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.
