Authors@Google: Joseph Stiglitz

Uploaded by AtGoogleTalks on 08.04.2010

>> Hi, I’m Al Verin. I’m the chief economist here at Google.
And it’s a great pleasure to introduce Joe Stiglitz. Joe and I have known each other
for longer than we care to admit. We were just comparing notes and I think the, I took
my first real class in economics from Joe in 1966 [pause] the fall of 1966. It’s hard
to believe that there was economics that long ago. [laughter] But Joe is one of the people
who’s really been responsible for, I think, changing the face of economics, where he became
the assistant professor.
All the excitement in the area at that time was about the work Joe and his collaborators
were doing on Information Economics; studying how isometric information affects the functioning
of economic institutions. And, as you know, he’s received a Nobel Prize for that work,
five years ago, or maybe or a little longer. Anyway, I’m going to cut the introduction
short because I know you are all anxious to hear. Joe is going to talk about his new book
"Freefall." Thank you.
>> Thank you very much. And as Al said, this crisis in a way is very much related to the
subject on which I have been doing research for a very long time, problems of asymmetric
information, or imperfect information. In a way, it’s sort of a case study in what
can go wrong in markets.
There have been a lot of books written and will likely to be continue to be written about
the crisis. Most of them are journalistic accounts of who did what when, who said what
to whom, and you know, what would have happened if the guy hadn’t had to go to the bathroom
at the critical moment in the negotiations, and how the world would have turned out to
be different.
My book is much more of a book about the battle of ideas. The kinds of ideas, the ideas particularly
in economics, that led to the crisis and that helped to inform the way we dealt with the
crisis; led in some cases to measures being taken that were not as effective as they might
have been. And talking a little bit, going forward, how those ideas should be, should
shape where we go from here.
In a way, economists are like doctors, we really like very sick patients and this, this
crisis is, is really good for us in that sense because the economy - this has really been
a moment of true dysfunction. Where the economy has not done very well, it really failed.
And by us trying to understand why it failed, I think we can get a lot of insight into how
economies function when they do; when they function more normally.
You know, the basic story of the crisis is, is really very simple. We had a bubble. The
bubble had sustained the economy. In fact [pause] during the period of the bubble, savings
rates came down to zero. It was clearly not sustainable, and as one of my predecessors
as the chairman of the Council of Economic Advisors, said 'that which is not sustainable,
won’t be sustained.' And it wasn’t sustained. The bubble is now broken. Savings rates are
increasing; they have already gone from 0 to 5%. If they go to historical average, it
will be 7%. The reasons to believe that it could go above that. All very good for long
term growth, good for, for people’s sense of security.
But the problem is that if people are saving, they aren’t spending. And if they aren’t
spending, the economy is weak. And it is not likely that, say that consumption will return
back to the way it was in 2007 any time soon. And it's every once in a while you hear somebody
from the administration or somebody in the market say 'the American consumers is back'.
And we should hope that that’s not the case because we can’t go back to the way things
were in 2007, and we are not likely to.
So, that’s part of the reason, only part of the reason, why, why my prognosis for the
economy is, is not very optimistic. I think it’s going to be a long haul to get us back
to normal.
But what I want to spend the first few minutes of my time, is talking about why we had this
bubble, why, why we’ve gotten ourselves into this mess. And that’s become a favorite
sport among economists and politicians from left and right, of you might call the blame
game. Who is to blame? And you can say the crisis is bad enough for a lot of people to
blame. But I’m going to try to argue it’s really the financial sector that’s really
to blame. They did, they, they messed up, and they messed up very badly. The regulators
failed, but they failed to stop the banks from doing the bad things that they were doing.
And you know, if you have a robbery, you can say that the policeman should have been there,
but you don’t blame the cop for the robbery. You blame the robber. And especially the case
if the cop was paid by somebody else to not be on the beat. It’s hard to blame the cop
and this is very much the case. The financial sector paid good money to make sure the regulators
weren’t doing what they were supposed to do. And so, we can’t really blame the regulators
for not being there.
But finally, I’m going to try to argue that, that behind the failures, particularly the
regulators but also the financial market, somebody else is to blame. And that is the
economics profession, other economists.
That the particular set of ideas that they pushed really provided some of the intellectual
framework that were used by politicians, by regulators, and led to, to the problem. So
let me begin talking a little bit about what the financial sector did wrong and why it
did, why it did so poorly.
The task of the financial sector is a very important task, but it is a means to an end
and not an end in itself. And that was, in a sense, one of our first failures. We really
thought of the financial sector as an end in itself. But the role of the financial sector
is to manage risk and allocate capital and to do what, to run the payments mechanism,
and to do this all these at very low transaction cost. That’s what an efficient financial
system does.
Well, our financial system misallocated capital. We had a lot of capital that was available
from around the world and rather than allocate most of that to sectors where it might have
been productive, you might all think that Google is an example, but there are other,
you know, innovations and technology, a very large proportion went into housing beyond
people’s ability to pay. And to put it in perspective, you know, I think no government
has ever wasted money on the scale of the American financial market, and it really was
a massive misallocation of resources.
The second thing they are supposed to do is manage risk [pause] but in fact they created
risk. They actually created uncertainty with these financial products, CDO, CDO-Squared,
credit default swaps and so forth. These innovations were supposed to help the economy become more
efficient, but as Paul Volcker's pointed out, there is no evidence that any of these innovations
led to increased efficiency of our economy. There is a lot of evidence that they contributed
to the, the failures that we’ve had.
The third thing that they are supposed to be doing is running a payment mechanism. I
mentioned this here particularly because modern technology should have allowed the creation
of electronic payment mechanism that would allow for the transfer of money. When you
go into a store, from your account, to the merchant’s account, for a fraction of a
penny. It should have cost us almost nothing. That’s what a modern electronic payment
You may not know it, but every time you use your debit card or your credit card, the merchant
has to pay Visa or MasterCard or American Express 1%, 2%, 3% or more of that transaction.
And they are not allowed to let you know what they're paying. But you are paying because
its increase is part of the transaction and inevitably gets passed on to you. And it generates
literally tens of billions of dollars of profits to the banks, but it’s a kind of exploitation
of their monopoly power.
They are supposed to do all these things, which they didn’t do, but they are supposed
to do all these things at low transaction costs. And our financial sector did it at
very high transaction costs. About 40% of all corporate profits went to the financial
sector in the years before the crisis. They were really garnering from the rest of the
society huge amounts for not doing what they should be doing. Well, that's not the way
a market economy, a capitalistic economy, is supposed to operate.
So you ask, why did it fail so badly? And part of my book is trying to describe this
process like, oh, peeling back the onion where, where every time you get an answer, there
is another question exposed by that answer. In this case, there's an obvious answer, at
least to an economist; and that is that there were flawed incentives. The banks had incentives
for short sighted behavior, for excessive risk taking, [pause] for trying to generate
high transaction costs.
But then that, that raises a new question. Isn’t a good financial system, isn’t a
market economy supposed to generate the kinds of incentives that actually make it work?
That’s one of the things that we try to pride ourselves. Market economists are creative
in the incentive structures.
Well, the answer to that is a whole set of other issues related to theories of agency.
You'll have to read the book to get the full answer to all these, these questions. But
it lies in, in problems that are more broadly called corporate governance, the way modern
corporations are organized. That they are different from 19th century capitalism where
there was an owner who makes the decisions. Modern corporations, the people who own it
are not the people making the decisions, for the most part. There are exceptions, but for
the most part that’s not true. And there is a separation between ownership and control,
and that league means that there are distortions even in the area of creating incentive structures.
So if you look at what happened to, say, to some of the major banks, the shareholders
did very badly, the bond holders did very badly, but who did very well? [Pause]The,
the, the managers of the banks. Even when the banks lost enormous amounts in value,
they walked off with hundreds of millions of dollars, which they kept, or billions of
dollars which they kept.
Well, this is a brief synopsis of why the financial sector performed so badly. The regulators,
this has happened over and over again, and there was only one period in the history of
capitalism in which we, these problems have not been recurrent. And that was the three
decades or so after the Great Depression when we introduced the set of regulations that
actually worked, and they prevented crisis from occurring.
But then we forgot about that. We thought we had created a new economy. We were so much
smarter than the past and so began the process of deregulation, particularly under President
Reagan. The, not only did we deregulate but we didn’t adopt new regulations. I should
make it clear this was bipartisan. Some of the, I describe here, some of the fights that
we had in the Clinton administration, where I opposed for instance the repeal the Glass-Steagall
Act; this was a law that separated commercial banking from investment banking. Commercial
banking is supposed to take money from ordinary citizens and invest it conservatively, because
when you go to the bank you want to be able to get your money back. And, you know, sort
of like when you put your card into the ATM machine and it says 'insufficient funds',
you want it to be because you don’t have enough funds in your account, not because
the bank doesn’t have enough funds in there, in the bank.
So, we passed the Glass-Steagall Act in the midst of the depression because it was realized
that mixing these two was very dangerous; [pause] the gambling kind of banking. We don’t
want to mix with the conservative banking, with the boring banking. There are conflicts
of interest and there was a third problem by allowing these banks to mix together, you
get bigger and bigger banks. And as banks get bigger, we have a problem you call 'too
big to fail'. If you are too big to fail, you have the real risk that if you gamble,
[Pause] if you win, you'd walk off with the proceeds. If you lose the tax payer picks
up the tab, exactly what happened?
So, all these were concerns that we discussed in the, in the Clinton administration. And
so, I opposed it. Treasury representing some people who, who had done very well by, by
this whole process advocating very close to Wall Street, and unfortunately, most of the
concerns that were raised have turned out to be, to be true.
Well, [Pause] it wasn’t just a question of deregulation. It was also a question of
not adopting regulations to reflect the new product, the new world. Like, like how, what
do you do with derivatives and credit default swaps?
That raises then the next question. Why did we not only fail in regulation, but failed
in getting the right regulators?
We had regulators who didn’t believe in regulation. That was not an accident. Paul
Volcker, who’s gotten a lot of attention recently, was the chairman of the Federal
Reserve in the period of the early days of eighties. And in terms of what central bankers
are usually graded on, he would have gotten an A+ because he brought down inflation from
double digit levels to a very low levels. But in return for this service to the country,
President Reagan fired him. And you have to ask, why? And the answer, at least from some
sources, is very clear. President Reagan wanted somebody who did not understand, believe in,
regulation. Paul Volcker understands the need for regulation, so he’s fired and they found
somebody who didn’t believe in regulation; who would help push through the repeal of
the Glass-Steagall, and that was Alan Greenspan.
But we should be clear, you know, one of the points I try to make in the book. A lot of
attention in a lot of the others books, a lot of the popular discussion, focuses on
the role of Alan Greenspan or the role of one other, you know, somebody else. What I
try to point out is that if Alan Greenspan hadn’t been there, Reagan would have found
another person who didn’t believe in regulation to be the regulator. And we would have probably
been in a very similar kind of mess that we are in today. That we shouldn’t focus too
much on particular individuals.
Well, that leads to the question. Why did, why did this occur? And two obvious reasons.
Why did the deregulation, appointment of people who didn’t believe in regulation occur?
And the obvious answer is two-fold. One of them is that special interest, the banks thought
they were making a lot of money, and some of them were making a lot of money off of
this deregulation - stripping away the constraints. And they paid a lot of money to get, to get
rid of them. There were five lobbyists from the financial industry for every congressman.
So they can’t escape with somebody telling them what they should be doing. There are
also major campaign contributors. All this is actually fairly well known, pretty obvious.
The second role, part of the explanation is the role of the economists and the ideas that
they put forward. A particular idea was that markets are self-regulating, are self-adjusting,
self-correcting. So you didn’t need government. It just got in the way and contributed to
the inefficiency of the economy. Well, we should have known that that idea was badly
flawed because we had something called the Great Depression. There are other instances
where the economy has not worked very well, other areas where it hasn’t worked very
well. But those were swept aside.
Now [Pause] one of the important ideas, probably one of the most important ideas in economics
is Alan Smith’s ‘invisible hand’. The notion that the pursuit of self interest leads,
as if by an invisible hand, to the efficiency of the overall well-being of the economy.
It’s a wonderful idea, if it were only true. It’s a wonderful idea because if it were
true, you would never have to ask any questions about ethics. All you’d have to do is to
say, 'what’s in my self interest?' And by understanding what is in your selfish-self
interest you would be doing the best for the rest of society. So, the only immoral thing
would be not to be selfish enough. And that really makes a lot of people feel very good.
You know. So, so this is really, this is, is as I say, the most important idea, I think,
in, in, in modern economics.
Well, [Pause] not surprisingly, economists have since Adam Smith put this idea forward;
have trying to understand the circumstances, the sense in which this idea is true. Some
of the really important work on this is done, is done by Ken Arrow at Stanford and Gerard
Debreu at Burkley.
One of the, Bruce Greenwald and I, a colleague of mine at Columbia, proved a very strong
result. We showed that whenever there is imperfect information, asymmetric information, which
is essentially always, then the reason that the invisible hand often seems invisible is
that it’s not there. That is to say, the economy, that this assumption that the markets
are efficient is just not true. And, I think; now people really are beginning to understand
that. I don’t think many people would say that the [pause] pursuit of greed by the bankers
has led to the overall wellbeing, efficiency of our economy. I don’t think you would
find anybody defending that proposition today.
So, that’s an example of, of where a certain set of ideas that free markets and federal
markets always work, is really, was already, undermined by research in economics. But unfortunately
many of the regulators, many of the people who were pursuing what I call the 'conservative
agenda' ignored these results. Another idea that has been very influential
throughout the work that was done at the University of Chicago by Gene Fama and others, talked
about the fact that markets are informationally efficient. That is to say that they transmit
information from the informed to the uninformed perfectly. [Pause] Now again, that was an
idea that, a very powerful idea, that markets are informationally efficient. It should have
been obvious. It’s not true. But [Pause] in some work that I did at Stanford a number
of years ago with Sandy Grossman; what we showed is just illogical proposition. What
we pointed out was that if it were true, nobody would have had any incentive to gather information
because somebody who didn’t spend any money gathering information would have all the information,
that somebody who spent the money. But if that were the case, nobody would spend any
money gathering information. And if that were the case, the markets might transmit a lot
of information, might efficiently transmit information, but we’re transmitting no information
because nobody would be gathering information. So, the market would, in fact, be very inefficient.
Well, these are again examples of the logical and empirical statements that had undermined
before the crisis, before the eighties. The belief that should have undermined the belief
that the markets always work efficiently. But those who were wedded to that belief really
swept aside these basic results. The crisis itself and the behaviors that we see in the
run-up to the crisis really illustrate a lot of market irrationalities. A lot of examples
of what might be called cognitive dissonance; of behaviors that are hard to reconcile with,
with any kind of rationality. Let me just give you a couple of examples. One of them
is that [Pause] they assumed that they were; those in the financial markets were assuming
that they were innovating in ways that were transforming the market dramatically. And
that was why they deserved very high salaries. But then they had a problem, because after
they created these new products, they had to estimate the risks associated with the
products. And where could they get data to estimate the risk? What they had to look at
[Pause] data, say for foreclosure, the innovations I'm talking about were like a new mortgages,
they had to look at foreclosure rates before they had done these innovations.
So, on the one hand, they believed that they had transformed the world. On the other hand,
they used data as if they had had no effect on the world. But, in fact, they had had a
very big effect but it was all for the worst. They, the mortgages that they had innovated
were mortgages that had much higher probability of foreclosure and predictably so.
There were many other instances. Let me give you one other that, that, two others that,
illustrate the sort of the intellectual incoherence. [Pause]One of the things that, that Alan Greenspan
advised Americans to do was to take out variable rate mortgages. Some of you may have variable
rate mortgages. Mortgages that the interest changes when the, the payments you make change
when the, when the T-bill rate or some other interest rate changes. [Pause]If you believe
in efficient markets, which is what Alan Greenspan said he believed in, the interest rate that
you pay on that kind of mortgage is on average the same as the interest you pay on a fixed
rate mortgage. Markets basically average out everything, so you can’t beat the market,
and that’s one of the basic propositions of efficient markets.
But he advised people to take out variable rate mortgages and the argument he gave was
that ten years earlier, if you had taken out a variable rate mortgage, you would have done
better than you would have with a fixed rate. Well, there’s a good reason for that. And
that was that markets always look at historical experience, and historically, interest rates
had never come down to 1%. But Greenspan brought them down to 1%. So he was the reason that
they were doing very well because he had broken what had been the historical pattern by bringing
interest rates down to this abnormally low level.
But if interest rates are 1%, what can you predict that they are likely to be in the
future? Well, you can be pretty sure, you don’t have to have a PhD to figure out they
are not going to go much lower than that. They are not going to go, but they could go
much higher than that. So, you are exposing yourself to a very high risk of interest rates
rises, which would, if you were fully [pause] you know, if you borrowed as much as you could
for the variable rate mortgage. If the interest rates rose as they predictably would, you
would be in a very tight, tight spot. And if you, or other people started to, couldn’t
manage the mortgage and you tried to sell your house, what could happen?
The price of all the real estate would start collapsing. You were told 'don’t worry about
rolling over your mortgage, or refinancing your mortgage because prices are always going
to go up.' You should have known that that wasn’t persuasive because they can’t go
up forever, particularly when most American's income was going down.
In 2008, for instance, real income, oh in the median, people in the middle, were 4%
lower than they were in 2000 adjusted for inflation. There have been a lot of, there
have been increases in GDP per capita, but all that went to the top 20% and the other
80% were either stagnating or declining. So, it was quite clear that you could not go through,
that you could not bet on market house prices going up forever. And particularly you couldn’t
bet on that if interest rates rose, which would be exactly the condition where you would
want to, when you might need to refinance or sell your house and buy another one, and
Well, here you had the guy who was supposed to be the expert on risk management not understanding
the implications of efficient markets, even though he claimed to believe in it; giving
people the wrong advice. What he should have focused on was a simple thing. You can’t
beat the market, [pause] especially if you are a first time home buyer who’s not spending
most of your time forecasting interest rates.
The difference between variable rate mortgages and fixed rate mortgages is a very simple
one, risk. And the question is who bears the risk? And it should be that ordinary homeowners
should not bear the risk, it should go to the market. So, he was giving exactly the
wrong advice. And, you know, it sort of makes you very worried when the people at the top
who are claimed to be the experts don’t know it and when all the people below them
are repeating that kind of advice.
Well, as I said, I could go on lots of examples of this kind of, what could only be described
as stupidity that was pervasive in the market. [Pause] This then got translated into a whole
set of policy frameworks. People like Greenspan, when people said that there couldn’t exist
bubbles, because they believed markets were efficient. If there was a bubble, it would
be evidence of a kind of irrationality and it was an almost religious doctrine for them
that, that couldn’t exist. So, when asked whether there was a bubble in the market,
he said, 'No, no, no it’s just a little froth.' And then he went on to say, 'Well,
in effect even if there's a bubble, we can’t be sure. We don’t know, we don't have any
instruments to deal with it, and in any case, it’s cheaper to pick up the pieces after
the bubble breaks.'
Well, I don’t think anybody would agree with that now. The cost of the breaking of
the bubble is literally in the trillions of dollars. It was a really very major mistake.
And all these propositions that are given are really very flawed economic propositions.
But let me say, it’s not just Greenspan and Bernanke, but a lot of other people who
were behind that, who were pushing these ideas.
Well, that brings me down to the, to where we are and where we ought to be going [Pause]
we have to stop at about what time?
>> [inaudible]
O, I have a little time for questions, so let me, [Pause] three, three issues going
forward. It’s very clear that the economy is not [Pause] in good shape. Growth has resumed,
but [Pause] for most Americans, the issue. Recession is not over as long as they can’t
get jobs, the unemployment; the official unemployment rate is just short of 10%. But more relevant
indicator is that more than one out of six Americans who would like a full-time job can’t
get it. Unemployment rates among particular demographic groups like Afro-American youths
are up almost 50%. The, more and more of the unemployed are long term. More than six months
are more than 40%. Something that we haven’t had in the United States.
Mortgage problems are continuing. The number of mortgage foreclosures are expected to be
higher this year than last year. So the problems are actually getting worse. There are new
problems beginning to show up in the commercial real estate. The states are having very serious
time make, meeting their budgets and the cut-backs coming for, coming on. All these are, are
reasons that I am pessimistic that there is going to be a quick recovery. In fact, may
the forecast say that we won’t be back to normal unemployment until the middle of the
decade and I think that’s probably rosy scenario.
The, so that’s why one of the first, I think we need a second round of a stimulus. [Pause]
The first round worked, it just wasn’t small enough, big enough. [Pause] I and many others
thought that we needed a stimulus of one trillion or more. The President wasn’t given that
choice, even though his own chairman at the Council of Economic Advisors argued that we
needed around 1.2 trillion. He was not posed, he wasn’t given that choice. It was narrowed
down to 800 or 600 billion dollars. He thought, or his advisors thought, the unemployment
rate was going to be 10%, and with the stimulus would be brought down to 8%. They say the
stimulus worked. Without it we would have had unemployment of around 12% and brought
it down to 10%, but that’s still much too high and it’s not going to be going down
any time quickly. So, I’ve been very supportive of, of, of a second round of a stimulus. [Pause]
When President Bush first began dealing with the problem, or not dealing with it, we threw
a lot of money at the banks, but didn’t do anything about the mortgages. And in my
mind, that was sort of like giving a mass blood transfusion to a patient suffering from
internal hemorrhaging and not doing anything about the internal problem. [Pause]
What the Obama administration finally did something, but it was again too little, which
is why the number of foreclosures is expected to be between two and a half and three and
a half million this year. And the problem was he didn’t do anything about the central
problem, which is one out of four mortgages are under water. That is to say people owe
more money than the value of the house. And he didn’t want to do anything about that
because the banks didn’t want him to do anything about that. The banks didn’t want
him to do anything about that because they want to live in a fiction that these mortgages
are perfectly fine. Any restructure in the mortgages would make them recognize the losses.
What they told, what they successfully did is get a change in accounting standards so
that they can pretend that these mortgages that were, even mortgages that were not up
to date, could be treated as if they would be fully paid.
So, that’s a second thing that we clearly need to do something, do something about.
In my book, I proposed something particular, what I call 'homeowners chapter eleven'. A
new form, a rapid form of financial re-organization for homeowners.
And the third part is dealing with the banks. [pause] When we were pouring money into the
banks, we didn’t have any vision of what kind of a financial system. We should have
known that we needed to downsize the financial system, but as we down side it, downsize it,
we want more of the money. We want the banks that actually do lending, the banks that,
the venture capital parts of our financial system we want to strengthen and parts of
it that are involved in speculation we want to reduce.
But what did we do? We poured money into the big banks that do speculation. And we let
140 of the smaller banks go bankrupt last year alone. So, the result of this is that
we have a more dysfunctional financial system. The 'too big to fail' banks are even bigger.
The problem has gotten much worse and the result of that is that, [pause] the problems
that we had have not gone away.
Finally, I began by talking about the failure of regulation to stop the banks from behaving
badly. We haven’t reformed the regulation, regulatory structure at all. [Pause] The proposals
that originally came out of the Obama administration and out of the House were totally inadequate.
The fortunate thing, the last month, the President Obama began to talk about some more effective
regulation dealing with the too big to fail banks, dealing with the conflicts of interests,
but not dealing with some of the core problems, like the problems of credit default swaps.
These are the things that got AIG into trouble. And just to give you one picture of how important
this one little piece is and they say that it’s a lot of complexity but one little
piece. American taxpayers gave AIG almost 180 billion dollars. And that’s a mind-boggling
Now when I was in the Council of Economic Advisors, we would debate for hours and days
[Pause]a school rebuilding program that would cost a few billion dollars, and we in the
end, people like Reuben said, 'We can’t afford to, to rebuild our schools in the inner
cities. We just don’t have enough money.' And we are talking about miniscule amounts
compared to what went to one company in, in, in a short period of time. It’s equal to
all the foreign aid that we’ll give to Africa over a quarter of a century. It is equal to
all the foreign aid, to all the countries of the world, from all the rich countries
in the world over a period of two years. And that just went out, without us having anything
to show for it.
So, that problem, having to do with the credit default swaps, nothing effective has been
done. The concern that I have is that [Pause] because we haven’t addressed these problems,
the likelihood is, there is a real risk that we will not only not recover as quickly as
we could have. That we risk another kind of crisis, such as the one we have in the not
too distant future. And that’s why I think it’s so imperative that we begin to have
a national debate. A more effective debate on, on what we can do to address what I think
of are some fundamental problems in our economy.
Let me open up for questions.
>>Male: [Inaudible]
>>Male: [Inaudible] We don't have a mike to pass around.
>>Stiglitz: Okay.
>>Male: If you could repeat some of the questions afterwards?
>>Stiglitz: That's fine.
>>Male: [inaudible] and just to start it off [inaudible] Actually, I’ve heard a lot about
the Glass-Steagall Act playing a key role. Do all we need is all we need to bring that
back or are there; do we need something much more modernized?
>>Stiglitz: OK. The Glass-Steagall Act is ... the question is, should we just bring
back the Glass-Steagall Act? For those of you who don’t remember, or don’t know,
the Glass-Steagall Act, it was what separated the commercial banks and investment banks.
And [Pause] as I said before, the repeal of that was something that I opposed and really
does pose a lot of risk to our economy. But [Pause] the world of 2010 is markedly different
from the world of the 1930s. And so, what was adequate then or appropriate then is not
adequate, you know, seventy, eighty years later. So, in my mind, we need to do something
along the lines of the repeal of the Glass-Steagall Act. And that’s some of the things that
Paul Volcker's has been advocating. Things like, for instance, not allowing the commercial
banks to engage in speculation on their account with the risk that if they fail we’ll pick
up the tab. Next that, this is called 'proprietary trading' by the banks. He's absolutely right,
but it’s only one fraction it's a third of what needs to be done.
There’s still a problem of too big to fail banks. There is still the problem of the credit
default swaps; there's still problems of excessive leverage. So there is a whole other series
of problems. It’s necessary but it’s not sufficient for addressing the problems that
we face.
>> Male: [inaudible] is there a shortage of long-term understanding on the part of policy
makers? You talked a [inaudible] little bit about the banks and the [inaudible] lobbyist
that they've employed. [Inaudible] I mean, do you see a lot of leadership in either Congress
or in the Executive Branch that, you know, understands [inaudible] these problems and
sees things [inaudible] long term beyond the [inaudible] six or [inaudible] twelve month
interactions? >> Stiglitz: The question was, are there many
people in the policy-making circles and in the, in Congress who understand what needs
to be done? Whos understand particularly a long term view of where we should be going?
I think the answer to that is, there are a few [chuckle] people who do understand this,
but relatively few. As I say, one of the real concerns that I’ve had is that almost nobody,
either in Congress or in the administration, has tried to articulate a vision of what kind
of a financial system we want. What, where do we? What, what, what is a financial system
supposed to do? And if you don’t know what it’s supposed to do, it’s very hard to
know how to reconstruct the one that clearly failed to make it more likely do what it should
be doing.
And, you know, just to pick up something that many of you may be aware of that I mention
very because you are, you know, so focused on technology. An electronic payment mechanism
is a simple function that we ought to have. No discussion of why it is that America doesn’t
have an efficient electronic payment mechanism; [pause] years after modern technology should
have allowed this to happen. So, that’s an example where, where, where I don’t think
there just a beginning of an awareness of these issues.
Part of the problem is also though that many of the people have quite, quite plainly been
overly intellectually captured, to put it in the best front, or bought, to put it in
the least, by those in the financial sector. So, for instance, let me give you, you know,
I can give the speeches of those in the financial sector just as well as they can. So, I'll
tell you, you know, for instance, after I have talked about the need for regulation,
they'll say, yes, but we have to be careful with innovation, and that sort of, you know.
You can understand the politicians understanding good words like regulation and then innovation.
You can, nobody wants to let the pendulum swing too far the other way.
Well, that’s where I keep emphasizing. Look at the sector actually resisted innovations
that would have been well for enhancing. And I saw that very clearly, for instance, when
I was on the Council of Economic Advisors. We proposed introducing inflation index bonds.
The notion was very simple. That if you are saving for retirement that’s 30, 40, 50
years away, you don’t know what inflation is going to be. And there is no product in
the private market that will insure you against that.
So, we proposed that the government produce a product that would provide inflation protected
bonds. Believe it or not, the private, the financial sector resisted this idea. And at
first I scratched my head and said I understand why you may not be innovative, but why do
you resist innovation? And the answer was very simple. People buy these and hold them
for their retirement. It’s a good thing, but not from the point of view of the financial
sector because they make money from fees. And if you buy and hold for forty years, you
are not buying and selling. If you are not buying and selling, you are not generating
fees, and that’s a bad product.
So, you know, the conflict of interest is, is very clear. So these are the people talking
to the politicians and I remember, you know when, say when I was pushing for this, they
would say, Oh, you are going to have a party and nobody is going to come to it. It’s
going to be a total flop. It’s actually been a very successful product and it would
be more successful and it will likely be more successful now that anxieties about inflation
are increasing.
So, I guess in the end what I’m saying is I think there is awareness of a few people
that we need to get long term, a longer term focus. But it’s relatively few people and
unfortunately a lot of the rhetoric of Wall Street has seeped down into the politicians
and they bought it.
>> Male: [inaudible] So, it seems like the proposed regulations is to make or to like
stop [inaudible] banks from getting too big to fail. But to me that kind of [inaudible]
institutionalizes the concept of if they fail [inaudible] we'll still pick up the [inaudible]
pieces, if they manage to get around whatever regulations [inaudible] we put in place. How
do we put in place like the ability for them to fail no matter what?
>> Stiglitz: You know, that's a very good question. The question is, rather than talk
about stopping banks from becoming too big to fail, how do we tie our hands, so to say,
no matter what your size if you fail, you fail?
And the answer to that is, there is no way that you can do that. And that flawed, that
way of reasoning has been very strong in the administration and some people who in some
of the banks. They say, especially some of the very big banks, they say, right now, 'You
should be tough with us! If we fail, particularly if my rival fails, you should let him die.'
And they are very explicit. 'We believe in death for bad banks.'
They say that now, but I can tell you what happened, will happen when they actually go
on the verge of failure, because I saw it. What they say is, you know 'Don’t save us
for our own sake but you have to understand if you don’t save us, there will be tremors
in the market, the market will collapse. 'And we heard that from our politicians who are
saying, you know, Geithner and Obama said, 'we are not saving the banks because we love
the banks. We are saving the banks because we have to do that to save the economy.' And,
you know, for those of you who understand economics it’s called the difficulty of
having exposed commitment. You, there is no way you can really commit yourself after the
event, not to bail them out. And what was so striking is that in this recent episode
we’ve seen really bad manifestation of this where [pause] it was very clear we needed
to save the banks because saving the banks would, if we hadn’t done that they would
have caused tremors.
But we could have used the ordinary rules of capitalism; ordinary rules of capitalism
say if a firm can’t pay what it owes it goes, the bond owners become the new shareholders.
The shareholders get wiped out. And in the case of a bank, if the bond owners don’t
have enough then the government puts in money to pay the depositors and the government then
owns it until it sells it. Okay? That’s the way it’s done all the time, we did it
in Continental Illinois, we do it all the time. But what we did in this crisis, the
guys from Citibank, the guys in Obama’s administration said [pause] 'if you do that,
the market will freak out.'
So what you have to do is not only save the banks but save the bankers, the shareholders,
and the bond holders. Citibank had 325 billion dollars of long-term debt. If we had converted
that debt into the new shareholders, we would not have had to pour money into Citibank.
But what they said was, it was totally extraordinary, it was breaking the rules of capitalism. What
they, what they did is, they said if we did that, it would cause all kinds of turmoil.
And so, we know that they'll say exactly the same thing.
They talk about creating living wills, a planned resolution. Again, a living will is perfectly
fine when everything is normal. But when banks go bankrupt, it’s not normal. And so what
you plan to do, the guy that you are planning to sell it to won’t be around when you plan
to sell it, when the whole market is collapsing. So, I feel very strongly that the only way
of addressing this is to stop the too big to fail banks.
The other point about the too big to fail banks is that it totally distorts the marketplace,
because the markets believe, and again nothing that you say will make a difference, the markets
believe that they will be bailed out. If a market believes that, what would that mean?
They can get access to capital lower interest rates. What does that mean? That means they
get to grow, not because they are more efficient, better in anything other than being big. And
so, what we're getting is more and more growth in the dysfunctional big banks at the expense
of everybody else, and it’s a, it's a, it's a destructive, dangerous dynamic. And that’s
why you really have to take strong action. Obama is proposing a tax on the big banks,
especially on the highly leveraged big banks. But I think that’s not enough because these
banks are not necessarily run by their shareholders: they are run by their managers, and they like
bigness. And so, even if the shareholders suffer, they are likely to push it forward
>> Male: [inaudible] we took questions before the talk and decided they were [inaudible]
voted up or down in popularity. The most popular one was [inaudible] saying that it was reported
that Obama's Stimulus Package was not, [inaudible] was not enough, and that's well backed-up
in your book. But are you concerned at all, that, are you concerned about our [inaudible]
debt levels? Are you also concerned about [inaudible] effectively endorsing [inaudible]
wasteful politicians?
>>Stiglitz: I’m certainly against endorsing wasteful politicians. Am I worried about the
debt? Yes. But, let me first point out that this way of framing the question is a little
bit misleading. In the context of any firm [pause] you don’t look at the debt. Anybody
looking at a firm looks at the balance sheet. In the balance sheet you look at the liabilities,
you look at the assets; you look at the difference, which is the net worth. And when the liabilities
go up and the assets go up [pause] and the assets go up more than the liabilities, you
say; fine the net worth is increased. So, only in the public sector do we have a financial
market that’s supposedly smart. That only looks at one half of the balance sheet. So,
the lesson of this is, it depends on how we spend the money. If we spend the money for
investments, then it’s a good thing.
Now, the banks, as I said repeatedly, were very short sighted in the run-up to this crisis
and unfortunately, this financial markets are continuing to be short-sighted. We should
be concerned about the long term national debt, not the short term. If we spend money
on investments, they will stimulate the economy in the short run, but the investments will
also grow our economy in the long run. And you can ask the question, [pause] what rate
of return do we need to get on our investments in order for the tax revenues that we get
from the short run growth and from the long run growth lead to an actual reduction in
the national debt in the long run? And the answer is a very low return; only about 5
or 6% return on investment, in public investment, will lead to a long term lower national debt.
And the evidence is that the returns from investments, for instance in, in public technology
are much much higher.
So, I think it’s really, pretty clear that it is foolish to cut back on those kinds of
expenditures, which stimulate the economy in the short run and grow the economy in the
long run.
Now the implication of the worry about the deficit is exactly the last part of your question.
We should be encouraging spending that yields returns. So, if from that point of view, two
clear examples of foolish spending was when we gave money to the banks, [pause] got back
67 cents on the dollar, and didn’t put conditions on them that encouraged them to lend. That
was wasteful money. And so, the one big instance of waste money that we’ve had is to the
The other big example in my own mind is war; military expenditures. We’ve been spending
hundreds of billions of dollars a year on weapons that don’t work against enemies
that don’t exist. Its good thing the enemies don’t exist given that the weapons don’t
work, [laughter] but the fact is we can have more security for less money. So, that’s
another example, and no matter what your view on this is, these spending, this kind of spending
doesn’t increase the economy in the long run. So, yes I worry about the deficit, but
it should be to encourage us to think about how we spend the money.
>>Male: We have time for one more question.
>> Male: [Inaudible] Republicans that are encouraging tax cuts with growing the economy.
And obviously you mentioned that, but what is your thought, exactly, on tax cuts? [Inaudible]
Obviously, [inaudible] take money away from the government, but to increase the stimulus
again, [inaudible] private market, [inaudible] private economy, [inaudible].
>>Stiglitz: The question was the role of tax cuts in stimulating the economy. [pause] There
are two kinds of tax cuts; household tax cuts and investment tax cuts. Let me separate those
two, the kinds of tax cuts that were, most of the tax cuts that were in the stimulus
package, were in President Bush’s stimulus tax package in February 2008, those are very
ineffective. And the reason is pretty obvious. The reason they were intended to stimulate
the economy. And one thing about a stimulus is, you have to spend the money. And if you
don’t spend the money, it may make you feel better; you pay off your debt. When I say
spend it, spend it on goods, not deleveraging, not getting rid of your debt. So they spent
it on these goods, they, they [pause] they didn’t spend it on goods. They, they, they
paid down their debt. They put it in a bank account. There were high levels of anxiety
about their financial positions, for good reason. But all that meant that roughly only
about 50% of it was spent. And the result of that is that they were very ineffective
in stimulating the economy.
The other part of tax cuts or tax credits are those focused on link. Very closely linked
between spending and the tax cut. An investment tax credit is that kind where you say to a
firm, if you spend money on investment, we will pay part of that cost through a tax credit.
Or if you hire a worker, then we will pay part of that cost through a tax credit. Now,
those at least have a clear link between the tax cut and the private spending, and they
have at least the potential of stimulating the economy [pause] even if they have some
effect, as you say, on the deficit. There’s a big, there’s a lot of controversy about
the magnitudes of those responses both in creating jobs or in stimulating the economy.
But I think in at least some areas - particularly when they are well designed in that there
are proposals for what are called incremental or marginal investment or jobs tax credits.
So that one of Obama’s proposals is to say to firms: if you hire more workers than you’ve
hired in the past, then you will, we will pick up a part of the cost. And those can
be effective. So, in my mind, the household tax credits are not a good way. And part of
the reason I don’t think they are a good way is, even if they worked, they are reinforcing
the problem that America had, which was excess consumption. And one of my criticisms of the
stimulus is that it should have been shifting us towards a new economy, where, with the
view of where we want to go. And we don’t want to go back to 2007 where we consumed
too much. There are whole new set of things. And that’s why I like the investment kinds
of tax credits because they are saying, we ought to, especially the green investment
tax credits, how are you going to re-shift the economy? That’s the direction. And providing
a little impetus in that direction.
>>Male: Thanks very much and can we get a [inaudible] big round of applause?