5 Disastrous Decisions That Got Us into This Economic Mess

By Joseph Stiglitz, Vanity Fair. Posted December 11, 2008.

The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues -- they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely -- which they hadn't -- the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.

The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems -- the flawed incentive structures and the inadequate regulatory system.

Was there any single decision which, had it been reversed, would have changed the course of history? Every decision -- including decisions not to do something, as many of our bad economic decisions have been -- is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You'll hear some on the right point to certain actions by the government itself -- such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.'s had the same perverse incentive to indulge in gambling.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, "I have found a flaw." Congressman Henry Waxman pushed him, responding, "In other words, you found that your view of the world, your ideology, was not right; it was not working." "Absolutely, precisely," Greenspan said. The embrace by America -- and much of the rest of the world -- of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

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Joseph Stiglitz, a Nobel laureate, is a professor of economics at Columbia University.

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