The Bank Bailout Has Failed - Part 2

Stiglitz Says Banking Problems Are Now Bigger Than Pre-Lehman

By Mark Deen and David Tweed
Sept. 14 (Bloomberg) -- Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.
“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview yesterday in Paris. “The problems are worse than they were in 2007 before the crisis.”
Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”
A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.
While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.
Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.
G-20 Steps
“We aren’t doing anything significant so far, and the banks are pushing back,” said Stiglitz, a Columbia University professor. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”
G-20 leaders gather Sept. 24-25 in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers earlier this month reached a preliminary accord that included proposals to reduce bonuses and linking compensation more closely to long-term performance.
“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”
Global Economy
Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.
“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”
The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.
The question then is who is going to finance the U.S. government,” Stiglitz said.
Stiglitz gave the interview before presenting a report to French President Nicolas Sarkozy that urged world leaders to drop an obsession for focusing on gross domestic product in favor of broader measures of prosperity.
GDP’s Shortcomings
“GDP has increasingly become used as a measure of societal well being and changes in the structure of the economy and our society have made it increasingly poor one,” Stiglitz said.
Assessing government’s contribution to economic output, which ranges from 39 percent in the U.S. to 48 percent in France, is one of the shortcomings of the GDP model, as is its difficulty in estimating improvements in quality of products such as cars instead of just quantity, Stiglitz said.
Similarly, increased household debt may drive up output numbers, even though that doesn’t amount to a real increase in wealth, he added.
While Stiglitz doesn’t recommend dropping GDP altogether, he wants governments to consider such matters, along with issues of environmental sustainability, in policy making.
“Most governments make a fetish out of it. If you take one message out of our report, make it avoid GDP fetishism,” he said. “The message is to encourage political leaders away from that.”


Professor Stiglitz expresses concern over some the issues that we have discussed over the past several months on this blog. In a previous post (July 16) we commented on the fact that the bank bailout has failed to address the problems in banks of which their lack of ability to lend in now evident, and that micro finance may become an alternative. There are three main problems:
  1. Too big to fail banks are now bigger. This is Corporatism at its finest. Privatise the profits and socialize the losses on the backs of the taxpayer. With Non-GAAP accounting standards, we have opaque balance sheets so no one knows how weak the banks really are. I suspect they are all insolvent as TCE often runs in the range of 6 to 8% before a major downturn.
  2. The world economy that is allegedly rebounding. This is Big Government spin doctoring at its finest. Many leading indicators show that there has been no improvement (look at SOX, Baltic Dry Index, and Asian Exports as examples). Some of these indicators may "roll over" in the near future and drop further, particularly if a trade war blossoms.
  3. US Government debt and other national debts. We need to ask ourselves and our government officials one simple question - What is the maximum amount of debt our country can sustain? Is there a limit? That answer is self evident. Debt is borrowing against future earnings where the interest costs are offset by the increased productivity in the economy. Borrow enough money, and have yearly interest cost start to approach the level of GDP and the system will begin to collapse. This is bond auction failure territory. It is the nightmare scenario because the effect on ordinary citizens who rapidly see their savings and net worth disappear, civil unrest rears its ugly head, and retirement dreams become only a fantasy. This is why individuals need to protect themselves by pursuing similar strategies that were expressed in this blog back in March, April and June.