Stiglitz laments US's "bogus" bailouts

Joseph Stiglitz, the 2001 Nobel Laureate, tells CentralBanking.com why the US administration must set up its own lender and stop pandering to the banks if it is to fix the economy.

Despite the criticisms that accompanied the original Paulson plan, the idea of removing toxic assets from banks' balance sheets has grown in popularity in recent months. Granted there remains little consensus on how to do it, with the issue of pricing remaining the key stumbling block, and US Treasury secretary Tim Geithner's idea of a public-private partnership has so far met with a lukewarm response. But for some, such as Joseph Stiglitz, the idea alone still remains unpalatable.

"The main reason why I've been critical of the toxic asset idea is that it may be seen as a non-transparent way of recapitalising the banks," Stiglitz tells CentralBankNews.com on the sidelines of a conference to celebrate Bank Negara Malaysia's 50th anniversary. He adds that the method will lead to the government overpaying for the assets. "An easy way of cleaning up the balance sheet is for the banks to sell their assets to the market. Why don't they want to do that? Because the losses would be too great," he says. "What's the government going to do with these assets? It's just going to sell them on to the market. So it's distribution and transparency that are the real issues here. And given what the United States government has already done in terms of giveaways, there is real reason to have suspicion."

Stiglitz terms the suggestion that Washington could foster transparency by restructuring the assets as "an example of the kind of bogus argument that is surrounding the discussion." "If one of the problems is restructuring then why can't the banks do it themselves? In fact, what we'd have to do is hire the same crooks, er guys, to restructure them that created them in the first place."

Stiglitz also denies that leaving the assets on banks' balance sheets raises the threat of a downward spiral where cash continues to be hoarded, the real economy gets worse, defaults rise and the assets become ever-more toxic. "That's the type of bogus argument the banks have been pushing," he says. "You don't need to have institutions that have proven incompetent in risk assessment to do more of the same."

He also says that there is little chance that the government could make a profit even if it paid more than the fire-sale price for the assets by holding them to maturity. "You say that the government could come out in the black because the foreclosure rates for the mortgages that back these assets have not been so high. Well, yes, but that's because it takes two years to go through foreclosure procedures in the US. We're just going into the worst parts of the decline. You can't use past statistics for future projections. If the market was willing to take the risk and do so then that would be one thing. But the market is saying that we don't have the confidence in our models, our valuations and that's why we're not wiling to buy this stuff.

"What is the price of holding to maturity? Paulson originally seemed to believe that it is just a question of confidence, that if we just get lending started then the prices will stabilise. That's almost surely a fantasy," Stiglitz says. "We had a bubble and he didn't want to recognise that because he participated in creating the bubble. So did Geithner and so did Bernanke."

So what would Stiglitz do? For him, the answer lies in creating a new government bank, the funds from which would be used for social protection, to finance stimulus packages and offset capital flows.. "You can create a new institution that can get lending started without the legacy," he says. "If you had taken the $700 billion allocated to the Troubled Asset Relief Programme and created a new financial institution, then there would be no shortage of lending, you could lend up to $8.4 trillion on a fairly modest 12:1 leverage ratio."

He also says the Federal Reserve could take further steps to affect banks' behaviour. However, he adds that the Fed's ability to do so may be hindered by its inability to understand the theory of banking. "I don't think they've fully taken onboard the way their actions may affect banks' behaviour and therefore the availability of credit and interest rates. It's even more then case with the Treasury, which has allowed banks to pour money out in dividends and bonuses when we were supposedly recapitalising them," he says. "There's a total lack of coherence. The banks' actions don't surprise me. What did was that the Fed and the Treasury didn't understand that they were incentivised to behave in the way which they have done."

The interview took place on 11 February

 

 

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