Stiglitz was SVP and Chief Economist of the World Bank. His greater claim to fame is as winner of the Nobel prize for Economics. He has also computed the cost of the Iraq War are $ 3 trillion and has documented it in a whole book.
He is the only person whose analyses of the current economic situation makes sense to me.
I like the format in his recent lecture given in Geneva ( Oct 5, 2008) and I will use it to consolidate the views that I have expressed over the past few months.
I travel a path different than his but basically end up with similar conclusions.
Stiglitz proposed four parts to his one-hour lecture:
· Diagnosis of the crisis: what went wrong?
· Why the bailout package is doomed to fail
· What should have been done instead
· The prospects for the US and Europe
What went wrong
Capitalism as practiced in the US is broken.
Greed has become the overall driving force of society
Every one is on the take and there is no recognition of conflict of Interest.
During the last decade, financial markets have generated 30% of all corporate profits in the US, there was little value for society,
Government runs a 9.3$ trillion deficit while household savings are close to zero.
The real track record of Wall Street being unable to allocate capital. Stiglitz admitted that today, the problem was larger and more systematic.
Wall Street was only concerned with maximizing resources, There was no innovation in a way that was actually beneficial to society.
Transparency was lost and we ended up with a number of extremely complex financial instruments that no one understood, not even the banks (what Warren Buffet called “the weapons of mass destruction of the financial system).
predatory lending. All the while, house prices went up and income for the average American went down during the past 8 years.
flawed probability models, as bankers only accounted for the statistical values of the past 20 or so years, completely disregarding history and thus having little understanding of the tales of probability distribution.
rating agencies were essentially paid by he same people who were supposed to be rated, thus creating a conflict of interest and a race to the bottom
The entire incentive structure was favoring an excessive risk taking scheme and a short term asymmetric compensation scheme
Inadequate regulations, which was in turn fuelled by a deeper macroeconomic problem: markets were flooded with liquidity by the FED, because the underlying macroeconomic fundamentals were faulty and based on the flawed ideology
Why the bail out will not work
The people who caused the problem are in charge of the bail out. The conflict of interest problem continues.
There is no recognition that the Political system is also broken. The special interest groups that resist real reform will resist them again and make it impossible for the right solution to emerge.
Underlying ideology. This ideology presumed a trickle-down effect and stipulates that by infusing Wall Street with cash, the wealth would somehow trickle down to the people.
The plan didn’t address the root of the problem, the foreclosures,
The bill didn’t propose an effective stimulus package for the real economy.
What should have been done.
The current Administration is not in a position to do anything except play for time, which is what they have done.
It is the next Administration who will inherit the mess.
The acknowledgement of the importance of nation states to bail out financial institutions
The need for a strong stimulus package that stops worrying about inflation (which was a concern of the past) and instead focuses on stimulating the real economy
A need to effectively address the foreclosure problem
A reversal of the tax reduction scheme
But the most essential aspect for Stiglitz was a restoration of confidence.
The days of the US as sole super power are over. Military defeats in Iraq, Afghanistan and Lebanon mean that weak nations are able to resist occupation. Without the power to exploit others, the entire definition of productivity will change.
The US is in denial about it’s lost status and will therefore be unable to come to terms with the real solution, which is an orderly withdrawal from trying to impose it’s solutions on the world. The Economic outlook is therefore very poor.
The prospects are bleak both in the US and in Europe, according to Stiglitz. However, Stiglitz ended on a positive note, mentioning that we are not necessarily headed towards a recession/depressio n, if, but only if, we used our knowledge of the past wisely.