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HARPER’S MAGAZINE/NOVEMBER 2008 $6.95
HOW TO SAVE CAPITALISM
Fundamental Fixes for a Collapsing System
A Forum with James K. Galbraith, Michael Hudson,Eric Janszen, Barry C. Lynn, Bill McKibben, Joseph E. Stiglitz,Elizabeth Warren and Amelia Warren Tyagi
USEFUL AMATEURS
How the Smearing of Barack Obama Got Crowd-Sourced
By Ken Silverstein Also: David Means and David Foster Wallace
ROGER D. HODGE: STEAL THIS ELECTION
FORUM 35
FORUM
HOW TO SAVECAPITALISM
Fundamental fixes for a collapsing system
I
f the financial debacles of the past decade—the enormous bubbles, the credit col-lapse and its trillion-dollar consequences—have taughtus anything about the American economy, it is thatcapitalists have done a remarkably poor job of safe-guarding the future of capitalism. Our system became sodominated by finance, insurance, and real estate, and bythe complex derivative securities these industries en-gendered, that the most eminent financiers (and their un-sleeping computers) were unable to protect us from eco-nomic shocks. For a number of years, farsightedcommentators—including in this magazine—warnedof the looming credit collapse, and yet the masters of oureconomy took no action until the crisis was alreadyupon us. Now we must not only repair our tenuous fi-nancial system but shore it up to withstand two great,gathering storms: dwindling energy supplies and accel-erating climate change. To this end,
Harper’s Magazine
asked a group of leading economic thinkers to offersweeping but concrete proposals for the rescue of capi-talism, and capitalists, from doom.
36HARPER’S MAGAZINE / NOVEMBER 2008
From the seventeenth-century tulip mania tothis century’s housing bubble, economies havebeen susceptible to the quest for the easy buck.Clever people will invariably circumvent regula-tions and accounting standards; they will seizeopportunities to prey upon the poor and the ill-informed, to profit by selling the notion of the freelunch. By now most people are aware that over thepast five years the financial sector has made badloans and extremely risky bets, that defaults on theloans and record losses on the bets have serious-ly damaged the nation’s (and the world’s) econ-omy. The downturn is likely to be so severe part-ly because we have succumbed to the opinionthat markets work best by themselves, unfetteredby government regulations. But the people mak-ing this argument are the ones who have beenserved well by it. We can do far more to protectagainst self-interest. In particular, we need to im-prove the incentives that drive those in the financeindustry, so that their interests align with those of the society and economy they are meant to serve.The financial sector is supposed to allocate cap-ital judiciously, making sure that it goes to areaswhere returns, when adjusted for risk, are highest.When capital is well distributed in this way, theeconomy is more likely to flourish in the shortterm and grow steadily over time. Capital marketsare also supposed to manage risk, transferring itfrom those parties less able to bear it to those thatare more able to do so; distributing risk in this man-ner encourages entrepreneurship and stabilizesthe economy. In return for performing this pub-lic service, the financial markets are generouslyrewarded—in recent years they have garnerednearly a third of all corporate profits.The financial system is
supposed
to do thesethings. But it is clear that America’s financialinstitutions have not managed risk; they havecreated it. The industry allocated hundreds of billions in bad loans to an inflated housing mar-ket, resulting in the greatest number of foreclo-sures since the Great Depression. With economicgrowth currently at a dreary 1 percent, there is al-ready an immense gap between what we are nowproducing and what we could be producing if this crisis had not occurred—a cumulative loss Iestimate will be in excess of $2 trillion.Too many bankers and other lenders have beenfocused on trying to beat the system by gettingaround accounting and banking regulations(through what is called accounting and regulato-ry arbitrage). Indeed, with bonuses based on short-term profits, they had every incentive to gambleand connive. And now that there’s a bust, no oneis being asked to pay back the hefty bonuses earnedduring the boom. On the contrary, even as theyare dismissed, those who helped send their firmsand the American economy into a tailspin arerewarded with generous severance packages. Theyare enriched regardless of what happens to in-vestors, homeowners, and others who lost so much.Unless we reform incentives, the financial sectorwill only try to circumvent whatever new regula-tions are put in place. We will simply have a shortrespite before the next crisis.One major problem with incentives involvessecuritization. The selling and reselling of mort-gages, with payments chopped into thousands of pieces, creates a new set of information asymme-tries, as buyers of securitized mortgages have less in-formation than the originators of the mortgages.To be sure, both investors and regulators shouldhave recognized the scam. But as mortgage origi-nators realized that buyers of securitized mortgagespaid little attention to who was taking out theloans and on what terms, they pushed through asmany loans as they could, regardless of their risk,and they invented ever more complex and pre-
Joseph E. Stiglitz is University Professor of Economics atColumbia University and winner of the 2001 Nobel Prizein Economics. His most recent book, with Linda Bilmes,is
The Three Trillion Dollar War: The True Cost of theIraq Conflict.
Illustrations by Raymond Verdaguer
realign the interests of wallstreet
By Joseph E. Stiglitz
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How to Save Capitalism: Fundamental fixes for a collapsing system
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