In the last economic crisis, a little over a decade ago, the U.S. “exported our way out of it,” says Columbia University Professor Joseph Stiglitz, who was awarded the 2001 Nobel Prize in economics.
“With robust exports, the downturn was relatively short. What’s unusual about this downturn … is that there is downturn in almost every other part of the world, and it’s very difficult for everyone to export their way out of the downturn.”
Stiglitz, who spoke at Mississippi State University, has been a critic of the way the current crisis — “a combination of an economic crisis and a financial crisis” —has been handled, but says, “I think there’s still opportunity to correct where we’ve been going.”
The crisis, he says, was caused by banks making loans based on little or no collateral and creation of a lot of esoteric hybrid financial instruments. “When these all went bad, particularly when the housing bubble broke, they discovered they were, in effect, bankrupt. And the government came in and rescued them.”
The bubble “actually sustained the American economy from the period 2003-07,” Stiglitz says. “Because of the bubble, not only was there a lot of new houses and construction; it also supported a high level of consumption. People were taking money out of their houses — in one year alone there was over $900 billion of mortgage equity withdrawal. From 2003-07, between 60 percent and 80 percent of the American economy was based on real estate, directly or indirectly.
“It was very clear that the American economy was all out of kilter, that it was not sustainable.”
The second part of the economic crisis was inventories, he says. “In the months following the collapse of Lehman Brothers just over a year ago, credit got very tight, the economy was sinking, firms started to reduce their inventories, and that slowed the economy. But they took the inventories down too far.”
The third factor in the crisis, Stiglitz says, is the longer-term problem in our economy, and that is the transition from a manufacturing to a service sector economy.
“So, all these problems were intertwined with financial sector problems in a kind of vicious circle: As the economy weakened, goods were overproduced, which produced problems for many firms — more bankruptcies and more foreclosures, which hurt the banks, and there’s a downward spiral.”
While much of the media attention was focused on the financial sector, the $700 billion TARP (Troubled Asset Relief Program) “was only the most apparent part of a massive bailout of the financial sector — the problems were much deeper.”
Even if banks were fully functioning, as they were before the crisis, Stiglitz says there would still have been the problem that “what was sustaining the economy before the crisis was unsustainable production based on the housing bubble.”
The seriousness of the problem is highlighted by the labor market, he notes. “While the ‘official’ unemployment rate is 10.2 percent, the unofficial rate is much, much higher. The official rate doesn’t include many long-term unemployed workers who’ve given up looking for a job.
“Also in the uncounted group are many people who’ve accepted part-time jobs because no full-time jobs were available. One out of six Americans who would like to have a full-time job cannot get one — the worst it has been since the Great Depression, and a very serious indictment of an economy not working the way it should.”
Even that “doesn’t fully describe the serious weakness in the labor force,” Stiglitz says. “For those working so-called full-time, the average work week is now down to 33 hours, the lowest it has been since those data have been collected since the end of World War II.”
The fact that government figures indicate growth has resumed means ‘officially’ that the recession is over, he says, “But for workers who can’t get a job, the recession is still here. There is enormous excess capacity in the business sector, but they can’t sell the goods. So, in any reasonable way of looking at it, we’re nowhere near out of recession.”
A relatively high unemployment rate is likely “for an extended period of time.”
The forecast for the U.S., Stiglitz says, is that for 2009-10 “we’ll be growing at about 1.5 percent — less than half the rate we need to grow in order to create jobs for new entrants into the labor force. So, the job deficit facing this country is actually going to get larger through the end of 2010.
“Then, we have additional problems. The government’s economic stimulus comes to an end mid-2011, and when that spending is withdrawn it will make the economy weaker. So, there are likely to be many bumps in the months and years ahead.”
While much of the focus in the current crisis has been on the residential mortgage market, he says “the commercial real estate mortgage market is likely to face very serious problems in the next three years.”
The good news is that parts of the world, particularly Asia, have bounced back relatively quickly. “China’s growth has slowed from around 12-13 percent to 8-9 percent. Not bad. But China, like all of Asia, is just too small economically to pull us out of recession.” Despite massive population numbers, “Consumption in all of Asia represents only about 40 percent of the level of consumption in the United States.”
When the bubble broke, Americans responded by starting to save more, Stiglitz says, and savings that were basically zero before the bubble burst, have gone up to around 5-6 percent, and some places as much as 8-10 percent. “For individual American households that were living beyond their means, this is a good thing. But for aggregate demand in the economy, it’s a problem. If people are saving and not spending, demand sags and that means a weak economy. That’s a fundamental problem we face going forward.”
A critical factor in this crisis was “reckless lending” on the part of the banks and the financial sector more broadly, he says.
“Bankers had incentive structures that were not designed to encourage prudence or good lending; they were designed to encourage shortsighted risk-taking: they got big bonuses when things went well, but they didn’t have to pay it back when things went badly. Performance was assessed on a year-by-year basis, not on a long-term basis. … It was a very foolish thing to do.
A consequence of all these high-risk incentives was that it allowed big banks to get bigger, Stiglitz says. “When you get big enough that you’re too big to fail, you have to score successes. If you gamble and you win, you walk off with the profits, but if you lose the taxpayer picks up the losses. It’s a one-sided bet, and the bigger you bet, the better off you are.”
Following repeal of the Glass-Steagall Act in 1999, there was an enormous increase in the concentration of the U.S. banking system, he notes. Big banks got larger and larger, the problem of the too-big-to-fail banks got worse and worse, and anti-trust regulation was no longer there.
“Regulation is designed to stop the kind of excessive risk-taking that can get an economy into trouble,” Stiglitz says. “After the Great Depression, there was a Pecora that analyzed what caused the depression and proposed a whole set of institutions and regulations, like the Securities and Exchange Commission and the Glass Steagall Act.
“As a result of that, we had 40 years in which we had no financial crisis; in fact, it was so successful, many countries imitated what we did. It was a remarkable period in world history — the 25 years after World War II is the only period of such duration all around the world in which there was no financial crisis, no banking crisis except for one in Brazil.
“Regulation worked in preventing crises, and there was a period of very rapid economic growth and stability.”
But, says Stiglitz, “People forgot. The lessons of the Great Depression became ancient history, and we enacted deregulation measures. Not only that, we had regulators who didn’t believe in regulation. In such a situation, you’re not going to get good regulatory enforcement.
“Alan Greenspan (former Federal Reserve chairman) was appointed because of his belief in free markets. His predecessor, Paul Volcker, had brought down inflation from double-digit levels to a very low level. Normally, if you had a central banker that had done that, he would’ve been given a grade of A-plus and automatic reappointment, but President Reagan fired him because he wanted someone who would push forward his agenda of deregulation.
“Finally, last year, Greenspan gave a mea culpa, saying he had not expected that banks would be as reckless as they were. But even in that speech, where he admitted his mistake, he didn’t grasp the reason that we had regulation in the first place. For someone who wants to gamble or take excessive risk, and it affects only himself or his family, that’s his own problem.
“The reason we have regulation of banks is that if a bank fails, it has consequences for those who are not a party to the transaction. There are systemic consequences not only for the American economy, but the global economy — people all over the world have lost their homes and their jobs, while the taxpayer is asked to pick up the tab.
“We don’t know what the full amount will be, but clearly in the hundreds of billions of dollars. Just think about what we could have done in this country with those hundreds of billions of dollars.”
Why did we have deregulation? Part of the reason, Stiglitz says, was “deficiencies in corporate governance”; another part was “deficiencies in anti-trust law and repeal of Glass Steagall.”
With banks doing very well, he says, they were able to exercise a tremendous amount of political influence.
“For every single member of Congress, the financial industry has five lobbyists. For the last few years, the industry has spent more than $5 billion in campaign contributions to members of Congress. So, it’s very clear they had incentive to eliminate regulation.”
The “self-interest” and “greed of the bankers did not lead to economic efficiency,” he says.