Stiglitz: The Fruit of Hypocrisy

Joseph Stiglitz:

The fruit of hypocrisy, by Joseph Stiglitz, Comment is Free: ...The new low in the financial crisis, which has prompted comparisons with the 1929 Wall Street crash, is the fruit of a pattern of dishonesty on the part of financial institutions, and incompetence on the part of policymakers.

We had become accustomed to the hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures - yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail.

Eventually, however, we were always going to learn how big the safety net was. And a sign of the limits of the US Federal Reserve and treasury's willingness to rescue comes with the collapse of ... Lehman Brothers, one of the most famous Wall Street names.

The big question always centres on systemic risk: to what extent does the collapse of an institution imperil the financial system as a whole? ... Last week ... Henry Paulson judged there was sufficient systemic risk to warrant a government rescue of ... Fannie Mae and Freddie Mac; but there was not sufficient systemic risk seen in Lehman.

The present financial crisis springs from a catastrophic collapse in confidence. ... Lehman's collapse marks at the very least a powerful symbol of a new low in confidence, and the reverberations will continue.

The crisis in trust extends beyond banks... How seriously, then, should we take comparisons with the crash of 1929? Most economists believe we have the monetary and fiscal instruments and understanding to avoid collapse on that scale. And yet the IMF and the US treasury, together with central banks and finance ministers from many other countries, are capable of supporting the sort of "rescue" policies that led Indonesia to economic disaster in 1998. Moreover, it is difficult to have faith in the policy wherewithal of a government that oversaw the utter mismanagement of the war in Iraq and the response to Hurricane Katrina. If any administration can turn this crisis into another depression, it is the Bush administration.

America's financial system failed ... and it must now face change in its regulatory structures. ...

It was all done in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. Some of America's best and brightest were devoting their talents to getting around standards and regulations designed to ensure the efficiency of the economy and the safety of the banking system. Unfortunately, they were far too successful, and we are all - homeowners, workers, investors, taxpayers - paying the price.

Comments

[tulsatime]

I think we are well past rescue when credit and most of the instruments that hang from it are carcinogenic. This is a perfect example of the 'kool-aid' that til recently had only been about belief, not practices. It's one thing to tell the lumpen that this is all fine, no problems here. It's quite another to try and pull the same BS on peers and the market.

[Jim]

Somewhere behind all of these financial instruments are the real assets that secure them, which I doubt will decline to even half their peak value. Had the lenders been forced to keep the loans on their books, the reckless lending that drove the spike in asset prices would never have happened. A simple regulation that these loans must appear on the books would go a long way to preventing this particular meltdown in the future.

[Bruce Wilder]

The lumpen have lost, or will lose, about $6 trillion in home equity wealth, while Wall St is asking for bailouts, because it is losing $1.2 to $2 trillion of home equity wealth, which had been collateralized into loans and securities. A sense of proportion would be nice, considering that very few Masters of the Universe are being asked to give back the record profits and bonuses of recent years.

From Bloomberg, December 2007: Lehman Brothers Holdings Inc.'s 2007 bonus payout, the first reported by a Wall Street firm, rose almost 10 percent from last year as revenue gains through August overcame a fourth-quarter decline.

Compensation, including salaries, benefits and bonuses, climbed 9.5 percent to $9.5 billion from $8.7 billion a year earlier, the New York-based company said today in a statement. Bonuses typically account for about 60 percent of compensation, or $5.7 billion compared with 5.2 billion in 2006.

Lehman, the fourth-biggest U.S. securities firm by market value, boosted 2007 revenue by limiting losses from subprime mortgage-related securities and lifting income from fund management, equities and investment banking. The firm said earlier this week that Richard Fuld, Lehman's chairman and chief executive officer, was granted a $35 million stock bonus for 2007, up 4 percent from last year.
Ah, the memories.

[Winslow R.]

"America's financial system failed ... and it must now face change in its regulatory structures. ..."

Specifics please! Fellow nobel prize winner Yunus would be a good place to start :)

[rufus]

"Somewhere behind all of these financial instruments are the real assets that secure them, which I doubt will decline to even half their peak value."

Jim, I disagree, this global credit crunch now crisis is evolving and gives all appearances that it will continue to evolve into a global asset write down.

I caught a little of Roubini on Charlie Rose this evening, and he posed a radical yet 'novel' idea; provide a measure/action to allow home owners to write down their mortgage debt, and stop the downward spiral of default, foreclosure, securities/assets erosion, firm failure. While Roubini pointed out that this would be a 'radical' approach, he believed this type of unusual strategy would be more likely considered or begun by a new president.

A suggested revision is wouldn't a Lame 'W' be a more fitting soldier to fall on the sword for undertaking a consumer bailout that would actually trickle up to the investment banks and their share holders? (LOL That this could really happen)

[reason]

Jim
but leverage increases both returns AND losses. Surely that is the point. Financial firms have been using leverage to push up returns and are paying the price.

[ken melvin]

"The lumpen have lost, or will lose, about $6 trillion in home equity wealth, ...

How, pray tell?

[rufus]

(LOL That this could really happen)<<

[rufus]

Apologies, clarifying "LOL" that 'W' would have the intestinal fortitude to do what is right.

[Patricia Shannon]

ken melvin says...

"The lumpen have lost, or will lose, about $6 trillion in home equity wealth, ...

How, pray tell?

This question is a joke, right?

[ken melvin]

No joke. The houses were never worth three-four-five times their actual value. Why would want to artificially maintain such? True, the complicity is very broad and includes dems, homeowners, ... but 'twas all always unreal. Why attempt sustain?

[Eric Dewey]

It all comes down to trust in one's leadership and counterparties.

And when trust is repeatedly abused, continuing to trust becomes increasingly irrational economic behavior...

[ken melvin]

Eric - are you saying we've become third world?

[Eric Dewey]

Ken, our physical infrastructure base alone probably prevents that from being the case - but that infrastructure is aging and may no longer be the best in the world.

The increasingly reduced level of trust in governmental institutions does suggest that we are gradually losing ground.

Before we get to third world, we'll likely slide slowly thru the second world - unless we decide to face up to reality and do something about it...

[Patricia Shannon]

ken melvin says...

No joke. The houses were never worth three-four-five times their actual value. Why would want to artificially maintain such? True, the complicity is very broad and includes dems, homeowners, ... but 'twas all always unreal. Why attempt sustain?

I agree.

[anne]

Though I have never though repeal of the Glass-Steagall Act relevant to the current financial crisis, though I could easily be quite wrong, I remember that the pressure mto repeal the act was such and the confidence so much that Citigroup bought Travelers Insurance before Congress had repealed the Act in 1999. Congress and the Administration were being dared not to repeal the legislation.

[Eric Dewey]

Anne, your memory of the repeal is accurate.

Also, without the repeal, BofA could not have purchased Merrill Lynch.

This is made even more relevant by the proposal from the Fed yesterday to relax restrictions on using customer deposits to fund non-bank subsidiaries - which is pretty clearly the plum that BofA needed in order to make the Merrill deal happen...check out naked capitalist's post on the subject...

[anne]

Right, Eric. I have to think through the entire "modernizing" process again, now.

[david]

Is there a good piece on the repeal of Glass-Steagal and its relationship to current goings-on anywhere?

[Samy Rabinovic]

I am not an economist; just a retired organic chemist and I love history. What I do not see in most discussions on why the economic crisis, meltdown of financial firms, etc. is the liquidity of the U.S.A.? Yes, what is the effect of our liquidity or lack of liquidity because of the wars in Iraq and Afghanistan? Everyone is debating the bail out of AIG and how taxpayers will have a debt burden of 85 Billion. It is a large sum but compared to the trillions of Dollars that the war in Iraq will end up costing, where do we find that money? My fear is that, as one of the bogglers alluded -- are we becoming a third world country? Will we need a suitcase of $$$'s to pay for our grocery? Most wars throughout history have been financed by outside sources like friendly bankers, at a profit, or by war bonds. It is the first time I see that we are at war with empty coffers; we give tax credits when we are running a deficit... As I said, I am not an economist...

[Real Person from the Real World]

As noted by others, our infrastructure is in bad shape, meanwhile we weren't finished in Afghanistan, and we started an expensive war in Iraq.
Our industries and manufacturing are all outsourced to other countries, the jobs that are left are either sales, marketing, and advertising, corporate/financial, or technology.
Sales people abound, even at commission only jobs, and the pressure to make the sale produces things like the mortgage crisis where the middleman collected their fees and ran, leaving the banks and mortgage holders in trouble.
The financial people on Wall street packaged and sold the mortgages, and now financial Armageddon threatens.
In technology, so much has been outsourced, but we've brought in people legally too, to take jobs, while ranting about illegal Mexicans taking low end jobs.
Foreign IT vendors are all over the place, and mostly they offer commodity people for commodity IT jobs. Visas were supposed to be for special needs, now they are the tried and true way for foreign entrepreneurs to cash in on wage arbitrage between the US and elsewhere.
Economists or people who think they are, rant that Americans don't save, but Banks pay 2-4% interest, while credit cards charge 20+% and jobs pay earners less and less, with permatemps, and loss of benefits.
If you don't make enough to buy what you need or get medical care, you charge it, and to pay the charges, you used your home equity, but now that is dried up.
Trying to get a job? commodity staffing companies abound, to take a cut of your pay, or if you are an executive, you go to a job coach! Commodity jobs have all sorts of barriers too? Questions to psych you out, and weed you out!
CEOs make 300+ times more than workers, and despite driving companies into the ground, walk off the job with millions of dollars in compensation.
We pay a fortune to middle eastern countries that support fundamentalist insurgents, for gas. As gas becomes more expensive and harder to find, the only response is to drill in more places!
No wonder this country is in trouble.