We are reading Joe Stiglitz’ book The Price of Inequality. There is much to commend about this book. Indeed, the growing inequality of the US should be a concern, even to those in the 1% who have benefitted most from the growing inequality resulting from the neoliberal growth of globalization across the period since 1980, especially.
In later posts, we will talk about more of Stiglitz’ findings and the value they play in helping us think through how we got into this precarious position and, more importantly, what we can do about it.
Here, we want to take issue with one tendency which recurs throughout the book: The tendency to severely criticize the bankers and the leaders of industry in regard to practices that led to difficulties. Perhaps the first and one of the most stringent vilifications is that of bankers. We think it is fair to say that Stiglitz feels a great many more of them should be in jail now, and the reason is that they sold financial products to people knowing the buyers would not be able to meet their obligations in regard to those products, or that the products were of such a risk that selling them amounted to foisting “junk” off on the unaware, examples being sub-prime mortgages and credit derivative products. It is perhaps even suggested that Goldman Sachs may have structured investments to fail and sold them to unwitting buyers as investments which were represented to be sound. Such allegations are generally not true, in our opinion.
This commentary is not intending to provide any more proof of its opinion than Stiglitz provided of his.
But here is our opinion: Certainly there may have been some who behaved that way. After all, the financial services industry now employs millions of people, and in a large universe of employees in any industry in any country and in any society–capitalist or socialist–there will be a small percentage of people who misbehave. One cannot deny that.
However, it is our opinion that to waste our time suggesting such broad malfeasance on the part of any significant segment of the financial services industry is missing where the focus should be and is unfair to people who worked in that sector.
Here is the problem: There is a tendency among many pundits to cast personal blame. After all, there was a crisis involved with finance, seemingly initiated by finance, bankers were in the center of it. Instruments they sold ended up worth less than their face value, some worthless, and some borrowers claimed they did not understand, even that they had been deceived in regard to loans they took out.
Better put, the federal reserve embarked on a program of easy money, stoking a home market with steadily rising values, leading citizens to conclude that there was no end to it all. Many highly respected expert forecasters supported such views. Then, the packages of loans that were made were commoditized into tranches of varying rate and risk, were examined closely and rated by respected rating agencies and then were sold, mostly to highly sophisticated wealthy investors in the market. When the bubble burst, home prices fell, unemployment rose, and there was much anguish and a search for those responsible. Incidentally, interest rates did not go up on those variable mortgages sold. They went down, but, nevertheless, due to the drop in home prices and the rise in unemployment, many found they could not meet their mortgage obligations. The fact that few have been jailed is not a poor reflection of our justice system, as Stiglitz implies, because there was quite a search, and few existed who actually engaged in criminal activity.
One might pause to ask, why wasn’t more criticism given to or taken by those borrowers and investors? After all, the borrowers borrowed the money–by and large, few were sought out in their homes and persuaded by bankers to borrow, and most of the derivatives were bought by people who had the capacity to understand or to know they couldn’t possibly understand (and thus avoid).
And, if there was little criminal activity, as we suggest, should we then seek to vilify those who acted within the law and regulation and ended up making mistakes? Mistakes are common in capitalism–in fact, in some respects, that’s what capitalism is all about–the law of the jungle, let the strongest win, so long as no laws are broken. People make mistakes all the time in capitalism. And as capitalism moves faster and faster, we experience more and more crises, in which finance is increasingly central. This is the system we all signed up for–increasingly liberal capitalism–that means increasingly frequent boom and bust. Why are we always looking for someone to punish? Are we asking that some greater rule of morality exist, superceding the actual law and regulation of the state? The laws and regulations are already sufficient to yield punishment to anyone who knowingly deceives another in regard to the description of a product for the seller’s gain.
The problem resulted from our capitalist system (#1) and from the financialization of capital (#2), from the lack of sufficient and effective government management and law and regulation of such (#3), and from incentives that were created within those financial firms which motivated a search for more and more sales of products. But, such search for sales was genuinely accompanied by a widespread belief that what was being sold was valid, good, and beneficial. E.g., it was good to help a low income renter be able to buy a home on a variable interest rate that was so low as to enable him to start to build some equity. There was no clever conspiracy among either management or employees in the financial system that this was a cycle and that it would come to a crashing end, thus sell as much of this “junk” as you can before the crash. That was not the belief. If that were the belief, it would not be hard to confirm–just look at the assets of the employees of the financial institutions who were selling the products–it’s likely their assets before the crash would look like those of their customers–new homes, new mortgages, and aggressive investment in the stock market with anything left over–the opposite of what any of us would have owned if we thought there would be another crash. And, after the crash, we imagine their balance sheets would look similar to those of their customers–a big loss! They lost millions too, when what they believed in crashed.
Incidentally, we find it somewhat perplexing, after decades of observing the boom and bust cycles our brand of financial capitalism has brought us, to see that after the bust in each cycle we search so hard for the perpetrators. Shouldn’t we look first to see who gained from the bust? And, if there was immediate gain (as in selling the economy short with one of the many instruments now available in our complex liquid market), the next thing to do would be to see if those were the people who were directing the financial service industry–i.e., key management–and did the financial institution gain as well, because only in those two “successes” would there be instant verification of motive and illegal behavior. Not hard to research, not hard to find. The truth is that in the troughs of our regular busts, there are VERY FEW who were prescient enough to have called it–to have forecasted it and prepared for it. And, those few don’t end up being the leaders of the financial services industry. They appear to be wealthy cynics who are playing the casino of financial capitalism, either hedging or so pessimistic that they will always (eventually) be right. And, again, there are VERY FEW of them.
Do we wish to make a different argument to support blame? That argument might go something like this–OK, Goldman also lost money when the market crashed in 2008. But, they made money across the recovery period because they were smart enough and liquid enough to be able to buy distressed assets at bargain basement prices. In that way, they gained from the bust. So, in time they gained. And so did other wealthy investors who kept cash on hand, because they understand that we are now in a perpetual boom/bust pattern and great opportunities exist if you can be ready to buy. In our opinion, one cannot blame them for that, and one cannot really believe they forecasted and helped to orchestrate the bust in order to profit from it. But, let’s note that there are certainly extreme behaviors and outcomes in financial capitalism wherein one can legally garner a position such as to powerfully influence a market in his own favor–such as the legal right to buy up positions in certain commodities so as to raise the price. If not prohibited by government (which capitalists disparage), then that can happen.
The financial services market is now arguably the most regulated market we have, far beyond that governing commodities trading. And, unfortunately, additional regulation is not likely to prevent future boom/bust cycles. It’s more likely that a change in the role of government/Federal Reserve will have greater preventive value.
The bankers are not the source of the problem. Point to capitalism if you wish. Point to neoliberalism. Point to the Washington Consensus. Point to Paul Volcker. Point to Ronald Reagan (and here in the UK to Margaret Thatcher). We want to excuse Joe Stiglitz for this error in his work–he’s a marvelously accomplished economist. He just never worked in private industry and those who have not, too often fail to fully understand how hard those people work to abide by the law and try to do the right thing–while trying to serve the profit motive of capitalism, which is the system into which they were born, not of their choice.