Interesting article in Vanity Fair, Capitalist Fools, by Nobel prize winning economist Joseph Stiglitz, traces our financial crisis to terribly flawed ideology — one that says markets are self-adjusting and that the role of government should be minimal. Stiglitz reports on Alan Greenspan’s testimony on Capital Hill this fall where, finally, Greenspan admits his ideology of unregulated markets was terribly wrong and the source of our financial crisis.
Stiglitz says that it is important to understand the history that brought us to our present crisis. He writes: “Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.”
He says, “Mistakes were made at every fork in the road—we had what engineers call a ‘system failure,’ when not a single decision but a cascade of decisions produce a tragic result,” and outlines five key developments in the history of the crisis:
No. 1: Firing the Chairman
Stiglitz writes, “In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. But Volcker understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand. … If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.”
Stiglitz writes that regardless of the well known dangers of derivatives — Warren Buffett early on called them ‘financial weapons of mass destruction’ — “the deregulators in charge of the financial system decided to do nothing”
No. 2: Tearing Down the Walls
Stiglitz writes, “In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. … When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risk taking. …
“In April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process…. As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives…. Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done.”
No. 3: Applying the Leeches
Stiglitz writes, “Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches…. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods.
“The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.”
No. 4: Faking the Numbers
Stiglitz writes, “On July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act…. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options…. Stock options provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
“The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings.”
No. 5: Letting It Bleed
Stiglitz writes, “The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself….
“The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.”
“The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.”
Joseph E. Stiglitz, a Nobel Prize winning economist in 2001, is a professor at Columbia University. He was Chairman of the President’s Council of Economic Advisors from 1995 to 1997 for Bill Clinton. He is also the former Senior Vice President and Chief Economist of the World Bank.
You get what you pay for. Pay people to cook the books and they will cook them. One point here is this is what you get when you tilt the wealth scales in favor of the rich, as Bush did. The other issue is that this is global wealth that runs around looking for the highest value that they appear to be getting, first to Dot Coms and Enrons, then to US housing. Where is next?
It can be difficult to find the light at the end of the tunnel when dealing with tight financial situations. Many feel burdened down with debt and things seem completely impossible to overcome. However, there are tools such as payday loans, credit card balance transfers, credit negotiating strategies and more that you can utilize to lessen or consolidate your debt. For example, payday loans are short term loans with a reasonable fee amount and are usually no longer than two weeks in length. This allows consumers in need to avoid excessive penalties for late payments with other creditors. Let’s say that you have a hundred dollars left on an auto loan or home mortgage payment, a payday loan would be the best alternative if you need immediate help to pay it off. Being late with payments on things like these can cost you as much as $75 on late fees. However, a $100 payday loan would cost between $15 and $30, leaving you a savings of $45 to $60 in late payment penalties. Another great way to help reduce debt would be to use balance transfers with existing credit providers. If you’re fortunate and have a reasonable credit score, you should be able to find a credit provider that will permit you to transfer over your high interest balances. You will enjoy a zero to 3% APR for a term ranging from six months to the life of the transferred balance. In this way, you will have an easier time paying down your debts quicker and eliminate high interest payments. The third thing you must be aware of is the fact that you can negotiate with your current creditors. Creditors are like a hungry pack of wolves competing for your business. They will do surprising things to keep you on board with them. Simply placing a call to your creditor and telling them that you have a better offer or rate somewhere else, you might be able to persuade them to fight for your business, which could lead you to a beneficial money savings solution. There are many things you can do to save money and pay your debt down a lot quicker – just do your homework. The sooner you do, the better. Avoid paying minimum payments on your debts. Paying only the minimum could keep you in debt for years. On a thousand dollar balance with an $18 annual percentage rate and a 2.5% minimum payment, it could take you almost thirteen years to pay off your balance! Get a strong hold on your finances – the sooner you act, the sooner you’ll reach the finish line to debt-free.
Payday loans? They have reasonable fees in Ohio because the industry lost their referendum on the law that stopped letting them charge 391%. They are still 28%, a large amount, although perhaps better than penalties from other lenders. And internet providers may try to charge 391%. Juggling balance transfers, essentially credit cards with broef teaser rates, is only good if you have a lot if discipline and have a way to pay off all of your debts. Teaser rates on mortgages were a prime source of the meltdown that has sent the economy into a downturn. Credit cards have sort of driven the “trick and trap” finance industry since lenders can hole up in states that want to attract them, and do virtually anything. Debt for anything other than a convenience while you pay all your debt monthly, or a long term investment that accords with your long term income and use of the item you are investing in, is exceptionally dangerous. We can not finance a consumer lifestyle with borrowed money and not have to pay the piper.
I agree with much of what Stiglitz says, but his effort to blame only Republicans is preposterous. The Community Reinvestment Act contributed significant to our economic woes. I most strongly agree with Stiglitz when he states that stock options as now practiced, are an invitation for “creative accounting.” We need to required the options be based on a longer term to incentivize CEOs to take into account the long-term effects of their actions.
The Community Reinvestment Act was not a factor in our economic woes. It only applies to depository institutions like banks and thrifts, while most of the problem subprime lending was by lenders that were not depositories, that is were just piles of money and not people’s accounts given for safekeeping. Something like 1 out of 4 subprime loans was by a lender regulated by CRA. The CRA did not provide for lowering standards. It also has very weak enforcement provisions. Virtually all lenders pass their CRA exams. Advocates may complain when a lender merges with another lender but rarely if ever have any mergers been denied. The CRA is more a dance that lenders have to do than an obstacle to sound lending practice, and certainly the idea that “the CRA made me do it (make bad loans)” is nonsense. They made bad loans because they made money making them.
The CRA has been used as a red herring to try to shift political blame onto poor and minority communities that lack effective advocates in Washington and the media, kind of like the welfare reform narrative we used to hearing. In fact the mortgage mess grew up in subprime and spread to the rest of the market, for the reasons that Stiglitz set forth. Basically the industry figured out a way to game the system, con investors and pay off or defund the people who were supposed to keep the system honest. Democrats are not immune to blame, particularly those whose states depend on the finance industry (often because of favorable laws that the Supreme Court allows them to “export” to other states), but Republicans certainly drove the process that made this possible, and lead the resistance to fixng the problem before the blowup happened. Integrity was the baby that they threw out with all the bathwater of regulation.
Stan, I believe that the Community Reinvestment Act played a significant role in the debacle we face. You state, “Something like 1 out of 4 subprime loans was by a lender regulated by CRA.” That is 25% and that is significant. The CRA may not have required the lowering of standards, but it encouraged it. Indeed, lenders discovered that they could make and then sell subprime mortagages to the poor and lower middle class and then sell those mortgages to Fannie Mae and Freddie Mac, they also discovered something else. They discovered that they could do the same to those who made a lot more money but were borrowing beyond their means.
Republicans did not drive the process that made this possible; that is partisan drivel. The CRA was originally passed by a Democrat Congress and signed by President Carter. Several Republicans, including Senator McCain recognized the problem and proposed fixes but were thwarted by Democrats. I am sure that there were many Republicans who were not interested in reform either. Admit it, both parties are by and large corrupt.
Rick, I agree that both parties are corrupt and anti-democratic. Our democracy is weak, ineffective, and produces a government that is far from being a government of the people or for the people. This reality should be alarming to every citizen, regardless of his or her political leanings. We live in a dream world that gives lip service to democracy, but the truth is, our society is under the control of anti-democratic forces, and predominant among those anti-democratic forces are our major political parties. Reforming our major political parties, I feel, is key to reforming and vitalizing our entire democracy. And a good place to start the reform process would be right here in Montgomery County.
But it is important to fairly and accurately apportion blame for the current economic mess we are in. To imply both parties equally are at fault is simply wrong — an error probably stemming from blind partisanship. The vast majority of blame, in the judgment of any impartial analyst, I believe, must go to the Republicans, because the Republicans had complete control of the federal government from 2000 – 2006 and control of Executive, Senate, and Supreme Court since 2006.
It was the Republicans who called the shots concerning financial and corporate regulation and who radically changed regulation procedures in place for many years. Under George W. Bush, the federal government showed new and astounding levels of contempt for average Americans and, amazingly, contempt and hatred for competency in government. Bush and the Republicans gave a free rein to corporations and financial institutions, and Bush, in fact, so brash was his contempt, failed to even fill many regulatory positions. It was the Republicans who engineered two wars and at the same time made huge tax cuts that overwhelmingly advantaged the wealthy. Under George Bush the wealthy have gobbled up much more of the nation’s wealth than what any democracy should tolerate. Under George Bush, well over $3 trillion in additional debt was added to our national debt, and, under George Bush, the level of confidence in our government and in our financial institutions became hopeless degraded. This eight years of Republican nonsense produced the mess we are currently in.
If our democracy had any backbone, or any reality, Mike Turner, and every Republican who gave Bush 90%+ support would have been kicked out of office.
Ok, Mike, what about the Democrats opposition to reforming the practices of Fannie Mae and Freddie Mac? How did two politically active Democrats get to the head positions of those two agencies?
Fannie Mae and Freddie Mac were actually relatively late comers to buying bad loans. Most of the action was in “private label” securitizations outside the control of Fannie Mae and Freddie Mac. What little floor there was to abusive practices was due to these agencies due to their volume but that was not enough. For whatever reason Fannie Mae was closely allied to Democrats and Freddie Mac to Republicans. Actually of course since our political system largely finances itself through private contributions, both parties must be on the take to banks “where the money is.” Democrats such as Biden, Dodd and Schumer from financial industry states get the most and have been in the way of reform but other Democrats such as Sarbanes and to a lesser extent Frank have far outstripped Republicans in protecting borrowers. Of course all Senators protect their states’ main industries regardless of what’s best for the country as a whole.
The idea of changing some traditional rules that excluded minorities from homeownership did not mean you had to turn abusive loans loose on those populations, strip all their home equity and eventually take their homes. Blkaming the victims does not work when the power and choices were elsewhere. However that sort of “class war” does play politically.
Rick, you ask, “What about the Democrats opposition to reforming the practices of Fannie Mae and Freddie Mac? How did two politically active Democrats get to the head positions of those two agencies?”
I don’t have an answer to that question. When I did my brief research on Fannie and Freddie, I didn’t notice that fact, but, I’ll grant that Democrats are not blameless either as individuals or as a party. I emphasized that in my last response when I said that both parties are corrupt and anti-democratic. Stan writes with more information about how specific Democrats acted in this whole matter.
My gripe about this whole matter stems from listening to right wing type commentators who early on, when this whole story broke, had a knee jerk reaction to blame the whole mess on the poor and on what they see and condemn as liberal pandering to the poor — the accusation was that liberals pushed Fannie and Freddie into making bad loans to poor people, and that these bad loans were the source of the financial system’s meltdown. This accusation is flatly not true.
There was incompetence and incredible greed behind the running Fannie and Freddie, regardless of who was in charge, and the fact that the top individuals were Democrats is irrelevant. My thinking is that since the control of regulation and control of any legislation dealing with regulation was in the Republicans hands, therefore, Republicans must accept the great preponderance of the blame.
I wrote two posts in early October showing my research:
Fannie And Freddie Not Responsible For Housing Bust; Affordable Housing Goals Not At Fault
October 6, 2008
“We Learned A Terrible Lesson,” Only One Person Questioned Fateful 2004 SEC Decision Unleashing Investment Banks October 3, 2008
Here is a question. Who should lose their home to foreclosure and why?
Stan, I don’t know the answer to your question. There have always been some home foreclosures — even when the economy was much stronger — such foreclosures have happened because of a combination of bad luck and bad judgment. A person attempting to live in a $500,000 home, might discover that, because of changed circumstances, he or she can only afford a $100,000 home. The idea that such an overextended person deserves a government bailout hardly seems justified.
This article points out that for as many as one in four mortgages the amount of the mortgage exceeds the market value of the property. Mortgage owners on such properties might simply walk away from the property, allowed the property to be foreclosed, because they see no sense in continuing with a situation in which, however hard they try to maintain payments, in the end they still stand to lose a lot of money. The cost of the government shoring up such properties, the article says, would amount to trillions of dollars. So, this is a complicated question.
Everything is inter-related. For example, if our country had a guaranteed health plan that would protect individuals from the economic devastation of catastrophic medical problems, there would be less foreclosures. What is happening in our economy should serve as a huge incentive to take actions, via government, that will build more justice, more fairness, into the basic structure of our whole society.