Dishonesty in the finance sector dragged us here, and
Washington looks ill-equipped to guide us out
By Joseph Stiglitz
The Guardian (UK)
September 16 2008
Houses of cards, chickens coming home to roost - pick
your cliche. The new low in the financial crisis, which
has prompted comparisons with the 1929 Wall Street
crash, is the fruit of a pattern of dishonesty on the
part of financial institutions, and incompetence on the
part of policymakers.
We had become accustomed to the hypocrisy. The banks
reject any suggestion they should face regulation,
rebuff any move towards anti-trust measures - yet when
trouble strikes, all of a sudden they demand state
intervention: they must be bailed out; they are too
big, too important to be allowed to fail.
Eventually, however, we were always going to learn how
big the safety net was. And a sign of the limits of the
US Federal Reserve and treasury's willingness to rescue
comes with the collapse of the investment bank Lehman
Brothers, one of the most famous Wall Street names.
The big question always centres on systemic risk: to
what extent does the collapse of an institution imperil
the financial system as a whole? Wall Street has always
been quick to overstate systemic risk - take, for
example, the 1994 Mexican financial crisis - but loth
to allow examination of their own dealings. Last week
the US treasury secretary, Henry Paulson, judged there
was sufficient systemic risk to warrant a government
rescue of mortgage giants Fannie Mae and Freddie Mac;
but there was not sufficient systemic risk seen in
The present financial crisis springs from a
catastrophic collapse in confidence. The banks were
laying huge bets with each other over loans and assets.
Complex transactions were designed to move risk and
disguise the sliding value of assets. In this game
there are winners and losers. And it's not a zero-sum
game, it's a negative-sum game: as people wake up to
the smoke and mirrors in the financial system, as
people grow averse to risk, losses occur; the market as
a whole plummets and everyone loses.
Financial markets hinge on trust, and that trust has
eroded. Lehman's collapse marks at the very least a
powerful symbol of a new low in confidence, and the
reverberations will continue.
The crisis in trust extends beyond banks. In the global
context, there is dwindling confidence in US
policymakers. At July's G8 meeting in Hokkaido the US
delivered assurances that things were turning around at
last. The weeks since have done nothing but confirm any
global mistrust of government experts.
How seriously, then, should we take comparisons with
the crash of 1929? Most economists believe we have the
monetary and fiscal instruments and understanding to
avoid collapse on that scale. And yet the IMF and the
US treasury, together with central banks and finance
ministers from many other countries, are capable of
supporting the sort of "rescue" policies that led
Indonesia to economic disaster in 1998. Moreover, it is
difficult to have faith in the policy wherewithal of a
government that oversaw the utter mismanagement of the
war in Iraq and the response to Hurricane Katrina. If
any administration can turn this crisis into another
depression, it is the Bush administration.
America's financial system failed in its two crucial
responsibilities: managing risk and allocating capital.
The industry as a whole has not been doing what it
should be doing - for instance creating products that
help Americans manage critical risks, such as staying
in their homes when interest rates rise or house prices
fall - and it must now face change in its regulatory
structures. Regrettably, many of the worst elements of
the US financial system - toxic mortgages and the
practices that led to them - were exported to the rest
of the world.
It was all done in the name of innovation, and any
regulatory initiative was fought away with claims that
it would suppress that innovation. They were
innovating, all right, but not in ways that made the
economy stronger. Some of America's best and brightest
were devoting their talents to getting around standards
and regulations designed to ensure the efficiency of
the economy and the safety of the banking system.
Unfortunately, they were far too successful, and we are
all - homeowners, workers, investors, taxpayers -
paying the price.
Joseph E Stiglitz is university professor at Columbia
University and recipient of the 2001 Nobel prize in