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Excellent and Credible Insights!,
This review is from: Freefall: America, Free Markets, and the Sinking of the World Economy (Hardcover)
Stiglitz believes that markets lie at the heart of every successful economy, but do not work well without government regulation. In "Freefall" he explains how flawed perspectives and incentives lead to the 'Great Recession' of 2008, and brought mistakes that will prolong the downturn.
Between 1996-2006, Americans used over $2 trillion in home equity (HELOC) to pay for home improvements, cars, medical bills, etc., largely because real income had been stagnant since the early 1990s. Economic recovery requires that we repay the remainder of these amounts, overcome stock market losses (10% between 2000-2009), the loss of some 10 million jobs, and reductions in credit card balances, and find an equivalent amount to the former home-equity sourced financing ($975 billion in 2006 alone - about 7% of GDP) to finance another consumer-driven GDP upturn - without the prior boom in housing and commercial building. Stiglitz also points out that the Great Depression coincided with the decline of U.S. agriculture (crop prices were falling before the 1929 crash), and economic growth resumed only after the New Deal and WWII. Similarly, today's recovery from the Great Recession is also hampered by the concomitant shift from manufacturing to services, continued automation and globalization, taxes that have become less progressive (shifting money from those who would spend to those who haven't), and new accounting regulations that discourage mortgage renegotiation.
Stiglitz is particularly critical of the U.S. finance industry - its size (41% of corporate profits in 2007), avarice (maximizing revenues through repeated high fees generated by over-eager and over-sold homeowners needing to refinance adjustable-rate mortgages that repeatedly reset), and 'sophisticated ignorance' (using complex computer models to evaluate risk that failed to account for high correlation within and between housing markets; 'eliminating risk' through buying credit default swaps from AIG - blind to the likelihood AIG could not make good in a housing downturn), and excessive risk (banks leveraged up to 40:1 with increasingly risky mortgage assets - 'liar's loans,' 2nd mortgages, ARMs, no-down-payments; taking advantage of the 'too-big-to-fail' and 'Greenspan/Bernanke put' phenomena). Much of this behavior was driven by lopsided personal financial incentives (bonuses) - if bankers win, they walk off with the proceeds, and if they lose, taxpayers pick up the tab. However, to be fair, any firm that failed to take advantage of every opportunity to boost its earnings and stock price faced the threat of a hostile takeover.
The impact of mortgage defaults is greater than one would otherwise expect because financial wizards found that the highest tranches of securitized mortgages would still earn a AAA rating if some income was provided to the lowest tranches in the 'highly unlikely' event of eg. a 50% overall default, thus boosting the ratings and saleability of lower tranches. (Fortunately for the U.S., many of these mortgages ended up overseas, spreading the disaster.) Another problem is that mortgage speculators make more profit from foreclosure than partial settlements. Meanwhile, investors worried that mortgage servicers might be too soft on borrowers required restrictions that make renegotiation more difficult and lead to more foreclosures. Similarly, those with 2nd-mortgages often found that those holding the second were unwilling to accept a principal write-down as their share of assets would be wiped out. Finally, new government regulations aimed at making banks seem healthier than otherwise allowed changing from 'mark-to-market' valuation of mortgages to long-term 'mark-to-hope' valuation - thus, writing down assets in a renegotiation would generate the very mortgage write-downs the new regulations avoided, and thus increased bank reluctance to do so.
"Freefall" also does an excellent job refuting many of the simple explanations, alibis, and remedies for the 2008 Great Recession. For example, Greenspan's 'nothing he could do' alibi is countered by Stiglitz's 'require higher down payments or margin requirements' (or increase interest rates). To those blaming Community Reinvestment Act requirements for increased mortgages to those with low incomes, Stiglitz says the default rates on those loans was less than in other areas; as for Fannie and Freddie being responsible, they came late into the sub-prime game. Responding to claims that increased regulation would stifle innovation and its role in economic growth, Stiglitz asserts that it is impossible to trace any sustained economic growth to those 'innovative' mortgages. (A 'real' contribution could have been made by less profitable innovative mortgages that helped homeowners stay in their homes.) On the other hand, he also admits that just giving more regulatory power to the Federal Reserve is not a solution - the Federal Reserve didn't use what it did have prior to late 2008; similarly, the SEC boosted leverage limits from 12:1 to 30:1 and higher in 2004 - exactly the wrong move. Banks suggest banning short sales in the future as a preventive measure - Stiglitz, however, points out that the incentive provided short-sellers to discover fraud and reckless lending may actually play a more important role in curbing bad bank behavior than government regulators have.
Other factors, especially government actions, also receive attention from the author. Overall, global supply exceeds demand - thus, the recovery focus needs to be on boosting demand. Stiglitz points out that growing inequality shifts money from those who would have spent it to those who didn't - weakening overall consumer demand. High oil prices have also impacted most those with low incomes, and probably encouraged Greenspan to hold down interest rates to counteract the negative impact. On a broader level, Stiglitz contends that IMF encouragement of national self-discipline and 'rainy-day' funds also weaken consumer demand. As for recommendations for more tax cuts and rebates, Stiglitz says these won't have much impact on consumers saddled with debt and anxiety, and as long as there's excess capacity, businesses will be reluctant to invest (Laffer's supply-curve tax-curve is an irrelevant theory, at best). Stiglitz even suggests elsewhere that the failure of Bush's 2001 tax cuts to stimulate the economy may have also influenced Greenspan to hold down interest rates for too long.
AIG, once bailed out, paid off billions to Goldman Sachs at 100% (Secretary Paulson's former firm), while defunct credit-default-swaps elsewhere were settled at only 13 cents on the dollar, says Stiglitz. Overall, he is very negative on the financial-sector bailout (TARP), believing that the money would much better have been used to capitalize new banks at 12:1 leverage, or not spent at all. The resulting bank subsidies were unfair to taxpayers (Treasury put up most of the money and got short-changed on potential benefits), and implementation was inconsistent - some institutions and stockholders were bailed out, others were not. (The reason lending 'froze up' is that banks didn't know whether they or their peers ere underwater.) The stimulus package, on the other hand, was too small (aimed at 3.6 million jobs, vs. 10 million lost plus 1.5 million new workers/year needing jobs), and was delegated to Congress without clear guidance. The result was a failure to provide mortgage insurance for those losing jobs, while instead creating the 'cash-for-clunkers' (mostly just moved sales from one period to another - [...] estimated only 18% were added sales, costing taxpayers $24,000 apiece; eight of the top ten purchases came from Asian manufacturers), ineffectual tax cuts, putting money into a failing auto industry, and increased road construction (greater global warming) instead of giving even more money to high-speed rail. The stimulus emphasis should have been on fast implementation, high-multiplier impact, and addressing long-term problems (eg. global warming). The employment situation now is worse than just the unemployment rate suggests - there are a record 6 applicants for every opening, the average work week is at 34 hours - the lowest since data was first collected in 1964, many have turned to disability instead of unemployment and are not counted.
Overall, Stiglitz believes there is far too much short-term thinking driving decision-makers, that business lobbies are too strong, and that markets are not naturally efficient. (Other inefficient market areas besides finance include health care, energy, manufacturing.) Meanwhile, we have done nothing to correct the underlying problems (big banks are even bigger) and Stiglitz also fears (reported elsewhere) the U.S. economy faces a "significant chance" of contracting again.
Interesting side-notes: 1)Stiglitz suggests that banks 'too-big-to-fail' should pay higher rates of deposit insurance, and incur restraints on executive incentives. In 1995 our five largest banks' market share was 11%, 40% now. Regardless, the world's largest three banks are now Chinese - #5 is American. (Not to worry - scale economics are no longer a factor for any of those banks, says Stiglitz.) 2)President Reagan made a major mistake in removing Paul Volcker as Chairman of the Federal Reserve Board and appointing Alan Greenspan in his place. Volcker had brought down inflation from more than 11 percent to under 4 percent, which should have assured his reappointment. But Volcker believed financial markets need to be regulated, and Reagan wanted someone who did not. Thus, Stiglitz believes regulations must be mandated, and enforced by a neutral, not political, source. 3)Repealing the Glass-Steagall Act in 1999 changed the culture of banking from conservative to high-risk, and also encouraged even larger institutions. 4)It is ironic that the Bush/Greenspan efforts to minimize government involvement in the economy resulted in our becoming de facto owners of the world's largest auto and insurance companies, and some of the largest banks. 5)Stock options are doubly damaging - they undermine stockholder wealth while remaining largely hidden from stockholders, and they encourage maximum short-term accounting manipulation to move stock prices up. 6)The U.S. national debt will reach 70% of GDP by 2019, and when it hits 90%, paying 5% interest on that debt will consume one-fifth of federal taxes.
Bottom-Line: Most books on current economic issues written for the public are superficial, or even worse, mere demagoguery. Stiglitz's qualifications - Nobel prize-winner in economics (2001), former Chairman of the President's Council of Economic Advisors (1995-97), and former World Bank Chief Economist help provide an important, interesting and credible alternative. "Freefall" was a pleasure to read.
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Showing 1-10 of 31 posts in this discussion
Initial post: Jan 12, 2010 8:05:34 PM PST
What a robust synopsis and review. Much appreciated.
Posted on Jan 15, 2010 7:59:57 PM PST
I agree wholeheartedly with Bry. Excellent review. I'm certain the book will be well worth reading. I thank the pragmatist for his time.
In reply to an earlier post on Jan 17, 2010 3:29:31 PM PST
Last edited by the author on Jan 18, 2010 10:45:25 AM PST
D. Weaver says:
Loyd, You're obviously focused on writing reviews - I've seen your posts on several of the books that I have an interest. What is also very clear is that you are extremely political. You lavishly praise authors to the left espousing big government socialist agendas, while authors to the middle are attacked, and to the right are maligned.
Based on your reviews it seems you're of the opinion that capitalism has brought more harm than good. The great irony of your persuasion is that ultimately nothing in history has even come close to elevating the material standard of living like the capitalistic system. Yet you still villify, maligne, and mock.
I read your review and it was exactly what I would I expect from a socialist, but in the end I found it of interest - bias clearly noted. The same way I find Keith Oberman or Shawn Hannity of interest. The difference between you and them is that we know the bias we're getting with them, but most people on this site have no idea the bias they're getting with you. I hope this post sheds some light on that.
In reply to an earlier post on Jan 19, 2010 4:47:14 AM PST
D, Not necessarily trying to defend Loyd. I am a self-described Leftist-an anarcho-syndicalist, if you will-, so I identify well with the likes of Stiglitz and Krugman. I feel Loyd outlined the contents of the book and provided some feedback based on his experiences. I see you have your own bias. "The great irony of your persuasion is that ultimately nothing in history has even come close to elevating the material standard of living like the capitalistic system." is such a specious assertion. We are in the midst of a $14+ trillion bailout predicted by many on the Left side of the spectrum, ignored by the Right, and there is no middle, so I am not sure of your reference there. I would argue that the make-up of economists in the US is about 90% Right to 10% Left. The 90% is what we have to endure day in and day out in the Press. I think most people picking up a Stiglitz book are not expecting Milton Friedman or Alan Greenspan (or Ben Bernanke, Henry Paulson, or Tim Geithner for that matter).
The $14 trillion makes the likes of Bernie Madoff seem like a back alley scammer, but without this Socialism, your precious financial system would have demonstrated even more clearly that it is a house of cards distorted by smoke and mirrors. The emperor has no clothes. Your Capitalism is the consummate Ponzi scheme.
In reply to an earlier post on Jan 19, 2010 9:34:34 AM PST
Last edited by the author on Jan 27, 2010 1:33:42 PM PST
D. Weaver says:
We all have opinions, but when someone like Loyd writes a five page reveiw it seems reasonable to add to the discussion that his history on Amazon is littered with smeer mongering extremism.
In reply to an earlier post on Jan 19, 2010 10:49:01 AM PST
[Deleted by the author on Jan 19, 2010 10:49:30 AM PST]
In reply to an earlier post on Jan 19, 2010 10:49:48 AM PST
[Deleted by the author on Jan 19, 2010 10:50:06 AM PST]
Posted on Feb 4, 2010 10:50:08 AM PST
Philip J. Murphy says:
Having just read Stiglitz's "The Three Trillion Dollar War: The True Cost of the Iraq War" I am looking forward to digging into "Freefall." It will take us a long time to get over the Bush/Greenspan era. Stiglitz points out in "$3T" than Greenspan, in effect invited households to pile on risk as he encouraged them to take on variable rate mortgages. The low initial interest rates allowed households to borrow more against their houses, enabling America to consume well beyond its means. Savings rates went negative for the first time since the depression. As interest rates inevitably rose, mortgage payments expanded beyond the ability to pay. Surprise????
In reply to an earlier post on Feb 12, 2010 2:19:12 PM PST
Last edited by the author on Feb 12, 2010 2:21:42 PM PST
Sounds like D. Weaver doesn't like what the reviewer is saying, so calls him a socialist. I suppose that is true, in some sense (at least to D. Weaver) of anyone who doesn't accept mere anarchy. His qualification of the reviewer as "extremely political" is even more interesting, as it seems to imply (along with his whines of "attack "maligne [sic] and "mock") that Keith Oberman and Shawn [sic] Hannity are somewhat more in the land of the living. D. Weaver should perhaps stick to those pundits, and allow the rest of us to worry about "the bias [we're] getting" by ourselves; we're grown-ups. If he has something substantive to say about arguments and facts, welcome.
In reply to an earlier post on Feb 28, 2010 2:58:39 PM PST
Dav Lev says:
I was employed by the Federal government for nearly 30 years. I became an Independent thanks to all that I saw working there that upset me, from labor-management relations, to the cronyism, to incompetence from the bottom down, to management's lies to just about everyone to look "good", etc. I now vote Republican at the national level..but will analyze the candidates elsewhere. I am against big govt, and for private industry, with some regulatons as necessary ( enforceable). Still, with all our problems, can we compare our economic system with it's 14t GDP, with, for example,
Russia, or India, or even China, for efficiency, services, innovation,
creativity and flexibility? I do never want the government involved in our lives from the cradle to the grave. Gov has it's good points..providing for a military, insuring everyone has food and a roof, and providing some jobs. But more government..no way.