December 10, 2008 – The Baseline Scenario

Other posts in this occasional series.

Joseph Stiglitz, the 2001 Nobel Prize winner and the most cited economist in the world (according to Wikipedia) has an article aggressively titled “Capitalist Fools” in Vanity Fair that purports to identify five key decisions that produced the current economic crisis, but really lays out one more or less unified argument for what went wrong: free market ideology or, in his words, “a belief that markets are self-adjusting and that the role of government should be minimal.”

The five “decisions,” with Stiglitz’s commentary, are:

Replacing Paul Volcker with Alan Greenspan, a free-market devotee of Ayn Rand, as Fed Chairman. (Incidentally, when I was in high school, I won $5,000 from an organization of Ayn Rand followers by writing an essay on The Fountainhead for a contest.) Stiglitz criticizes Greenspan for not using his powers to pop the high-tech and housing bubbles of the last ten years, and for helping to block regulation of new financial products.
Deregulation, including the repeal of Glass-Steagall, the increase in leverage allowed to investment banks, and the failure to regulate derivatives (which Stiglitz accurately ascribes not only to Greenspan, but to Rubin and Summers as well).
The Bush tax cuts. Stiglitz argues that the tax cuts, combined with the cost of the Iraq War and the increased cost of oil, forced the Fed to flood the market with cheap money in order to keep the economy growing.
“Faking the numbers.” Here Stiglitz throws together the growth in the use of stock options – and the failure of regulators to do anything about it – and the distorted incentives of bond rating agencies – and the failure of regulators to do anything about it.
The bailout itself. Stiglitz criticizes the government for a haphazard response to the crisis, a failure to stop the bleeding in the housing market, and failing to address “the underlying problems—the flawed incentive structures and the inadequate regulatory system.” (There’s regulation again.)

Continue reading “Causes: Free Market Ideology” →

An interview with Representative Jim Moran in the National Journal reminds me that we haven’t heard much about sovereign wealth funds recently. These are the large pools of money (in foreign currency) that were created as a result of large cumulative current account surpluses in some parts of the world (e.g., oil exporters, China, Singapore). They were quite controversial back in mid-2007, with concerns being raised – by Congress and others – regarding various aspects of their operation.

There are still some issues around the lack of transparency of these funds, although a great deal of progress on this dimension has been made (including in and around the IMF) and we learned to worry more about black boxes in other parts of the financial system. But these funds might be coming back as a discussion item; for example: can they, should they, would you want them to, invest in US banks to help speed a turnaround?

Personally, I think the underlying current account surpluses are going to fall – this is one likely implication of the decline in world trade for next year that the World Bank is forecasting and the counterpart of what must be an increase in US savings (and thus a fall in our current account deficit). The accumulated stocks, in the form of sovereign wealth funds, will remain but they are no longer on explosive growth paths and this should take most of the edge off the conversation. But how open the US remains to various kinds of capital flows – and on what exact terms – will be a prominent issue on the Congressional agenda as we move into 2009. We do, after all, want people to buy the debt we will issue to fund the fiscal stimulus.