Friday, October 10, 2008
See Shrill Nobelist Know-it-all
Everyone has had a teacher in high school or college who was sure to solve poverty if the government would only implement his plan. For example, if the poverty line is $20,000 per year, and there are 30 million Americans below the poverty line, all we have to do is take the $600B we spend on the Defense budget, and give that to the poor! Solves poverty, and lowers violence, and it's a mathematical proof--certain to be true. Why doesn’t everyone listen to me!
Stiglitz is pathetic in this little tirade, how he caricatures those who disagree with him, his inconsistencies, his assumption that bad things only happen because of insufficient government involvement (though, he hates the Iraq war, which in his mind has nothing to do with true government). He blasts the immorality of conservatives, for example, noting that his friend told him that when former Federal Reserve Chief Paul Volker was informed his tight monetary policy would ‘kill’ Latin America in 1980, he said ‘that’s not my problem’! Monetarism, of course, was based on a religion (in spite of Friedman and Schwartz’s A Monetary History of the United States). Easy credit in the 2000’s created this crisis, foolishly giving homes to too many, but then he also notes the current crisis is tragically causing millions to lose their homes, and ignores the intellectual and political genesis of easy credit.
He argues firms are ‘stupid’, as evidenced by the fact of paying dividends, which is tax inefficient, even though there are many issues in signaling and asymmetric information that explain why the debt and equity choice is not degenerate at 100% debt (and further, that a 100% debt-financed company is, in effect, equity). As one who then complains of The Economic Establishment ignoring asymmetric information, this ‘proof’ of stupidity contains a massive amount of cognitive dissonance (you have to love Nobelists, at top universities, who have had top jobs in government, railing against The Establishment).
‘Anybody looking at the behavior of financial markets, would have predicted what happened’, he says, ‘This is not 20-20 hindsight’. Sure, who didn’t call this credit crisis? His own work goes a long way of explaining the situation we are in, in his opinion, though Stiglitz and Weiss (about markets breaking down with asymmetric information), or Grossman and Stiglitz (about the impossibility of efficient markets), actually gave support to the kind of meddling by the government that was a major impetus to the relaxation of traditional underwriting standards. The disease is now the cure.
He argues that Long Term Capital Management blew up because they based their models on the work of Scholes and Merton, though these guys were mere merely marketing figureheads, and the actual investment strategies of LTCM were made without input or oversight of Scholes and Merton, and were hardly derived from a canonical option pricing formula.
Businessmen are stupid, but even stupider are the Corporate boards, and finally investors. Everyone is an idiot, so giving the government more power is clearly a good idea (as everyone knows, only really smart people get into government (except when Republicans are charge)).
He thinks his models of asymmetric information explain the problem we are in. Well, in a very, very vague way, but one could also say the roots of the crisis were mentioned in Adam Smith ('people are self interested') or the Bible ('money is the root of all evil'). His models show how certain assumptions cause markets to break down, but these are models, and his assumptions are just as 'unrealistic' as any other, because they assume a very specific information sets for all the actors, surely highly idealized . The implications of his models are ambiguous, because depending on how you modify the information of various parties, you can get opposite results, thus in practice, the efficacy of regulation is both an empirical matter, and needs a lot of common sense, two areas where Stiglitz is at a comparative disadvantage.
Markets with imperfect information are not necessarily Pareto optimal--therefore this crisis would have been avoided if we had more regulation? As if the financial markets were not already a highly regulated sector, and the body whose full-time job of monitoring Fannie had absolutely nothing to say about he relaxation of credit standards, instead focusing on interest rate risk, or games executives played to get their big bonuses (important, to be sure, but still). When the regulators were doing it wrong, 10x more does not help. His model basically is like the cartoon below: I have highlighted issues in abstract models of perfect markets (under certain assumptions, equilibrium breaks down), therefore, it explains the current crisis in our highly regulated markets.
Joe Stiglitz has done some great work. But if you consider his balance sheet, the absolute amount of his good ideas versus his bad ideas, he is insolvent. Reading the wacko letters to the editor in the local Arts Weekly gives a more balanced, and accurate view of how we got here.