- Freefall: America, Free Markets, and the Sinking of the World Economy
- Norton (2010)
One of the many disquieting things about the Great Recession that began in 2008 is how much the theory and practice of "business as usual" survived intact, not only in the world of business, but in politics, and the public forum as well. "One might have thought," says Joseph Stiglitz, near the beginning of Freefall, "that with the crisis of 2008, the debate over market fundamentalism -- the notion that unfettered markets by themselves can ensure economic prosperity and growth -- would be over. One might have thought that no one ever again -- or at least until memories of this crisis have receded into the distant past -- would argue that markets are self-correcting and that we can rely on the self-interested behaviour of market participants to ensure that everything works well."
But that's not what happened. Wall Street and the other global centres of finance didn't appreciably change their way of doing business, and in the U.S., the financial sector, while happy to accept taxpayer bailouts, stubbornly resisted even minimal forms of government regulation, investing substantial sums of money in lobbying efforts to prevent constraints on its methods of transacting business.
Not until mid-2010 was a moderate fiscal regulation law levered into place.
Earlier, President Barack Obama and the Democratic Party representatives in the American Congress passed modest but significant health care reform legislation as well as a stimulus package in an effort to refurbish infrastructure, maintain public services, especially schools, and ultimately reduce a 10 per cent official unemployment rate (the "real" numbers, it's claimed, may be half again as high). Every initiative of the new president was almost unanimously opposed by the Republican Party opposition. Moreover, conservative political forces in the U.S. moved further to the populist right under the banner of a "Tea Party" movement, accompanied by a ratcheting up of the decibel level in the public forum, thanks to a rabid right wing media.
If the recession and near collapse of the economy might have been expected to instill a new respect for the role of government in public affairs, given that government action is what averted catastrophe, there has been little evidence of it.
Nor has there been much of a swing away from the libertarian ideas and rhetoric that have had free play ever since the era of President Ronald Reagan in the 1980s. Even though the effects of the recession are visible everywhere, the debate in the U.S., Europe and elsewhere some two years after the "freefall" focused not on further measures to alleviate joblessness, home foreclosure and diminishing public services, but instead concentrated on fears about government deficits.
The resulting proposals to "tame" those deficits would further reduce services, government revenues and consumption exactly at the moment when, according to many economic thinkers, further stimulus is precisely what is called for.
Joseph Stiglitz is one of those economists. Stiglitz is the 2001 winner of the Nobel Prize in economics, former chief economist of the World Bank, an advisor to the Clinton administration, a Columbia University professor, and one of the thinkers who predicted and warned against the impending recession well in advance of its advent.
In Freefall, Stiglitz attempts to explain some of what went wrong. His book is both an interim report on the causes of the crisis and a running assessment of the remedial measures taken by the Obama administration in its first year in office.
A library of economic prescriptions
Stiglitz's book joins a growing (and perhaps groaning) shelf of works that try to explain the extraordinary economic events of the first decade of the new century, events that proved contagious in a "globalized" world where, as we're frequently reminded, national economies are interconnected.
The profusion of books inspired by the economic crisis that deserve at least mention here present both detailed narrative accounts of the capitalist meltdown, such as William Cohan's House of Cards: How Wall Street Gamblers Broke Capitalism (2009), New York Times financial reporter Andrew Ross Sorkin's thriller-paced Too Big To Fail (2009), and Michael Lewis's The Big Short: Inside the Doomsday Machine (2010), as well as more analytical forays. The fiscal investigations and autopsies range from those that probe historical precedents, such as Liaquat Ahamed's Lords of Finance: The Bankers Who Broke the World (2009), a re-telling of the run-up to the 1930s Great Depression, to works attempting a broader overview of the present.
Among the more readable volumes about the market: English novelist John Lanchester's populist Whoops!: Why Everyone Owes Everyone and No One Can Pay (2010; the American edition is titled, I.O.U.), and various lively but more scholarly studies, including Paul Krugman's The Return of Depression Economics (2009), Jeff Madrick's The Case for Big Government (2009), Nouriel Roubini and Stephen Mihm's Crisis Economics: A Crash Course in the Future of Finance (2010), and Stiglitz's own Freefall. I'm focusing on the latter as something of a stand-in for an impressive array of analyses that necessarily cover similar and overlapping ground.
Stiglitz's book "is about a battle of ideas, about the ideas that led to the failed policies that precipitated the crisis and about the lessons that we take away from it." It's a critique of shattered illusions and, in terms of what might be learned, an argument for what can be called "social democratic" economics and politics.
"Economics need a balance between the role of markets and the role of government -- with important contributions by nonmarket and nongovernmental institutions. In the last twenty-five years, America lost that balance, and it pushed its unbalanced perspective on countries around the world," says Stiglitz.
Not just a failure of character
In looking at "the making of a crisis," Stiglitz warns against "too facile explanations" that begin and end "with the excessive greed of the bankers." Yes, the bankers were greedy, but in part that's because they had "incentives and opportunities" to be greedy.
Stiglitz emphasizes the interconnectedness of the elements that produced the crisis: a phantasmal housing bubble generated by worthless "sub-prime" mortgages; the bundling or "securitization" of those mortgages through instruments of fiscal "innovation" invented by very clever operators; the sale of those packages by both mainstream and "shadow bank" sectors to large investors, including mutual funds, pensions and other banks around the world; the absence of regulation of both institutions and innovations, or the collusion of regulators who gave their imprimatur to Ponzi-scheme-like speculation; and the inevitable, even predictable, bust that followed the artificial boom.
It was mortgage securitization, the bundling and sale of "toxic" mortgages, "that proved lethal," says Stiglitz, who likens the whole process to the attempts of medieval alchemists to turn base metals into gold. Here, "modern alchemy entailed the transformation of risky sub-prime mortgages into AAA-rated products safe enough to be held by pension funds. And the ratings agencies blessed what the banks had done.
Finally, the banks got directly involved in gambling -- including not just acting as middlemen for the risky assets that they were creating, but actually holding the assets." When the day of reckoning came, it was not just investor institutions and individuals who were stuck with worthless assets; it turned out that the banks, both mainstream and shadow, had also been caught off guard.
Markets manufactured risk
Summing it up, Stiglitz charges that "America's financial markets had failed to perform their essential societal functions of managing risk, allocating capital and mobilizing savings, while keeping transaction costs low. Instead, they had created risk, misallocated capital and encouraged excessive indebtedness while imposing high transaction costs."
The high transaction costs made for ballooning profits and instant multi-million-dollar bonus compensation for the money managers.
"At their peak in 2007," notes Stiglitz, "the bloated financial markets absorbed 41 per cent of profits in the corporate sector." That's a number worth thinking about. It's a reminder that in the midst of all the razmatazz, the economic system wasn't making money from making things, but making profit by moving money around (often, imaginary money).
While the details of the story are fascinating, the fiscal innovations downright exotic, and Stiglitz's telling of the tale engrossing, there's something more going on here, and the shrewder observers, like Stiglitz, Paul Krugman, and Nouriel Roubini are quick to see it.
"The current crisis," says Stiglitz, "has uncovered fundamental flaws in the capitalist system, or at least the peculiar version of capitalism that emerged in the latter part of the twentieth century in the United States.
It is not just a matter of flawed individuals or specific mistakes, nor is it a matter of fixing a few minor problems or tweaking a few policies." Rather, there's something wrong with capitalism.
'Dr. Doom' weighs in
However, none of the major analysts at hand is proposing anything more than a social democratic reform of capitalism. This is not Karl Marx and The Communist Manifesto of 1848.
In arguing that the "problems are more deep-seated," Stiglitz notes that even in the last quarter-century, "this supposedly self-regulating apparatus, our financial system" has repeatedly required government rescue from crisis. As for the world outside of the U.S., Stiglitz, who once worked for the World Bank and is something of a "crisis veteran," reports that "crises in developing countries have occurred with an alarming regularity -- by one count, 124 between 1970 and 2007."
Stiglitz also has the virtue of not treating the numbers as abstractions; repeatedly, he points to the toll caused by these crises on actual human beings.
Nouriel Roubini, an economics professor at New York University, where his gloomy but accurate predictions of the collapse earned him the sobriquet of "Dr. Doom," goes further in underscoring the point that crisis is inherent in capitalism. He describes the idea that markets are stable, solid, dependable, self-regulating entities as a "simple, quaint belief."
Roubini's book Crisis Economics, as he and his co-author Stephen Mihm explain, "returns crises to the front and center of economic inquiry... It shows that far from being the exception, crises are the norm, not only in emerging but in advanced industrial economies. Crises -- unsustainable booms followed by calamitous busts -- have always been with us... Though they arguably predate the rise of capitalism, they have a particular relationship to it. Indeed, in many important ways, crises are hardwired into the capitalist genome."
A chorus of reformers
In his focus on the nature of "crisis economics," Roubini indirectly echoes some of the ideas in Canadian analyst Naomi Klein's The Shock Doctrine (2007). In her book on the rise of "disaster capitalism," Klein argues that laissez-faire capitalist thinkers systematically seize on economic crises and other catastrophes to impose their version of American-style "cowboy" capitalism (or "neo-liberalism," as it's sometimes called) on the world.
Roubini, relatedly, says that beyond the exploitation of crises by a particular school of capitalists, economic instability is part of what capitalism is all about. The amelioration of capitalist crises, insofar as it is available, is state regulation of capitalism to prevent "bubbles," and the use of government as an instrument of economic stimulus in hard times.
Stiglitz, Krugman and Roubini represent themselves as proponents of capitalist markets, but insist on the reform of such markets in the name of democracy, justice and a morality that is seldom heard about outside of certain church pews and select university classrooms.
Stiglitz's Freefall provides a running assessment of the Obama administration's measures in response to the present recession as well as to the systemic flaws of capitalism. Stiglitz says that his experience as an analyst of Obama's policies has been "painful." The "spirit of hope" that marked the arrival of a new, more liberal president has substantially diminished.
Neither Stiglitz, Krugman or Roubini, three of the most prestigious economists working in the U.S., is satisfied that the American or global response to the crisis amounts to more than half-measures and muddling through. Although they call for policies that are much stronger than the programs and rules established to date, there's a political problem.
Where is the will?
It is not clear that the Obama administration, even if wanted to implement stronger measures, has the political clout to do so. What is most evident about American politics in the first years of the new century is how deeply divided the world's most powerful empire is, riven by seemingly irreconcilable economic, cultural and political values.
No doubt, it's too much to demand that economists like Stiglitz and his intellectual peers offer not only economic remedies but political formulas that will permit their implementation.
Roubini cites a line from John Maynard Keynes, one of the mentors of the age. Keynes criticised economists who, "in tempestuous seasons... can only tell us that when the storm is long past, the ocean is flat again."
So far, the ocean is not yet flat again, and even the best economists, as the subtitle of Stiglitz's book suggests, tend to leave us with a familiar sinking feeling.