The Roaring Nineties: A New History of the World’s Most Properous DecadeBy Joseph E. StiglitzW.W. Norton256 pages, $25.95
conomists are intellectual practitioners who adopt basic assumptions they know are incorrect, and then extrapolate conclusions they declare to be true. Here’s how it works: 1) assume that perfect competition exists, and 2) assume that demand will equal supply (provided that assumption 1 is correct, which it isn’t), and 3) assume that everyone in the marketplace has perfect information. Now proceed to steps four and five and design economic policy, which you are free to make up yourselves.
This is not an exact science. Joseph Stiglitz, Bill Clinton’s Chairman of the Council of Economic Advisers and a former Vice President of the World Bank, has made a distinguished career for himself by demonstrating that assumption number 3 is not true. He collected a Nobel Prize for showing that, when it comes to buying and selling, some people (usually sellers) know more than others. Of course, anyone who has ever bought a used car knows this, or a tech stock… Sometimes, an inside look at the great minds running the world can be a little unsettling.
In his new book, The Roaring Nineties, Stiglitz explains how these “information asymmetries” were responsible for the wealth bubble of the last decade and its sudden and unceremonious popping around 2001. Unfortunately for us, Dr. Stiglitz did not realize that information asymmetries can be smoothly transmogrified into fraud and corruption until after he left government, when he was no longer in a position to do anything about it. Meanwhile, he had been an influential part of the administration that presided over the largest wholesale corporate swindle since that lamentable information asymmetry that resulted in collapse of the savings and loan industry way back when.
As he did in his last book, Globalization and Its Discontents, Stiglitz attributes much of what happened during the 1990s to policy makers’ mistakes. For example, the deficit reduction promoted early in the Clinton presidency was a “lucky mistake” that accounts for the exaggerated ups and downs of the economic cycle in the late 90’s and early ’00s. The lower deficit allowed the recapitalization of U.S. banks and refueled the economy quickly for two reasons. First, the Federal Reserve, under Chairman Alan Greenspan, signed off on an accounting mode that permitted banks to hold long-term government bonds without setting aside reserves to protect themselves against the risk of a fall in bond prices, so they had more capital to lend. Second, the Federal Reserve neglected to raise interest rates early in the recovery, “as the Fed would surely have done if it hadn’t underestimated the recovery’s strength, just as it had seriously underestimated the force of the decline that preceded it.” Stiglitz attributes both mistakes to Greenspan and shows how they rebounded to the benefit and profit of banks and CEOs. Curious.
“Mistakes” are a useful conceptual tool for Stiglitz as he sets about explaining the boom and bust of the 1990s. Because he will not admit the existence of social classes as any kind of defining force in economics or politics, it seems that Greenspan and the U.S. Treasury Department, meaning Lloyd Bentsen (remember him?), Lawrence Summers, and Robert Rubin, were responsible. In The Roaring Nineties, it is quite clear that Dr. Stiglitz doesn’t like Alan or the rest of them and that he sees the bubble as a consequence of their mistakes, and the bust as the result of their carelessness at home and their bullying abroad. Mr. Clinton, of course, remains above the fray, but, briefly, this is what happened under his authority:
Misguided deregulation and bad tax policies were at the core of the 1991 recession, and misguided deregulation, misguided tax policies and misguided accounting practices are at the core of the current downturn. American investors had trusted the corporate auditors, and the auditors had betrayed that trust. Similarly, investors had trusted the Wall Street analysts about which stock to buy, and those analysts too had betrayed that trust.
So, for a period of about 10 years, the largest national economy in the world was/is operating on the basis of misguided policy and misplaced trust. This is a very thin historical argument, especially since we now know that the same financial interests that created the bubble and benefited most from it, also escaped most of the consequences when it burst. Unlike the rest of us.
Talk about “lucky.”
The biggest boom beneficiaries were, of course, those individuals managing and manipulating the balance sheets of large corporations in such a way as to attract ever-larger quantities of investment capital, which they then squandered. One of their more imaginative techniques was the use of stock options, which they issued to themselves but which they were not obliged to include on their corporate liability statements. As a result, stockholders who had actually paid for their shares had no way of knowing what the CEO or the corporation really earned. Small investors buying into the boom with their retirement savings had no idea how heavily their stock was encumbered by future debt or how much the value of their own shares had been diluted. Stiglitz points out that, as Chairman of the Council of Economic Advisers, he protested this financial sleight of mind, but he was overruled by the U.S. Congress and by Lloyd Bentsen at Treasury. Through the use of stock options, compensation for senior corporate managers grew to absurd proportions, such that by 2000 in America, CEOs collected more than 500 times the wages of the average U.S. employee.
“Creative accounting” was another technique employed by corporations to “share and shift risk.” Mostly shift. Accountants had devised derivative financial products that allowed them to make the debts of Corporation A disappear into the liabilities of Corporation B, owned by Corporation C, which was also owned by Corporation A and by Corporations X,Y, and Z, all of which had issued truckloads of stock options to the CEOs of Corporations A and B. Got that?
When Stiglitz arrived in Washington in 1993 and confronted this state of affairs, he claims that he was concerned. He and the Council of Economic Advisers met regularly to discuss this very issue.
We were aware of the difficulties that derivatives posed in assessing the true financial state of a bank, or for that matter any firm, but we felt there was little we could do, especially in an era in which regulations were being stripped back. In part, we trusted the market and so we were ready to keep a careful watch without taking action to safeguard the markets from derivatives. In retrospect, we could have done much more to improve the quality of reporting, and to restrict the extent of risk exposure.
But clearly, derivatives had been designed for the express purpose of obscuring the approximate value of Corporation A. Derivatives were nothing more than walking, talking information asymmetries. Presenting them as legitimate financial products devised to share risk is disingenuous. If derivatives actually served their function, then they represented a form of theft because they fraudulently persuaded potential investors to buy stock in corporations that held hidden debt and risk. If they didn’t serve this function, then they had no reason to exist in the first place, so why not prohibit, or at least regulate them?
The creation of the ’90s bubble was a function of deregulation, and Stiglitz’s book details this well. The deregulation of financial institutions allowed banks to invest in and lend to the same corporations. A bank could and would hide the fact that a corporation in which it had invested was borrowing heavily, as that information would cause the value of the bank’s stock to fall. Brokerage houses, analyzing and picking stocks for clients, could participate in mergers and acquisitions worth millions to them, involving the same corporations whose stock they sold. So even if the stock looked suspect, the analyst would still recommend it in order to keep the merger deals moving. Auditing firms, responsible for producing and publishing independent analyses of a corporation’s financial status, could also serve as consultants for the corporation. Because their consulting contracts were so lucrative and because they had room to fudge, auditors became reluctant to publish financial information damaging to the corporation.
Notice the information asymmetries between the banks, the corporations, the brokers, and the auditors on the one hand and the public on the other. Notice also, that once upon a time these sorts of business arrangements were more commonly known as conflicts of interest, bribery, and fraud.
Not any more, though. The interesting element of the ’90s bubble is that, to a large extent, none of this was illegal. The laws had been loosened or had failed to keep abreast of the innovations in technology and finance. Why was that? As it turns out, mistakes were not factors in this equation. As Stiglitz himself informs us, when the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board tried to require that stock options be quantified as corporate expenses, Senator Joseph Lieberman authored a resolution to stop them. When Arthur Leavitt at the SEC raised questions about auditors and conflicts of interest, Congress passed legislation, over Clinton’s veto, intended to limit securities litigation, so that stockholders could not sue auditors for misrepresenting a corporation’s value. In spite of its author, the book shows that the ’90s bubble and bust had little to do with errors or negligence. The runaway economy was the consequence of a deliberate campaign on the part of powerful interests to escape government regulation by reducing the scope of public information and control.
The missing concept here is finance capital. The interests of finance capital were central to the sudden priority assigned to deficit reduction over public investment after Clinton was elected, central to the nomination of Lloyd Bentsen and later Robert Rubin as Secretaries of the Treasury and their policies at the International Monetary Fund, central to the policies adopted by the Federal Reserve Board, central to the inclusion of financial services in international negotiations regarding trade liberalization, and to the continued deregulation of utilities, equity markets, and the financial sector itself. Even so, Stiglitz is incapable of analyzing the class structure of the U.S. economy. For him there are only individuals, such as Greenspan or Rubin, or the entire collective: America. He is at his most confusing when he uses the term “we” to describe what was going on during the two-term Clinton presidency or what must be done now. At times, “we” refers to the administration, at others it refers to America as a whole, or to the human race. Occasionally, it includes only the ’90s good guys: Joseph Stiglitz and Arthur Leavitt. We never see finance capital pushing for policies that favor profits and accumulation, while working people pull for more equitable political programs. Because of this fundamental confusion it is often difficult, in this book, to tell just who did what. Here’s Stiglitz on America abroad:
We stood too for civil and human rights, for a new internationalism, for democracy. In the Cold War, we had befriended ruthless dictators, paying little heed to what they stood for and what they did, simply because they were on our side in the fight against communism. The end of the Cold War gave us more freedom to stand for traditional American values—and we did that.
We did? What values?
Although not explicitly identified, finance capital does appear in the book most clearly when Stiglitz discusses globalization. At the international level, class economic interests are harder to hide because they must use the State directly to negotiate policies favorable to them. So Clinton’s administration sacrificed public domestic investment to deficit reduction and began to operate in the international arena by pushing for trade agreements and international loan conditions that allowed the free movement of capital. But once again, Stiglitz analyzes international events through the eyes of the unknowable “we.”
But even as we opened up new areas, we did so in an unbalanced way. The United States pushed other countries to open up their markets to areas of our strength, such as financial services, but resisted, successfully so, efforts to make us reciprocate.
It is when writing about globalization, that Stiglitz, in spite of himself, most clearly outlines the power of finance capital. He describes Treasury repeatedly “winning” internal administration battles. But he also describes his own defeat at the hands of Treasury as if it were the consequence of a lack of awareness and information. He regretfully learned that aggressive trade stances, particularly where U.S. financial firms were involved, contributed to international economic instability by forcing other countries to remove the capital controls that slowed and restricted the movement of “hot money.” The disappointment in how we managed globalization was all the greater because of what might have been… We had no vision of what kind of a globalized world we wanted, and we weren’t sensitized enough about how what we wanted would be viewed by the rest of the world.
Now you have to ask: Does Dr. Stiglitz sincerely believe that if he and others in the Clinton Administration had only realized in time that the private purchase of other countries’ banking systems was not the most effective way to spread prosperity, then the U.S. government would have opposed it? And since we now realize this, why haven’t “we” adopted new policies to compensate for the mistakes of the past?
We haven’t done this because we didn’t make mistakes. For some, the ’90s worked out quite well, and the ’00s are looking even better. In his book about the same era, Locked in the Cabinet, Robert Reich did a better job on class conflict as it operated in the Clinton Administration. He too calls finance capital “Greenspan” or “Wall Street,” but he analyzes the different positions in the boom that different classes had:
Greenspan haunts every budget meeting, although his name never comes up directly. Instead it’s always our ‘credibility’ with Wall Street. It is repeatedly said that we must reduce the deficit because Wall Street needs to be reassured, calmed, convinced of our wise intentions. Never before in the history of mankind have the feelings of a street had such decisive force. The ancients worried about the moods of the skies, mountains, seas, and forests. We’re placating a pavement.
In Reich’s lexicon, “we” refers to the Clinton Administration, caught between the public’s demand
or investment as C
inton the presidential candidate had promised, and Wall Street, which Reich acknowledges, managed the actual presidency.
Greenspan is whispering into eager ears, deciphering the mood of the Street, prescribing the precise medicine needed to keep the Street healthy and happy. He wants the federal budget to be balanced. He doesn’t want taxes to be raised. That means that spending must be cut, and the Street couldn’t care less what the spending is for. Public investments? The Street doesn’t give a damn.
Throughout Reich’s book, opposing social classes battled for control of the administration, and when Bentsen showed up as Treasury Secretary, Reich says he knew the Street had won. This sense of real economic interests in conflict, however, is missing from Stiglitz’s account of the ’90s. He is therefore at a loss to explain how and why the anti-globalization movement consolidated itself so forcefully here in the United States in 1999. If we were all thrashing around in the information asymmetries and policy mistakes that created the bubble, why did such vocal and effective opposition to liberalized trade as the next step in the deregulation process materialize in Seattle and on the streets of Washington, D.C. ?
American economists, as a class of their own, are uncomfortable talking about finance capital, or oddly enough, about capitalism as a system. As a result, their analytical tools are reduced to market principles that your grandmother knows are false. If the economy could be fixed by technocrats handing out more and better information, then who is stopping them? If deregulation was a mistake, why aren’t “we” re-regulating instead of pushing the policy farther? Stiglitz is good at describing the immediate causes and consequences of corporate greed and malfeasance, but he is at a loss when it comes to defining underlying economic structures. As a result, he has no concrete proposals for the future. He hopes only that
Perhaps the next administration will have more success in addressing our long-run needs, and in ways which will ensure that a new-found prosperity will be shared by all America and indeed by all citizens of the world.
Oh, indeed. Gabriela Bocagrande’s review of Joseph E. Stiglitz’s Globalization and Its Discontents (“Mistakes Were Made,” January 17, 2003) appears in the anthology Censored 2004: The Top 25 Censored Stories (Seven Stories Press).