Interview Transcript: Joseph Stiglitz, Oct. 20, 2010
By Sam Gustin and Michael Rainey
Prof. Joseph Stiglitz is University Professor at Columbia University and Chair, Columbia University Committee on Global Thought. He teaches classes at the Columbia Business School, the Graduate School of Arts and Sciences (Department of Economics) and the School of International and Public Affairs. Stiglitz was awarded the 2001 Nobel Prize in Economics and served as Chief Economist of the World Bank from 1997-2000. (Main article here.)
DailyFinance: Over the last three years, the U.S. economy has experienced the worst crisis in decades. Is the worst over?
Joseph Stiglitz: No. You might say the worst if you thought of the worst as the immediate weeks following the collapse of Lehman Brothers where we didn't know where the bottom would be; we've pulled back from the brink. But in terms of most Americans, the question is, are they likely to be able to get a job? One of six Americans who would like a full-time job right now cannot get one. Are things going to be better than that in the next year or two? The answer is probably not. It might get a little better, but there's also a substantial risk that it could get worse.
Do you anticipate a "double dip" recession, where the economy returns to two consecutive quarters of negative growth?
I think there's a possibility, but in some ways that's not the key issue. The key issues for most Americans are two-fold right now. One is, is it likely that the economy will be growing fast enough to create enough jobs for the new entrants to the labor force so that the jobs deficit gets reduced? The answer is almost no one sees growth in 2010, 2011 and even into 2012 at that rate. So we are going to maintain this gap of 15 million unemployed, 26 million Americans who would like a full-time job that can't get one. That situation is likely to be maintained. And it is possible that it might get a little worse; it might get a little better.
The second thing that is weighing down on most Americans is the threat of losing their home. The fact is that one out of four Americans with a mortgage are now underwater. They owe more money on their home [than the value of their home]. The bubble in the housing market crashed in 2007, and we're beyond three years now since that happened and there is no recovery in sight. The housing market might get a little better. There's a greater likelihood it will get a little bit worse. But going back to where they can say their home is their reserve for retirement or paying for college education? The likelihood of that happening is just very low.
What should be done about all of these people whose mortgages are underwater? Should there be a suspension of foreclosures?
Stopping the foreclosures is a palliative. It's a temporary measure. We have to understand that the problems have been festering for years, not just the last three years. In the years prior to the breaking of the bubble, the financial industry was engaged in predatory lending practices, deceptive practices. They were optimizing not on producing mortgages that were good for the American families but in maximizing fees and exploiting and predatory lending. Going and targeting the least educated, the Americans that were most easy to prey on.
We've had this well documented. And there was the tip of the iceberg that even in those years the FBI was identifying fraud. When they see fraud, it's really fraud. But beneath that surface, there were practices that really should have been outlawed if they weren't illegal.
So now, we have the legacy of that, plus all kinds of practices that are designed to get people out of their homes, to take advantage. It's not just the things that have been exposed, the robo-signers and that kind of thing. There are temporary judges hired in to process millions and millions of Americans losing their homes. The system was not designed for dealing with a failure of this magnitude.
Are we talking about widespread illegality or simply exploitative, but technically legal, practices? Where do you draw the line between outright criminality and mere exploitation?
It's very hard to draw the line, and that's almost a lawyer's issue rather than an economist's, but I think what we can say is there was a considerable amount of what was done should have been illegal if it wasn't.
This is a really important point to understand from the point of view of our society. The legal system is supposed to be the codification of our norms and beliefs, things that we need to make our system work. If the legal system is seen as exploitative, then confidence in our whole system starts eroding. And that's really the problem that's going on.
Because people are being told, "Well, you signed this." Well, if you have a legal system that encourages, allows, that kind of predatory behavior, something is wrong. And we know that something is wrong. Because the banks used their political power to make sure they could get away with this. There were a lot of people pointing out the predatory behavior. There were some initiatives to try to restrain the banks from doing it. And they used all their political muscle to ensure that they could continue engaging in these kinds of predatory behaviors.
Is this an argument for trying to restrain the influence of major banks and corporations on our political system?
Oh, very clearly. Look at the regulatory reform that got passed. It was an intense battle. And you had on one side a few banks. And on the other side you had 300 million people, American people. And it was really right in balance. Five or six banks equal to 300 million people. And in the end we got what you might call an unsatisfactory compromise. We moved a little bit in the right direction. For instance there was an agency set up to try to protect consumers.
But they made huge exemptions and exceptions so that, for instance, a lot of the predatory practices in automobile loans are going to be able to be continued. Why is it OK to engage in bad lending in automobiles and not in the mortgage market? Is there any principle? We all know the answer to that. No, there's no principle. It's money. It's campaign contributions, lobbying, revolving door, all of those kinds of things.
How do you respond to the argument that trying to restrict corporate political donations is somehow infringing on the free speech of corporations?
Corporations are a legal entity. We create them. And when we create them, we create all kinds of rules. They can go bankrupt. And that means they owe more money and they get away scot-free. They can create an environmental disaster, and then go bankrupt and again go away scot-free. So, as legal entities we have the right to make the rules that govern them. As individuals we have certain basic rights. We aren't created by the law. We exist by nature. But corporations are man-made. They are supposed to serve our interest, our society's interests. And we are creating them with powers that are not serving our society's interests.
Let me give you an example of something I think we ought to do, part of the way we have to deal with the consequences. Corporations are supposed to be owned by the shareholders. If you hired somebody to go do some work for you and you gave them some money, you would say that you have the right to make sure that they spend the money you gave them the way you tell them to. You should have the right to look at their books.
Right now, the shareholders, who are supposed to be the owners, have no say in pay. They have no say in the decision about how much their CEOs get paid. In some countries there is a sense of corporate responsibility. There's a sense that the shareholders own it, and the owners should have the right to vote, at least in an advisory sense.
If you're going to rob your shareholders, shouldn't they have the right to say I don't like this? And yet in America, the corporations have been resisting this. I think it's the same thing in the area of advertising and campaign contributions. As a shareholder, I should have the right to make sure the corporation that works for me, that I own, doesn't go against my interest. For instance, as a shareholder in BP -- I'm not, but if I were -- I want them to have safety, I don't want them to pollute the country. And I'm going to say they should act in a socially responsible manner and a responsible way. Shouldn't we have that right?
What do you think it is about the U.S. that makes it so hard to achieve corporate responsibility?
I think it's basically a vicious cycle in which we've gotten ourselves, because the corporate executives control the corporations. The corporations have the right to give campaign contributions. So basically we have a system in which the corporate executives, the CEOs, are trying to make sure the legal system works not for the companies, not for the shareholders, not for the bondholders – but for themselves.
So it's like theft, if you want to think about it that way. These corporations are basically now working now for the CEOs and the executives and not for any of the other stakeholders in the corporation, let alone for our broader society.
You look at who won with the excessive risk-taking and shortsighted behavior of the banks. It wasn't the shareholder or the bondholders. It certainly wasn't American taxpayers. It wasn't American workers. It wasn't American homeowners. It was the CEOs, the executives. And they use all kinds of language that quite honestly is deceptive. So they talk about incentive pay. We all believe in incentives as economists, it's the one thing we talk about. And who could object to incentivizing people to work harder? Sounds good. But if you look at the details of the incentive pay, it was incentives to act not in the interest of the shareholders and bondholders, but in the interest of the CEOs and the executives.
Explain how those incentives around compensation were motivating executives to act in a way that was contrary to their shareholders' interests.
Let me give you two examples. They got more pay when they got stock options. When the value of the stock goes up, they get the upside. But when it goes down, they don't have to share the losses. When you have a system like, you have an incentive to gamble because you get the upside, but somebody else bears the losses. So that's an example of incomplete sharing inducing excessive [risk-taking].
But it's even worse than that, because if your pay is related to the stock market performance, then you have an incentive to try to deceive the stock market. In the long run, information may get out, but you have a short term, and so if you can deceive them for a few years, get your stock options, sell out before the news strikes, then you walk off with a lot of money. And that's what they've done.
So you ask the question, why did they move so much of the risky activity off balance sheet? Now, partly it was to deceive the regulators, let's be fair. Partly some of this was to deceive the tax collector. But a major part was to deceive the shareholders, so it looked like they were doing much better than they were. Share prices go up, their bonuses go up. Some time down the line, the truth will come out. But by then, they've cashed in.
A good example of that might be [former Countrywide CEO] Angelo Mozillo, who recently paid tens of millions of dollars in fines, a small fraction of what he actually earned, because he earned hundreds of millions.
The system is designed to actually encourage that kind of thing, even with the fines.
During the S&L crisis, people actually went to jail. Do you think there's any chance that's going to happen with the mortgage crisis.
I know so many people who say it's an outrage that we had more accountability in the '80's with the S&L crisis than we are having today. Yeah, we fine them, and what is the big lesson? Behave badly, and the government might take 5% or 10% of what you got in your ill-gotten gains, but you're still sitting home pretty with your several hundred million dollars that you have left over after paying fines that look very large by ordinary standards but look small compared to the amount that you've been able to cash in.
So the system is set so that even if you're caught, the penalty is just a small number relative to what you walk home with.
The fine is just a cost of doing business. It's like a parking fine. Sometimes you make a decision to park knowing that you might get a fine because going around the corner to the parking lot takes you too much time.
Are there any steps regulators can now take to make the penalties more painful?
I think we ought to go do what we did in the S&L [crisis] and actually put many of these guys in prison. Absolutely. These are not just white-collar crimes or little accidents. There were victims. That's the point. There were victims all over the world. What worries me is that the Dodd-Frank bill, the regulatory bill that we passed a few months ago, gives responsibility to a set of regulatory bodies – the bill itself has all kinds of holes and exceptions – but the regulatory agencies, in many cases, are the same people that were in charge as we pushed to the brink.
So do we have any confidence that these guys who got us into the mess have really changed their minds? Actually we have pretty [good] confidence that they have not. I've seen some speeches where they said, "Nothing was really wrong. We didn't get things quite right. But our understanding of the issues is pretty sound." If they think that, then we really are in a sorry mess.
What happens when fines and other penalties lose their deterrent value in preventing or deterring people from committing crime?
There are many aspects of this. Economists focus on the whole notion of incentives. People have an incentive sometimes to behave badly, because they can make more money if they can cheat. If our economic system is going to work then we have to make sure that what they gain when they cheat is offset by a system of penalties.
And that's why, for instance, in our antitrust law, we often don't catch people when they behave badly, but when we do we say there are treble damages. You pay three times the amount of the damage that you do. That's a strong deterrent. Unfortunately, what we've been doing now, and more recently in these financial crimes, is settling for fractions – fractions! – of the direct damage, and even a smaller fraction of the total societal damage. That is to say, the financial sector really brought down the global economy and if you include all of that collateral damage, it's really already in the trillions of dollars.
But there's a broader sense of collateral damage that I think that has not really been taken on board. And that is confidence in our legal system, in our rule of law, in our system of justice. When you say the Pledge of Allegiance you say, with "justice for all." People aren't sure that we have justice for all. Somebody is caught for a minor drug offense, they are sent to prison for a very long time. And yet, these so-called white-collar crimes, which are not victimless, almost none of these guys, almost none of them, go to prison.
Can we draw a direct line from the outsize influence of the executives and the bankers -- because these skewed incentives and penalties out of whack didn't just arise out of a vacuum. How did we get to where we are?
It's clearly the influence of campaign contributions and lobbyists. Let me give you another example of where the legal system has gotten very much out of whack, and which contributed to the financial crisis.
In 2005, we passed a bankruptcy reform. It was a reform pushed by the banks. It was designed to allow them to make bad loans to people to who didn't understand what was going on, and then basically choke them. Squeeze them dry. And we should have called it, "the new indentured servitude law." Because that's what it did.
Let me just tell you how bad it is. I don't think Americans understand how bad it is. It becomes really very difficult for individuals to discharge their debt. The basic principle in the past in America was people should have the right for a fresh start. People make mistakes. Especially when they're preyed upon. And so you should be able to start afresh again. Get a clean slate. Pay what you can and start again. Now if you do it over and over again that's a different thing. But at least when there are these lenders preying on you should be able to get a fresh start.
But they [the banks] said, "No, no, you can't discharge your debt," or you can't discharge it very easily. They have a right, now, to take 25% of your before-tax income. Now imagine what that means. Let's assume that you wound up, as it's not that hard to do, with a debt equal to 100% of your income. You're making $40,000, and your debt is $40,000. You have to turn over to the credit card company, to the bank, $10,000 of your before-tax income every year. But, the banks can now charge you 30% interest.
So what does that mean? At the end of the year, you've paid the bank $10,000, a quarter of your income. But what you owe the bank has gone from $40,000 to an even larger number because they're charging you 30%. So you're debt is larger. So the next year you have to give a quarter of your income again to the bank. And the year after. Until you die.
This is indentured servitude. And we criticize other countries for having indentured servitude of this kind, bonded labor. But in America we instituted this in 2005 with almost no discussion of the consequences. But what it did was encourage the banks to engage in even worse lending practices.
We've made it so difficult for individuals to discharge their debt and have this fresh start, and yet it is just taken for granted that a corporation or a company can blow up and then they can file for bankruptcy and then they can start over.
We give rights to corporations that we don't give to ordinary Americans. One of my proposals in my book Freefall -- one of the ways to deal with this foreclosure problem, the fact that one out of four Americans who have a mortgage are underwater: They owe more money on their home than the value of their home. Their home used to be what they used as the reserve for paying their kids college education, for their retirement. Now it's a liability, not an asset.
So what I've argued is, we have these laws called Chapter 11 to give a fresh start to corporations. We say it's very important to be able to do this quickly, we want to keep jobs, we want to keep the corporation going as an ongoing enterprise.
Families are as important as corporations. Keeping kids in school, not forcing them out of their home, keeping the community together, is certainly as important as keeping a corporation alive. So what I've called for is a homeowner's Chapter 11. So what you do is you write down the mortgage, what they owe, to the value of the house. And you convert the debt into, make [the bank], in a sense, the new equity owner. And when they, sometime in the future, sell the home, if there is a capital gain they share that with the bank. That's the way the bank is protected. Nobody would do this just to escape; there is accountability here. But it gives homeowners a fresh start and it would deal with a significant part of our foreclosure problem.
It sounds like that would be a reasonable and actually quite popular plan. Do you think there's any chance that would be enacted?
Not as long as our banks have the kind of political influence they have today. There were some people in Congress that were pushing for a variant of this idea, and the banks came down really, really hard, for an obvious reason. The banks want to pretend that they did not make bad loans. They don't want to come into reality. The fact that they were very instrumental in changing the accounting standards, so that loans that are impaired where people are not paying back what they owe, are treated as if they are just as good as a well-performing mortgage.
So the whole strategy of the banks has been to hide the losses, muddle through and get the government to keep interest rates really low. So the Fed lends to the banks at zero interest rate, or almost zero interest rate. We wish we could borrow at that [rate] – if we could borrow at that [rate] we would also solve the foreclosure problem. So the government is basically giving money to the banks at very low interest rates, and then they're lending it on at much higher interest rates, and that's recapitalizing the banks. Money [is also] being paid out in bonuses -- not all of it is going to recapitalization, some of it goes into the pockets of the bankers.
The result of this is, as long as we keep up this strategy, it's going to be a long time before the economy recovers, because that huge spread between what they can get money from the government and what they can lend is dampening the economy.
Introduction to Value Investing
Are you the next Warren Buffett?View Course »