|
THE FINANCIAL CRISIS, THE US ECONOMY, AND
INTERNATIONAL SECURITY IN THE NEW ADMINISTRATION
New School University
New York City
November 14, 2008
9:30 – 11:00 Session I: The Current Crisis
Lucy Webster as Moderator:
We now have the first panel. Each of the four presenters will have fifteen minutes to speak, and then there will be half an hour at the end for comments and questions from the rest of us. Joe, you’re first on the program, is that okay?
Joseph Stiglitz:
First, let me say it’s a pleasure to be here, and to say I agree with almost everything that Jamie said. In particular, I agree that we’re going to need not only a large stimulus, but a sustained effort. What I want to do in my remarks is to try to highlight a few of the issues going forward, the likely controversies, and what views I have on those. I’ll come back to the issue of the size of the stimulus in a few minutes.
The first issue is the general framework that the Bush administration has taken to try to revive the economy. It has been, you might say, too little too late and very badly designed. They didn’t want to believe that their economy policies had the disastrous effects that they did. Actually, I had argued that their tax cuts in 2001 and 2003, plus the war in Iraq, played an important role in leading to this crisis. Let me try to explain why.
The tax cut in 2001 and 2003 wasn’t designed to stimulate the economy. It was something that was already on the agenda. It was an attempt to lower the taxes of upper-income Americans to exacerbate the inequalities that had been growing for a long time. That’s not how they would put it; but still that was the effect.
It didn’t stimulate the economy very much. You spend that much money, you have some effect; but it didn’t stimulate the economy enough. That put the burden of adjusting and responding to the breaking of the tech bubble – which supported the economy in the ‘90s - on monetary policy.
The war made things worse, because the war led to an increase in the price of oil. We were spending hundreds of billions of dollars importing oil. Money that would have gone to keep the American economy going was being sent abroad. Again the American economy was weakened, and again the burden was placed on monetary policy.
They responded with a reckless enthusiasm, lowering interest rates and lax regulation. Lowering interest rates was not enough; you had to basically lend to anybody who was not on a life-support system with liar loans, negative amortization loans, where at the end of the year you owed more than you did at the beginning of the year. They said, “Don’t worry if you’re getting more and more in debt because the house prices were going up,” in a kind of pyramid scheme.
From an economic point of view, there were two obvious things that were wrong with it: First it was based on a notion that there was a free lunch. Anybody who borrowed, the more they borrowed, the richer they were going to be. Borrowing is not that difficult. It’s repaying that’s the problem. It was really based on the notion that anybody who was “smart enough” to find a mortgage broker to give them money would be a rich person. There isn’t that much money lying on the street; but that’s what they believed.
The second thing, of course, was the notion the prices of houses could keep going up when real incomes of most Americans were going down. Again, as I jokingly say, you don’t have to have a Nobel Prize to figure out you can’t spend much more than a hundred percent of your income on housing every year. That was the hypothesis that underlay the notion that these prices could go up and up and up forever. It was just a matter of time before that particular set of ideas slammed into reality.
The tax cut in 2001 and 2003 and the war fed this housing bubble. The housing bubble fed a consumption boom. Savings fell to zero. We are now facing some of the consequences of that. But from a macro point of view, the deep question that we have to face is what will replace that as a stimulus to aggregate demand? There’s not likely to be another tech bubble; we’ve been through that game. Not another housing bubble. that means that there may be a problem of an insufficiency of aggregate demand for an extended period of time.
I’ve written that part of this has to do with the global system. We live in a global economy, and in particular, we need a reform of the global reserve system. One of the consequences of the global reserve system is that, particularly given all the volatility, countries want to hold reserves. Dollars are one of the forms in which they hold reserves. The result of that is that we’re exporting T-bills, rather than automobiles or other products. It’s fine to export T-bills, but T-bills don’t give a lot of jobs. So there is this structural problem in our global economy, which we faced before. Keynes talked about it. When you look at it from a global point of view, part of the global deficiency in aggregate demand is caused by the surplus economies, economies that are taking income in and not spending it. He had proposed—and in my book, Making Globalization Work, I revived that kind of idea—in effect penalizing countries that have surpluses to encourage them not to have those surpluses. The way we do that is that we have an annual emission of this new global currency, and those who have these surpluses don’t get that emission. It’s a way of rebalancing the global economy.
The reason why I mention this is that it’s going to be very difficult to solve this problem in the United States alone. This is going to require a global solution over the long run. The rest of my remarks I’m going to focus on the shorter run, on the United States, and on our failed response.
As I said, in our failed response, in February, we had a tax cut, again—the all-purpose solution for the Bush administration to any economy problem. I and many other people thought it would not work. With the mountain of debt, the anxieties going forward, they would not spend very much of their money. that turned out to be the case. Different studies give different numbers—20 percent, 50 percent—but still, it didn’t stimulate the economy very much. That is why there is the need now for a much larger stimulus.
What the administration has been doing has been another version of trickle-down economics. Throw enough money at Wall Street, and some of it will trickle down to the rest of the economy. It hasn’t been happening very fast, and it hasn’t been working, and in a way, predictably so.
One of the reasons it’s not been working is that, again, to use another analogy, it’s like a massive blood transfusion to somebody suffering from internal hemorrhaging, internal hemorrhaging of the foreclosures. We’re not doing anything or very much about the foreclosures; in fact, the administration in a perverse way says, we don’t want to help ordinary Americans, we don’t want to help foreclosures. We need to help the core of the American economy, the American bankers, investment banks particularly, who got us into the mess. It’s not surprising to me that things have not been working very well, because who do we put in charge of straightening this out? The same people who got us in the mess. If they understood economics, presumably they would not have gotten us into the mess. The fact that they’ve done so poorly is consistent with their failures before that.
Let me just very briefly outline what should be done. We have to do something for the foreclosures. If we don’t, even if we give more money to the banks today, there’s going to be more defaults, and their holes in the balance sheets are going to open up. It won’t solve the problem.
I talked about doing three things: The first is helping homeowners. For instance, right now we pay in effect 50 percent of the housing cost of homeowners, who are upper-income homeowners, in New York State. We pay through tax deductions on interest, mortgage interest and real estate taxes. We pay 50 percent for upper-income; nothing for lower income people. It’s very peculiar. It’s not only inefficient; it’s also obviously inequitable. If we converted the tax deduction into a tax credit it would make housing more affordable. As a general principle, the housing subsidy has been questioned by economists as distorting the resource allocation in our society. That’s a debatable question about whether you want to encourage home ownership; and that is the main misgiving I have about this kind of proposal. But if it were going to be promoting home ownership, we should be helping it at the bottom end, not at the top.
Interesting, one of the things that the UK does that I think we ought to give serious consideration to: For people who are long-term unemployed, the government, as part of the unemployment program, picks up paying for the mortgage. They recognize, when people lose their jobs, it’s not just the flow of income. There are two anxieties: One of them they don’t have in the UK: health care. We ought to pick up that. The other one is losing their home. That is a real anxiety. so they try to make life more bearable. When the government fails to maintain full employment, they take a responsibility and say, okay, we’ll help pay your mortgage. There’s no moral hazard here. Nobody really is going to say, I want to be fired in order for you to pick up my mortgage. it seems to me that’s one thing.
The second thing: Reform bankruptcy law. We changed the bankruptcy law a couple of years ago in a perverse way, and I think it actually may have had a part in the crisis. Because what it did was try to make it more difficult for people to discharge their debt. by making it more difficult, it encouraged the bankers to lend more, because they said, “We have them over a barrel.” A minimum-income person making, now, about $14,000 a year—not a great income—can have 25 percent of his wages garnished to pay a debt. That seems to me to at least raise very serious issues. It’s more difficult for a homeowner to restructure his debt than it is somebody who owns a yacht. We made it deliberately very difficult. I think we ought to do it just the opposite. I call for a homeowner’s Chapter 11. Chapter 11 is designed to allow firms to restructure their debt in a quick way to maintain the continuation of the business—jobs, organizational capital - all the things that make an enterprise a going enterprise. You can think of the home as a similar kind of thing, and we should allow people whose homes are under water—that is to say, the value of the mortgage is greater than the value of the home, whose income is limited--to go through an expedited process of Chapter 11 bankruptcy, to write down the amount of debt, convert in effect the debt to equity. That is to say, the bank would then get a large share, perhaps all of the capital gains in the home. That would separate out speculators from homeowners. The homeowners are not buying the home for the capital gains; they’re buying it to stay in it. that’s a second proposal.
A third proposal is to use some of the low-cost availability of funds by the government to help ordinary Americans to own their homes. In effect, what we are doing now: Wall Street says, lend us the money, give us the money. We’ll repay you. What we are doing is using the government’s ability to borrow to help Wall Street, but not using it to help the rest of America, and we ought to be doing that. There actually is a bill that was very constrained that was passed, so we even have the legislative framework. Just expand that to allow them to lend—and we could discuss the exact terms. It wouldn’t cost the government anything. It wouldn’t add to the deficit to lend and by restructuring the mortgages, make them more affordable.
That’s one set of issues. The second set of issues is restructuring TARP. When Paulsen first came forward with his proposal, almost every economist said, “This is a stupid idea.” It will never be able to be implemented quickly, and something needed to be done quickly. That turned out to be right, and he finally gave in. What was interesting is Congress did, over his objection, put in this provision of equity injection, which is now the one that they’re doing. But, as always, the devil is in the details, and if you want to mismanage something, you can even mismanage a good idea; and that’s what Paulsen managed to do.
You can see that by contrasting what Gordon Brown and the UK did and what the US did. The UK designed [their bailout] to try to make sure that the money went to recapitalize the bank, to lead to more lending—very careful with the way they did it; I don’t have the time to go into it in detail. But basically they did things like the following: They said there has to be some accountability. The CEO’s had to go. They said we aren’t going to pour money in while you’re pouring money out; you can’t pay dividends until you’ve repaid us. No issue of signaling. That’s the usual argument against cutting dividends: it would be a back-signal. Does anybody think there’s not a problem in our banking system? I mean this is the most absurd argument that I’ve ever heard, that somehow they’re going to discover some problem in the bank because they’re cutting the dividends. What’s remarkable is a company that has no profits, wiped out four years of profits in one year, would even be considering giving a dividend, let alone giving bonuses.
TARP has to be restructured. That is going to be one of the big issues facing the next president, because there will be many people in the financial markets, including some of his potential advisors, who will be saying, “A deal’s a deal. Paulsen made a bad deal, but now we have to honor it.”
The other view is every contract has unspecified terms. Everybody understood what the intent of Congress was. The Fed all the time is giving gifts to the banks that were not part of the contract. No one ever said that the Fed had to take junk as collateral, which is what they’ve been doing. You can just say, “You play game, we’ll play game. If you don’t play game, we don’t play game. If you don’t do what you’re supposed to do, you can’t have access to the Fed window using junk as collateral. You have use T-bills, like we go back to the old system.” I think there are a variety of ways in which the regulator can help in providing incentives for them behaving better than they’ve been behaving. There’s a little bit of evidence that they’re doing that.
Let me just make a remark about one other issue, which is going to be a contentious issue; and that is regulation. The president yesterday in his talk tried to suggest that we have to be careful about overreacting. That is the mantra that went off and that we’re beginning to hear: Regulation will stifle innovation. , what is very clear is that the innovation in the financial sector has been what we might call self-referential, like a lot of research in academia. It can only be explained as talking to other academics. This is a case where the only benefit was the financial sector. It did increase their profits to the point where they’re at 30 percent of all corporate profits. But, the financial sector is a means to an end. The end is making our economy more efficient. If you looked at an economy with a large financial sector, that’s a sign that something is wrong—except if it’s exporting it to other foolish people. In the UK you can justify it, because they found a lot of other foolish people to buy their services. We do a little bit of that, but mostly, we’re selling it to ourselves. What we are doing is having this means to an end becoming an end in itself. But as an end in itself, it didn’t do what it was supposed to do; it didn’t manage risk and it didn’t allocate capital well. Yet, it took an enormous amount of money away from the rest of the economy. I’m head of a commission called the Commission of the Measurement of Economic Performance and Social Progress. One of the issues that we’ve been talking about is should we even include, or how much of the financial sector should we include in GDP, as opposed to an intermediary product. The point is that most innovation was engaged in regulatory arbitrage or accounting arbitrage, trying to get around the regulations. They succeeded, but at great cost to the rest of us. It was innovation, but they didn’t do what they should have done: things like, what do people care about in risk management? The ability to stay in your home. 3.6 million Americans have lost their homes. they didn’t innovate in the ways that would make our economy more efficient.
I actually argue that if we had good and strong regulation, it will encourage our best students to use their creativity, rather than trying to figure out how to scam the rest of us, to use their creativity to create products that will help our economy manage risk and allocate capital better.
There are ideas out there, like the Danish mortgage bond market—not a new idea; it’s only 200 years old. It has proven itself, but the financial markets have resisted it. with that, let me stop.
Moderator (Lucy Webster):
Okay, we started a little bit late. Next is Marshall Auerbach, who’s offered to be quick so that we might be able to catch up with ourselves.
Marshall Auerbach:
Yes, I’m usually the fill-in speaker that gets us back on time. Just to give you my background: I actually don’t come to this from an academic background. I’m actually in the dreaded world of finance, although I’ve spent most of my time looking at emerging markets. I have seen Wall Street work its magic on many of the economies in which I’ve lived, in East Asia in particular. I started in Hong Kong in 1982, and I saw the Hang Seng index in my first year go from 600 to 1100 back down to 695 again; and I saw the dollar go from 650 to 1250; then I saw the Singapore-Malaysian market decline 50 percent in two years. I started in 1982. I have a very, very different perspective from someone who might have started in the US during that period, because they would have come just at the start of an amazing bull market and thought, “This de-regulation stuff is absolutely fantastic,” and really believed the gospel of the market.
I, by contrast, saw quite a lot of capital destruction, so I have a very different perspective. I guess one of the points that I would make today is that I would be very cautious of listening to some of the advice coming out of some of the leading Wall Street banks over the next few months. Jamie, at the beginning of his presentation, talked about the fact that we’ve had a financial crisis that is now metastasizing into an economic crisis; but there is an implicit argument [from] many of the people who are now proposing solutions, that once we take care of the banking system, everything else will take care of itself. That is, I think, laying the groundwork for a counter-attack for some of the more dynamic fiscal measures which I think are likely, hopefully, to be proposed by the new administration. There is a sense, for example, that we can’t afford to have the government spend too much money. You even saw this in the election debates. You noticed in the first debate, Jim Lehrer said, “Now that we have this $700 billion package, what are you going to cut from your programs?” The argument being that we can’t afford this. This is typical IMF thinking, which I think has become very prevalent in the last 25 years.
I was in East Asia in 1997, and I remember that when the East Asian economies were suffering from a similar type of crisis that the advice given to them by the IMF was, well, raise your interest rates and appreciate your currencies—absolutely the exactly wrong advice that any sensible person would have given them. I know that Professor Stiglitz was one of the courageous voices criticizing what the IMF was doing at the time. Fortunately those countries eventually did ignore everything that the IMF told them. They let their currencies go. They began to export and reflated their economies. They made other mistakes subsequent to that; but the point is that the IMF has certainly not been giving good advice for the last 25 years. It’s tended to represent the interests of the financial sector at the expense of the real economy.
Post that period, one had hoped to see the IMF indulge in a bit of mea culpa and learn from the experience, and of course subsequent to the recoveries of those economies, the IMF did say, well, I think we’ve learned, and we’re not going to make the same mistakes again going forward. Of course I see recently that in the discussions with the bailout with Iceland, for example, one of the provisions of the loan that is talked about to the Icelandic economy is you have to raise your interest rates from, I think, 12 percent to 18 percent. I wonder how much has actually been learned by the IMF, and yet, as I say, this type of snake oil seems to be very, very prevalent, despite all the evidence to the contrary that it hasn’t worked.
I also spent time in Japan, and Japan was a wonderfully efficient, well-run economy for most of the 1980s. Things worked like clockwork. They had low inflation, high growth. Then the US treasury came in 1985-86, and they said to them, Nonono, you’re doing this all the wrong way. You have to deregulate your financial markets because your allocation of capital is very inefficient, and this doesn’t work for us at all, it’s very unfair. Of course, the Japanese, with great reluctance, did exactly what the Treasury told them. That, I think, subsequently lay the seeds for their own bubble economy, because they essentially lost control of their own economy and credit system. they are still feeling the after-effects of that 25 years later.
I think that’s a very salutary example of the challenges that we face ahead in this country. I mean, here we are in Japan. The Nikkei a few weeks ago touched a level that it hadn’t hit since 1982, a 25-year low. It’s not going to be a quick solution to the kinds of problems we have here. Japan, I might add, was a substantial creditor nation with a substantial pool of savings; so that’s another problem we have.
The other argument, of course, you hear now today, is, well, we can’t go big because we risk having a dollar crisis. Foreign creditors are likely to withdraw their capital supporting us. I accept that that is a risk, although I’ve always said that in effect for the Chinese or the Japanese to do that right now, that’s effectively like the economic equivalent of playing the nuclear option. It is very, very possible that there will be some private sector creditor revulsion. I don’t think they can afford to go small, because if they do, the problem is likely to get worse. My experience observing emerging markets has been that hemorrhaging economies tend to provoke more capital flight than growing economies. I sincerely that President-elect Obama will be bold and will courageous and will actually be aggressive in terms of introducing the kinds of fiscal, the fiscal stimulus along the lines of what Paul Krugman, for example, was advocating today in The New York Times. You probably need something in the range of $5-600 billion. Don’t go small, don’t be cautious; because I think the alternative is likely to be far worse.
I would also hope that he will be similarly bold on regulation. The notion that regulation is always invariably bad is one these myths. Jamie Galbraith mentioned a paper that I’d written earlier, and I’m happy to send it to him later on; but I noted there that under FDR, if you look at the statistical way in which unemployment was measured in those days, it actually tends to understate the achievements of the New Deal. There has been a tendency, I think, in the last 25 years, to denigrate the achievements of the New Deal, to suggest that it wasn’t really that effective, and that the only thing that really sorted out the US economy’s problems is war. You can see why this administration would be—that would be a very appealing perspective from the point of view of this administration. But I think it’s very, very problematic that we’ve had this notion over the last 25 years that fiscal policy is invariably bad, that government regulation is invariably bad, and that FDR’s achievements were poor. My point is that the historic record does not indicate that at all; but you have some self-serving historical revisionism going on to support a neo-liberal market agenda, which I think has, for the most part, been highly destructive, not just for the US, but also for global economies. I’m hoping that the onset of the new administration will mark a change in that approach and a new chapter going forward. I will leave it at that to keep us back on time. Thank you very much.
Moderator:
Our next presenter is Pierre Calame, who has come to us all the way from Paris.
Pierre Calame:
I am not American, so allow me to put the questions we discuss in an international perspective. The coming G20 summit will focus on the financial regulation and bond supervision; but there is a risk that it addresses only the symptoms, not the causes of the current situation. If world’s leaders don’t look closely at structural changes to be done, the summit will be of limited interest.
Stabilizing the banking system, as mentioned by James, is but a first step, necessary but not sufficient. You mentioned the recovery of the US economy; I would like to focus on the global economy. To do that, let us go back to the root of the problem and grasp what is really at stake here. It will give us, I hope, the guidelines to cast a new monetary, financial, and energetic global system.
As for the structural causes of the current crisis, I would like to make eight observations, each of them being well-known; nevertheless, putting them together and looking at their consequences might open new perspectives.
The first one concerns the slow but steady decline of the U.S. in the global economy. The U.S. made up half of the world GNP at the moment of the first Bretton Woods conference; today it’s roughly a quarter. This means that a more multilateral system is not a choice; it simply reflects reality. The new system should rely on the relations between major regions of the world, and this will represent a major change in the current world order.
My second observation: since the 1970s, there has been a growing trend to “financialize” the economy. What do I mean by “financialization”? Let me define it by two main characteristics: creation of a unified financial market, with a continuous flow of transactions that pay no regard to national frontiers nor physical distance, and a gradual power shift within the market economy from non-financial firms to international finance. We have to trace back the causes of this change and look closely at its consequences, if we want to respond properly.
Which leads me to my third observation: financialization took off in 1971 when Richard Nixon decided to suspend the gold convertibility of the dollar. This had three major consequences. First, dealing with foreign exchange risks became a major concern for non-financial international firms, and these firms developed strategies in order to minimize the risks and exploit the possibilities. Second, currency trading grew very rapidly and represents today 97 percent of all financial flows, which has nothing to do with real creation of wealth. And third, the role played by the dollar in global financialization allowed the U.S. economy to escape from macroeconomic discipline.
The next observation concerns the oil shock of 1973. It proved that oil plays a central role in the monetary and financial change. First, the TOE, the ton of oil equivalent, become at that time a full-fledged currency, a medium of exchange, and a standard of value. Second, the oil shock created a large surplus of petrodollars and gave
a new impetus to finacialization.
My fifth observation is about demography: the aging of rich societies led to the accumulation of savings, and the storage of value function of the currency, of money, has acquired a new meaning. The $15 trillion managed by the pension funds is the third most important driving force of financialization.
My sixth observation concerns the technical systems that led to the progressive merger of money and finance. The Society for Worldwide Interbank Financial Telecommunications (SWIFT) was created in 1973; combined with parceling long-term risks, it has contributed to the merger of money and finance. In this way, finance has transformed interpersonal relationships and concrete forms of risk sharing into myriads of anonymous transactions. It was also in the 1970s that shareholders begun to take revenge on firms, asking for more and more shareholder value. This made short-term financial results increasingly important in defining business strategy. If family businesses are doing as well as they do, it is because they still focus on the long-term interest and try to foster solidarity between top management and the rest of the staff.
At last my eighth observation, made already by Joseph Stiglitz: the financial system has become an end in itself. It has developed techniques and compensation schemes which only benefit itself. In the U.S. between the 70s and today, the profits of the financial sector passed from 15 to 30 percent of the total amount of profit. These observations define the scope of the new framework that has to be invented and put in place. As we see, that framework must encompass money, finance and energy. It should give priority to long-term thinking, and it has to focus on true-wealth creators instead of financial institutions.
Where do these considerations lead us? I would like to make following suggestions. First, we need a global agreement, a new Bretton-Woods to address three interconnected issues: monetary systems, financial regulation, and energy regulation. My point is that we cannot treat them separately. Second, we need to do this with a multilateral approach in mind, at the level of world’s major regions. The main candidates for the building blocks of the new international system are America, Europe, East Asia, that is China and surrounding countries, and probably South Asia, that is India and surrounding countries.
Third, we need stable exchange rates between the four regions, monitored by an international organization, probably by the IMF, and regularly revised. And we need an internal monetary union within each region.
Fourth, we need new regulation mechanisms. I will not comment on that, because all of the other participants talked about it.
Fifth, we need to stabilize the cost of energy and of basic commodities through the creation of global stocks that should become a means of payment between multinational companies.
Sixth, we need to create negotiable energy quotas as a full-fledged currency. It makes no sense to use the same money, the same currency, to pay for human labor and for non-renewable sources energy. Money will therefore play at least two roles: it will help us moving toward sustainable development and curb climate change, and it will stimulate the demand on human labor without raising the demand on nonrenewable energy.
Seventh, we need to review the economic and financial systems in order to create incentives for long-term thinking and responsible behavior. It is not, or at least not only, a matter of personal ethics and individual responsibility; it is also a matter of measures like suppressing schemes of financial reward based on the number of transactions, banning stock options or granting voting rights to shareholders only once they have owned stocks for a certain period of time. When you think of it, you don’t give the US passport to a tourist that just arrived in the country; and yet it is exactly what we do in economic life. As soon as you buy a stock, you can participate in decision-making. It’s an enormous incentive for speculation and a premium for the raiders.
And eight: we need to invent a new function for money - as storage of a reserve of assets that will be used in the future. The principle seems clear: such a currency should measure the conditions for future prosperity of the world; having a share of that specific asset is the only legitimate way a generation can claim a part of future prosperity when it gets old. The real gold of tomorrow is the natural, human, immaterial and material capital of the planet. The practical means to have it, to move in that direction, have yet to be invented; but if we would spend half the energy we spend for the so-called innovative finance and accounting, we would certainly find solutions. When there is true commitment, there is always a way out.
Let me add a last point: we need a large diversity of currencies. Global trade can go along with communities of different scales and different natures, organizing their own internal exchanges, as it happens with complementary currencies. Our world is and has to be a world of both increased universality and increased diversity.
Moderator:
Finally we have a presentation from Marcellus Andrews, and then we will have time for comments and questions.
Marcellus Andrews:
You know, when you follow really smart people, and you’re a fairly unknown guy, and smart people over here and over here, they say almost everything that needs to be said. We have Perry Mehrling in the audience, my colleague at Barnard whose course I’m teaching. It’s hard to teach a money and banking course at this time. After you call about fractional reserve banking, I mean really. Textbooks are insane, are crazy. No point to them. Really, market efficiency and all that? Please.
You’re the last guy talking. You have to figure out what to say. I’ve been meditating on a couple of things. If you don’t mind my bothering you for a few minutes, I want to lay them out in the most provocative form possible.
We wake up every day in this economic crisis, and as Professor Galbraith says, Professor Stiglitz says, we have a short-term problem, and we need major stimulus and smart stimulus, and we need to forget all about this prudent finance stuff that is just simply a way of keeping us from doing what we need to do to survive. We’ve also heard about the experiences in East Asia and the need to restructure the global macro system so that it makes some sense.
When I think about that, I also think about what we see here. We have a bailout that reminds me of nothing so much as a hostage situation, where the kidnapper grabs somebody and says, “My feelings are hurt because you didn’t pay me enough money. If you don’t pay me enough money, I’m going to cry, and then I’m going to hurt this person, and then I’m going to snatch somebody else.” See, the thing is, they’re doing this in the living room with police. The police of course just give up more money. You’re going to say, “That’s crazy.” Right? Why don’t we restructure society so that we prevent kidnappings? That makes some sense, you know?
Because let’s think about it: For example, in this Money and Banking course I’m talking about, that Perry’s got me teaching, here it is, I’m studying institutions, banks, financial markets. I’m trying to tell students I barely understand it myself, and I’m trying to tell students that we’ve got institutions that are supposed to price and manage and mitigate risk; and what these institutions are doing is manufacturing and amplifying risk, doing it in such a way that the risk is hidden from the regulators, hidden from the markets, hidden from the public, hidden from the people who are manufacturing the risk. Okay? My students say things like, “Marcellus, we read the textbooks, and we read the stuff you tell us about. Aren’t financial markets supposed to allocate capital to its most efficient uses and circumstances that allow for the management of risk?” I say, yeah. And they say, “Well, haven’t all these foreclosures, bankruptcies, these empty houses where your mother lives in Cleveland, and people killing themselves because they lose their jobs and their houses, wouldn’t that suggest that there’s been a massive misallocation?” I say, yeah. Then they say, “Okay, so, um, we now have the people who massively misallocated capital tell us what to do, right?” I say, yeah. They say, “’Cellus, listen, um, we hear you’re a hardcore guy from Philly, right?” I say, right. They say, “Is this the Philadelphia way? Is that what we see here on a national scale?”
I’ve been thinking about that. I’ve been thinking about that because I’m thinking about the role of finance, as my colleagues have spoken about. I’ve been thinking a couple of things I’m going to share with you: If we back up and think about where this started from, everything that’s been said is absolutely right, where this problem came from. I think about the political economy of low taxes and low regulation in an economy where the majority of the people of this country – well, a minority at the time, but perhaps the majority now – couldn’t afford the American dream. We cut a social deal. Our social deal was to essentially finance consumption, any acquisition of assets, by people who’d been abandoned by the economic, political, and social elites of this country in a world of economic and technical change. To finance that by debt. we asked Wall Street: Wall Street, why don’t you find a way to lend money to, and to manage the risk of, people who really can’t afford to borrow money. Steelworkers in Cleveland who don’t have jobs, poorly educated and suffering, folks who work in bodegas in the Bronx, folks who want the big house, who want the TV, but who can’t really afford it, whose incomes will never allow them to afford it, folks who have to use their credit cards to pay their health insurance. Wall Street, you find a way to do it. Wall Street did it. Wall Street did it. Because we ceded power to an instrument, a corporate form of financial management. we asked markets to solve social problems. Somewhere along the line we seemed to forget that the corporation is apart of the social infrastructure, and its performance, particularly in the management of risk, is to be judged by whether or not our social needs are enhanced by the use of various of forms of financial instruments, by various forms of financial institutions.
We’re now in a position where we’ve got automobile companies that are about to fail. We’re afraid to use bankruptcy because of the long-term economic and financial consequences involved. We’re afraid to use bankruptcy with regard to Bear Stearns because we were afraid if Bear Stearns went away, the plumbing of the financial system would collapse, and therefore we’d have economic crisis. See what I mean by a hostage situation?
This drove me back to Charles Lindbloom and even Carl Polanyi to ask, does the corporation fit anymore? In our current system, the way we meant it, the corporation is a device for accumulating capital, for driving gross, for managing our productive affairs; and we somehow let the financing of this entity dominate, as has been said. I keep wondering to myself, maybe after we somehow deal with the effective demand problem that we have, maybe the most radical and important thing we need to do is revisit the nature of the corporation, revisit it at its basic level. Who and what is it for? Who are its stakeholders? How do we finance this in such a way that we manage risks effectively and punish those whose risk-taking behavior threatens the entire system?
I can’t help—I’m sitting this close to Joseph Stiglitz, you know? Mr. Imperfect Information. I’m thinking to myself, this guy, lots of articles and books about what prices can and can’t do, what risks can and cannot be managed, ways in which we have to find mechanisms for properly pricing all of the negative externalities and all of the market failure associated with private management of risk. I hear that, I see that, I can write down some of the models. He’s too smart, so I can’t write them all down. I can write down some of them. I’m thinking to myself, we’ve got a mechanism for the chartering and for the bare management of corporations that are charged with accumulating capital through financial markets and managing, and allocating, and mitigating risk; and we manage to pay no attention to what this man writes. We manage to pay no attention to the fact that we have organized our economy and our society in such a way that the management of risk is not an essential part of how we design our institutions. if those who manage these risks and fail have a role because of their political power in the regulation of the system and the writing of the laws, indeed have a voice at all—
One of the reasons I’m a bad economist—and I’m a really bad economist—I just can’t help thinking that when we design institutions and we insist on using institutions that cannot possibly be operated safely, when we ignore the warnings of someone like Mr. Stiglitz, when we structure a social contract that deliberately ignores the needs of the majority of the people in circumstances with declining real incomes and growing inequality, and we use debts to do something that can’t possibly be done, and when it all fails, and we allow the people—us, and the institutions, the flawed institutions that we use, the corporations—to have a say in recovery and reconstruction, we are insane. We are simply nuts.
My own research over the next little bit will be about how to rebuild corporations and how to rethink financial markets so that, after this crisis is over, almost done, after this crisis is finished, when we have done the things that Professor Galbraith, Professor Stiglitz, and others say we should do, if the Obama administration, should that administration fail, some other political force has the moxie to do what’s necessary, I think we need to revisit the nature of the productive enterprise, how its financed, why it should be silent—a tool, not a voice in politics or anything else. Thank you.
Moderator:
Now is a time when people can go to the microphones, or you can just speak, I think. Do we need the microphones for purposes of pickup?
Paul Davidson:
Two things, one about hidden problems: Joe Stiglitz and I were at a meeting in 1999, after there was a sub-prime Russian default and [?] problem which froze up international financial markets. We knew there were problems when you over-leverage things and you make loans. It wasn’t a surprise. But the real question is, and Joe and I and this whole group at [ONTEC?] tried to get a new international payment system, which I think is the point. We cannot do anything in the United States until we solve that problem.
For regulation, Joe, the problem is going to be as follows. Robert Rubin, Alan Greenspan, or their ilk are all—and Wendy and Phil Graham—are all going to say, if you put regulation on United States financial institutions, then people will work through the Swiss banking system. It’s so easy to move your money—so that you cannot regulate here unless you regulate globally, which is not likely to occur, certainly not in Switzerland anyhow. What you have to have is what I used to call capital controls, but since I had a debate with Nigel Lawson I no longer use that phrase because that’s like saying sharing the wealth is socialism; so I use capital flow constraints, and that’s the important part. We can’t do anything in the United States anymore - we’re a global economy - until we handle the international problem. We no longer can have a currency hegemony system. We have to have some sort of international payment system which doesn’t rely with the dollar being the dollar standard. That’s going to be the hard part.
Joe Stiglitz:
I want to make a couple comments. First, I think that that concern that you’ve raised is one that has been weighing on the minds of people like Barney Frank, who are trying to redesign the financial, think about redesigning the financial system; and it’s one of the ways in which I think there’s been an attempt to scare away regulation. Because I think there is, actually, some evidence that countries with good financial markets, including sound regulation, will actually do better than those that are more volatile because they have weak financial regulation. That’s the first point. I’m not sure that it’s as bad, that there is necessarily that race to the bottom. It’s clear that they are trying to sell us that there’s a race, but I am not clear that there is a race.
Secondly, I do know that many of the G-7 are worried about trying to coordinate our concern about trying to get a global regulatory system. That is one of the things that will be on the meeting tomorrow.
The third point is that I think that we can do a lot in what I call ring fencing. That is to say, I don’t care if people go and gamble in Las Vegas, and I don’t care if they go gamble in the Cayman Islands; I just care if they gamble in ways that affect me. The question is, can we make sure that our financial system isn’t touched by gambling going on elsewhere. I think the answer is yes, that, for instance, a simple rule: that no American bank can engage in any transaction with a bank from any country that does not subscribe to the common standards. That will end the Cayman Islands, or at least induce it to be a better. As we all know, the reason people do banking in the Cayman Islands is not because it has a comparative advantage, because the weather is good for banking. There’s a long history that bad weather induces people to stay inside, and that’s better for banking. . The issue isn’t whether we can do it; it’s really the political economy issue that was being raised. Yesterday we had a conference, and there was a guy who had been working at Lehman Brothers, who said when he was hired, they opened up an account for him in the Cayman Islands. That was part of the welcome package. That’s part of the framework. These loopholes are not there by accident. But I think we may have turned a corner, because I think that’s one of the silver linings that we may be able to use this occasion for doing something about it.
Two other points I want to make very briefly: One of them is, the nature of these problems has been long anticipated. There are no surprises here except for those who want—I just was rereading one of my papers I wrote in 1990 at the beginning of the securitization process. I predicted what would happen as a result. I even went down to predict the details, like their underestimating the degree of the correlation and underestimate the probability that the prices would fall. Reading it, I was a little bit impressed with myself that I had not only identified the problems of asymmetries of information that would be opened up by securitization, but even underestimating some of the mistakes.
The final point I want to say is at least among some of us the word that we’re using is capital count management, rather than capital controls. I don’t want enforce a new vocabulary here, but capital count management is the official way of talking about these things that have been viewed as bad in the past.
David Gold:
I just want to raise two issues to throw out for discussion, one probably people saw. There were some stories in the paper about how retail sales collapsed in October, which probably means the post-Christmas sales are going to start Thanksgiving weekend this year. Related to it was one exception to that, which was that Wal-Mart sales went up. In the short run that can be interpreted as people moving down-market because their incomes are tight. I think the other thing it indicates is a longer-run problem, because the success of Wal-Mart isn’t just because they import from China or have supply-chain management, but because the demand for their products has grown because of stagnations of income.
We all know median income in real terms has been roughly stagnant, which of course is one reason why debt has expanded, because people are trying to maintain living standards. But I’m wondering whether that isn’t part of the long-term problem that we’re discussing, and part of the long-term structural solution. That is, to give you one example: I went back and looked at, for example, flow of funds data right after the 2003 tax cut. As you know, flow of funds indicates where asset purchases and sales are going. There was a sharp increase in the personal purchases of foreign assets, foreign financial assets, which certainly suggested that part of what happened with the tax cut is the people receiving it bought foreign financial assets, that they moved the money out of the country pretty quickly.
I think what we’re getting is a real imbalance, where the driving force of consumer demand has moved down-market, while the upper part of the income distribution, which is supposed to generate the savings, according to the trickle-down theory, has actually been buying assets all over the world. How much of that comes back, we don’t know; but it does suggest a structural problem that was at least hinted at in the campaign because of Obama’s notion of raising taxes on the upper income and lowering it for others. I think that’s one issue about long-term structural reform.
The other issue, which obviously we need to raise, given that it’s Economists for Peace and Security, is the military budget, which of course in real terms is higher than it’s been at any point since World War II. Although, as a share in the economy, it’s not as high, there’s going to be obviously pressure to keep pushing it up. There’s no indication from the Obama people about where they would stand on this, because they’ve talked about expanding various elements, or whether they would even address issues about all the inefficiencies, which are absolutely immense, within the National Security apparatus. That raises issues around what if there is pressure to raise the military budget, what will not be raised because of that. Usually people talk about, well, non-military government spending, which is primarily health, education, and infrastructure, which is exactly what we need, both to deal with some of the issues of inequality, but also because certainly over the last 50 years we know that economic growth is increasingly dependent on human capital, knowledge, and infrastructure. again, as a long-term issue, I just want to throw those out as a possibility to consider when we talk about the restructuring.
Moderator:
Who would like to comment on that? Marcellus.
Marcellus Andrews:
Yes, I would. I agree with your interpretation of the shift in consumption spending toward Wal-Mart; but it brings up an interesting issue. I have come to the view that part of our long-term problem, as I noted in my remarks, is not just inequality. It is also declining real incomes for folks in the bottom 60, or maybe even 70, percent of the income distribution, and rising costs for education, health care, and so forth that were managed, to some degree, by debt-based social contract pioneered by those who gave us supply-side economics. The popping of that bubble is consistent with the economic collapse we seem to be facing, made worse by the recklessness in the financial markets. The political problem we face in dealing with the reconstruction of the social contract along the lines that you mentioned is that there’s going to be a fight over the use of public resources and the tax code as to whether we’re going to have what I would call social overhead infrastructure expenditure and public consumption, or whether we’re going to essentially make room for those who have to keep.
One of the reasons I’m thinking hard about the position (both economic and frankly, political) of the financial sector – and I guess I insist that this is not just a question of regulation, but a question of power and whether certain sectors of this system get to have a voice in the restructuring of the social contract – is that, if I hear your point, there’s a certain fear about the abandonment of the American social contract in an age where capital is global and where one doesn’t have to say “stay.” I think unless we face the political problem, we won’t be able to do the thing we need to do.
Joe Stiglitz:
Two comments; they’re both somewhat theoretical. The first is that the point that several people have raised of the change in the distribution of income towards upper income, away from lower income, is related to, in a way, an old argument that goes back to pre-World War II discussion. There was a worry as we emerged from World War II that there would not be sufficient aggregate demand. There was a theory of under-consumption. Modern economic theory has talked about theories of adjustment that says we don’t have to worry about that, that the economy always gravitates to full employment. Keynes’s view, of course, was very clear that that might happen, but it would happen too slowly and not necessarily in a stable way. I think that that really is something that ought to be given some attention. What are the processes of adjustment, and where are they likely to take us, and why are they unstable? If we don’t address the underlying inequalities, which is another way of trying to get up consumption, where is the current kind of system leading us? Because there will be some adjustment, but the questions is what?
The second one is an idea that one of my colleagues, Bruce Greenwald, has suggested, and I want to just throw it out, because I haven’t yet figured out the extent to which I agree with it; but I think it’s an interesting idea. What he’s suggested is that one thing about the Great Depression was that it occurred, it was a defining moment where we realized that we were no longer an agricultural economy, and that part of the adjustment of the Great Depression was the end of agriculture. It wasn’t that by saying end of agriculture, we have a very prosperous agricultural sector; but it only employs 2 to 3 percent of our economy, because we had an enormous productivity increase. It’s both an achievement and a problem.
Manufacturing was the base of our economy in the 75 years since then, but we’ve had enormous success in our manufacturing sector. We’ve had enormous productivity increases. We’ve had globalization, which has transmitted a lot of this knowledge around the world. If you take that view, what it suggests is that America may be going through – and advanced industrial countries more broadly going through – a wrenching adjustment. The adjustment is that manufacturing is no longer our competitive comparative advantage; and secondly, that manufacturing is not going to be absorbing as many jobs. We’ll be able to have all the television sets in the world that we want – one in every room, one in every closet – and that providing all the goods to most of the people in the world will still not employ very many people, just as providing all the food will not employ very many people.
If that’s true, obviously some adjustment is going to be entailed in our economy – America particularly, but global economy. If that’s true, then we ought to be thinking about, as we are thinking about responding to this crisis in the short run, how will our spending help us transition to a new structure of our economy. That’s where part of the debate we haven’t been talking about so far, about the bailout of the automobile industry, goes. That’s an attempt to try to preserve the old economy, an old economy, whose CEOs have proven their incompetence. Now we want to maintain them. Or is another way of facilitating the transition, making them a different kind of manufacturing, green economy, and so forth? I just raise that as an idea that I’m not sure how to evaluate, but I think is an interesting perspective.
Moderator:
Perhaps we want to give the car companies another chance …
Q:
I am Doug Cliggett. I’m a graduate of The New School, and I manage a long-short mutual fund – mutual fund, not hedge fund. My question is about us being held hostage and the idea of a need to recapitalize the US financial system. If you can accept the Federal Reserve’s data – I don’t know who else’s to use – the US financial sector had $63 trillion in assets at the beginning of the year. That $63 trillion was sitting on $4.5 trillion of equity capital. Since the beginning of the year, we’ve nationalized Fanny and Freddie, so that took about $5 trillion from the private sector to the public sector in assets, sort of round numbers. I’m sure we’ve lost something like 5 percent of asset values if we did any kind of honest accounting. Let’s say we’re down to about $55 trillion in assets right now. We’ve probably lost 70 percent of that equity capital, so let’s say we have $55 trillion in assets, $1.5 trillion. If we were just to go back to 1997 capital ratios, which probably were too aggressive, it would imply that the US financial system needs somewhere between $6 and $7 trillion of new equity capital. It makes the $250 billion first tranche of TARP look like a really bad joke. It can’t do anything. But $5, 6, 7 trillion to recapitalize existing balance sheets is 50 percent of our GDP. I guess I’m left, as is the Lex column in the FT this morning, with the only way out of this as really a whole-scale nationalization of financial systems. How do we manage that? How on earth do we manage shrinking this balance sheet that there’s no way we can support?
Moderator:
Okay, let’s give them a minute to think about that, and have another question, please.
Q:
Thank you. Rania Antonopoulos from the Levy Institute.
The question actually is very much related to what Joe Stiglitz was commenting, and also the last speaker was talking about in terms of the political economy of the situation. There is of course an immediate task, and everybody has spoken to that in terms of managing at this point the financial crisis and its repercussions. But what if central banks, and ministries of finance, and everybody else that has been turning a blind eye and facilitating a lot of what led to the financial crisis is not an accident? What if the stage that we have entered, the financialization stage, is actually a third stage once you go away from agriculture and primary extraction, manufacturing, now finance capital, and now we’re asking, what next?
In terms of proposing how one prepares the economy, the Obama campaign, as advisors, that many of you are internationally, what would your thoughts be on that? Thank you.
Moderator:
We have Doug Cliggett’s question, and then this question now about what next after finance disappears. Who would like to comment on either or both of those, please?
Marcellus Andrews:
What next? To take Professor Stiglitz’s discussion of the automobile industry and ask why, implicit in his remarks, it may not be a very good idea to save that particular company, or to save the CEO’s, and yet we have to figure out what to do with workers and regions of the country. I have colleagues up at Barnard and Columbia who spend a lot of time wondering if the thing the United States might think through is the so-called green economy. In this process of saving aggregate demand and preventing an L-shaped recession-depression over long periods of time, reinvesting in infrastructure, reinvesting in schools, health care, and the capacity of people to work and live, my colleagues tell me, the economists need to figure out a way to turn this economy into a place that generates the clean technologies, the clean ways of living, the clean ways of moving, not simply for ourselves, but for the rest of the world. We pioneer a form of progressive green capitalism that makes the proper use of markets, one that figures out how to price carbon, dispose of it, deal with that difficult question of coal, and gradually produces the technologies and the ways of life that we then export to the rest of the world. That strikes me as about right. It strikes me also that that would require a redefinition of the role of the state, a redefinition of the nature of the mixed economy, and a fight over who ultimately owns the state. That strikes me as what next. I don’t know how to do that, but that strikes me as what’s next.
Joe Stiglitz:
Let me just try to—I agree, by the way, very strongly. I think this is one of the opportunities that this crisis offers.
On the other question, I think the best way to try to think about it is the following: We have a certain amount of assets in our society. We have human capital, physical capital, land—that’s here. It hasn’t been destroyed—a little of it has, but most of it has not been destroyed. All you’re talking about are claims on those assets. the system that we have of claims on assets has gotten a little jumbled up. People were betting large amounts of money, so much amount of money that A owed B, B owed C, but B can’t pay C because A can’t pay B. One way of thinking about this crisis is everybody was gambling with other people’s money, and our whole system of claims on these assets has gotten jumbled up. What we need to do is straighten it out. that’s what bankruptcy is about. It doesn’t destroy the assets. The car company still is there, the machines are there. It’s important, because who controls the claims not only determines future income, but also determines decisions. If you allow the same guys who made the bad decisions to remain in the place of making the decisions, they’ll make probably the same bad decisions. Going back to the automobile company, these guys are the guys who said, “I don’t want to think about global warming, I don’t want to think about making energy-efficient cars.” Every time anybody proposed a regulation, it went to the lawyers to try to stop it. Why should we trust these guys to go into a green economy? That’s not where their heart is. That’s why there has to be change in management of a massive kind.
Going forward, to keep an economy going, you have to have credit. Credit is basically claims on future resources, or claims on resources today that you’re going to pay back. The banks are just a vehicle for certifying credit worthiness. Who should I give assets today to in response to a promise to pay back in the future? Our investment banks have shown that they are not capable of making those judgments. Again, my view is just, get rid of them. I mean, I’m being a little bit extreme, but what I want to do is raise the conceptual issue. The conceptual issue is there are some people, some regional banks that have done not too badly. They were caught up and made some judgment mistakes. it’s trying to recreate a system of credit flow which is necessary in order to maintain the production flow and to straighten out the whole set of complicated claims. When you talk about trillions, people say there are trillions of dollars of CDO’s, well beyond the global GDP. What are those? Those are just massive gambles. How do you make the massive gambles? People owe you trillions, so you can owe other people trillions. That whole system of massive gambling on other people’s money has fallen apart. I don’t think it’s a big deal.
Moderator:
We have about two or three more minutes. We have a question here quickly?
Q:
I’m Parul Jain, I’m an investment strategist. My question really is that, you know, the assessment, the private assessment of risk, the credit worthiness of individuals, of firms, and so on, have been badly shaken up, and in fact what we’ve been through is kind of like a ratings shock. There have been several proposals put on the board for how we should engage in perhaps credit rating agency reform, perhaps have a centralized credit rating agency that is quasi-independent arm by itself. I wanted to find out what the panel thought about that.
Moderator:
Okay, that’s a great question, and then Polly Cleveland, who’s a long-time supporter of Economists for Peace and Security.
Polly Cleveland:
Thanks. I actually have a question, which is: there’s a lot of talk about a stimulus, a big stimulus, a huge stimulus, but very little talk about where we should be spending this money and where we shouldn’t be spending it, and how we should be raising it, and how we should not be raising it. I was appalled last week by Krugman’s column saying, “Oh well, it was World War II that saved us from the Great Depression.” Surely, military spending is the absolutely worst kind of spending, and it’s not good for the economy, and Joe’s worked on that. We have to look at spending on human capital, which seems to be a much faster and better way. But let’s look clearly at what we should and shouldn’t spend, and how we should and shouldn’t raise it; because any old spending could be terrible.
Moderator:
Thank you very much. Comments.
Marshall Auerbach:
I agree with that last question. I wrote a paper on this. Beyond the obvious things of extending unemployment claims and food stamps, etc., I do believe in the general thrust of green infrastructure, and generally just public infrastructure in general. You have bridges falling apart in Minnesota. That in itself should be a clear indication of what we should be doing. I would also substantially cut military expenditure and probably transfer that to something else. The only politician that’s actually made that statement publicly is Barney Frank. I think he talked about 25 percent cut in military expenditure, and I thought, yeah, well, back on Planet Earth. It would be nice if that happened, but I don’t see it. Unfortunately, I do fear that the Pentagon has got such a powerful influence on the US body politic that I wonder if there will be a serious cut in military expenditures. That is my great concern. But obviously you’d love to see that reduced. The US spends more on its defense than the next 20 countries combined, according to DNI.net. You wonder how much more we need to spend to feel secure. I totally agree with the comment; but whether it’s done—
Q:
[…?]
Marshall Auerbach:
A good point, but we’re talking about having the same people stay on at Defense. Granted, Secretary Gates seems to have kept us out of a war in Iran, but I’m not sure anyone’s really talked about something radical like winding down 800 bases that we have abroad, for example, or taking troops out of South Korea.
Moderator:
The other question that was asked before the one about military spending. Can someone comment on that?
Marcellus Andrews:
Yeah. It’s very interesting, again, teaching Perry’s course and learning about the rating agencies and what they do and how they do it, and the fact that we have market-based rating agencies rating products of their customers. It strikes me that those conflicts of interest are best eliminated by having third-party independent agencies. But I’ve also been wondering about whether or not we need to think, as Professor Stiglitz indicated, we need to think more carefully about securitization as a whole. My wife is a theoretical physicist, who, when I described what securitization was, said, “Okay, so here’s what you economists and smart guys in finance did: you used the techniques of statistical mechanics to treat asset prices like subatomic particles, right?” I said, “Yeah.” She said, “Okay, the thing is about subatomic particles, there are a whole lot of them. They all move around more or less on their own, right?” Okay, I’m saying okay to her because I don’t know. Then she says, “Yeah, but now you’re treating these things like asset prices, right? These assets are in people’s portfolios, right?” I said, right. And she says, “All these people more or less think the same way, right? Even if these people never talk to each other, these suckers are automatically correlated, right? Okay, the only economics I know is to know you, Marcellus, and I figured this out.” Now we have all manner of financial instruments that come from using even more esoteric techniques in mathematics. For example, what she was reading in the Physics Journal was about the use of statistical mechanics in the mathematics of Hilbert spaces to come up with all sorts of new stuff. I wouldn’t know a Hilbert space if it bit me, I’ve got to be honest with you. She says, “Okay, so wouldn’t it behoove somebody to actually do the math first about whether or not these new products would actually enhance, multiply, and thereby make risk a bigger problem before you ever went out and sold it? I mean, I know we don’t test bad food from China in this country; but you would think that the people who came up with these instruments would at least try it out first, wouldn’t you?” Seems to me that’s not a bad point.
Moderator:
By the way, we have someone here who’s a good physicist and a good economist from China who will be speaking later, and perhaps he can comment on these issues. I think we should call this session to a close, and I want to thank everyone here for all their extraordinarily creative ideas. [End panel.]
|