Joseph Stiglitz: Bankers Made Reckless Bets on the Economy, Knowing Taxpayers Were Going to Pick up the Tab

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The Nobel Prize-winning economist argues the banking industry “failed in their core societal function,” helping lead to the great economic crash of ’08.

Zach Carter: How did we get here?

Joseph Stiglitz: Well, there are so many pieces that contributed to our getting here that it’s hard to distill into something simple, but the bottom line is that the banks acted recklessly in their lending, in their gambling, in their management of risk. They made bad judgments about credit worthiness. In a sense, they failed their core societal function of allocating capital and managing risk. They misallocated capital and they mismanaged the risk. What I tried to do with the book is peel back the onion and ask – this is not the way capitalism supposed to work – why did things happen so badly? And here there are a number of factors. One of them was that the bankers had the incentive to engage in short-sighted behavior and excessive risk-taking. You have to ask, “Why is that?” And the answer has to do with problems of corporate governance and a host of other problems that I try to delineate in the book.

On the other side, though, they were allowed to get away with it. And here the issue was deregulation. We stripped away the regulations that had worked so well in the quarter century before 1980. We’d known about the potential for these problems for decades and we had figured out how to stop them, but then we stripped away those regulations. Then you have to ask why we did that, and it had to do with the ideology and with financial interests. The bankers wanted to be unrestrained and they painted the political process, shaped it to make sure they could get away with it. The economists provided some arguments for why it would be a good thing.

ZC: I want to focus on that word ‘capitalism.’ A lot of people who are advocates of financial reform are being described as ‘populist’ or ‘socialist.’ But it seems to me that one of the core thrusts of your book is that the system we had in place in the mid-’70s was a good system, and nobody was screaming about our socialist banking system at that time. What do you make of the current debate over the banks?

JS: What we have now is not real capitalism. I give it the name “ersatz capitalism” because what we’re doing is socializing losses and privatizing gains. That’s worse than real capitalism, of course, because it means that there are distorted incentives. So the banks can write these credit default swaps and crazy derivatives knowing that if things go bad, the taxpayer is going to pick up the tab. So the first point I want to make is that today’s system is not real capitalism. It’s gambling at the expense of the taxpayers.

The other point that I would make is about the use of the word “populism,” which is used in a number of different ways. One meaning of populism is a government that responds to the concerns of the people. Of course, that is what democracy is supposed to be about, so reformers shouldn’t worry about being labeled populist in that sense. But the other use of the word is much more negative in tone, and it describes a situation where political leaders promise things that are beyond the laws of economics.

In this crisis, I actually think of these bankers as being the populist figures in that sense. It was the bankers who tried to pretend that they could break the laws of economics. The things they were telling poor people — borrow all this money, don’t worry about your ability to replay, house prices are going to go up, you’re going to be a wealthy person — and by the way, you can share some of that wealth that you’re going to get by giving us big fees — well, that was unreality. There’s no such thing as a free lunch and the bankers were promising a free lunch both for themselves and for everybody else. So the irony in all of this is that the people who ought to be most accused of that kind of populism, that out-of-touchness with reality, are the bankers themselves.

ZC: Speaking of reality, one of the most astonishing aspects of the deregulatory movement has been the popularity of these ‘off-balance sheet vehicles’ in finance. The banks actually refused to account for a lot of transactions and regulators just shrugged it off. You won your Nobel Prize for work on information asymmetries – where did this bogus accounting come from and is there any defense for it?

JS: One issue that I try to raise in my book Freefall is that good information is necessary for the functioning of a market economy. The banks’ accountants were originally very clever in coming up with legal deceptions to avoid paying taxes — you might call it “creative accounting.” But then they discovered they could use some of the same techniques to deceive investors. And that’s a lot of what all of this great, high-paid talent in the banking industry was up to over the last 20 years. They weren’t trying to make our economy work more efficiently; they were engaged in what we call regulatory accounting and tax arbitrage. In other words, they were deceiving investors, deceiving the tax authorities and deceiving the regulators.

ZC: In Freefall there’s a paragraph where you’re talking about Henry Paulson coming to Congress with a three-page TARP bill and demanding the bailout money with no strings attached. You say it looked like a classic problem in developing nations where the financial sector basically uses the government to steal from the public. When has this taken place before and what does it look like?

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