Getting the History Right

Over at Vanity Fair, Nobel Prize-winning economist Joseph Stiglitz has a short, easy-to-read article on the major decisions that led to the current economic crisis., highlighting five that he believes are the most important:

1. Firing Paul Volcker - Federal Reserve Chairman Volcker had been successful in his position by any measure, but he also believed that markets should be regulated. Uncomfortable with that viewpoint, President Ronald Reagan replaced him with Alan Greenspan, who eventually presided over two massive bubbles - technology and housing - and in so doing, essentially failed at his primary duty: maintaining the stability of the financial system.
   


2. The repeal of the Glass-Steagall Act - Glass-Steagall was a product of the Great Depression, and was meant to "curb the excesses of that era, including grave conflicts of interest." The central mechanism of Glass-Steagall was to investment banks and their tolerance for high risk separate from commercial banks, which depend on stability. Its repeal - the result of a $300 million lobbying campaign and headed by former Senate Banking Committee Chairman (and McCain campaign adviser) Phil Gramm - led directly to the clamor for consistent high rates of return which only risky investing can produce.


3. The Bush tax cuts of 2001 - The Bush tax cuts actually did very little to stimulate the economy in the face of steadily increasing energy prices. Because of that, the Federal Reserve was forced to keep the wheels greased with low interest rates and lots of liquidity, which in turn fueled the housing bubble. Further, easy money for housing encouraged leverage, allowing those who would not normally have been able to purchase a home to not only do so, but then borrow against it, fanning the flames of over-extension and driving the household rate of savings in the United States into steeper decline, and ultimately, negative territory.


4. Faking the numbers - In 2002, in response to the collapse of Enron and WorldCom, the Sarbanes-Oxley (SOX) Act was passed in an effort to shore up public trust in the accounting numbers reported by corporations. Unfortunately, while SOX confronted the most flagrant abuses, it failed to address accounting for stock options, which in turn provided an incentive for top management to mis-report results in an effort to drive up the price of equity. This in turn was fed by the fact that the securities ratings companies were being paid by the same firms they were charged with evaluating, and the end result - manifested today in the credit market turmoil - is a crippling absence of trust in the financial system.


5. The financial sector bailout - The hastily assembled bailout package cobbled together by Treasury Secretary Hank Paulson has been a model of ad hoc reactiveness. Worse, when Treasury began providing banks with the funds they needed, it was done in a way that both cheated American taxpayers and failed to ensure that the money would be used for lending, which was desperately needed to kick start the credit markets. (Banks were permitted to continue paying dividends to their shareholders as public money was being poured money in to keep them afloat, and a restriction on limiting pay for executives at companies receiving federal dollars was removed by the Bush Administration.)

Dr. Stiglitz concludes with the following:

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.

A commenter on a previous post opined that this sort of exercise in root cause analysis can be traced simply to human greed, and amounts to little more than finger-pointing. I concur with the first portion of that statement, but take issue with the second, as does Dr. Stiglitz. In fact, he states that the purpose of his piece is to "get the history right" so as to not only avoid repeating the same mistakes in the future, but to ensure that the policies and people who have driven us to the brink are removed from the levers of power. That will only be the case if we refuse to let free market fundamentalists mythologize what has taken place.

* Regular readers of Sensen No Sen will know that I agree with this point, although I think it is important to note that Dr. Stiglitz's language is imprecise. Markets ARE, in fact, self-adjusting, but because collapses and wild swings are part of that self-adjustment, they can more properly be regarded as not TOLERABLY self-adjusting.

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Meanwhile, Mark Fiore does a wonderful job capturing the attitude of "crybaby capitalism" in the animation below: