Of America, free markets & freefall

The antidotes to the crisis, concocted by many of the players who stirred the original toxic brew, have pulled the US economy back from the brink.
But those remedies won’t prevent future crises, Joseph Stiglitz, winner of 2001 Nobel Prize for Economics, writes in “Freefall: America, Free Markets, and the Sinking of the World Economy.”

In contrast to the regulations that emerged from the Great Depression, which promoted growth and stability, the response to this crisis has led to a less-competitive financial system dominated by banks that are too big to fail, he writes.

Modern alchemy
Stiglitz, a professor at Columbia University in New York, focuses on banks’ failure to assess and manage risk, especially when risk is disguised by complex financial instruments. Such “modern alchemy” transformed risky sub-prime mortgages into A-rated products dubbed safe enough to be held by pension funds, he says.

America’s financial markets also failed to allocate capital productively, he says. “At their peak in 2007, the bloated financial sector absorbed 41 per cent of profits in the corporate sector,” Stiglitz writes. To add insult to injury, some of those profits were spent influencing Congress to make certain the government would not regulate risky derivatives or curb predatory lending.

Finally, flawed incentive structures fostered corruption, encouraging deceptive accounting that would lead to higher stock prices and higher bonuses for Wall Street managers.

By 2008, the nation’s economy was in a freefall and the US, a country that purported to revile socialism, had to socialise risks banks had taken and intervene in markets in unprecedented ways, Stiglitz writes.
But where does that leave the financial system and, more importantly, the US economy?

It’s very likely we will have a very slow recovery. The healthcare situation in the US, with its issues of equity and access, also has implications for US growth, Stiglitz said. Health affects productivity, and the cost of healthcare affects competitiveness, he said. “To make things worse, we have made the fundamental mistake of linking the provision of healthcare to employment, creating strong interactions between deficiencies in the health care system and problems in the labor market,” he said.

The solution to that problem would be to move to a single payer system that recognises health as a social cost, not an employment cost, Stiglitz said.
The biggest risk to economic recovery is “very, very strong political risk” posed by those who argue for deficit reduction.

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