The U.S. government has botched its handling of the economy over the last eight years, according to Nobel Prize-winning economist Joseph Stiglitz. He explained how the U.S. created the global recession – and how we can get out of it – in a public presentation on his new book, Freefall: America, Free Markets, and the Sinking of the World Economy, at the Brattle Theatre in Cambridge, Mass., on January 25.
Stiglitz, a professor at Columbia University, received the Nobel Prize in Economics for his work on markets with asymmetric information. The presentation was moderated by Cullen Murphy, an editor-at-large for Vanity Fair.
Banks created this "mess"
"How did we get into this mess?" Murphy asked, prompting a one-word response from Stiglitz: “Banks.” Others – including regulators and economists – also participated, and “there’s lots of blame to go around,” Stiglitz said, but banks played the leading role.
Banks made the following mistakes, Stiglitz said:
- Misallocating capital
- Taking on excessive risk
- Charging transaction fees so hefty that financial services companies accounted for more than 40% of U.S. corporate profits in 2007
"At the individual and organization levels, incentives were distorted, so they became incentives for excessive risk-taking," Stiglitz said. These incentives encouraged bankers to profit in the short term at the long-term expense of consumers and shareholders. For example, they spurred the creation of mortgages that were bound to land borrowers in hot water once interest rates rose. But bankers didn't care, as long as they could make money off the mortgages.
Regulators could have reined in the banks, but they failed to act. "Part of the problem was that we appointed regulators who didn't believe in regulation," Stiglitz said. While he agreed that the Federal Reserve bears some responsibility for the financial crisis, he doesn't blame the bubble on the low interest rates set by the Fed.
"If the financial system had been working well, low-cost capital could have been the basis of a boom," Stiglitz said. "The real problem was that the financial system failed, and the Fed didn't stop them," he said, referring to the bankers. The Fed's belief in market fundamentalism – "the notion that unfettered markets by themselves can ensure economic prosperity and growth," as Stiglitz wrote in his book – led it to fail as a regulator.
Economists were also to blame. They provided the "intellectual armor" that banks and regulators used to justify their actions, Stiglitz said, and many of them failed to see the intellectual inconsistencies in their beliefs.
