Joseph Stiglitz: Freefall

Well said --

Many people want the government to protect the consumer. A much more urgent problem is to protect the consumer from the government.
Milton Friedman

A major source of objection to a free economy is precisely that group thinks they ought to want. Underlying most arguments against the free market is a lack of belief in freedom itself.
Milton Friedman

Only government can take perfectly good paper, cover it with perfectly good ink and make the combination worthless.
Milton Friedman

Howard Roark,

I hope people read your comments a few times. Yours is among the finest viewer responses I have seen on this site.

To criticize the "free market" as having failed or to indict Capitalism for the housing bubble and its predictable burst, is the current "big lie." Our markets and economy are nowhere near free. We have hundreds of thousands of pages of regulations on all facets of our economy, with banks and financial institutions facing regulations so complicated, that they must have teams of lawyers to make sure they are following them all.

Might seem like that on the face of it, but whenever you're buying something innovative, you're not actually paying your money for whatever you buy as much as for research into whatever Sony, Unilever or whoever might want to launch onto the market, or not, sometime in the unforeseeable future - whether you're interested in it or not.

The ethics of govt involvement in a market economy is a complex issue, as complex as the subject itself; but the standard objection that you're paying for stuff you don't want or need - as a consumer or as a tax payer - while people get profits they didn't earn is obsolete. We've gone way past the point where things can be that simple.

@cat1012000, "The teaparty does not advocate "No government" we want limited government. The fact that government pre-empted "Bucket Laws" that had protected the market from abuses in unconscionable."

DUH!

Teapartiers, in their dogmatic embrace, have failed to understand that government pre-empted "Bucket Laws" arose from 'limited government'. Government's regulatory powers were intentionally limited by the Republican Congress/pResident at the behest of a few capitalists not at the behest of the people.

Perfect competition and perfect information need perfect people, meaning perfectly rational people. It might seem reasonable to assume that the size of a market would iron out individual irrationality (think Gaussian distribution), but dynamic effects of market behavior - the market affecting the people in it more than the reverse - mean that even large-scale, statistically significant markets do not act rationally, but will massively destabilize on a positive feedback loop given the circumstances, such as in a major recession. The "hidden hand" only allows for stabilizing negative feedback loops - great theory, might even work on humans that have evolved from, say, cats.

Is it any wonder that Bay Area liberals love this guy? He preaches government nanny-statism, where so-called "intellectuals" like himself can impose (through force, if necessary) their ostensibly superior knowledge, wisdom, and virtue on others. This is the height of arrogance, to say the least.

To blame the current financial crisis on "greed" is like blaming an airplane crash on gravity. "Greed" and "self-interest" have been around since the days when our ancestors, Thag and Oog first started walking upright on two feet.

If one is truly serious about understanding the housing bust which led to the current financial crisis, they need to begin by understanding the origins of the housing boom. This is what Austrian economics teaches us.

In so far as the Fed kept interest rates too low for too long, it encouraged massive malinvestments as a result. Interest rates are nothing more than the price of saving and borrowing. Prof. Stiglitz, who claims to understand the importance of information symmetry, should understand this. When the price "signal" on saving and borrowing is distorted by the Fed, this impacts those sectors of the economy most sensitive to interest rates. In this case, the Fed's artificially low interest rates led to the purchase of homes using long-term mortgage debt and encouraged new housing construction (capital investments).

Think about it. In a truly free-market, when interest rates (i.e., the price of credit / debt) decline, this price signal tells market participants that the amount of money saved exceeds the amount borrowed. Low interest rates properly inform people that further savings will not be rewarded as much as before, while borrowing the excess capital sitting in bank vaults will be encouraged. The opposite price signal of rising interest rates tells market participants that borrowing has exceeded savings, and the former will no longer be encouraged, while the latter will be rewarded (this is what should have happened from '01 to '06).

Stated another way, when the Fed discombobulates this critical price signal and prevents interest rates from working properly by keeping them artificially too low, people assume money is available to be borrowed, when in fact it is not. Thus, people who might have prudently saved their money otherwise, decided to spend instead. Hence, the housing boom resulted in not only a glut of home purchases (and construction), but many of these same people went out and bought flat-screen T.V.'s, granite countertops, new furniture, new cars, etc. And they used artificially low-interest rate credit cards and home equity loans to do so.

Prof. Stiglitz is correct when he blames the Fed, but to say that Alan Greenspan was biased toward free-markets is a red-herring. Greenspan may have been an Ayn Rand devotee in his earlier years, but by merely working as Fed Chairman he surrendered all claims to being a free-market advocate. The Fed is the antithesis of a free-market! When Greenspan presented his mea culpa before Congress and stated that his previous assumptions about bankers acting rationally was misguided, does anyone really believe this? Greenspan was trying to divert attention away from his own failures as Fed Chairman.

Now, tell me… Is the Fed a government agency or a private entity?

And I haven't even mentioned the Community Reinvestment Act (CRA), the implicit government guarantees of Fannie Mae / Freddie Mac debt, the Federal Housing Administration (FHA), and all the other misguided government-led initiatives promoted under the guise of "social justice," "affordable housing," "compassionate conservatism," and the "ownership society."

Nor have I mentioned that President Obama continues to promote these failed policies, while forcing banks to "renegotiate" home loans and preventing credit card companies from properly pricing risk. In the meantime, Obama has given his nod of approval to Bernanke to continue running the printing presses like there is no tomorrow (i.e., keep interest rates - you guessed it - artificially low).

For a humorous, yet common-sense, understanding of the crisis, see the rap video (yes, I said, "rap") titled, "Fear the Boom and Bust" - http://econstories.tv/home.html . It does a great job of contrasting Keynesian nostrums with Hayekian realism.

Government funding did have a lot to do (or everything to do) with the creation of the Internet; originally called the DARPA net. It was largely used to foster communication between public universities. I have never heard that IBM and AT&T had a lot to do with it. I do know that AT&T did not want anyone to hook up anything to their infrastructure that was not purchased or rented from them which I am sure prevented quite a lot of innovation.

IBM is also a product of government funding in a way. IBM was the initially the Tabulating Machine Company. Its first product offering was a machine that tabulated the national census.

Also, if you want to talk about the Web, it was also not created by any private actor. It was invented by Tim Berners Lee when he was at CERN, a public European organization. Private companies during the 90s did severely limit the potential of the Web through the browser wars and almost ruined it, but through the efforts of WaSP (the Web Standards Project) this has been largely reversed.

Where to begin?

Stiglitz is Paul Krugman on steroids

Tax cuts didn't work because people saved the money. You need to spend money to stimulate. And by the way, banks need to loan more money.
And where do banks get the money to lend????? If you said from people who put their money in the bank(uh saving it that is). Pass Go and collect $200.00
In short, the more people save the more money banks are able to loan. That's kinda the banks reason for being. Thus it's not spening that stimulates, but increasing the velocity of money.

Stiglitz tells us this is a failure of the private sector, then spends the rest of the time explaining the extent of the governments failure.
He mentions how the only nongovernment person in on the AIG negotitiations was the head of Goldman Sachs.
Of course, the government officials were the victims of silly academics who told everyone wall street knows best: I doubt you can find any free market economist who would make such a cornball statement. Wall street doesn't know better than anyone else; the difference is that wallstreet functions within certain constraints: Mainly profit and Loss. Remove said constraints by, oh say... artificially keeping the cost of borrowing money very low(cheap money or low interest rates) and Wall Street will behave
accordingly. Yet what player is big enough to remove those constraints for Wall Street as a whole?
If you said the Federal Government in the form of the Fed, pass Go and collect $200.00!
Stiglitz tells us how banks hid their losses so well, they even hid them from themselves. Ya gotta love stories about a bunch of rubes who outsmart themselves. It can't get any better than that! So we'll continue with economists who hide the governments role in starting this whole chain of events so well that they even hide it from themselves.
Ok let's go to the video tape: If you've heard of the Community Reinvestment Act (http://en.wikipedia.org/wiki/Community_Reinvestment_Act)
you don't need to finish the class: Pass Go and collect $200.00
The law was passed to fix a problem the government created when it decided to
push home ownership: Redlining introduced by the National Housing Act of 1934.
But let's get right to the objections mentioned by the article in Wikipedia. "the FDIC, Chair Sheila Bair, FDIC Chair, Sheila Bair, delivered remarks noting that the majority of subprime loans originated from lenders not regulated by the CRA, calling it a "scapegoat" and declaring it "NOT guilty."
But the question isn't about where loans originated or whether these lenders were regulated by the CRA. The question is whether financial institutions purchasing these loans, in the form of securitized mortgages, were regualted by the CRA and whether such purchases were influenced by
CRA ratings. That is if a bank wished to expand and believed that approval by regulators hinged on their CRA rating, they might have a powerful incentive to make such purchases. In this context, it's interesting that
former Fannie Mae CEO Franklin Raines "said it might have been a catalyst encouraging bad behavior, but it was difficult to know."
Likewise, Bob McTeer, president of the Dallas Federal Reserve Bank from 1991 to 2004, said “There was a lot of pressure from Congress and generally everywhere to make homeownership affordable for poor and low-income people. Some mortgages were made that would not have ordinarily been made.” He also said “When a bank made a decision to purchase mortgaged-backed securities, they would somehow determine if some of them were in zip codes covered by the CRA, and therefore they could get CRA credit."

Yea Joe definitely a private sector failure! Also ya might want to go back to school to learn the definition of the Invisible Hand. It's certainly not
anything like your oversimplification. Hayek referred to it as an unsurveyable pattern. One might say that greed does lead to the most
public good provided it's constrained by a competitive environment.

It is with imperfect information where free markets shine. He forgot to mention that the government also has a treasure trove of imperfect information.

Every accusation I have heard leveled against free markets (people making purchase decisions by the use of their very own mind) applies doubly to the government. Inefficient? Yes. Prone to error? Yes. Vulnerable to undue influence and populist hysteria? Yes.

But worst of all, the government can enforce it's flaws with guns. You wanna change brands? Talk to the sheriff.

Stiglitz is misinformed. For one thing the government did not create the internet. Many private companies worked on it. At the time, the two biggest players, AT&T and IBM, were prevented from inter-netting by regulations. IBM was forbidden from operating telcom lines and AT&T was prevented from offering computing services.

What most people refer to when they are talking about the internet is the World Wide Web. At first the government didn't even know that the Web had been created. When they found out it was already creating so much wealth and commerce that they didn't even want to touch it. They didn't even tax it. There is no way the early web could have progressed so quickly and overcome so many technical problems if the government was watching over their shoulders. It is a glowing example of self governance, unless you listen to Stiglitz.

A better example would be if he reached into his pocket. Within reach of everyone in that room is their cell phone. Cell phones were not created and developed by government mandate. They were made for the pleasure of rich people. Rich, noisy lawyers who pranced around with them in libraries and cafes. Then they trickled down to us. Cool.

He is also wrong on free markets. He says that banks are reckless. Are they more reckless with their own money than the government is with ours? A company I worked for made reckless loans. Why? Because right after we created the loan the government would buy it from us. They were called conforming loans. I remember the CFO telling me that no banker would make these kinds of loans, but the government would underwrite them.

The biggest problem with economic stimulus is not that they are hugely expensive, it's that they don't work. And because it doesn't work the government does it again. Everyone will pick through the many ways the stimulus was badly implemented, but they never consider that the problem is that it was implemented. It creates only an economy of scavengers.

In the three hundred years that markets have been at least partly free they have taken us from subsistence living and indentured servitude to global telecommunications, travel at faster than 15 miles an hour, space-flight, and digital cameras.

Stiglitz would very literally prefer feudalism and serfdom. He sees the markets as only something to help the government run the economy, instead of the thing that created the economy that allows us to afford a government.