Joseph Stiglitz: Capitalist Fools





... 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 remove Paul Volcker as 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.

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....


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Harry Binswanger - 12/11/2008

Bramwell has it exactly right. Socialism fails--dependably, unrelievedly. Half capitalism half socialism fails--half the time.

Only laissez-faire works, because laissez-faire means: "leave alone." Who is to leave us alone? The government. What is the nature of government action? Coercion. Government is a gun. So "laissze-faire" means: freedom--no governmental guns pointed at the heads of the innocent.

Freedom is required for financial well being because freedom is required for men to act rationally. Subject them to coercion, as we've been doing in the housing market, banking industry, insurance industry, and men will act irrationally. Thus the crises.

Note the crisis came in the *most regulated* areas of the economy: the housing industry and the financial industry. It didn't come in the computer industry or the marketing industry, even though those are larger than housing and finance.

Half-socialism is too much socialism by half. If we want a 21st century, progressive economy, we need the 19th century in politics and law. To move forward in business and technology, we need to roll back the mountains of regulations, break the chains, unleash the innovators.


Richard Bramwell - 12/10/2008

Stiglitz should know better. This crisis was neither a failure of laissez-faire capitalism nor Ayn Rand's ideas, it was a failure of intensive regulation —with Greenspan's hypocritical contributions. From The American Competitive Enterprise Institute:
While the Dow collapses, we have a bull market in government regulations. The 50-plus departments, agencies and commissions are now at work on 3,882 rules; 757 will affect small businesses. More than 51,000 final rules were issued from 1995 to 2007.

That’s nearly 54,000 NEW regulations, added to what was there before, in only 12 years! It likely includes includes Sarbanes-Oxley, which set business leaders into a panic to comply with its often uninterpretable and self-contradictory language.

That is hardly Rand's laissez-faire capitalism; that’s massive socialist/fascist government interference! At root, those are the very ideologies Rand spent her lifetime hoping to save Americans and America from. Now, when the effects of those destructive ideologies from Washington hit the fan, everyone is blaming laissez-faire capitalism instead. They are ridiculous, uninformed, or dishonest.

Greenspan dropped any pretense of understanding Rand's arguments well before he became head of the Fed., and he then became a major part of the problem. His monetary policy (fiat printing of and suppression of interest rates (held at 1%!!), when Rand would have said “let the market decide”, were an appalling government intervention. Add in the HUD, CRA, CDS, Fannie Mae, Freddie Mac and the recipe for a catastrophically distorted market, including the trading of derivatives, was complete. Stiglitz invokes the name of Paul Volcker as if his regulatory controls were some legitimate example of regulation. But Greenspan used similar interventionist techniques to those used by Volcker. Stiglitz even praises Volcker for keeping prime under 4%, yet disregards Greenspan's 1%!!! If anything, Volcker set up a non-capitalist interventionist tangle, which were then massively enhanced by Greenspan's interventions.

As for the businessmen, & home buyers, who certainly are not innocent in this debacle, Edward Cline wrote, "Reason and rationality flee when force becomes a factor in men’s decisions, to be replaced with the pragmatism of punishment-avoidance or a risk-free shot at easy money."

So, dear reader, imagine YOU are the CEO of a large financial organization. Your competitors are complying with the regulations and appear to be making good for their shareholders, while things are getting tight for your firm because you are finding the regulations acquire too much risk. What do you do?

Or, you want to buy a house, and the government directly or indirectly tells your lender they will protect him from default so long as he keeps the mortgage interest low. What do you do?

You do the pragmatic thing. You join in, and trust in the state's easy money guarantee! As a CEO, if you are able to understand the fraud in the government’s game, you build yourself some protection for when the government's house of cards collapses. As a homeowner you know housing booms turn into busts, so you do not overextend yourself. However, most people believe the "government is here to help" (say, by regulation), so the aforementioned characters don't protect themselves.

They would not have dared to engage in the risky lending or buying that lead to the crisis, were it not for the handful of people in the US government who believed they were smarter than the free market and installed legislation to distort it. Without those people, lending rates would have adjusted themselves years ago, paper money would not have been printed like it grew on trees (e.g. “helicopter Bernanke”) and the present crisis would never have materialized.

Capitalism is the only *moral* system because it let's a man keep what he produces; it was the American system. An historical and geopolitical look at nations shows that those which are more free have citizens who prosper more by their own effort, and live more peacefully. Free markets made America great, from 1776 to the late 1800's, and then serious regulations began. Even America's poor were wealthy compared with the middle class of other nations. Just as capitalism (and businessmen as a whole) should not be blamed for the failure of a government to adhere to capitalist principles, nor should Ayn Rand be blamed for a protegé's failure to act on her principles.

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