Fairness needed when dealing with crisis, says Stiglitz

 

A POLICY aimed at restoring Ireland’s competitiveness through wage cuts requires an emphasis on fairness, according to the Nobel Prize-winning economist Joseph Stiglitz.

In an interview with The Irish Times, he said one of the most successful countries in dealing with the current global crisis was Iceland, because it hadn’t invested taxpayers’ money in its banks in the way Ireland is doing, and could devalue its currency.

Devaluation and the banking collapse had given room to other sectors of the Icelandic economy, crowded out during the boom, to revive. Ireland cannot devalue as it is in the euro zone and the Government has, as an alternative, proposed that wage cuts could contribute to a restoration of international competitiveness.

Stiglitz said there needs to be a fair and universal reduction in wages and prices. “There is an argument and there is some validity to it, that if you can do this, and it is a question of whether you can do it, then it can be a substitute for devaluation. A uniform cut in wages and prices, everywhere.”

The idea could be made more progressive, he said, if higher earners took a higher cut in salary, and price cuts were highest in basic necessities. “The problem, of course, is will everyone actually do this? Will the doctors, the lawyers? So the [trade] unions’ worry is that, if we do our share, we will get screwed, again.”

He said that by this he meant that people saw the banks being given taxpayers’ money, but not householders burdened with negative equity and/or mortgages they now found they couldn’t pay.

There is a need to be creative because of the way the social fibre has been stretched by the banking crisis, he said. “Broader deals” are required that can encourage the economy while “giving people a sense of equity”.

In the US he has suggested a scheme, involving the courts, where people in negative equity or who are having difficulty with their mortgages, would be able to have the size of their debt written down by the banks.

He believes such a move would assist economic activity – by alleviating the distress and the sense of entrapment felt by so many people – while also creating more realistic bank balance sheets.

He believes the write-offs should be such as to create house equity for the borrowers, with a mechanism for repaying the banks at a later date in the event of property prices improving. Unless they deal realistically with their mortgage debtors, banks will remain in an unhealthy state, and attempts to recapitalise them will fail to achieve their objective.

As former senior vice-president and chief economist of the World Bank, and an economist with a life-long interest in development issues, Stiglitz has seen many crashes and economic crises during his career. He sees the moves taken by governments such as ours, and those in the UK and US, as fitting in with a pattern whereby the taxpayer gets fleeced by the banks when banks get into difficulty.

Ironically, as someone who has been a long-time critic of what he calls “market fundamentalists” – such as former chairman of the Federal Reserve Alan Greenspan – Stiglitz recommends that the “normal rules of capitalism” should apply. When a bank fails, its shareholders should lose their shirts, and the bank’s bondholders should be given shares for their debt. If that doesn’t work, then banks should be nationalised, with a view to being privatised later.

“If that doesn’t happen, then you have privatised profits and socialised losses,” he said. “To my mind there is no excuse for not applying the normal rules. It is the free marketeers who say we want a bailout.”

He said the only places where the objective of bank rescues – the resumption of normal lending – has been achieved, is where banks have been nationalised.

He gave a stark example of the sort of “theft” of the taxpayer he believes has occurred in the US. The American Insurance Group (AIG) had credit default (insurance) arrangements with Goldman Sachs. When the US Government put $180 billion into AIG, $13 billion was “passed on directly to Goldman Sachs. We didn’t get anything for it. We’ll never get the money from AIG”.

He said a settlement between such parties should be for 13 per cent of the amount involved. He added that no one has ever explained why they got $13 billion rather than 13 per cent of that amount.

What happened was akin to an insurance company cancelling a fire insurance policy, and “paying you as if your house had burned down . . . no one has ever been able to explain the rationale for this giveaway”.

The Government has identified three huge difficulties it needs to address in order to revive the Irish economy: fixing the banks so they can lend; fixing the public finances; and restoring competitiveness. Asked about the public finances issue, Stiglitz said the first thing a government has to do is not waste money. “It is a time to be very thoughtful about how you spend money . . . wasting money on a badly designed bank bailout is really dangerous.”

He also said it was important to recall that after a crisis an economy has the same resources as it had before. “In a fundamental sense there is no reason that you should be less productive than you were before.”

The really large losses occur from the loss of potential output that occurs post the crisis, because of difficulties with “the jumble of claims” that exist, such as those between banks, or between banks and their customers.

“The morass of sorting out the claims is what destroys the productivity of the economy. But the real losses are not using your resources fully. To my mind that should be the first priority: how do we keep our resources being moved efficiently and fully?”

He said Ireland had a particular problem because it was a small and open economy, so money spent by the State quickly left the economy. But cutting back on areas such as investment in education, and teachers, will affect competitiveness. “Don’t get mired in deficit fetishism,” he said.

Internationally, he said, the financial sector has used “fear” to influence governments’ bank-rescue plans.

During the Bush presidency, the “war on terrorism” was used to justify the invasion of Iraq, even though it had nothing to do with the war on terrorism, he said.

“The financial sector did the same thing. They used fear, the notion the sky would fall . . . Nobel Prize winners like [economist] Paul Krugman all come to the same conclusion: that that fear was not a rational fear.

According to Stiglitz, if the “normal rules of capitalism” had been used, the market would have worked better. “If you converted Citibank’s long-term bonds into equity, it would have been $325 billion [€220 billion]. That would have been a well-capitalised bank. That would have given more confidence than the little trickle of money the federal government could afford to give. So it would have given more confidence to the market if we had played by the rules of capitalism.”

He continued: “So in Ireland there is all this discussion, what about foreign investors? Well, the fact is, if you go ahead and do it in this way, that will cost you . Foreigners will look at your national debt and know you will have to increase taxes or decrease the quality of public services – you will be a less attractive place. I think it’s common sense.”

What happened with the collapse of Lehman Brothers on September 15th, 2009, is being used by the financial sector in the way George W Bush used the September 11th, 2001, attacks, Stiglitz said. “9/15 is to finance what 9/11 is to the war on terror.”

Lehman showed that, if you do things stupidly, you can make a mess of it, “but no one is proposing to do things as badly as . . . on 9/15”.

“Most agree you are going to keep the institutions alive. That’s not the debate any more. The debate is how you are going to keep them alive, and are you going to give away money to the shareholders and the bond holders.”

Stiglitz was asked how administrators around the globe acting in good faith could facilitate what he believes is a massive fraud.

He cited the huge political clout of banks in the US, where they are the largest contributors to the two main parties.

“I think it is the case that he who pays the piper calls the tune. But secondly, and unfortunately, we have turned to the financial markets as the gurus for a very long time, and they see the world through particular lenses.”

Stiglitz noted the tendency of financial people to see a rise in bank share prices as evidence a rescue plan is good.

“When you think about that for a moment, that’s a very stupid argument. Obviously I can get the bank shares up, just give them a lot of money. But that’s not a measure of if you are going to get lending up, or of getting the taxpayer a great deal.”

People from the financial sector are still being used as advisers. “We should have lost confidence in their judgment,” he said.

Stiglitz was awarded the Nobel Prize for economics in 2001 for his work, with others, on asymmetric information and its effect on markets.

The theory says that because of the conditions in which they almost always have to operate, markets are far from being as perfect as “free market fundamentalists” believe them to be.

For this reason, government intervention in the marketplace is required to a greater extent than the fundamentalists believe.

In his Nobel prize acceptance speech, Stiglitz quoted the British economist, John Maynard Keynes.

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.

“Practical men, who believe themselves quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”

In an article in Vanity Fair magazine in January, Stiglitz wrote about how the debate over how the US, and the world, had come to be in the crisis it was in, would dictate the debate over future policy.

The view that emerges as to the efficiency of the market, or the level of government intervention that is required, will be a factor of the view that emerges as to where the major flaws lay.

The crisis has had a mixed effect on free market ”fundamentalism”, Stiglitz told The Irish Times. “In very many circles the ideology has been very badly damaged.” However in some areas, belief in market perfection continues.