The forces behind the fiscal meltdown

January 25, 2010|Chuck Leddy, Globe Correspondent

Winner of the Nobel Prize for economics and a specialist on globalization, Joseph Stiglitz suggests that the US financial crisis that triggered the present global recession could have been avoided.

Stiglitz strongly rejects the idea that the crisis “just happened’’: It occurred because of conscious decisions by stakeholders, including bankers, regulators, investors, and debt-laden consumers. During the bubble, these groups failed to accurately assess the risk, Stiglitz argues, because they chose not to.

Stiglitz points to the acceptance of the idea that unregulated markets are both self-correcting and maximize social good: “Economies need a balance between the role of markets and the role of government . . . America lost that balance’’ with disastrous consequences. Stiglitz says that “financial innovations’’ that grew in a largely unregulated financial sector, from subprime mortgages to credit default swaps, served to maximize bankers’ fees while putting the financial system at risk.

Stiglitz doesn’t scapegoat the bankers or investors who pushed financial risk to its limits and beyond, but instead blames “fundamental flaws in the capitalist system.’’ Then he meticulously and brilliantly describes these flaws. For example, banks and their managers were compensated according to the fees they generated. Underwriting bad (“innovative’’) loans and then transferring the risk through securitization - grouping the loans into pools, then selling shares in those pools to investors - generated massive profits and huge bonuses for years.

Stiglitz says that incentives promoted “the quantity of mortgages originated, not the quality.’’ The game was simple, boost the number of mortgages by watering down lending standards (e.g., “no income, no problem’’) and then move the garbage down the river by securitizing the risk.

This amounted to a game of musical chairs in which the last one standing when the music stopped lost. And the last one standing was not the bonus-laden bankers or the negligent regulators, notes Stiglitz, it was the American taxpayer. The banks took such great risks, Stiglitz asserts, partly because they knew that if they lost, the government would bail them out.

Stiglitz calls it the triumph of “Corporate Welfarism American-style,’’ which he describes as “the privatizing of gains and the socializing of losses.’’ The author asks some basic and provocative questions, such as why massive bailouts focused on banks instead of homeowners who are now awash in debt.