Joseph Stiglitz: Bankers Made Reckless Bets on the Economy, Knowing Taxpayers Were Going to Pick up the Tab
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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?
JS: Oh, it's happened in many emerging markets. Mexico was one of the cases where it happened, and that was just before I arrived at the World Bank and we were seeing some of the consequences there. But what happens in the process of bailouts is that money goes from public purse to somewhere else. And you have to trace the money and what you discover is the money goes from the public, from the taxpayer, and it inevitably winds up in the hands of some of the same people who caused the crisis. And it's often done in a very obscure way, just like the creation of the crisis itself, into things that are hard to detect -- off-balance sheet transactions and the like.
What has absolutely amazed me about this crisis is the lack of transparency that created it is now being reflected in the lack of transparency in the bailouts. And the Federal Reserve is saying that it's not subjected even to the Freedom of Information Act. Here we have a public organization that is refusing to disclose where the money went.
ZC: The public's money, at that.
JS: That's right. Bloomberg [News] had to sue, Bloomberg won the suit and rather than saying, "We made a judgement call that wasn't right," the Fed said, "No, we're going to appeal because we don't want people to know." It's not like anyone has been advocating to have every scrap of information immediately available in the moment of the crisis. That obviously could cause a little bit of a turmoil. But now we're more than a year after Lehman Brothers. It's no longer a question of market stability but a question of accountability.
ZC: Are other central banks this secretive?
JS: This is part of the mentality of central banks. Remember, the central bankers are often people from the banking community, the same community that has been involved in the inventive, creative use of these off-balance-sheet kinds of non-transparent vehicles. So they know that information is money, and the best way to profit is to try and keep everything quiet.
ZC: 'Too big to fail' has become a household term, but how did things really play out when Lehman Brothers went under? If policymakers had just looked at Lehman's involvement in the commercial paper market, it's at least conceivable that the bankruptcy could have been managed without so much fallout. Could Lehman have gone through a prepackaged bankruptcy similar to what Chrysler and GM experienced? And if so, what would it have looked like?
JS: Clearly, we could have managed an orderly resolution for Lehman. You know, there have been big financial companies – Continental Illinois – that have gone bankrupt without any trauma to our economic system. And so we know how to manage these things. There is a little bit of a question about whether there was legal authority to do it because Lehman was an investment bank not a commercial bank, so the ordinary FDIC process wouldn't apply.
ZC: Well, Lehman was a lot bigger than Continental Illinois, but we still managed to come up with something for Chrysler and GM, and the FDIC process didn't apply to them.
JS: The point I was going to make is that everybody knew that there was going to be a problem with Lehman Brothers several months before it actually went under. If there really wasn't any legal authority to deal with it, Bernanke and Paulson should have gone to Congress and said they needed it. So the fact is, this legal authority issue was just an excuse for policymakers. The bailouts of AIG and Bear Stearns involved very unusual measures. These guys were willing to bend the law, and they could have done a lot more than they did on Lehman Brothers. But they were in the business of picking winners and losers. There were a lot of discussions about how they decided who to bail out and who to not, and the sheer recklessness of the process is just inexcusable.
ZC: But what do we do now? After Lehman, the government can say it will let these mega-banks fail, but the credit markets won't buy it. The big banks are still able to raise money at lower interest rates and take bigger risks because investors think the government will spare them from losses. Is there a way to establish a fair playing field in finance that doesn't involve breaking up these banks?
JS: It's very difficult. You know, the studies have shown very clearly that the very big banks, the banks that we call too big to fail, have a competitive advantage not because they are more efficient, but because they can get access to capital at lower costs. Everybody knows that they're effectively guaranteed by the U.S. government. And that really tilts the playing field and leads to a very adverse dynamic in which the big banks actually get bigger. The bigger you are, the better the implied government insurance, and that accelerates the process of concentration in a few banks. It's very, very unhealthy from an economic standpoint. It undermines competition and drives up interest rates. We want low interest rates to get our economy recovering. This goes in exactly the opposite direction because it weakens competition.