Joe Stiglitz: The Only Way The Geithner Plan Works is if Taxpayers Lose

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Joseph E. Stiglitz is a professor of economics at Columbia who was chairman of the Council of Economic Advisers from 1995 to 1997 under President Clinton.  He was awarded the Nobel prize in economics in 2001.  He has been crtical of globalization and his willingness to stand up to Larry Summers during the Clinton adminsitration likely led to him being forced our of the World Bank.  

He is also the former Senior Vice President and Chief Economist of the World Bank. He is known for his critical view of the management of globalization, free-market economists (whom he calls “free market fundamentalists”) and some international institutions like the International Monetary Fund and the World Bank.

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At the World Bank, he served as Senior Vice President and Chief Economist (1997 – 2000), in the time when unprecedented protest against international economic organizations started, most prominently with the Seattle WTO meeting of 1999. He was fired by the World Bank for expressing dissent with its policies.

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Stiglitz always had a poor relationship with Treasury Secretary Lawrence Summers. In 2000, Summers successfully petitioned for Stiglitz’s removal, supposedly in exchange for World Bank President James Wolfensohn’s re-appointment – an exchange that Wolfensohn denies took place.

http://en.wikipedia.org/wiki/J…

And he has a Nobel Prize for his work:

Stiglitz’s most famous research was on screening, a technique used by one economic agent to extract otherwise private information from another. It was for this contribution to the theory of information asymmetry that he shared the Nobel Memorial Prize in Economics in 2001 “for laying the foundations for the theory of markets with asymmetric information” with George A. Akerlof and A. Michael Spence.

http://en.wikipedia.org/wiki/J…

In his 2001 book, Globalization and Its Discontents, Stiglitz took on Rubin and Summers’ “Washington Consensus” of neo-liberal policies:  

Stiglitz argues that the policies pursued by the IMF are based on neoliberal assumptions that are fundamentally unsound:

Behind the free market ideology there is a model, often attributed to Adam Smith, which argues that market forces–the profit motive–drive the economy to efficient outcomes as if by an invisible hand. One of the great achievements of modern economics is to show the sense in which, and the conditions under which, Smith’s conclusion is correct. It turns out that these conditions are highly restrictive.

Indeed, more recent advances in economic theory –ironically occurring precisely during the period of the most relentless pursuit of the Washington Consensus policies–have shown that whenever information is imperfect and markets incomplete, which is to say always, and especially in developing countries, then the invisible hand works most imperfectly.

Significantly, there are desirable government interventions which, in principle, can improve upon the efficiency of the market. These restrictions on the conditions under which markets result in efficiency are important–many of the key activities of government can be understood as responses to the resulting market failures. [2]

Stiglitz argues that IMF policies contributed to bringing about the East Asian financial crisis, as well as the Argentine economic crisis. Also noted was the failure of Russia’s conversion to a market economy and low levels of development in Sub-Saharan Africa. Specific policies criticised by Stiglitz include fiscal austerity, high interest rates, trade liberalization, and the liberalization of capital markets and insistence on the privatization of state assets.

http://en.wikipedia.org/wiki/G…

When written, that book was heresy and treated as such by the Bush reactionaries and the Rubin/Summers neo-liberals.

George Soros, however, described the book as “Penetrating, insightful…. A seminal work that must be read.” http://en.wikipedia.org/wiki/G…

The free market fundamentalists hated it, even though its real target was Rubin and Summers, and not the reactionairies.

Daniel T. Griswold of the Cato Institute labels the book a “score-settling exercise distorted by the author’s own political prejudices and personal animus.” Griswold takes issue with what he claims is Stiglitz’s assumption “that protectionism enriches those nations that practice it” and notes that “while he is not questioning free trade, Stiglitz is disparaging the free flow of capital. The book blames the East Asian Financial Crisis almost entirely on one factor: capital account liberalization.”

http://en.wikipedia.org/wiki/G…

Now, more heresy in the New York Times this morning:

The Obama administration’s $500 billion or more proposal to deal with America’s ailing banks has been described by some in the financial markets as a win-win-win proposal. Actually, it is a win-win-lose proposal: the banks win, investors win – and taxpayers lose.

Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down, with a proposal marked by overleveraging in the public sector, excessive complexity, poor incentives and a lack of transparency.

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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.

Paying fair market values for the assets will not work. 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.

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What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships – with the private sector in control – have perverse incentives, worse even than the ones that got us into the mess.

http://www.nytimes.com/2009/04…

If you want to learn more, Please read the entire op-ed by Stiglitz, which is two pages on the net: http://www.nytimes.com/2009/04…

Make no mistake, Like Paul Krugman, Siglitz is not a socialist.  He’s a capitalist, but one who is comfortable with government intervention in the economy to create social goods.  Perhaps social democratically leaning might well describe him.  In any event, President Obama’s neo-liberal economic polcies are coming under attack from many highly credentialed left of center economists, revealing that for all the rhetoric, change and hope are quite ephemeral when it comes to propping up our flawed system.  

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    • TomP on April 1, 2009 at 5:16 pm
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    Siglitz, Krugman, Dean Baker, James Galbraith and other economists who dare to tell truth to power.  

  1. 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.

    Paying fair market values for the assets will not work. 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.

    I mean, if saving the banks at taxpayer expense isn’t the plan, what is?  Isn’t the fact that we call it a “bailout” fairly telling?  And for that matter, how does nationalization not shift the losses to the government?  Is he suggesting that in nationalizing the banks, the government would do so no longer intending to service their debt?  How do the taxpayers not lose by nationalizing insolvent banks, and having to cover their losses however deep they go?

    I’m not arguing againt nationalization by saying this; I simply feel that Stiglitz is making a misleading argument here.  Yes, the banks have lost much of their capital.  Yes, to fix that problem, the capital has to come from somewhere, and no one has stepped up but the government.  The lost money includes lots of money that is publicly guaranteed in any case, like pensions and FDIC protected accounts.  The government also wants to step in and recapitalize the banks because the loss in public goods, in national wealth and university endowments and so on, is greater (in their mind) than the loss in public goods from using government funds to recapitalize the banks.  But, regardless of whether you use the Geithner plan or nationalize, each of these ideas adds up to exactly the same thing: using taxpayer money to recapitalize the banks.

  2. & I think he’s absolutely correct.

    The problem is, how do we convince Obama to dump the Chicago School and pay attention to the economists who saw this coming & were correct every step of the way?

    I think Obama means well.  I don’t think he has any great expertise in this area of finance, and he’s listening to “esperts” who are shills for what’s been done over the past almost-40 years.

    Since Reagan, in fact.  Obama may be too young to remember what it was like to live in an economy that was not run by the oligarchs, for the oligarchs.

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