LIKE THE FALL OF THE WALL

For Nobel Prize winner Joseph Stiglitz, market fundamentalism survives with the crisis

[This interview published in: Frankfurter Rundschau, 11/7/2008 is translated from the German on the World Wide Web, www.fr-online.de.]

Mr. Stiglitz, your book is titled “The Three Trillion Dollar War.” Is there a connection between the financial crisis and the Iraq war?

Yes. Firstly, the Iraq war has much to do with the higher price of oil. Americans financed the increased price of oil on credit with foreign money. The American Federal Reserve acted shortsightedly when it lowered the interest rate to revive the economy. The mixture of low interests, excessive liquidity and lax oversight on money institutes led to the financial crisis. Secondly, the Iraq war was completely financed with credits. National indebtedness rose two-thirds in only eight years. In August 2007 something had to be done but the government was not concerned until February 2008. What it then did was very reserved in view of the enormous budget deficit. The way the war was financed will lengthen America’s economic downswing.

Do we face the greatest crisis since the Great Depression?

This is certainly the most serious problem since the Great Depression. But there won’t be comparable negative effects like 1929. The financial institutions of the US caused the current momentous problems with so-called “financial innovations” designed to manage risk. Instead they created a new kind of non-transparency with tremendous consequences. No one knows now how bad things really are. Compared with the banking sector, the consequences of the crisis are much milder for the real economy. At the time of the Great Depression, there was 25 percent unemployment. Today thanks to the economist John Maynard Keynes, we know hot to stop things before they develop as terribly as then. The government should immediately begin investing in the infrastructure, education and other projects that help strengthen our economy and competitiveness.

Is the financial crisis the end of the Reagan-revolution?

Former US president Ronald Reagan appointed Alan Greenspan as chairman of the Federal Reserve because he trusted the free play of market forces. The real estate bubble arose during Greenspan’s term in office. Although Greenspan had many instruments for counter-measures, he failed. His predecessor Paul Volcker was known for keeping inflation under control. He was fired because the Reagan administration did not trust appropriate de-regulation. One thing is clear today: to correct the problem, we need political leadership and legislation that exercises more control on the financial markets.

Who is most to blame?

The destruction was largely the work of Wall Street. Wall Street people forgot their real reason for existence, namely to manage risks and use capital rightly. They were frauds with the money of unknown people knowing taxpayers would step in the breach if the losses were too great. They knew they were “too big to fail,” too big for the state to let them crash. Therefore they failed to limit risk. They used capital wrongly. Enormous sums flowed into the real estate market that exceeded the human possibilities of shouldering them. Too little capital was made available to the high-tech firms that are now changing our life. The rage that many have toward people on Wall Street results from the defensive stance of bankers. Their high income is well deserved, it is said. Moreover they had raised productivity in such a way that everyone would be better off on account of the profits of the financial sector than without them. We only see now that they in no way made the economy more efficient. They simply built the house of cards and decimated rather than improved the productivity of the economy. The life of people in the country was relieved since hundreds of billions were borrowed on credit from foreign countries to service the consumer frenzy and the housing boom.

What could improve the system?

Regulations are necessary to restore trust. By that I mean rules for corporate governance, that is principles for the business community, performance incentives and interest systems. We must make sure the rest of the country is heard, not only the voice of Wall Street. A commission for financial products should be a part of the new system. It must guarantee that no products can be bought or sold by banks or pension funds that are unbearable for people. Such a commission could help strengthen innovativeness, protect homeowners and make our economy more efficient.

Did Europe react rightly?

The reaction of European governments is interesting. Germany’s promise to guarantee all bank deposits should help increase trust in the country. The British plan for revitalizing the banks and partly nationalizing them is certainly the right way. In my opinion, pressure from Europe helped US Treasury secretary Henry Paulson modify his bailout plan. The first version was a washout.

Does the financial crisis mark the end of an epoch?

Apart from some stubborn hardliners, everyone would say this is the end of market fundamentalism. The fall of Wall Street for market fundamentalism is what the fall of the wall was for communism. It shows the way of this economic order is not workable. Now the governments must act.