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Lessons lernt from the financial crisis - The secret of the invisible hand

Source: Süddeutsche Zeitung-online - A guest contribution by Joseph E. Stiglitz
Translation english to german: Helga Klinger-Groier []
Translation back into english (here): Eulenspargel

What will come after the big crisis? The world has lernt a few valuable lessons, but at a high price

The best you can say about 2009 is: It could have been worse. We succeeded in retreating from the abyss at the brink of which we stood in 2008, and for most countries 2010 will in all likelyhood be a better year.
The world has lernt a few valuable lessons, but at a high price as regards today's and tomorrow's prosperity - an unnecessarily high price, since these lessons could have been learnt earlier.
The first lesson is: markets are not self-correcting. Lacking adequate regulation, they have a tendency towards excess. In 2009 it became clear to us why Adam Smith's invisible hand often stays invisible: because it simply does not exist.

Means of the poor sent to the rich

The egoistic striving of the banker does not increase the common good of society, it was not even useful for share-holders. Certainly the house owners who lost their homes did not gain anything from this system, nor did the employees who lost their jobs, nor the pensioners who had to watch their old-age provisions evaporating into thin air, and neither did the taxpayers who had to pay hundreds of milliards (US: billions) to save the banks.
In the face of the imminent collapse of the whole system, the safety net of the state - which was intended for helping people in need - was generously extended to banks, then to insurance agencies, to auto manufacturers, even to auto credit organizations. Never yet was so much money diverted from so many people to so few.

Shares of state gifts

The taxpayers had to carry money to exactly those institutions from whom they were ripped off - through usurious credits and opaque fees. And then they had to watch how their money was used to pay out exorbitant bonuses and dividends. Dividends are supposed to be profit shares. Here they have mutated to shares of state gifts.
The actions to save the banks from ruin unveiled the all-embracing hypocrisy. Those people who preached restraint where a social program for the poor was under debate, pointing to the strained state budget, themselves now loudly clamoured after the biggest social program of all. Those people who always blew the horn of "transparency" contributed to the construction of a financial system in which the bankers no longer understood even their own balance sheets.

Waiving of debts for the financial sector

And the State shifted into ever more obscure forms of saving the banks because of the need to hide the fact that the banks were receiving gifts. Those who had previously spoken about "accountability" and "responsibility" now wanted to cancel the debts of the financial sector.
The second lesson we learnt, is why markets do not function as they should. There are many reasons for market failure. In this particular case, the reason was the perverse incentive system of credit institutes that were too big to allow them to fail.

Keynesian politics work

When they gambled and won, they pocketed the profits. When they lost, the taxpayer had to step in. Markets do not function well if the available information is incomplete, but incomplete information is a central component of the financial world. The collapse of a bank burdens the others with additional costs, and the collapse of the entire system would lead to costs for taxpayers and employees worldwide.
Third lesson: Keynesian politics work. Countries like Australia, that follow well thought-out economic stimulus programs, came faster throgh the crisis.
Other countries stuck with the same old economic orthodoxy behind which the finance jongleurs have stood, and which got us into this plight. When a national economy slithers into a recession, then we get budget deficits because the tax income sinks faster than the spending.

Fiscal policy goes beyond fighting inflation

According to the old teaching you have to lower the deficit - either by raising taxes or by lowering spending - in order to "regain trust". But this policy almost always led to a reduction in the total demand. And thereby the economy slowed down further, and trust was undermined still more - like in the 1990s when the International Monetary Fund insisted on just such a measure.
The fourth lesson is that monetary policy is more than fighting inflation. The excessive concentration on the one factor inflation resulted in some Central Banks simply ignored what was happening with the financial markets.
The costs of a mild inflation are minimal compared to the costs that national economies have to bear when the Central Banks allow an unchecked growth of bubbles.
The fifth lesson is: not every innovation results in greater efficiency and productivity for the national economy, let alone in a better society. Private incentive systems are the essential thing, and if these are improperly constructed, then it can lead to excessive risk-taking and unduly shortsighted behaviour. An example: the usefulness of many of the new finance products that emerged in the last few years is difficult to verify, or to quantify, but the costs associated with these new products are evident and enormous.

Capital misguided to the greatest extent

The finance engineers did not created products that helped common people to manage the risks involved in their home ownership. On the contrary, their products were geared to perfectionize the exploitation of lesser educated people, and to evade government regulations that aimed at making the markets more efficient and more stable. In consequence, finance markets that were meant to carry out risk management themselves actually generated risk, and were responsible for grossly misdirecting capital flows.
We will soon discover whether we have lernt the lessons of thie current crisis better than we did before. However, if the USA and other industrial countries fail to make greater progress in reforming the finance sector in the course of 2010, then we could unfortunately once more have an opportunity to draw lessons.