Guiding the Invisible Hand
Freefall: Free Markets and the Sinking of the Global Economy
Allen Lane, 2010
With the proliferation of esoteric financial instruments, a shift toward massive private and public sector leveraging, and the slow emergence of enormous real estate bubbles, the finance sector was primed for a meltdown. Predictably, the hidden spread of risk in financial instruments like derivatives and collateralised debt obligations, combined with a diffuse over-investment in toxic sub-prime mortgages and mortgage-backed securities, led to the now infamous crisis of September 2008 and unprecedented government intervention. The many looming signs of catastrophe that appeared during the heady years after the 2000 dot-com technology bust were ignored by many free market ideologues in the financial community, but the near collapse did not come as a surprise to everyone. A few prescient analysts, including famed New York Times columnist Paul Krugman and billionaire currency trader George Soros, had publicly voiced their concerns repeatedly by noting the dangerous confluence of flawed corporate governance, inadequate regulatory oversight, and myopic asset risk management.
Few commentators, however, were as consistently outspoken as Joseph Stiglitz, a visionary Nobel laureate in economic sciences from Columbia University and former chief economist for the World Bank. Stiglitz, a political centrist and neo-Keynesian economist who worked extensively in previous Democratic administrations, warned policy makers repeatedly that the United States was headed toward a deep, painful recession if pre-emptive interventions were not made. But Fed Chairman Alan Greenspan had a close relationship with the private sector and saw no reason to reverse long-cherished beliefs in rolling back government oversight and keeping interest rates low—until it was too late.
As a result, Stiglitz’s latest writings are rife with righteous indignation. He spares no one—not even President Obama—in the absorbing, fast-paced Freefall: Free Markets and the Sinking of the Global Economy, a work that engrosses the reader and brings to life even the dullest of economic concepts. As he systemically confronts heavyweights like Obama’s chief economic advisor (and former Harvard president) Larry Summers, George W. Bush, and the CEOs of major investment banks from around the world, Stiglitz critically assesses the current state of everything from the euphemistically titled American Recovery and Reinvestment Act (i.e., the stimulus package) to the role of the Federal Reserve and the policy responses of developing countries in the immediate aftermath of the crisis. His fast-paced prose reads like a thriller and his thoroughly researched insights are packed into an illuminating 297 pages as he scathingly separates fact from fiction, dogma from truth, and economic theory from hard and inconvenient realities.
Throughout the book, Stiglitz emphasises the borderline-jingoistic mentality that pervades much of the financial community. Emboldened by the sense of being “too big to fail”, banks engaged in increasingly risky activities and predatory lending practices. To support these activities, bankers initiated a multi-decade push for deregulation and significantly reduced government involvement in the financial sector. With hundreds of millions of dollars in political contributions, the banking sector was able to wield considerable influence in the political sphere—often at the expense of average citizens. Once the 2008 collapse occurred, bankers were only too happy to reap the rewards of their political “investment” in the form of taxpayer-subsidised bailouts and hefty bonuses. Indeed, Stiglitz deadpans that “a country [i.e., the United States] in which socialism is often treated as an anathema has socialised risk and intervened in markets in unprecedented ways.”
Of course, with their combination of astounding potential rewards, excessive risk-taking, and aggressive virility, major Wall Street finance firms have a tendency to attract and encourage the ethically challenged—the kind of people who are willing to take risks with the assets of others and show little regard to the final outcome. Stiglitz argues that we should not be surprised when markets function in a suboptimal manner; indeed, individuals acting only in their own self-interest are likely to ignore the negative effects of their actions. It should be made clear that Stiglitz is not “anti-capitalist”—far from it. He makes it apparent, however, that we cannot assume that markets will be self-correcting in the absence of a progressive regulatory regime.
Interestingly, Stiglitz is particularly vehement in his criticism of President Barack Obama. He sees little change from the Republican, far-right days of Obama’s predecessor, the justifiably vilified George W. Bush. Although Obama was elected on the promise of “hope” and “change” and was forced into the midst of an economic crisis from his first days in office, Stiglitz claims that he has taken little restorative action beyond placating Wall Street and maintaining the status quo of the troubled global financial system. He describes how the Obama administration has shown a disturbing ongoing complacency toward bankers and an unambiguous willingness to accede to Wall Street’s increasingly brazen requests. By failing to rein in rogue banking practices, Obama has allowed a resumption of, among other things, high-frequency, high-risk transactions and a culture of outsized bonuses. Additionally, Stiglitz notes that Obama missed a historic opportunity for reform by maintaining a holdover of many of Bush’s core team of advisors, raising questions surrounding the feasibility for change under the new president.
Stiglitz lucidly outlines the painful outcomes of the recession and demonstrates that the symptoms still show only limited signs of abating. The stimulus appears to be having some material effect, although it was likely too small and included too many tax cuts and transfer payments. Unemployment, often seen as a lingering indicator of economic stability, is still hovering around 10 percent. Although investment portfolios have recovered substantially from the lows of late 2008 and early 2009, many have still lost cherished retirement and educational savings. Furthermore, university graduates find themselves lost in the current economic climate, with entry-level jobs becoming increasingly scarce as employers tighten their belts and become increasingly reluctant to assume new salary obligations.
Perhaps most alarmingly (especially for American readers), it appears that many developed countries have squandered the opportunity to secure their long-term financial future. Stiglitz describes the well-supported contention that there has been a gradual capital outflow from developed countries to developing countries from around the world. Oil-exporting countries, flush with cash from America’s estimated $1.4 billion in oil imports per day, have set up sovereign wealth funds that run into the hundreds of billions of dollars (Abu Dhabi alone is estimated to have over $650 billion). In addition, emerging export-based countries like China have begun to assume an increasingly activist role in international economic policy. Through actions like purchasing enormous amounts of U.S. debt in the form of T-bills and treasury issuances, the Chinese have helped to maintain artificially low interest rates and the accompanying American debt-driven consumption patterns.
Leafing through the pages of Freefall, it becomes clear that the deeply engrained neo-conservative theories of the efficient, self-regulating nature of economies are hopelessly outdated. We have seen first-hand the economic, social, and environmental devastation wrought by an over-reliance on these economic models. Stiglitz argues that the developed world needs a reformed financial system that will perform the two core functions of a sound banking system; namely, providing an efficient payments mechanism while assessing and managing risk for loans.
In addition, Stiglitz makes clear that the inherent nature of economics has fostered a lack of responsibility in the financial sector. If we hope to overcome the embedded propensity towards amorality and, indeed, immorality, tough choices will need to be made and tougher questions will need to be asked. Citizens, policymakers, government leaders, and the private sector itself might even need to (re-)consider how we value outputs in our economy.
Stiglitz is willing to ask these big picture questions. Are employees at hedge funds, arbitrage organisations, and aggressive private equity firms really worth their big bonuses and lucrative salaries? Shouldn’t we be looking to better reward those who bring tangible assets and innovation to the economy—the entrepreneurs, the developers, the innovators? What steps can be taken to make the financial system more equitable in the short-term, more stable in the mid-term, and more sustainable in the long-term? Whether we will be able to craft an economic regime that takes into consideration a broader set of stakeholder interests and concern is up for debate. However, one thing is certain; if decisive action is not taken soon, it sure seems unlikely.
Joel Krupa is reading for an MSc in Environmental Policy at Mansfield College, Oxford.