Mon May 23rd, 2011 at 06:57:49 PM EST
Crossposted People's View
In the early months of the Obama administration, with the economy in free-fall and Bush's bank bailout having poured hundreds of billions into an apparently bottomless bank collapse, Nobel Prize winners Paul Krugman and Joe Stiglitz among others "on the left", authoritatively and confidently explained that the policies advanced by the new Administration were naive, stupid, complicit, and sure to fail abysmally and catastrophically. The extent of the error made by these economists and others, like Dean Baker, Simon Johnson, and Robert Reich, not to mention all their often ludicrously ignorant followers in "progressive" blogs is all the more remarkable given their subsequent lack of interest in figuring out why they were so wrong or even admitting to error in the first place.
I was under the impression that he might bring in the voices of brother Joseph Stiglitz and brother Paul Krugman. I figured, OK, given the structure of constraints of the capitalist democratic procedure that's probably the best he could do.
-Princeton Professor Cornel West (not a hotel porter)
The basic Krugman/Stiglitz argument was that the financial markets had correctly priced bank assets as junk and so the biggest banks owed more money than they could ever repay and the government should "nationalize" them. The Administration, on the other hand, said that the financial markets were in the grip of a panic and that arranging for temporary government and government/private finance would calm things down at less cost to the taxpayer. Obviously, Geithner, Obama, and Bernanke were correct and the critics from the left were incorrect - the banks have stabilized, the "toxic assets" purchased by government have turned out to be a great investment, and the economy is recovering slowly, not smoldering in ruins. But the strangest thing about the incorrect analysis of the "left critics" is that it's based on a fundamentally right wing view of the economy wrapped up in a bunch of pseudo-populist signifying. The right insists that that market price is value. The right insists that financial markets are rational. And the right is contemptuous and derisory about reformers.
Here's Stiglitz on April Fools Day 2009:
What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a "partnership" in which one partner robs the other. And such partnerships -- with the private sector in control -- have perverse incentives, worse even than the ones that got us into the mess.
So what is the appeal of a proposal like this? Perhaps it's the kind of Rube Goldberg device that Wall Street loves -- clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.
But we are already suffering from a crisis of confidence. When the high costs of the administration's plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.
All the elements of right wing economics are in play here including the ridiculous emphasis on "confidence" because the right wing always wants the government to soothe the troubled nerves of the market and the conspiracy theory beloved of John Birchers. Joe Stiglitz is a smart guy and a good liberal at heart, but this argument is very much like the argument that Ron Paul made - and for a reason. Here's Krugman a week earlier
As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there's a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.
In fact, this is exactly the same doomed plan that Ireland adopted so far - and with terrible consequences. Imagine what would have happened if the Federal government had pushed Citibank (and it didn't need much of a push) in 2009. Citi would have dragged down BOA and WellsFargo with it (and God only knows what would have happened in Europe). Instead of working on the auto rescue and the Green energy investment programs and starting the health care reform, the Administration would have been sinking in an effort to manage $3trillion of assets and "clean up the their books". GE capital would have followed - undoubtedly dragging down manufacturing output - instead of investing in green automobiles and locomotive factories GE would have been battling creditors. The US government would have taken responsibility for the debts of those banks and it would have cost hundreds of billions of dollars. And this is not even considering the problem that the US government didn't have the authority to seize Citigroup - it would have had to try to pull Citibank away from the holding company and manage one part of the monster while the other part flailed away destroying Japan's economy and generally wreaking havoc. "Clean up their books
" - wow, everything is so simple if you ignore all practical difficulties. One imagines Paul Krugman with green eyeshades on poring over the Citbank books trying to make it all work out.
It's also worth noting the tone of these criticisms. We didn't get "The new Democratic President wants to do right, but this is why I disagree", we got contempt and implied accusations of criminality and Paul Krugman saying "I am in despair".
Fortunately, instead of following the "left" plan of sinking the entire federal budget into bank recapitalization, the Feds were able to divert TARP money to GM and Chrysler and hundreds of smaller community banks. They were able to focus on trying to restart the manufacturing basis of the economy. They took the student loan subsidy away from Wall Street. They passed a financial reform law giving the government legal right to wind down large non-bank financial institutions and claw back bonuses from management. They got health care reform passed. And they pushed a lot of the cost onto the shareholders of the banks. Citigroup shares are worth 1/10th of their 2007 price even though the bank itself has stayed operational.
To answer the question of why these bright and well informed people were so wrong, we have to understand how strange it is to see a supposedly "left wing" critique based on financial market valuation. The administration said that while there were bad loans and bad mortgage bonds, investors were not making a rational assessment of the state of the market and were caught into the domino effect of debt during these kinds of crisis. During the Bush/Greenspan bubble, investors borrowed money so they could get more valuable bonds and stocks. But when the prices started to fall, some of them had to sell right away to pay their bankers back - and this made prices drop even more which forced more investors to sell in a panic to pay back their loans and so on.
As an example: when Geithner was running the Federal Reserve of NY (FRBNY), AIG faced immediate bankruptcy and to prevent that the FRBNY essentially purchased a pile of "toxic assets" from AIG for about $24billion - this was the so-called Maiden Lane III transaction. The assets were unsellable at the time. "The infallible market" had judged them valueless. Since then, however, the AIG assets have paid back $12billion in interest and principle and the remaining part now has a market price of as much as the original investment. Those "toxic assets" were worth something like 30% more than the purchase price even though at the time they had a "market value" of near zero. This is one of the transactions that Stiglitz was calling a transfer of public wealth into private hands. AIG shares are about 1/40 of 2007 price - the shareholders lost almost everything - and the Feds look like they will get most of their money back (Paulson and Bush began by giving AIG $85billion in loans so it's a long haul).
And Krugman and Stiglitz were hardly alone with their "market value" argument. The "left" and "progressive" blogs have been full of strange stories about the need for "mark to market" and the horror of the Federal Reserve printing money, and other staples of the right since the crisis started. I think that what we are seeing is the final collapse of the old left - just a few decades after the collapse of communism. With socialism either discredited or absorbed into the mixed systems that dominate the world economy and with the disintegration of the old alliance between left wing intellectuals and the traditional labor movement, "the left" has been reduced to a social club of disgruntled professionals allied with a media/academic "style" that has nothing to do with class, social justice, or effective politics. What we get from them is not change we can believe in, but a mix of right wing populism and elite technocracy in drag.