Friday, March 27, 2009

Stiglitz: Capitalist Fools

A good history of the financial crisis and its long term causes at Vanity Fair. This is the one I would start with:
No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In
November 1999, Congress repealed the Glass-Steagall Act—the culmination of a
$300 million lobbying effort by the banking and financial-services industries, and
spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated
commercial banks (which lend money) and investment banks (which organize the sale
of bonds and equities); it had been enacted in the aftermath of the Great Depression
and was meant to curb the excesses of that era, including grave conflicts of interest.
For instance, without separation, if a company whose shares had been issued by an
investment bank, with its strong endorsement, got into trouble, wouldn’t its
commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An
ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-
Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to
make sure that the problems of the past do not recur. As an economist, I certainly
possessed a healthy degree of trust, trust in the power of economic incentives to bend
human behavior toward self- interest—toward short-term self- interest, at any rate,
rather than Tocqueville’s “self interest rightly understood.”
The most important consequence of the repeal of Glass-Steagall was indirect—it lay
in the way repeal changed an entire culture. Commercial banks are not supposed to be
high-risk ventures; they are supposed to manage other people’s money very
conservatively. It is with this understanding that the government agrees to pick up the
tab should they fail. Investment banks, on the other hand, have traditionally managed
rich people’s money—people who can take bigger risks in order to get bigger returns.
When repeal of Glass-Steagall brought investment and commercial banks together,
the investment-bank culture came out on top. There was a demand for the kind of high
returns that could be obtained only through high leverage and big risktaking.
Congress and the Clinton administration undue Glass-Steagall separating commercial from investment banks, a law specifically passed after the great depression to keep banks away from market related risks. Then Congress pushed the GSE home lenders to loosen credit standards and lend to poorly qualified borrowers. That of course is the same group of congressmen who are pointing fingers at bankers for doing what the Congress said they could. What a bunch of schmucks. None of this is to excuse the venality and lack of ethical standards among Wall Street executives.

Thanks to Fullemoney for pointing out this article.

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