Five Blunders, Part II

Let's rejoin our skein from yesterday about the five blunders Nobel economist Joseph Stiglitz pointed out in his recent Vanity Fair article. These mistakes have done much of the damage that has put the US economy in its present dire straits. You can read his whole article here.

Mistake Number Four he calls "Faking the Numbers." In the wake of the collapses of the Enron and WorldCom houses of cards, Congress passed the Sarbanes-Oxley Act to encourage accurate accounting. Unfortunately, they failed to follow S.E.C. Chairman Arthur Levitt's advice to crack down on stock options. These ingenious dodges to inflate executive pay off-salary offer two tempting incentives: to paint rosy pictures of the company's performance to inflate the stock's value, and to get management concentrating on quarterly numbers instead of the long term health of the firm. To add to the problem, rating "agencies such as Moody's and Standard & Poor's are paid by the very people they are supposed to grade. As a result, they've had every reason to give companies high ratings," including those whose portfolios were founded on "toxic mortgages."

Mistake Number Five entails weaknesses in the $700 billion financial bailout plan. One of these is that Treasury Secretary Paulson threw money into some institutions and not others and did not require it be made available to make loans. "He even allowed banks to pour out money to their shareholders as taxpayers were pouring money into the banks." Another is that nothing was done to address the cause of the problem, all those mortgages going into foreclosure. Stiglitz likens it to giving a bleeding patient a massive blood transfusion without stitching up the cut that's causing the blood loss. Here is massive government intervention, with about half the money being spent so far. But once again, the reluctance to provide no-nonsense requirements for what the banks ought to be doing with the money is mitigating the program's effects.

It all boils down to a consistent flaw that ties together all five blunders, the expectation that the great movers and shakers of finance and industry will do the right thing for themselves, their stakeholders and the country without firm regulations mandating it. As Stiglitz puts it, "The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal."

Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, "I have found a flaw." Congressman Henry Waxman pressed him, responding, "In other words, you found that your view of the world, your ideology, was not right; it was not working." "Absolutely, precisely," Greenspan said. The embrace of America - and much of the rest of the world - of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.