other regulatory agencies? (in Australia, Europe or the US?)


davidp said...


I see in the quote "“Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world"

My guess is that is referring to the approach of Central Banks (or the relevant regulators) to handling financial innovations - drawing on Rabee's earlier posts - this seems to be more of what is going on - though it doesn't detract from the main argument - key causes are more likely to be things common to financial markets across the world than very-US specific.

I appreciate the arguments about contagion - but my casual impression is that there seems to be fundamental problems internationally too. Am happy to be corrected if wrong though...

observa said...

You're right David that Stiglitz is really cherry-picking the bits the suit his political narrative. You see the obvious shortcomings with-
'Applying the leeches - providing tax cuts to mainly upper income earners did little to stimulate the economy which was driven by a wash of liquidity and incentives which favoured capital gains over hard work. Giving the spivs a chance in life.'
That 'wash of liquidity' he so readily acknowledges but skates over (it's the spivs stoopids!)was really the monopoly preserve of central bankers and they clearly got it wrong.(In China's case the ultimate Keynesians were even prepared to manipulate the exchange rate to further contribute to that puzzling 'savings glut' for so long) Stiglitz simply points the finger at 'the spivs'. However there is always greed and the smattering of Gordon Geckos. What Stiglitz doesn't want to admit is that in failure to control and curb monetary expansion everywhere, it eventually unleashed the widespread and comfortable, symbiotic relationship between the Louis Leeches of Govt and the Gordon geckos of finance. Everyone was happy with the ponzi scheme(those govt coffers and CEO paychecks along with house prices, shares and super returns for joe average) until the day the Lehman Bros music died and now we see their true colours with their bailout buddyism.

Spengler could see through it back in May with his article- 'The monster and the sausages' Asia Times-

"It is fashionable these days to blame the Americans for borrowing instead of saving. In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht's devaluation in 1997, except in size and global impact.

The monster is not the financial system, crooked and stupid as it may have been. The monster is the burgeoning horde of pensioners in Germany and other industrial countries. It is easy to change the financial system. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe's senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China's appetite for savings vastly exceeds what its own financial market can offer.

There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.

..... There simply aren't enough young people in America to borrow money from Europe's and Japan's aging savers.

The world kept shipping capital to the United States over the past 10 years, however, because it had nowhere else to go. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren't enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios"

As he says it's all Peter Pan and fairy dust now, because of demographics and that simple fact-
"There is nothing complicated about finance. It is based on old people lending to young people."

davidp said...


I can see how in theory cutting marginal tax rates can encourage risky behaviour (but not just that specific to particular asset markets). The question is whether it is empirically important.