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Stiglitz to IMCA crowd: Hunker down for painful recovery

No froth in this economist's speech. He sees governments-in-a-box and political instability

Tuesday, May 18, 2010 – 5:42 AM by Elizabeth MacBride
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Joseph Stiglitz: Whenever I give a speech in Europe, I thank they. They purchased half of our toxic mortgages.

In a speech that boiled the causes of financial crisis down to perverse incentives in the banking industry and unsustainable American consumption, economist Joseph Stiglitz made the case for greater regulation of financial services and predicted a painfully long, slow global recovery.

“When you make big mistake, there are big, long-lasting consequences,” the Nobel-prize winning economist and Columbia University professor, told more than 1,650 attendees the annual Investment Management Consultants Association conference in Orlando, Fla., yesterday.

Stiglitz, 67, kicked off the conference, which lasts until Thursday. IMCA, a traditional haven for wirehouse brokers, is drawing more brokers from IBDs. It combined two national conferences into once national event this year and saw attendance for a single event climb by about 200.

Stiglitz made a careful, practiced presentation with a few spots of black humor. His predictions were largely bleak. Governments have exhausted the tools of monetary and fiscal policy, he said. The Asian economies are growing, but they are not large enough to lift Europe and the United States. He is known for his critical view of the management of globalization and free-market economists.

He predicted a return to normalcy by the middle of the decade. “The process of de-leveraging is a slow process,” he said. “Right now, we’re just moving the debt around and slowly de-leveraging.”

Yawns over $1 trillion bailout

Stiglitz made his remarks against the backdrop of two still unfolding consequences of the crisis: the debate over financial reform happening in the U.S. Senate this week and the economic turmoil in Europe, where even the promise of a $1 trillion bailout by European and American governments has failed to assuage the crisis.

Stiglitz, whose stock has risen as his criticisms of deregulation and his fears of recession proved well-founded, had something to stay about both: he said that a better regulatory system could help prevent or minimize future crises, and he warned that the recession American exported to Europe is about to be passed back across the Atlantic again.

He traced the roots of the financial crisis to an illusory view of the market as self-regulating.

“The only period when there were no crises was 25-30 years after the Great Depression, when we had good regulation,” he said.

After the de-regulation movement began, he said, there were more than 100 crises, mostly in developing countries. Governments and the IMF launched bailouts.

Serial rescues

“The wrong inference was made that markets worked,” Stiglitz said. “Markets worked, but only because they were rescued.”

The frequency of the bailouts led banks to take risks, off and on their balance sheets, that they shouldn’t have, he said.

“Securitization meant the originator did not bear the cost of flawed mortgage products,” he said. “This was based on the idea that a fool is born every minute.”

He added:“Globalization had opened up a global market for fools.”

The banking system’s risk-taking combined with Americans’ unsustainable consumption patterns to create the real estate bubble.

“The median income in 2007 was 4% below the median income in 2000” he said. “Almost all the increase in GDP (in those years) was to people at the top, the people whose money you are probably managing.”

“You don’t have to have a PhD to understand you can’t spend more than 100% of your income on housing.”

European crisis

Stiglitz acknowledged that one of his biggest worries is that the economic turmoil in Europe will lead to political instability.

“At this point, the crisis appears more likely to give rise to extreme right-wing movements,” he said, noting that wars even can grow out of such crises. “People begin blaming each other.”

He said Spain is on the precipice, despite years of conservative policies. The country was running a surplus and had better bank regulation than the United States.

Now, it has a huge deficit, a 20% unemployment rate and 40% unemployment among young people.

He described the box that the governments of Europe and the United States find themselves in. Monetary policy has been exhausted; the remedies of fiscal policy are coming to an end. Almost as an aside, Stiglitz gave credit to the government stimulus, saying that without it the unemployment rate would have peaked at 12% instead of 10%.

But now, governments face huge deficits without many tools at their disposal.

If they increase taxes to reduce the deficits, growth will slow, and the deficits will be reduced less than expected.

“This is reminiscent of the Argentinean death spiral,” he said.


He offered one idea for aiding the American economy.

Pointing out that although the federal government bailed out the banks, little has been done about the foreclosure crisis, he advocated for a homeowner’s Chapter 11. In essence, homeowners would restructure their loans in exchange for giving the banks equity in their homes. The banks would have a claim on future capital gains.

He noted that the rate of foreclosures is expected to be 2.5-3.5 million in 2010, he said, higher than the number in 2009. One in four Americans is in possession of a mortgage that’s underwater, he said, suggesting that the high level might delay a recovery because it keeps people from moving for new jobs.

“Imagine the lives of American who wake up every day with the burden of a debt they can’t get out from under.”

Without specifically advocating for a policy, he talked about how too-big-to-fail is a big problem. Banks have an even greater incentive to make too-risky bets. “This is ersatz capitalism,” he said. “We socialize the losses and privatize the gains.”

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