Saturday, September 27, 2008

Stiglitz: Who is to Blame for the Financial Crisis?

Nobel Laureate Joseph Stiglitz lays out the blame:
Many seem taken aback by the depth and severity of the current financial turmoil. I was among several economists who saw it coming and warned about the risks.

There is ample blame to be shared; but the purpose of parsing out blame is to figure out how to make a recurrence less likely. ...

One can say the Fed failed twice, both as a regulator and in the conduct of monetary policy. Its flood of liquidity (money made available to borrow at low interest rates) and lax regulations led to a housing bubble. When the bubble broke, the excessively leveraged loans made on the basis of overvalued assets went sour.

For all the new-fangled financial instruments, this was just another one of those financial crises based on excess leverage, or borrowing, and a pyramid scheme.

The new "innovations" simply hid the extent of systemic leverage and made the risks less transparent; it is these innovations that have made this collapse so much more dramatic than earlier financial crises. But one needs to push further: Why did the Fed fail?

First, key regulators like Alan Greenspan didn't really believe in regulation; when the excesses of the financial system were noted, they called for self-regulation — an oxymoron.

Second, the macro-economy was in bad shape with the collapse of the tech bubble. The tax cut of 2001 was not designed to stimulate the economy but to give a largesse to the wealthy — the group that had been doing so well over the last quarter-century.

The coup d'grace was the Iraq War, which contributed to soaring oil prices. Money that used to be spent on American goods now got diverted abroad. The Fed took seriously its responsibility to keep the economy going.

It did this by replacing the tech bubble with a new bubble, a housing bubble. Household savings plummeted to zero, to the lowest level since the Great Depression. It managed to sustain the economy, but the way it did it was shortsighted: America was living on borrowed money and borrowed time.

Finally, at the center of blame must be the financial institutions themselves. They — and even more their executives — had incentives that were not well aligned with the needs of our economy and our society.

They were amply rewarded, presumably for managing risk and allocating capital, which was supposed to improve the efficiency of the economy so much that it justified their generous compensation. But they misallocated capital; they mismanaged risk — they created risk.

They did what their incentive structures were designed to do: focusing on short-term profits and encouraging excessive risk-taking.
So, here's the question for readers: Who do you blame?


  1. It's pretty obvious that the Community Reinvestment Act had a role. Bush and McCain both tried to rein in the GSE's who answer not to the SEC, but to HUD. A lesser problem was rating organizations turning the other way.

  2. The ability for the big 5 investment banks (Merrill Lynch, Goldman Sachs, Bear Sterns, Lehman and Morgan Stanley) to leverage huge sums of money was changed in 2004 by the SEC. This enabled these institutions to leverage up to 40 times their assets. The previous level was 12 times. They also changed their financial holdings so that they were much more focused on short term loans rather than looking long term.

    Here are a couple of links that describe the lead up to the bailout.

    This link is to a Princeton discussion about what caused the failure. The video is about an hour long.

  3. Here is the truth, watch the whole thing:

  4. Who's to blame, you ask?

    The Democrat Party has the most blood on their hands here. They tried to strong arm Fannie and Freddie to give money to poor people who couldn't give it back. They strong armed banks into doing it, or they would call banks "racists" and protest them.

    Who are these people? Barney Frank, Chris Dodd, and Barack Obama (who through ACORN bullied banks into giving money to poor black people).

    Those are the ones to blame for screwing us over. You can spin it any way you want, but ask yourself this.. If there was a single Republican or two that they could nail for this, don't you think Pelosi et al would be having hearings now? They can't find a single Republican to nail for this because at the epicenter of this quake stand nothing but liberal democrats.

    Vote wisely, America, or you will get indeed, more of the same.