Stiglitz Demonstrates His Ignorance

One of the Great Prophets Has Spoken. Yes, Joe Stiglitz, Nobel Prize winner, has told us how to “fix” Wall Street. I must say that if he is the epitome of the Nobel Prize winning economist, then the Nobel really is worth less than a Fannie Mae mortgage security.

It seems that the Great One correctly pointed out that the Fed was too aggressive in pumping up reserves and, thus, helping pump up the housing market well out of all decent and sustainable proportions. However, his “solutions” are a sick joke, and are as follows:

1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.

Hmmm, Joe, does that mean we get rid of that law which attempts to set executive salaries, the one in which there can be no write-off for more than a million dollars? It seems that Congress created some new moral hazards with that one in 1993, but I don’t see you calling for repeal of this stupid law.

2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for “human consumption.” Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people’s money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had — attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.

Say what? We need to have government regulators determine what is the politically-proper loan/value rates, and who should qualify for loans and who should not? When the government agrees to backstop nearly everything, does that not create the moral hazard? Why not get rid of the moral hazard first?

3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.

Oh, we create another entity and pull from the same pool of political hacks that gave us this problem in the first place. No doubt, Stiglitz believes we should pull this list from the faculties at Harvard and Stanford, since all of them are wise beyond understanding. Gee, and I thought that the Fed had those Great Wise People already on its board.

4. We need to impose other regulations to improve the safety and soundness of our financial system, such as “speed bumps” to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.

On one end, the Fed pumps up reserves. On the other end, the government blocks lending. This really is intelligent, Joe.

5. We need better consumer protection laws, including laws that prevent predatory lending.

Uh, Joe, we already have those laws. We also have a law that orders banks to lend to people with bad credit, called the Community Reinvestment Act.

6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is “too big to fail.” If it is that big, it should be broken up.

Hey, let us start with Fannie, Freddie, and the Federal Reserve. Let us blow up those entities completely, stop backstopping other banks and brokerage houses that insist on buying worthless securities, and “too big to fail” will take care of itself. Please, no more expansion of anti-trust law.

The irony here is that Stiglitz received his Nobel for developing the theory that individuals in the marketplace engage in “signaling” to separate themselves from competitors. What Stiglitz does not recognize, however, is that losses ALSO send signals. However, it seems that Joe does not recognize what those signals are telling us.

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9:40 am on September 17, 2008