Free Markets, Free People
The “too big to fail” intervention in the financial realm may have put us in an even worse position:
Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.
“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”
A comforting thought.
Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.
“We aren’t doing anything significant so far, and the banks are pushing back,” he said. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”
Key phrase – “politically difficult”. I.e. it may cost the Democrats and Obama some political capital. Wouldn’t want them to have to make difficult political decisions, would we – so the hope is they can “outsource” it. Make the decision out to be one that a group of leaders came up with and thus a broad consensus that gives the administration some political cover.
“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”
That depends on what that political cost is calculated to be.
“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”
The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.
“The question then is who is going to finance the U.S. government,” Stiglitz said.
Indeed – and here we are set to spend even more money on a pet domestic issue.
A number of economists, including Paul Krugman, have panned Timothy Geithner’s plan to recapitalize banks by buying toxic assets in a complex and highly leveraged way that puts the taxpayer’s dollars at risk.
Joseph Stiglitz, a Nobel economist, has piled on. In fact, his is probably the most damning opinion I’ve seen. Stiglitz says that first of all, Geithner has analyzed the problem incorrectly. Geithner keeps telling us it is a “liquidity” problem. Stiglitz says “poppycock”:
The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.
What he means is their “capital”, or assets are in worthless loans. Yes that’s right – worthless. So, as he points out, paying “fair market value” for these assets won’t work, will it? They’re worthless.
So what does Geithner propose?
Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.
Stiglitz explains the proposed process very well, demonstrating it fairly simple and straightforward examples how the taxpayer takes the majority of the risk, and, given the nature off the “assets”, will absorb the majority of the losses.
But Americans are likely to lose even more than these calculations suggest, because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets that they think the market overestimates (and thus is willing to pay too much for).
But the market is likely to recognize this, which will drive down the price that it is willing to pay. Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. With the government absorbing the losses, the market doesn’t care if the banks are “cheating” them by selling their lousiest assets, because the government bears the cost.
That is a process driven problem. The Geithner process guarantees the outcome because that is the most likely outcome, banks not being stupid and with the government bearing the cost.
Bottom line – taxpayers are going to get hosed and hosed good.
Stiglitz provides an interesting alternative which gives you an idea of how poorly he regards Geithner’s plan:
Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan. After all, the F.D.I.C. has taken control of failing banks before, and done it well.
Given only those two option, I’d say Stiglitz has a point.
Of course, the argument we’ve made since day one is we ought to let them go bust, get it over with and begin the recovery. That’s the same argument we made concerning GM and Chrysler.
Instead we’ve gotten these insane plans driven by the administration which has thrown literally trillions of good dollars after bad – and to no apparent avail.
This madness has got to stop.