Freefall

By James Kwak

I only recently finished reading Freefall,* Joseph Stiglitz’s book, so this review comes about two months late. It took me a while partly because I was busy, but partly because I didn’t feel a lot of dramatic tension . . . since I agreed with almost everything he said.

Unlike most crisis books, Freefall is relatively short on what caused the financial crisis. The historical background is mainly laid out in Chapter 1, “The Making of a Crisis,” although there is discussion of specific problems in later chapters, such as Chapter 4, “The Mortgage Scam.” Mainly this book is about the response to the crisis, what was wrong with it, and what needs to change in the future.

Reading the book gave me a familiar feeling. You see, our book (13 Bankers) is largely about historical and political background–our Chapter 1 begins with Thomas Jefferson and Alexander Hamilton, although most of the book is about the period since 1980–so there is relatively little topical overlap between the two. But where they do overlap, particularly in the discussion of government responses to the crisis, I had the sensation that we were saying much the same thing.

In Chapter 5, “The Great American Robbery” (by which Stiglitz is referring specifically to the bailouts of 2008-2009), Stiglitz replays the debate of a year ago over how to rescue the financial system–a debate that pitted Stiglitz, Paul Krugman, Nouriel Roubini, and others, who favored government takeovers of sick banks, against Tim Geithner, who convinced the rest of the administration that it was better to support the banks in their existing form. Stiglitz is actually considerably more acerbic than Simon and I:

“Almost surely, the failures of the Bush and Obama administrations will rank among the most costly mistakes of any modern democratic government at any time” (p. 110).

“The Bush and Obama administrations had made a simple mistake . . . that the banks’ pursuit of their own self-interest was necessarily coincident with what was in the national interest. . . .

“Nor did the deregulators and the politicians who stood behind them want to admit the failure of the economic doctrines that they had advocated. They wanted to return to the world as it was before 2007” (p. 111).

“Just as Bush used 9/11 and the fears of terrorism to justify so much of what he did, the Treasury under both Bush and Obama used 9/15–the day that Lehman collapsed–and the fears of another meltdown as a tool to extract as much as possible for the banks and the bankers that had brought the world to the brink of economic ruin” (pp. 118-19).

The problem, Stiglitz argues, is that even if the financial system was stabilized, the way it was stabilized has made the recovery “slower and more difficult than need be” (p. 135), and has also helped undermine public confidence in government, exacerbating the dysfunctions of our political system.

When it comes to financial regulation, Stiglitz is also highly critical, although here he aims his guns more at the financial sector than at the administration (the chapter is titled “Avarice Triumphs over Prudence”). Because of the threat of regulatory capture, he favors simple rules: “the regulations have to be simple and transparent, and the regulatory structure has to be designed to prevent excessive influence from the financial markets” (p. 149).

And this is what gave me that comforting feeling. I generally feel insecure about what I write. Having a Nobel Prize winner saying many of the same things makes me feel a little more confident. That doesn’t mean that what we wrote is true (many Nobel Prize winners have said many things that were false), but it reduces the chances that we wrote something that is stupid.

Freefall has a considerably wider scope than just finance, however. Stiglitz also discusses other issues such as the role of government in the economy, global imbalances, and the faults of the economics profession. So I would consider it more than just a crisis book; it’s Stiglitz’s blueprint for what needs to change in the world.

* I got a free copy from the publisher.

29 responses to “Freefall

  1. The persistent unraveling of the Great Depression reforms, including the abandonment of Reg. Q in the 1980s, began the downward spiral against sensible, and understandble, regulation of finance.

    And you’re absolutely right about the stubborn pride that still today maintains that the less regulation and government “interference” in markets, the “better” will be our economy. It’s a stubborn ideology and despite copious and obvious evidence to the contrary, it’s adherents still control much of government.

  2. Steve Scharbach

    I found Freefall excellent. I also recommend Cassidy’s “How Markets Fail” for a good discussion of why the Chicago school free market mantra is both disconnected with reality as well as very weak as a theory. I’m getting your book too.

    You guys did a great job of explaining what went wrong and why. Now we need to face up to a larger issue. The American economy is simply unable to support its middle class and many of the poorer classes. And it is unable to sustain its trade deficits for much longer.

    You would be doing a great and necessary service to
    1) provide a situation analysis on the state of the US economy and why it is deteriorating, why wages are falling and why there is no remedy in sight for our trade deficit and then discuss what sort of new economic paradigm our nation needs to 1) support a decent standard of living for all Americans, 2) rid ourselves of recurrent meltdowns, 3) become net neutral on trade and 4) operate in a manner that’s consistent with an sustainable environment.

    I think we need to consider a sort of protectionism, to guarantee decent jobs in this country, accepting the trade off that stuff will be more expensive and counterbalancing it with full employment, a decent if not lavish standard of living for all Americans and a clean and sustainable environment, with good governance of our national resources.

    We need a market-based system that provides equitably for all of us. Its seems to me we’ll need to create and use a public capital base to make this happen. We need to figure out how to do this without making the mistakes of too much government central planning of supply and demand, but with the kind of overall vision and planning both Stiglitz and James K Galbraith advocate.

    Please consider taking a leadership role in suggesting ways we change our economic processes so we can all look forward to a better economic outcome than we have now.

  3. You certainly get a lot of free books James. It seems spending all this time running a popular blog has at least some advantages =)

  4. I’ll give this a look. Stiglitz’s analysis always seems rather ligth to me though. I’d rather have Simon explain the role of CDOs etc, and the political economy side.

  5. Okay, you got me hooked.
    Please provide the titillating details of which Nobel Prize winners made false pronouncements. You can stick to only those awarded the prize in economics, which by the way,was nothing the Nobel foundation asked for. I read the Swedish bankers started that one.

    I only know of one and he was absolutely dumbfounded that his thesis fell apart during Reagan’s 8 years. Yes, the data shows the money supply increased much more than 3% for those 8 years and yet the inflation rate fell from 1982-1989

  6. Scot Griffin

    Just read pretty much anything written by Milton Friedman, and you won’t have any trouble identifying that which he said that was either false, plainly wrong or deeply misguided.

  7. As Krugman has been advocating, we need China to stop devaluing its currency.

  8. As I have said before in these comments, while I generally do agree with Stiglitz’s prescriptions, I found his rhetoric unnecesassarily, and frustratingly, confrontational at times.

  9. AJ, given the multi-trillion dollar disaster, ‘confrontational rehtoric’ is something we should be looking for. Frankly, I’d be setting up a Wall St gallows, and keeping it well-stocked with fresh meat.

  10. I say Amen to Barry, just above. I am only
    2/3 through the Stiglitz book. It is the
    closest thing I have yet seen to giving what
    I keep calling for here: something we should be
    _for_, not just criticism, although he gives
    plenty of that too.

    I think it is a sensational book and should be
    read by us all. I have one complaint, and I
    would like to voice it loudly: While “Freefall”
    has copious notes, IT DOES NOT HAVE AN INDEX!!
    Is there any excuse for a serious non-fiction
    book these computerized days not to have an index?
    I can’t think of one.

    Best wishes to all,

    Alan McConnell, in Silver Spring MD

  11. Yeah, that’s exactly what I mean. That kind of rhetoric is great for getting those who agree with you excited. It is decidedly unhelpful for persuading those who are skeptical.

  12. Historically, in great revolutions the skeptics and do-nothings go to the gallows as well. No additional convincing required.

    Not advocating it. Just say’n.

  13. “You want to talk to God? Let’s go see him together, I’ve got nothing better to do.”
    Indiana Jones

  14. I concur. Having to tutor yr 2 economics in 1980, I read one of MF’s theoretical articles – there was such an obvious error in it that I asked the lecturer about the (inconsistent) assumptions made in it. The only reply I got was that everyone knew MF’s theories were flawed.

  15. I am a Stiglitz fan, and I do think he deserved more of the administration’s ear then he got. But we know huge egos don’t usually mix well, so he was doomed the minute Larry Summers became Head of the Economic Council (I almost did a Freudian and typed Treasury Secretary). If I was to criticize Stiglitz on one thing, it is he has forgotten (or is taking advantage of people’s general short memories) that there was an extreme extreme amount of fear in the markets at that time (9-15 or some proximity of). They didn’t exactly have a choice to sit down with a stern face and “tell banks how it was gonna be” (my words).
    But I think post-March 2009 they could have been a little more hardball. And one of the HUGEST mistakes was paying AIG 100 cents on the dollar. ANYONE (including Geithner) who believes the banks, who had NO OTHER CHOICES of creditors at that time, could insist on the contract rights to get 100cents on the dollar, is an ABSOLUTE F’*King MORON. When a friendly uncle offers to pay 75% of your debts, or some Mafia don is going to bash your head in, you don’t quibble that you didn’t get your 100%. And the public would have allowed for the exception, just like they did with the GM union contracts. There is the rub.

    Along with an inept, impotent SEC…. an NYFRB working blatantly together with large banks to hide information from the SEC (which will probably continue if Senator Dick Shelby has his way)…. and on and on and on….

    But overall Stiglitz is great and overall always worth reading. That last name probably means he comes from “good family stock”.

  16. Actually I get very few. I’m looking at my shelf now. I got Stiglitz, Yves Smith, David Wessel, Charles Morris, and Justin Fox’s books for free. I think I paid for the rest, although for a couple I borrowed Simon’s free copies (he gets more than I do) and later returned them.

    I periodically get offered free books but I generally turn them down unless I was going to read the book anyway, because I don’t have time and I don’t want to waste the publishers’ money.

  17. Well, “false” may have been an overstatement. But there is the fact that two Nobel Prize winners lost huge amounts of money in LTCM.

  18. The lack of an index really annoyed Simon, too. My guess, based on my little experience around the publishing world, is that they didn’t have time; you have to finalize the pagination first and then index the book, which costs you a couple of weeks. So my guess is someone made the call to get the book out sooner and sacrifice the index.

  19. I don’t know if you’re interested in a contrary view-point AJ, but there is an interesting debate going on in the comments section of Professor Bill Mitchell’s website about the relative importance/unimportance of China’s currency manipulation right now. Personally, I’m not sure where I stand on the issue yet, but I’m inclined to think it’s a side-show to fixing some of the more fundamental imbalances in the U.S. economy. Anyway, if you’re interested here’s the link to the main article. As I said before, the debate is going on in the comments section as we speak:

    http://bilbo.economicoutlook.net/blog/?p=8788#comments

    A similar debate occurred last month at the same website:

    http://bilbo.economicoutlook.net/blog/?p=8117&cpage=1#comments

  20. Given the dollar’s status as world reserve currency I highly doubt the U.S. will become “trade-neutral,” any time soon. To get U.S. dollars the world has to export to us more goods and services than they import; there is just no way around that within the international economic framework currently in place. There are advantages and disadvantages to this status, and personally I’m not sure where I stand on the issue. However, given the reality of the current economic climate in the rest of the world, it is just not very likely that the dollar is going to be replaced by another currency any time soon. Therefore, I think it is more important for U.S. citizens to accept reality and try to find ways to develop the “public capital base,” you mention than to opine about China’s currency manipulation. The fault…is not in our (economic trading partners), but in ourselves.

  21. A few examples of how Stiglitz is frustrating:

    1. He repeatedly confuses write downs for impairment with marking to market. Now, admittedly, it has been a few years since I have been intimately familiar with the details of accounting for fixed income securities, and there have been changes since then, but if my recollection is correct, this is either frightening ill informed or shockingly misleading. Naturally one suspects the latter. Marking to market allows the recognition of fictitious paper profits (and losses) wheres write downs for impairment do not.

    2. He declare market prices imperfect but the best we can do in a down market, mere moments after decrying lending at bubble prices per se unreasonable (or “bad”) in an upmarket. Perhaps its hard to accept, but bubble can (and do) happen without any significant evil-doing. (Which isn’t to say that there was none)

    3. He regularly ignores the distinction between the mortgages and structured products based on mortgages. They aren’t the same for all purposes. Most notable accounting.

  22. Tony Foresta

    Intriguing commentary AJ. From my pedestrian perspective the entire “derivatives” (bundled mortgages or structured mortgages or collaterallized debt obligations, et al) markets – are massive, complex, unregulated PONZI schemes. Stiglitz describes the elephant in the room flaw in the system no one wants to recognize or redress. The system, the entire global financial system is widly corrupt and oligarchic. Thefew have commandeered waytomuch wealth and power from fartoomany. The current system is doomed to fail, because the fundamental economics are unsound and the basic math awry.

    Either we sheepishly bay into the newworldorder, and fascist domination by individual predators and oligachs, or we right these horrible wrongs, come what may. No doubt the financiers doing godzwork, will punish the people in every way possible for our insolence and determination to see the rule of law, and justice prevail, – and the predatorclass financiers and oligarchs will eventually be forced to give back some of the monstrous wealth they have stolen over the last few decades…. so… obviously – that’s not going to happen.

    The American middleclass is dead. We have no future, and all the old pipedreams of upwardmobility, and the anythingispossibleinAmerica gibberish no longer resonate with any truth or reality. The people are being enslaved by criminals who repeatedly and insistently break the law at the government’s behest and with the full knowledge and consent of our socalled leaders.

    This is NOT America. The predatorclass and predatorclass oligarchs are accountable for grotesque mismanagement, collusion, fraud, insidertrading, taxevasion, and other crimes and misdemeanors. Our leaders (and there are none now) must summon the courage to press accountability on the predatorclass and begin the arduous process of righting the horrible wrongs of our financial system, and truly work in the peoples best interests. We all know that we’re doomed though because – NOTHING is going to change!

  23. mondo pinion

    Well, duh. Suddenly, when the great middle class is the victim, you people wake up to the problem. Bet Central America was aware of it a long time ago. Wonder why?

    This is NOT America? O yes it is. America hasn’t changed, dude. Your position has. You didn’t care about injustice as long as you could “invest” — that is how the predatorclass was empowered.

  24. As my father once told…

    “Even the geniuses get it wrong.”

    It’s strangely reassuring, in a schadenfreude kind of way, when the mighty, arrogant take a dive.

  25. America over the past three decades resembles the old Martin Niemoller line about
    Germany, but with different names.
    “When they busted the unions, I was not a union member so I remained silent.
    When they offshored the industries I was not an industrial worker so I remained silent.
    When they outsourced the white-collar jobs I was not a white collar worker so I remained silent.
    When they let the infrastructure rot away I was not an civil engineer so I remained silent.”
    usw…

  26. Tony Foresta

    Anyone who denies that America has NOT changed, and for the worse is either deluded, or massively dis or misinformed. I’ve always been lower middleclass, with the exception of five years before a divorce, and was and never will be an investor in the markets. I’ve owned homes, and artwork, and gold, – but never stocks. What has changed is opportunities. What has changed is employers forcing abusive, intrusive, and unnecessary requirments on potential employee’s. Credit checks, drug tests, numerous cards and certificate requirements. I never recall any employer 18 years ago, when I was leaving college forcing such unnecessary intentionally prohibitive requirements in the hiring process. Criminal checks, and drug tests where the employment requires such as transportation, healthcare, or heavy equipment use for example, – but how an earth, can Wall Mart, or Homedepot justify a credit check for an 8-10 dollar an hour jobbing stocking shelves. Most people making that slave wage are not going to have sterling credit scores.

    What has changed is labor wages being stagnant for 35 years, while the core cost of living outlays increased massively in every category over the same time frame.

    What we inhabit now a nation owned and controlled by the predatorclass and predatorclass oligarchs, wherein the people have absolutely no voice or representation in the conduct of the government, and the predatorclass and predatroclass oligarchs alone and exclusively receive all the bounty, protections, advantages, goodwill, and largess from the government they alone own and control.

    This is not America. Our founding fathers, and those that fought and died in defense of idea and the ideals that formally defined America are turning in the graves. This is NOT America.

  27. Tony Foresta wrote”

    “Anyone who denies that America has NOT changed, and for the worse is either deluded, or massively dis or misinformed. ”

    We’re about to see how worse.

    Fed must reveal bailout records

    Mar. 19, 2010 5:48PM – Globe & Mail – excerpt

    “Information on which banks got government loans to survive financial crisis can’t be withheld from media, Manhattan court rules.A panel of the 2nd U.S. Circuit Court of Appeals in Manhattan said in two separate opinions that such information isn’t automatically exempt from requests under the Freedom of Information Act.

    Cases were brought by News Corp.’s Fox News Network LLC and Bloomberg LP. The two companies sought details about loans that commercial banks and Wall Street firms received and the collateral they put up. The appeals judges had received written arguments on behalf of other news agencies including The Associated Press.

    The Fed argued that if it identified banks that drew emergency loans, it could cause a run on those institutions, undermine the loan programs and potentially hurt the economy.”

    http://tinyurl.com/yetbk5r

    We live in interesting times.

  28. Even Krugman got some things wrong. He was a long-term vociferous proponent of NAFTA and “free” trade. Now that it’s eviscerated America’s domestic production economy he’s fallen awfully silent about NAFTA….

  29. Most certainly the present crisis was a regulatory failure of Biblical proportions. I was in the middle of this mess from 2005 to 2007 consulting with a nationwide mortgage lender in risk management. All of the Wall Street “due diligence” teams would interview me – asking only two questions. “are 10% of originations being reviewed AND how is the sample chosen?” Same exact two questions from the part-time examiner (not enough full-time people to get the job done). Not a single inquiry about what we saw when pealing the layers back OR if we were writing any “suspicious activity reports”.

    One thing need to be added to James’ comments on regulation from Stiglitz’s book – “the regulations have to be simple and transparent, and the regulatory structure has to be designed to prevent excessive influence from the financial markets ”AND POLITICAL INFLUENCE”.

    I was a state securities commissioner. We examined for the first time ever a broker/dealer in the state and found severe fault with a financial advisor trading naked call options for a retired schoolteacher and losing her life savings. Along with the SEC we came down hard on the FA. However, since the FA was my elected official boss’ father’s broker that exam was three in one – FIRST-LAST-ONLY.