What is the price to rise again when it is free to fall?
Many are caught by surprise with the dire consequences of the financial crisis that struck in 2008 arising out of an uncontrolled ‘financial engineering’ activities. While that is true, this book, however, objectively advocates that such happening was not unforeseeable and inevitable. It has blatantly finger pointed the blame to several people and institutions alleged to be responsible to have consciously allowed such disaster to occur. Federal Reserve, Wall Street, Alan Greenspan and Bush are among the most frequently cited as those who, with power and authorities, have failed to properly put a stop to risky and outrageous financial activities.
Excessive risks coupled with excessive leverages have created an array of very deceiving products. This was done when the so called creative and sophisticated financial innovation was actually made by simply relying on an old set of data taking no account the current development and changes that market are experiencing.
Regardless their financial standing, there have been irresponsible promises from bankers telling that the new mortgage-based products, subprime being the epicenter of all, are perfectly safe and to be enjoyed without worry. This was identified as, among others, the very factor that triggered an overwhelming excitement of the public to subscribe the products.
Unbecoming of any other typical American authors who would normally be singing praises of policies introduced by the past presidents, Stiglitz opted to analyse whether the President Roosevelt’s New Deal had really pulled America out of The Great Depression or was it actually the effect of the World War II. The early chapters of this book refresh the reader’s comprehension on the nature and structure of various products created to enable unlimited leverages aimed to multiply profits and monetary gains especially by the big boys in the financial industry. As a result many toxic assets and liar loans were introduced. Needless to mention the Bernie Madoff’s Ponzi scheme.
Damaging renegotiation and securitisation were among the activities by which investment banks were eager to slice and dice the mortgages and have them packaged and repackaged, before eventually being offered as a new product to the markets crossing the border. A thorough scrutiny will reveal that the toxic mortgage packages have been sold and resold even to foreign players. Wall Street, which was once exporting sophisticated and secured financial products, is now exporting its debts to the whole world. Hence, it comes as no surprise that the following impacts of the financial crisis hit not only the US market but the whole world.
Unlike other books on the same subject, which normally are very diplomatic, Stiglitz puts it in the most direct manner that the underlying evil of all this troubles was “fee”. Banks are eager to offer more and more financing and refinancing, even when the borrowers are obviously not qualified, simply because more financing and refinancing will mean more and more fees.
More fees will bring in more profits and more profits will lead to more bonuses. Its simply an epitome of avarice triumphs over prudence. In addition to poor and seriously flawed risk management models that banks adopted, the situation was worsened when the rating agencies which were supposed to access and certify the risk profile of a product independently, have unfortunately joined the wagon; by becoming unreasonable fee-driven institutions. They are not precluded from the race to the bottom since they prefer to please their clients rather than telling them the head knocking truth. Such attitude can even be traced prior to Enron and WorldCom crisis in early 2000s. The risk assessment exercise is no longer objective but commercial. Fee was everything and had become the central subject in all decisions made prior to the arrival of the crisis.
Following its claim above, Stiglitz further contents that refusal of those in power to carefully analyse and control the market and protect the public interest has escalated the situation. The excuse given, nobody was at the position to foresee such a financial disaster, neither the market players nor the regulators. However, Stiglitz strongly believe that the defence is baseless and in fact arbitrary. There have been many warnings given by experts, adumbrating that there were many signs to suggest that the market was going to collapse very badly. Nevertheless, such reminders fell into deaf ears of those who were excited making money out of public’s financial ignorance. Crisis is, therefore, what the US market and the world economy were left to wrestle with.
Ranting by the public who expects the government to step in and do something to save the country when it faces a crisis is something inevitably normal. Nevertheless, the fact that the plan is from the government never guarantees that it will work. There are enormous instances to illustrate how the government’s stimulus would just exacerbate the market. Thus, this book offers a very useful set of principles that should be reflected in any stimulus package designed by government, namely (i) it should be fast, (ii) it should be effective, (iii) it should address the country’s long-term problem, (iv) it should focus on investment, (v) it should be fair, (vi) it should deal with the short-run exigencies created by the crisis and (vii) the stimulus should be targeted at areas of job loss.
Effectiveness of a government programme was also discussed by analyzing many policies introduced by both previous and current leaders. Bush’s February 2008 tax cut that was intended to encourage more spending was severely criticized for being an instrument to escape the wealthy and rich class from heavy tax apart from their failure to fully understand the degree of severity that entails a crisis. This is evidenced by their readiness to pour as much money as possible to bank with the intention to restore the economy to its health and reignite the credit flow and save the real estate market. This was done with the belief that there is a lack of liquidity in the market. Therefore,, they introduced the Public Private Investment Program (PPIP) which used $75 to $100 billion in TARP Capital. Unfortunately, they were wrong and Stiglitz explained that the real issue was that the banks made bad loans and were excessively leveraged.
Extremely erroneous, will most probably be the best phrase to describe the flawed approach taken by the US government in redressing the problem. And, naturally, contrary to what that had been done by the US government, Stiglitz promoted the need of the country to have a “balanced budget multiplier”. He proposed that the government may achieve this by expanding the economy by raising taxes on upper income Americans to finance an expansion of government spending, especially investment. This proposal is based on the notion that the total American consumption can be restored on a sustainable basis if there is a large redistribution of income applied across the social classes, from those at the top to a large number of those at the bottom. This is even more possible when the market is found to have excess capacity and production is limited by demand instead of supply.
Focus of true measure of a stimulus programme’s success is, the book claims, not the actual level of unemployment, but instead what unemployment would have been without the stimulus. In doing so, there are a few basic economic principles that must be upheld. Firstly, the conservation of matter. It holds that a problem, like toxic assets, cannot be solved by simply shifting its ownership from banks to government. Secondly, a solution must be forward looking, let bygones be bygones. This principle contradicts with the government’s act of spending so much cash trying to help problematic and sinking banks. A better course of action to be considered is to utilize that tax payer’s money to establish a few new banks which may reignite a fresh and problem-free credit low. Thirdly, money should be targeted to where it will most stimulate the economy. And finally any bailouts must help restructure the financial system to make it better serve the functions that it supposed to serve.
Actions that can be revisited to improve the current system is what this book has to offer to complete its discussion on the financial crisis. Amongst others, the need to revise the bankruptcy law and to have a more regulated and controlled market especially when American-style capitalism is now facing its rainy days. Stiglitz believes that stricter financial regulations will never hinder innovation as claimed by most bankers. Nevertheless there are six challenges that must be accordingly addressed, namely (i) the gap between the global demand and global supply, (ii) high interest rates, (iii) the surfeit of saving, (iv)the manufacturing conundrum, (v) inequality arising of globalization and lastly (vi) stability. It is believed that dealing with crisis and preventing future crisis is as much a matter of politics as it is economics.
List of suggestions this book proposes includes the actual roles of government. It is suggested that government should (i) maintain full employment and a stable economy, (ii) promote innovation, (iii) provide social protection and insurance and (iv) prevent exploitation. This is even more crucial that, despite a few simple changes demonstrated by IMF under the stewardship of new managing director, Dominique Strauss-Khan, IMF remains an old boys’ club of the rich industrial states. Such observation reinforces the need to have an improved relation between China and America, a new global reserve system and fostering a new multilateralism.
Lastly, Stiglitz emphasises on the priority of having a new society. The discussion starts by commenting on the practices of banks and the public that have shaped the market and society, such as misallocation of human talent. It continues by bringing in the realm of reality where the society needs security and rights without denying the want for leisure and sustainability. In conclusion, this book explains that a crisis, in and of itself, is something that can be anticipated and the process of restoring economic to its health must not be a zero-sum game. A comprehensive and well-contemplated approach is crucially required and must be materialized with due regard to the fact that market needs to be effectively regulated and monitored. In short, this book is simply the new combat kit necessary for a comprehensive understanding of the 2008 financial crisis, written in a language that any layman will be able to understand and appreciate. The mantra is simple. It is free to fall, but costly to rise.