Five Blunders, Part I

In an article in Vanity Fair, former Chairman of the Council of Economic Advisors Joseph Stiglitz lists five major mistakes from the eras of Reagan, Clinton and Bush II that have led us to our current economic crisis. Stiglitz, a Nobel laureate, is currently a professor at Columbia University. To read his entire article click here.

Mistake Number One was not reappointing Paul Volcker as Fed Chairman in 1987 and replacing him with Alan Greenspan. Volcker had accomplished the near-miraculous, bringing inflation down from 11% to 4% in his seven-year tenure. "But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of objectivist philosopher and free-market zealot Ayn Rand." That person was Alan Greenspan.

Greenspan helped lead us into not one but two bubbles, the tech bubble of the late 90s and the housing bubble of the 00s. He refused to take preventative regulatory measures in both cases. Stiglitz explains he could have increased margin requirements to restrain the tech stock bubble and prevented the predatory and no-documentation "liar loans" that inundated the mortgage industry with the bad paper at the root of the present meltdown. The latter was debated in full on the Council of Economic Advisors to which Stiglitz belonged, but Stiglitz relates that the deregulators won the day, so as not to stifle "innovation." Events have shown what such innovation built on fraudulent data can lead to.

Mistake Number Two was repealing the Depression-Era Glass-Steagall Act which had "separated commercial banks (which lend money)and investment banks (which organize the sale of bonds and equities)." The principle was to prevent conflicts of interest. Without it, the very institution that had its shares issued by its own investment bank arm (and rated AAA, of course) could feel pressured or obligated to lend that arm money. When Stiglitz objected he was told not to worry; the industry would create its own walls of separation. Instead, a $300 million industry lobbying campaign and the legislative muscle of Sen. Phil Gramm prevailed.

Mistake Number Three was the Bush tax cuts of 2001 and 2003. Going primarily to the wealthy, they did little to stimulate the economy, a task which was left up to the Fed. The Fed acted with "low-interest rates and liquidity," putting millions into the housing market who couldn't really afford to be there. The war in Iraq used up further money and led to huge oil price increases. The savings rate fell to zero and the capital gains rate was cut in half. High-risk speculation was thereby encouraged and productive investment such as in manufacturing and infrastructure was starved for funding. The national debt increased 70% in just a few years.

All the pieces were now in place for a massive "correction," i.e. the unwelcome intrusion of reality into this Fantasyland of wishful thinking. I'll proceed to the Fourth and Fifth mistakes and a general summation tomorrow.