"Capitalist Fools"

What caused the crisis? Joe Stiglitz says it was “system failure” based upon a single, incorrect belief:

Capitalist Fools, by Joseph E. Stiglitz, Vanity Fair: There will come a moment when the ... task before us will be to chart a direction for the economic steps ahead. ... Behind the debates over future policy is a debate over ... the causes of our current situation. ... 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 ... understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing... Greenspan['s] flood of liquidity combined with the failed levees of regulation proved disastrous. ...

No. 2: Tearing Down the Walls: The deregulation philosophy would pay unwelcome dividends... In November 1999, Congress repealed the Glass-Steagall Act... The most important consequence ... lay in the way repeal changed an entire culture. Commercial banks 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 ... 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 risk-taking.

There were other important steps down the deregulatory path. One was ... to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher)... 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. ... Nothing was done.

No. 3: Applying the Leeches: Then along came the Bush tax cuts... 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... 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 flood of liquidity made money readily available in mortgage markets... 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... [T]he decision encouraged leveraging, because interest was tax-deductible. ... The Bush administration was providing an open invitation to excessive borrowing and lending...

No. 4: Faking the Numbers: ...[I]f 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 ... a fundamental underlying problem: stock options. ...[A] 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...

No. 5: Letting It Bleed: The final turning point came with the passage of a bailout package... As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions ... were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.

The original proposal by ... Henry Paulson ... 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 ...—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted... 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. ...

The other problem not addressed involved the looming weaknesses in the economy. ... Without quick action by government, the economy faced a downturn. ...

Was there any single decision which, had it been reversed, would have changed the course of history? ... 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.  ... 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.

Comments

[evagrius]

"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."

I liked the remark about leeches; very apropos.

[robertdfeinman]

Stiglitz draws one general conclusion that markets are not self-adjusting, but most of his complain is directed at bad actors.

I see the lesson as the reverse, there is an inherent incompatibility between capitalism and democracy. As practiced in the US freedom of speech has turned into freedom to use money to buy political influence. The result is that it is private money that drives government and that this is the systemic failure. Getting the Reaganauts into office was just the logical outcome of this. The Dems did nothing to stop the tide, at most all they have done over the past 40 years is to improve social services somewhat. And even there two of the biggest programs occurred under a Republican president.

States in Europe, which are much more "socialist" in practice, don't allow big business to control government as much. This means practical things like limiting the number of political appointees in the permanent government, shortening and putting limits on campaigning spending and retaining part control of key industries.

The countries also adhere more closely to Galbraith's balance of forces since the third leg of labor also wields significant power.

The free market mythology was not the basis for the corrupt actions of the recent past, it was just a convenient ideology dreamed up by the paid pundits to lend an aura of theory to plain old capitalist greed. If Laffer hadn't come up with his "curve" some other justification would have been invented.

Sure we can put back some oversight, but both parties still believe that the faster we can inflate the capitalist balloon, the better. Even limits on campaign spending and lobbying won't do much because there is no voice of the people movement that can act as a counterbalance.

Notice that Obama, while appealing to the little people for support, managed to raise more money than has ever been raised before, and by a wide margin. He had no alternative, that's the way the game is played.

Get the money out of politics and then we'll see if we can sustain some real reforms.

[Bruce Wilder]

Behind the naive expectation of market "self-regulation" is the failure of corporate governance mechanisms amidst ever-rising executive compensation.

The huge rise in compensation for executive management since 1980 ought to be enumerated here, and set aside the general tendency to re-organize businesses in ways that undermined the integrity of corporate governance. The abandonment of the mutual form of organization for Savings and Loans, and the abandonment of the partnership in investment banks, stand, in my mind, as bookends to this whole era. Changing leverage ratios at investment banks wasn't done to benefit the shareholders particularly, but to free up a greater income stream for executive compensation. The problems with options is just one problem with excessive executive compensation. Shareholder equity is disappearing -- somewhat unevenly -- but there's no executive pay clawback; and these companies are using their bailout bucks to continue to pay "retention bonuses".

[kthomas]

"defecits don't matter"

[Bruce Wilder]

The executive class loved 'em their MBA Prez.

[mmckinl]

Stiglitz has nailed the institutional causes of the current crisis.

Underlying and caused by the system was the buildup of debt. Aggregate debt in the U.S. is now over $50 trillion.

What is called for is the write down of much of this debt otherwise the economy will take years and years to turn around and never really recover. We need FDRs Bank Holiday or a Swedish Plan to clean up bank balance sheets.

After the cleanup we need to place banks in the category of a public utility under a Public Central Bank so that credit, debt and money supply can be managed in aggregate. Until the creation of credit and currency is managed in aggregate we will have booms and busts.

[RPB]

The incentives given everyone from the mortgage bankers to the i-bank CEOs percipitated this crisis. The incentives to produce short term gains was far too high and severely discounted the benefits of long term success. Pay packages, bonus structures and commission incentives were strongly biased towards short term production. Perhaps if a longer term outlook was injected along with the success of the company as a whole injected into the payment structure we would have had more prudence in lending, securitization, investment and investment bank leadership. Perhaps this will be a necessary step going forward.

[Fred]

Nowhere does he mention perverse incentives. Nothing the government did, whether under Republicans or Democrats, required the shareholders (via the board of directors) to reward CEO's based on short-term stock market gains as opposed to long-term corporate welfare. Imagine if the CEO's of AIG, Lehman Brother, et al had been paid a modest cash salary plus a chunk of stock (not stock options) with the stipulation that the stock could not be sold by either the CEO or his heirs for 20 years—we would never have had problems with those corporations under such a regime. Furthermore, if we didn't have these damned honey-pot pension funds, there would have been no one to unload the toxic paper onto, other than stupid individuals who deserve to be fleeced (the great argument for why state lotteries and legalized but taxed gambling is such a good idea). Bank unwilling to hold toxic paper themselves, no one but a few middle-class boobs to buy the toxic paper, means the toxic paper would never have been created and hence we wouldn't have the current crisis.

CEO's looking out for numero uno are no more to blame than small-time flippers doing likewise. CEO's are supposed to be ambitious and thus greedy. Put the responsibility where it belongs—negligent shareholders who allowed a system of perverse incentives to be set up, and stupid voters who act as accessories to these negligent shareholders via bailouts at taxpayers expense, thereby sparing the shareholders the full brunt of the punishment they are due.

[spencer]

REPUBLICAN ECONOMIC PRESCRIPTION:

Take two tax cuts and call me in the morning.

says...

About one-quarter of stockholding households own stock worth less than $5,000. The middle class (between the 40th income percentile and the 60th income percentile) owns only about $15,000 in stock. Most stock-owning households -- about 2/3 -- hold stock only indirectly, generally in tax-favored retirement accounts So the investors are about 3/4 of the electorate, including, say, Bill Gates, and a family with a $50,000 annual income and a $15,000 401(k) account. And it votes thinking it's Bill Gates, and for an economic policy that benefits Bill Gates.

The middle-class investor should get disabused of the notion that they are all Bill Gates.

They are not executives or the capitalists they pretend to be. They are laborers. They should accept that, give up their pretenses, and vote for policies accordingly, all these aberrations would stop naturally.

[Noni Mausa]

Mark Twain has a funny description of his visit to see the Piltdown Man, and by describing each aspect of the fake fossil separately, it takes some effort by the reader to realize the pose of the Piltdown Man -- he is thumbing his nose at the observer.

Similarly, each of these elements contributed by apparently uncoordinated actors, combine to have formed a shakedown the like of which the modern world had never before seen. I read posts like these and ask myself "Is it within the realm of belief that all these elements just happened to create such a structure?" Nope. I can believe in the Tooth Fairy more easily than believe that.

Noni

[David]

Actually, I believe the markets are now in the process of self adjusting and self regulating and have been since Oct. 2007. Whatever happened to critical thought in this world.

I will not argue that mistakes were made, but to throw the baby out with the bath water is silly.
We need free markets and they need to have common sense regulations and rules to protect the system from itself.

Ideologues, whether from the left or right, always have to push their agenda. Proud to be an Independent. We need to have a viable 3rd party in this country because the two we have right now are a joke.

[Jas Jain]

--
"Capitalist Fools" led by bad economists!!!!!!

For example, Chair-moron Burn-ass-ke. Please read Burn-ass-ke. His key policy tool to fight deflation was intended to INCREASE "the Aggregate Demand" for goods and services, or at least keep it from falling more than slightly (shallow recession).

Please tell me for what goods and services the Fed can increase "the Aggregate Demand" for to offset those that it can't stop from falling.

Americans are over-housed, over-autoed, over-weight, over-indebted, over-employed... IT IS OVER FOR AMERICANS IN TERMS OF INCREASING CONSUMPTION. Americans have been consumed!

Chair-moron Burn-ass-ke CANNOT increase the demand all the time after it was pushed to the limit with the expansion of the household debt via the Housing Bubble. It was my Peak Debt thesis.

America would be a much better place without economists.

Jas

[Bruce Wilder]

I sort of agree with Fred, but, unlike Fred, I know that top management generally controls the corporate board of directors, and shareholders -- even big institutions with large holdings -- labor under many and considerable legal handicaps, that limit assertions of control. It is something that ought to be reformed, but as things stand, it is not clear that shareholders have enough real power, that holding them "responsible" at this point can have any behavioral effect. Obviously, where the losses wipe out equity value, the shareholders suffer, and rightly so; those are the rules. Given the other rules, though, losses falling on the shareholders is not enough to change anything with regard to out-of-control executive compensation.

Executive compensation is clearly out of control, and in the typical American business corporation, the shareholders are just another "other" in the story of making money by risking "other people's money".

[bob mcmanus]

Aggregate debt in the U.S. is now over $50 trillion.

One person's debt is another person's asset, to be leveraged and arbitraged and speculated with.

[calmo]

Any links for those stats anony?

Very melvinesque spencer...and I am glad to B in such fine company (learning the short and sweet of itall) [and not litterin like this]...and hearing Stiglitz's #4 reminded me of your slightly wider, stronger and mo betta claim that information gathering generally has been increasingly underfunded in the last decade.

Stiglitz, a huge comfort to me at the moment...ok, along with the rest of you people.

says...

Joe..."...flood of liquidity combined with the failed levees of regulation proved disastrous..."

Regulations written by the lobby groups representing the people being regulated proved to be useless. Lobbies still abound, so what will change? The flood of liquidity magnified the problem many fold. The result of trying to stimulate the way to prosperity is that credit for normal business activity has virtually ceased.

You can't continuously increase total public/private debt as a percentage of GDP. You can't use policy to foster a negative savings rate, and still fund capital goods in a sustainable manner. You can't let lobby groups that represent the institutions being regulated write the regulations, and expect any reasonable degree control to result.

The rest of the world will force change in return for a resumption of loans. The process will not be smooth.

[Fred]

I am aware of nothing that prevents large players like Calpers, Vanguard, Fidelity, Harvard endowment, etc from ganging up and targeting corporations one by one until they have voting control, then forcing the board of directors to create a system of CEO compensation along the lines of what I suggested. Namely, cash to pay the CEO's living expenses, plus stock that can't be sold for 20 years. Once this system of compensation is set up, the stock market will almost surely reward the aforementioned players with a higher stock value. After reaping their profits, the players can move onto the next target. We thus have a virtuous circle that does nothing to infringe on minority shareholder rights and thus no reason for the courts to interfere. If a fixed corporation later falls off the wagon, so to speak, then go back and fix it again, and be rewarded again.

Yes, there is some money in corporate pension plans that can't be mobilized to do the above, but then this money can't be mobilized to oppose the above either, so it is a wash. There is plenty of money that can be mobilized, and the market should reward such mobilization, and that is all that matters.

We don't need takeovers and privatization and leverage buyouts and we don't need new laws or regulations. All we need is for the stockholders to get angry and translate that anger into voting action, using laws that have been in place since the 19th century.

[Jas Jain]

--
Forgot to mention that Milton Friedman, Alan Greenspan, Bernanke, Krugman, Stiglitz, etc., are ideologues and partisan whores employed by the propaganda machine.

As I said, America would be a much better place without economists because they don't make Adam Smiths anymore and they happen to be the best that money CAN buy. Money Culture breeds whores.

Jas

[Greg Ransom]

What a cartoon.

What a one-sided cascade of Democrat and leftist talking points.

What an embarrassment for economics.

And Brad De Long makes fun of Lawrence White.

Give me a break.

I find it rather a disgrace that folks like Stiglitz are in the first instance political hacks -- Democrat party / leftist political hacks.

Is there any discussion of Fannie Mae and Freddie Mac here? How about the CRA and the changes in subprime policy under Clinton and Bush? Any account of all the "mainstream" Keynesian Democrats on the Federal Reserve board, such as Alan Binder? Any discussion of Greenspan's essentially mainstream Keynesian macroeconomic views?

As far as economics goes, folks like Stiglitz play mathematical games they call "economics" as a mere sideline hobby -- and use the math to bewitch themselves into a radically false understanding of economics itself. Again, an embarrassment for economics -- and for science.

[zero]

Wilder "Executive compensation is clearly out of control"

So why not raise marginal tax rates and eliminate loopholes? Seems like a reasonable response.

says...

Ransom -

Go read the article and see what an idiot you just made of yourself.

Nothing new there.

Your insistence it was the CRA - even afer it has been thoroughly debunked by anyone who looks at it - shows your true colors. That's worse than hackery.

And Brad DeLong should make fun of Larry White, and Austrians in general. They actually understand more than you do - you're a sad representation of the Austrians - but that doesn't help much on the intellectual front. There's a reason they are laughed at.

[Jon H]

"Notice that Obama, while appealing to the little people for support, managed to raise more money than has ever been raised before, and by a wide margin. "

The vast majority was small amounts from the little people. I believe the total for internet contributions was about double the amount from traditional big-dollar fundraising events for the well-heeled.

It's simple: if you make it easy for many people to give money (such as a $10/month automatic repeated contribution) you can raise lots of money. ESPECIALLY if you don't use an inefficient mechanism like direct mail that eats up 60% of the money raised.

[CBBB]

The big pension funds are also headed by CEOs who want to use the culture of excess compensation to be excessively compensated themselves. They will never "rock the boat" by ganging up on other CEOs.

[ken melvin]

I'm wit Joe and rdf and bruce and calmo, ... We see too much of the pick a bone type analysis. Such an overview is critical. See no conflict w/ what rdf's saying and what Joe's saying. Suspect that they need be combined; along with a good look at offshoring, investment opportunities, means of distribution, ..., reality. Think I'll keep and eye on Fred, and - maybe - quarantine for Greg.

[Easy Money]

The Austrians are laughed at? Who's laughing now? The economics establishment that laughed at the Austrians will no doubt try to shift the blame, but their moral bankruptcy is being steadily exposed.

Give it time. Already anyone smart and paying attention can see the inflationist agenda promoted by the economics profession is the root cause of this crisis. Wait till it's obvious to everyone that Zimbabwe awaits at the end of this road. The inflationists patron saint, Helicopter Ben, will be in hiding by then.

[Patricia Shannon]

Fred, you are crazy. How are the stockholders going to have control over the CEO, unless one or a small group that can work together own a majority of the stock? And what power does someone have who owns tiny pieces of a multitude of stock thru mutual funds?

[realpc]

No mention at all of the real estate bubble and the sub-prime mortgages? Not very subtle selecting of information to support an ideology.

[JIMB]

Just utter trash. All of the bad effects follow from ONE essential element: "You do the work, I'll print the money" ... in other words the Fed. since 1914 it has been the same. Apologists for more government intervention are out in force trying to blame the market when honest people are forced to use government money designed to benefit government's debt addiction and insiders. It's funny this is considered a "conspiracy" when it is so overt. A conspiracy? Maybe 100 years ago .... right now it's right here.

That's the dirty secret behind 'sustaining consumption'. It's propaganda for the elite. Consumption is a tiny portion of the economy, 75% of which is business spending. GDP isn't "gross" it's net of business expenses which totally distorts the picture.

If anything, we need less consumption and more production. Sure would be better if people could produce more and so afford more debt, you think? This can't be patched together. It needs to pass from incompetent to competent hands.

So chalk it up to creation of the Fed in 1914 ... All the bubbles, the waste, the corruption, the unnecessary foreign wars (financed in large part, by you guessed it, printing money), etc, etc. Let's return to constitutional government (shut it down, for our children's sake), sound money, freedom, and prosperity.

[ECONOMISTA NON GRATA]

An economic or business model based on a faulty premise is doomed to fail as we have witnessed. A rescue plan, TARP or Auto, based on a faulty premise is also doomed to fail. The only success that you can anticipate from the fore-mentioned, is an extension of the uncertainty and the public's anxiety caused by such uncertainty. I anticipate public upheavals in the near future.

We need to start a conversation as it relates to holding those who were responsible for this mess accountable. This was no accident ladies and gentlemen. I see criminal intent and negligence and if our new President Elect is not up to the task of seeking justice for the scoundrels who are responsible, I fear that we are in for some serious blood letting.

It's time to settle the score Mr. President Elect, the American People want and deserve justice. Give it to them.

Best regards,

Econolicious

[mark ii]

Question:

Why did the oft mentioned 'flood of liquidity' produce only house price inflation (or perhaps a general asset price inflation) and not a good old fashioned general rise in the price level?

After all if there had been a general rise in the price level the monetary authorities would have had to do something about it and all this may have been averted.

For me this is a key cause of the crisis and should go on the above list (if pressed for an answer I may be forced to mention something about inequality... what exactly about inequality I don't know).

Answers...?

It has troubled me over the period I have been lurking here
why this flood did not go on to cause a correspondingly massive inflation, that is after all what you should expect. Answer: well really it did, it caused a house price inflation (incidentally not just in the US but the UK, Ireland, Oz, NZ, Spain, South Africa, Czechland )

[Bruce Wilder]

Pitch Forks! Torches! Guillotines!

[mark ii]

damn, please disregard the last paragraph of last post, was cut and pasted from elsewhere.

[Patricia Shannon]

Fred, I saw your more detailed post after I posted my previous comment. I still don't see the logic. Aren't pension funds just another business headed by a Ceo and other executives who benefit from the system the way it is? The people who are supposed to be get the pensions don't control the people at the top.

[Bruce Wilder]

mark ii: "After all if there had been a general rise in the price level the monetary authorities would have had to do something about it and all this may have been averted."

You mean, of course, if it had driven up wages, something would have had to be done.

One might suppose it had something to do with Bernanke's "savings glut" and China.

[Fred]

what power does someone have who owns tiny pieces of a multitude of stock thru mutual funds?

If you don't receive proxies, because the mutual fund does the voting for you, then you can investigate what their position is on corporate management. If they don't care, then move your money to another mutual fund and tell themm why you moved. Corporations are mini-democracies. Just as with politics, one voter can do nothing, but a group of voters working together has power to effect change. But this appears too much work for you and the other freeloaders here. Too much effort to participate in the voting process. Yet you have plenty of energy to complain and look for someone other than yourself to blame when things go wrong due to this failure to participate.

[Fred]

Aren't pension funds just another business headed by a Ceo and other executives who benefit from the system the way it is?

With regards to corporate pension funds, the person in charge of the Exxon pension fund, for example, answers to the Exxon CEO and thus will never vote to restrain pay for the Exxon CEO. But that is a minor matter in the grand scheme of things, since most stocks are NOT owned by corporate pension funds.

The CEOs of state pension funds are bureaucrats appointed by politicians, who are elected by voters. Ultimately, I would like to see all state pension funds (and the Social Seucrity trust fund) abolished in favor of simply paying government pension on a pay-as-you-go basis, precisely because state pension funds are honey-pots that scream "steal me!" to Wall Street.

Labor union pension funds are controlled by labor union heads, who are elected by labor union members.

401ks are a bad idea as presently constituted for two reasons. First, the average person should be in government bonds (TIPS) and not stocks. Second, some corporations limit the mutual funds participating in their 401ks to mutual funds who promose NOT to interfere with corporate management. The solution is to require (via Congress) for all 401ks to allow access to all mutual funds and/or require all 401ks to be limited to government bonds (TIPS). Take your choice.

Everyone else has direct voting rights or the right to move their money to another mutual fund company.

[Patricia Shannon]

Fred, what kind of work do you do? Do own stock? How much? Are you in any groups that are doing what you say other people should be doing?

I don't own stock, and I don't intend to do so ever.

[Patricia Shannon]

We also all need to be going to city council meetings, county commissioner meetings, school board meetings, etc. in our spare time. Why do you think "they" don't want to shorten the work week, and want to make it impossible to retire? We would have time to do things like this.

[calmo]

Patricia reminds me of nailing overhead in tight quarters:Fred, you are crazy.Boinked me self right between the eyes with the claw ...didn't have a chance to move.
But obviously, Fred bounced back with a vengeance.
..So, famously non-freeloading FredJust as with politics, one voter can do nothing, but a group of voters working together has power to effect change. But this appears too much work for you and the other freeloaders here.can you splain why there is this issue with representation of shareholder interest...seeing how they just need to "work together"...seeing how this power is all "potential" and not practiced...not really.

[Bruce Wilder]

Fred: "I am aware of nothing that prevents large players like Calpers, Vanguard, Fidelity, Harvard endowment, etc from ganging up and targeting corporations one by one until they have voting control, then forcing the board of directors to create a system of CEO compensation along the lines of what I suggested."

We get that, Fred, but your not-knowing is not the same as not-being. This is not an area where I have any expertise, but I understand that there are some serious legal constraints on these large players, which prevent the scenario you outline. Some of these players have been motivated, in recent years, to do more "monitoring" and public hectoring, but the choice of such tactics reflects these very real limits in law, as well as the urgency of the need for intervention on behalf of shareholders. I wish I knew enough of the details to be more informative, because I agree with you on the general need for corporate governance reform. There is an academic literature, and who knows, maybe there's a blogiverse as well, which someone will point to.

[don]

I want to repeat points made by RPB, Fred and Wilder, because I see it as a glaring omission in Stiglitz's piece. Incentives from executive pay are a big part of the problem.
For example, consider the rating agencies. There are natural, mutual economic interests for bond issuers and rating services in having honest rating services, because it increases the market for the bonds by greatly reducing information costs of borrowers. But the services of a rating agency loses all value if it loses its good reputation. For many years, this fact was sufficient to overcome the conflict of interest in having the rating agency paid by a particular bond issuer for a particular bond issue.
But if you offered me 100 years of regular pay for taking a few dodgy risks (and no punishment but unemployment for losing the bet), suddenly the deck is stacked against prudent due diligence. Short term considerations eclipse the need to maintain the long run viability of the firm.

[bullbust]

If they don't care, then move your money to another mutual fund and tell themm why you moved. Corporations are mini-democracies. Just as with politics, one voter can do nothing, but a group of voters working together has power to effect change.

I do agree with your ideas, but this plan wont work. The main problem is index funds.

Index funds are the incarnation of shareholder apathy. A significant failure by any measure.

Corporate governance by shareholders require some shareholders to do policing. The entire exec & fund_manager ecosystem is not suited for this.

Index funds are in fact a free-ride on some active shareholders reining in management of any company in the index. What happens when institutions hold the majority of shares? When there is no single big shareholder trying to police management?

says...

Bruce Wilder says...
Pitch Forks! Torches! Guillotines!

Just say where Mr Wilder.

[evagrius]

There's been a lot written about "game theory" and how that can help us understand human actions and interactions.

That may be true but there's a "caveat" about it. It requires that the "players" actually adhere to the rules and, if they don't, the game ends.

This crisis shows that the "players", the major players, aren't adhering to the rules, any rules, at all.

Full penalties should be imposed...banishment, exile, public ridicule, etc;etc;.

But...given the way the "game" has been played recently. all that will happen is a few minutes in the penalty box.

[calmo]

"For example, consider the rating agencies." says don, maybe missing Stiglitz's #4 Faking the Numbers: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... But agree the executive compensation package is generally not only outrageously self-serving but short term and another reason why gov, not industry, needs to oversee these rating agencies: CEOs cannot be expected to out-perform their Invisible and Short-term Handed duration in offices that have longer terms consisting of many CEO terms...which is the first thing they demand you forget:a company that may have a successor CEO in the future...when your stock is hopefully still payin dividends but the current CEO is long gone with his retirement package.

[Fred]

I understand that there are some serious legal constraints on these large players

Vanguard has no constraints on the sort of involvement I am advocating:

https://personal.vanguard.com/us/content/Home/WhyVanguard/AboutVanguardCorpGovernPrinciplesContent.jsp

Maybe the state and labor pension funds have some constraints, though I doubt it. We are not talking about hostile takovers and buyouts. We are merely talking about voting in a board of directors that looks after the shareholders interests.

The real reason most mutual fund companies won't do anything to shake the boat is not laws against this, but rather that corporations won't allow them participate in their 401ks if they get a reputation for boat-shaking. You can imagine what a chilling effect this has. How many people are really going to change mutual funds because their current fund doesn't actively strive after good corporate governance? Basically none. How many customers might be lost by getting a reputation for boat-shaking and hence excluded from 401ks? Potentially a lot.

Anyway, if there are legal constraints on the big players, then Congress can change these constraints. Also, Congress can change the rules so people can invest their 401k money in any mutual fund company, thus eliminating the problem of corporations punishing the boat-shakers by freezing them out of their 401ks. It will far more productive in the long run for citizens to demand these 2 changes from Congress than to demand the other sorts of changes I see mentioned in this forum and elsewhere. And it isn't just a matter of civic responsibility. Imagine the sense of joy we'd all feel if the stockholders rebelled tomorrow and began cutting future CEO compensation packages down to reasonable proportions. No clawback, but at least some sense of revenge and justice at last done.

Corporate governance has been a problem since time immemorial. Adam Smith mentioned it, it takes up a full chapter in Benjamin Graham books in the 1930's, it was the reason for the rise in hostile takeovers and leveraged buyouts starting in the 1970's, Buffet and Munger have been hammering on the theme for at least a decade, etc. Solving the problem should be much easier than in Graham's day, since stock ownership is now concentrated in the hands of big intermediaries like pension funds and mutual funds, rather than dispersed, and because the internet makes it easy to coordinate those who are ganging up for a proxy war. All that is really necessary for a revolution is a few small changes by Congress and then awareness, anger and action on the part of the stockholders.

To answer Patricia's question, as of recently, my financial fortunes and those of the corporate stock and bonds markets have become closely intertwined. If they sink, I sink. Interesting how I enjoy arguing against my own self-interests when I talk about the stockholders needing more punishment. Maybe it helps to keep my mind clear amidst all the alternating fear and greed of these turbulent times. For stocks, I buy index funds and index ETFs through Vanguard. They have the corporate governance policy linked to above, though I have my doubts as to how well they apply this policy (due the boat-shaking issue). Of course, index funds/ETFs are the ultimate form of freeloading but then I don't pretend to be perfect.

[Patricia Shannon]

Fred, I do wish more people would do be more active in public affairs. But I also recognize that they have jobs, children, yardwork, housework, etc. And life is finite. We want to do some fun stuff, too. Also, our society teaches us to be self-centered and competitive, making it harder to instigate and maintain common action.

[Fred]

I do agree with your ideas, but this plan wont work. The main problem is index funds.

The Vanguard mutual fund company gets proxies for each and every stock they own in their index funds and they can then vote those proxies as they see fit. Indexers do not have to be passive with regards to corporate management nor is there any reason why active investors are necessarily active in this regard.

[robertdfeinman]

Just for the record:
Big donors contributed 47 percent of the funds for the Obama campaign versus 60 percent for George Bush in 2004 and 56 percent for John Kerry that same year, according to a recent analysis by the non-partisan Campaign Finance Institute based on data through mid-October.

This is better than previous candidates where the range was 60% or so. It also disguises the effect of bundlers who can walk in with $100K from Goldman Sachs (an actual contributor), but in "small" donations. Corporations are prohibited from donating to campaigns, but how does anyone know that part of the annual bonus wasn't a repayment for the "contribution" to a specific campaign favored by the firm?

It was a master stroke, although I don't think it was planned, that got average people to contribute small amounts. This had little effect on the amount of money raised but gave the contributors an emotional stake in the outcome.

Whatever the details, the main point remains, money is driving elections and elections lead to public policy choices.

[Larry]

Judging by the comments his articles elicit, Stiggy is not one of our more helpful pundits. Instead of my usual point-by-point comments, I give you only this:

I've been shocked at how merely enraged his writing has been during the crisis. Yes, he, like fellow Nobelist Krugman, warned of problems to come. But Krugman (especially once he gave up bashing Bush in every piece) and Delong and of course Thoma and many others have been far more on point.

The last thing we should do is pay attention to his prescriptions. Check Scientific American for a few more rantings.

[evagrius]

So...the game is rigged.

No rules for the game, right?

Then, who are the losers, who are the winners?

[Eddy]

JIMB at 5:02pm Just utter trash. All of the bad effects follow from ONE essential element: "You do the work, I'll print the money" .....

And that is no shit sherlock. Everyone go back a read it.

Gutenberg Greenspan had absolutely nothing whatsoever to do with deregulation - just the opposite. That's when massive governmental intervention began. And lets all remember what happened when GG tried to do the right thing at the end of Bush I. That's how Clinton got into office, and you know he swore never to try that again. If Clinton hadn't opened trade with China we would have been here much sooner. I got yer higher general price levels fer ya. Actually we are still not here since the inflation party hasn't yet begun.

Wait for it. It will. Markets certainly are self-adjusting when the interference runs out of legitamacy.

[Joe]

I am guessing price control is also allowed by the government. We can't just blame the Markets for doing this, we have to look at political corruption, monopoly greed. If we just go around blaming a philosophy of free market where the consumer chooses what products to buy, with the freedom of choice. Ideally Capitalism is very nice but in reality cannot be fully implemented same came be said about socialism. We need to find the hidden lines,and truths, and find a "third way." not every medicine is going to cure every disease.

[bullbust]

The Vanguard mutual fund company gets proxies for each and every stock they own in their index funds and they can then vote those proxies as they see fit.

Oh they can. And they may be, but basically the corps don't have to listen - you are an index fund, you invest in the components of the index. You are a shareholder of the fund, you take your investment to another index fund, your investment is not changed at all. So why do the corps care if you switch index funds?

Unless you are big enough to control the corp, no one cares a bit what you want.

[Linda]

Bruce Wilder says...

mark ii: "After all if there had been a general rise in the price level the monetary authorities would have had to do something about it and all this may have been averted."

You mean, of course, if it had driven up wages, something would have had to be done.

One might suppose it had something to do with Bernanke's "savings glut" and China.

Given the decline in trust-worthy-ness of the numbers coming out of government over the past 8 years, at least, is it beyond the realm of possiblity that there WAS a much larger price-level rise than was reflected in popular measures from our government? Last year when people began complaining about grocery prices, gas prices, housing prices, etc., I couldn't figure out where they'd been for the past 5 years. No one noticed when the price of a loaf of bread doubled? No one noticed when prices rose modestly and packages shrank? No one noticed what it was costing to rent a simple apartment? Or worse, to get health care? Until last year?

Bruce Wilder is right, of course, that the only inflation those in government, who are quite amply paid, would have felt a need to address would have been rising wages. That, of course, wasn't happening, as has been presented many many times here and elsewhere. While we were quite regularly being told that interest rates could be held so low because inflation wasn't too high, do we wonder what accurate inflation figures might have been if there wasn't an advantage to the low interest rates for somebody?

I'm with those who see too many coincidences here. I keep wondering if there's someone sitting, knitting, waiting for the day when enough people run out of patience, or money, or food to eat...

[Barkley Rosser]

Greg Ransom,

Regarding Fannie and Freddie, the claim that they are responsible for the subprime crisis is baloney. They have engaged in all kinds of shady accounting and nonsense, and, of course, if one wants to go way way back, Fannie invented the secondary mortgage market back in the 1930s. But in the more recent shenanigans, they were pressured by those who said they should behave more like their fully private competitors. It was only in 2005 that they got into backing subprimes, a big mistake of course, but one being made long after the horse had left the barn, and most definitely not the source of the problem.

[Gegner]

You are correct to point to money in politics as the 'root' of the problem.

So, how do we solve this problem...not that people with money want this problem solved.

We need to go 'cash free'. How does this solve the problem? There would be no way to transfer funds between individuals.

Then we arrive at a second problem.

How we 'choose' leaders.

Shouldn't these guys 'earn' the job?

Look over the past 230 years and think about how well picking a leader via a 'popularity contest' has worked out.

Over he past seventy years, this has devolved into a contest of who could raise the most money with which to paint their opponent in the worst possible light with.

Did we really end up with competent leadership?

Make them prove, through their past actions as well as a competition that allows us to evaluate both their integrity as well as their problem solving skill that they have earned he right to lead...even if they look like a tree frog.

One final 'Martian' brainwave...leaders are precisely that leaders, not legislators.

We, especially after the most recent administration, need to put the law beyond the reach of any individual or group smaller than society itself.

Kings pardon criminals, legislators should not have such power.

We will not enjoy the rule of law until the law is removed from the reach of the self-interested.

[calmo]

Linda sends us a period train:I keep wondering if there's someone sitting, knitting,
waiting for the day
when enough people run out of
patience, or money,
or food to eat......and who can resist this little cabooser?
Not me. So there's tyro knitter calmo
sitting, knitting,
waiting for the day
when enough people run out of
....potatoes to skewer
with those knitting needlesTwas the devil knitting that made me do it...who could resist that?
Not me.

[Jas Jain]

--
"I see criminal intent and negligence and if our new President Elect is not up to the task of seeking justice for the scoundrels who are responsible, I fear that we are in for some serious blood letting."

ECONOMISTA NON GRATA,

I agree. We have organized gangs in control and only the collapse of the system will cure that problem, or get rid of these evildoers. Unfortunately, most economists support the gangs, or even work for the gangs.

Jas

[MW]

To put CEO pay in perspective, look at how much private equity firms pay their CEOs. There's no corporate governance principal-agent problem with them, they can hire and fire CEOs at the drop of the hat and pay them minimum wage if they wanted to. Economic studies have shown that looser corporate governance structure increase a CEO's salary, but do not play a big role in the exorbitant salaries.

And I have to say, the author pointing to the Bush tax cuts is as dumb as conservatives pointing to CRA. While repealing Glass-Steagall may have had some influence, it's still worth noting that most traditional banks have weathered the crisis and investment banks were still the ones to fail. The issue is not bank insolvency but more precisely banks getting into cash-hording mode to increase reserves. Japanese banks did similar things only with losses on boring mortgages at the peak of the Japanese housing bubble. ARMs, the death-kneel of Wachovia and WaMu, have been around since long before Glass-Steagall was repealed.

A bigger issue was formerly boring instruments, credit default swaps and the like, becoming big under the same regulation scheme as the 1990's. CDS's and other instruments have value to a financial market, but counterparties should expect payment when they bet right. Instead of a central market, the over-the-counter derivatives precipitated bank runs by those counterparties after Lehman failed, spreading quickly to AIG. In other words, AIG could have been allowed to fail under a better regulatory schemes, as brokerage houses do all the time.

Better (not just more) regulation of securities is needed to prevent bank runs. The boringness of banks prevented any depression-like contagion from spreading in the late-80's. But the author here appears to say markets do not self-adjust in any circumstance anywhere and that's just asinine. With state control of any industry out there (as opposed to just regulation), the government always overinvests in politically-connected constituencies. The government should instead let the auto industry downsize due to oversupply as well as allowing the building industry to downsize as well, moving resources to more efficient, more necessary uses. That will happen as long as banks still lend to companies and individuals with good credit and government's main job is making sure that still happens in our liquidity trap.

[Worker]

Bruce and Fred,

There aren't substantial limitations on the pension funds and others. In fact, they are obligated as fiduciaries to vote for beneficial proposals.

The biggest problem is the relative bargaining positions of the CEO and shareholder. There is a hugely disproportionate incentive for the CEO, as recipient of shareholder largess to manipulate and game the system, to push for a new package when the shareholders feel dependent on him (ie. the market likes him).

I would compare the bargaining position to well organized public sector workers in big city.

The board members are the pols. CEO are public sector unions, with large incentive to take as much as they can and to manipulate the political process and to put pliant political allies in control. The shareholders are voters, who have limited interest in the details of the process. The voters can also be swayed by the political appeals of their friendly local workers (competent CEO's), even when it may result in longterm harm to their interests. The easiest way to game the system is by promising huge benefits that don't accrue until the future, and then underaccounting them. CEO's do this mainly through stock options. Unions do it through pension guarantees, work rules requiring routine overtime, etc.

Result is that by the time the voters realize they've been taken (New Jersey pensions, or Bob Nardelli's Home Depot package), the checks are long cashed. And, in some sense this disinterest is rationale since the voters/shareholders can always leave a disfunctional high tax state or sell their shares.

There is a solution to both of these problems- to force the voters/ shareholders to approve the package, accounting immediately and transparently for all costs. Ironic that unions are pushing this "say on pay" in the corporate sector.

[Aaron from NJ]

My .02 excuse the long winded post.
First my politics as a point of order… I’m a very moderate independent. I spilt tickets on a regular basis. I’m a Bloomberg voter or a very liberal republican or very conservative democrat. I like Sam Nunn (D of GA), Jim Baker of Texas, I’m very libertarian on social policy to the point of sounding like a left winger, and very data driven on everything else hense the love of all things econ.
Its not surprising to me that Dr. Stiglitz, is doing the “Paul Krugman” model of political economy to make a few bucks by leveraging his world class technical economics brand to be a media “neo-left political economist”.
I take issue with his revisionism of these 5 points.

1) Paul Volcker (I’m a big fan of his and the job he did in 79-83’) had lost lots of political support in the mid-80’s from farmers, mid-west industries.

Here is the real history of Volker leaving the Fed.
http://query.nytimes.com/gst/fullpage.html?res=9B0DEED91339F930A35755C0A961948260
http://query.nytimes.com/gst/fullpage.html?res=9B0DE0DD133FF931A35755C0A961948260
I don’t know why Dr. Stiglitz didn’t query this.
Great article on the Fed & its functional value in the last 95 years
http://www.nytimes.com/2008/11/05/business/05views.html

2) Tearing down Glass-Steagall Act
Great article that details the history of how Glass-Steagall Act was repealed.
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

with that said, the Glass-Steagall Act was coming down at some point, the US financial system & architecture had become so fragmented and diffuse that is was becoming non-competitive globally. The momentum that existed crossed party lines and was an industry priority. The financial services industry spent $100’s of millions to repeal it and they got the yield on their investment -
I agree with what he said about regulatory changes or lack of them to address leverage in capital ratios.
“There were other important steps down the deregulatory path. One was ... to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher)... 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. ... Nothing was done. “

3) Tax Cuts

I don’t understand how a world class economist can make the observations he made in point 3
“The tax cuts played a pivotal role... 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. ... “
I find this strange if look back at when the tax cuts occurred in 2002-03 it was during our last recession, though it wasn’t huge in impact the policy is normal for stimulating demand. I wasn’t in favor of those tax cuts by themselves but I didn’t think or do now that they caused the end of the world. Also, reducing interest rates (which we are doing now) has been the policy when inflation is not on the horizon.
“The flood of liquidity made money readily available in mortgage markets... 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. “
He is correct that flood of liquidity made mortgages cheap and easy, but lets start by stating that it was individuals preferences to overinvest in housing stock as a % of net wealth or debt was the key issue. After the stock bubbles of late 90’s and the downturn of 01-02 individuals wanted to overinvest in another “ easy money bubble” housing was it. Yield that historically has never existing in housing as an investment occurred between 1993-2007. With an acceleration between 2003-06.
Then the perverse incentives that were system wide and had been for decades waiting for just the right products to and individuals desire to have historic yield that were unsustainable to power up the housing boom.
Lastly the actors that were asleep at the switch were everywhere (The Rating Agencies, Fed, Treasury, HUD, OCC, FDIC, SEC, Congress, Media, Investment community, pension funds, individual buyers, State regulators, on and on)
“The cut in the tax rate on capital gains contributed to the crisis in another way... [T]he decision encouraged leveraging, because interest was tax-deductible. ... The Bush administration was providing an open invitation to excessive borrowing and lending...”
This last point makes almost no sense, as cutting tax gains is not what fueled the leveraging it was the fact that the products that existed system wide were perfect for a housing bubble and accelerated it because they mostly unregulated off-balance sheet OTC based so not subject to capital requirements or the same supervision. Where were the rating agencies while all this was happening. They were also chasing business.

4) Faking the numbers

I largely agree with his faking the numbers, stock options are a small part of the issue. The real issue is corporate governance, we don’t have independent board of directors in the US for public corporations.
Carl Icahn says it better then anyone else.
http://www.icahnreport.com/report/2008/10/100-million-rea.html
5) Letting it bleed
I don’t understand this point at all, maybe I need to have a Nobel prize in econ and then say markets are bad and the root of all things wrong in world history (a little hyperbole)
I’ve been against the bailouts for a basic reason: they don’t work.
IMF study on bailouts success.
http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf

Great summary on the report.
http://www.chinadaily.com.cn/world/2008-09/28/content_7067829.htm
NY Times summary of the report
http://dealbook.blogs.nytimes.com/2008/09/26/lessons-from-previous-banking-blow-ups/

“The original proposal by ... Henry Paulson ... 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 ...—and nothing was being done about the source of the problem, namely all those foreclosures.”
Isn’t the real issue with foreclosures is the fact that with 10% mortgages are in trouble, no demand for housing, overinvestment in housing, 10 months of housing inventory, housing pricing that is still too high
Valuable time was wasted... 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. ...’
Restarting lending isn’t the issue, its balance sheet quality, capital ratios, de-leveraging. What we really need is massive consolidation of the financial industry 10,000’s of financial firms (8000 banks, 10,000 hedge funds, 2000 mutual funds, thousands of specialized investment firms, insurance firms, etc.) With so much overcapacity, no yield why would they lend more.

[Vigs]

"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."

I still believe this. I honestly do. Despite the "place we are today," free markets do adjust to regulate themselves. I'm dissapointed in Greenspan for turning his back on his idiology.

The "place we are today" is somewhere in the middle of a market correction, where the market is trying to punish the players who have been irresponsible.

You want to overleverage on risky ventures => punish.
You want to overcompensate Execs => punish.
You want to build and market unwanted cars => punish.
Your union management pushed too hard for too long => punish.
You want to lend your money to poorly run companies => punish.

The "problem" is that these market adjustments hurt. Sometimes they *really* hurt. This is intensified by the fact that we Americans are spoiled now. We want two cars per household, and iphones for the kids, and lots of Christmas presents and secure retirement portfolios. We want Kobe Bryant and George Clooney. We want our cake... and we want to eat it too!

If you don't want the pain of the free market, let the government regulate. They can do this, for a price. Sometimes the government does this well and sometimes they do not. But when government fails us (as it sometimes does) and people have forgotten how free markets work, where will we be then?

[Rex]

Look at Thoma's face, just look at his face. How can you trust a man that looks like he does? He is despicable!

[Aaron from NJ]

My .02 excuse the long winded post.
First my politics as a point of order… I’m a very moderate independent. I spilt tickets on a regular basis. I’m a Bloomberg voter or a very liberal republican or very conservative democrat. I like Sam Nunn (D of GA), Jim Baker of Texas, I’m very libertarian on social policy to the point of sounding like a left winger, and very data driven on everything else hense the love of all things econ.
Its not surprising to me that Dr. Stiglitz, is doing the “Paul Krugman” model of political economy to make a few bucks by leveraging his world class technical economics brand to be a media “neo-left political economist”.
I take issue with his revisionism of these 5 points.

1) Paul Volcker (I’m a big fan of his and the job he did in 79-83’) had lost lots of political support in the mid-80’s from farmers, mid-west industries.

Here is the real history of Volker leaving the Fed.
http://query.nytimes.com/gst/fullpage.html?res=9B0DEED91339F930A35755C0A961948260
http://query.nytimes.com/gst/fullpage.html?res=9B0DE0DD133FF931A35755C0A961948260
I don’t know why Dr. Stiglitz didn’t query this.
Great article on the Fed & its functional value in the last 95 years
http://www.nytimes.com/2008/11/05/business/05views.html

2) Tearing down Glass-Steagall Act
Great article that details the history of how Glass-Steagall Act was repealed.
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

with that said, the Glass-Steagall Act was coming down at some point, the US financial system & architecture had become so fragmented and diffuse that is was becoming non-competitive globally. The momentum that existed crossed party lines and was an industry priority. The financial services industry spent $100’s of millions to repeal it and they got the yield on their investment -
I agree with what he said about regulatory changes or lack of them to address leverage in capital ratios.
“There were other important steps down the deregulatory path. One was ... to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher)... 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. ... Nothing was done. “

3) Tax Cuts

I don’t understand how a world class economist can make the observations he made in point 3
“The tax cuts played a pivotal role... 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. ... “
I find this strange if look back at when the tax cuts occurred in 2002-03 it was during our last recession, though it wasn’t huge in impact the policy is normal for stimulating demand. I wasn’t in favor of those tax cuts by themselves but I didn’t think or do now that they caused the end of the world. Also, reducing interest rates (which we are doing now) has been the policy when inflation is not on the horizon.
“The flood of liquidity made money readily available in mortgage markets... 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. “
He is correct that flood of liquidity made mortgages cheap and easy, but lets start by stating that it was individuals preferences to overinvest in housing stock as a % of net wealth or debt was the key issue. After the stock bubbles of late 90’s and the downturn of 01-02 individuals wanted to overinvest in another “ easy money bubble” housing was it. Yield that historically has never existing in housing as an investment occurred between 1993-2007. With an acceleration between 2003-06.
Then the perverse incentives that were system wide and had been for decades waiting for just the right products to and individuals desire to have historic yield that were unsustainable to power up the housing boom.
Lastly the actors that were asleep at the switch were everywhere (The Rating Agencies, Fed, Treasury, HUD, OCC, FDIC, SEC, Congress, Media, Investment community, pension funds, individual buyers, State regulators, on and on)
“The cut in the tax rate on capital gains contributed to the crisis in another way... [T]he decision encouraged leveraging, because interest was tax-deductible. ... The Bush administration was providing an open invitation to excessive borrowing and lending...”
This last point makes almost no sense, as cutting tax gains is not what fueled the leveraging it was the fact that the products that existed system wide were perfect for a housing bubble and accelerated it because they mostly unregulated off-balance sheet OTC based so not subject to capital requirements or the same supervision. Where were the rating agencies while all this was happening. They were also chasing business.

4) Faking the numbers

I largely agree with his faking the numbers, stock options are a small part of the issue. The real issue is corporate governance, we don’t have independent board of directors in the US for public corporations.
Carl Icahn says it better then anyone else.
http://www.icahnreport.com/report/2008/10/100-million-rea.html
5) Letting it bleed
I don’t understand this point at all, maybe I need to have a Nobel prize in econ and then say markets are bad and the root of all things wrong in world history (a little hyperbole)
I’ve been against the bailouts for a basic reason: they don’t work.
IMF study on bailouts success.
http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf

Great summary on the report.
http://www.chinadaily.com.cn/world/2008-09/28/content_7067829.htm
NY Times summary of the report
http://dealbook.blogs.nytimes.com/2008/09/26/lessons-from-previous-banking-blow-ups/

“The original proposal by ... Henry Paulson ... 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 ...—and nothing was being done about the source of the problem, namely all those foreclosures.”
Isn’t the real issue with foreclosures is the fact that with 10% mortgages are in trouble, no demand for housing, overinvestment in housing, 10 months of housing inventory, housing pricing that is still too high
Valuable time was wasted... 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. ...’
Restarting lending isn’t the issue, its balance sheet quality, capital ratios, de-leveraging. What we really need is massive consolidation of the financial industry 10,000’s of financial firms (8000 banks, 10,000 hedge funds, 2000 mutual funds, thousands of specialized investment firms, insurance firms, etc.) With so much overcapacity, no yield why would they lend more.