Explaining the Current Financial Crisis

Dr. Kamran Mofid, Economist

Posted Oct 7, 2008      •Permalink      • Printer-Friendly Version
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Explaining the Current Financial Crisis

by Dr. Kamran Mofid, Economist

On 10/6/08 Dr. Mofid, an internationally renowned economist, and founder of the Globalisation for the Common Good, in a letter to his subscribers, wrote the following on the current economic crisis:

In the last couple of weeks, 100s of billions of Dollars, Pounds and Euros of tax payers money have been poured down the drain to bail out a non-functioning, unregulated, unaccountable financial system. The money that we were told was not there to pay for improvements in health, education, housing, transportation, pension, child care,..to name but a few. Moreover, no body has been charged yet: one law for them and another one for the tax payers! The profits were privatised when the going was good and the costs have been socialised, now that the going got tough, heaven on earth for them and hell for the tax payers!

Where are the market forces now, you might ask? Where are all those neo-liberal economists now, singing the praises of the market, deregulation, liberalisation, privatisation, free tade, share/property-owning democracy,..? Where are they now, telling us how to maximise our profits and income, how to minimise our costs and how to exploit the natural resources, all for the sake of maximum economic growth, and then tell us how to externalise the costs and consequences to the tax payer or to the people of Bangladesh for example, when they get flooded.

Where have they gone now? Why are they so quiet now, not sharing their wisdom on the wonders of the market and competition and scarcity with us all!  I wonder if all these billions that tax-payers have given will work in rescuing the economy where mammon has taken over? My answer is: it will not, as long as the so-called experts/economists do not admit that without humanity, ethics and justice, economics and business are house of cards built on shifting sands.

Many millions of words have been written on this meltdown, on what went wrong, but not much on why it went wrong. The overwhelming majority agree on the role of one vital element: dishonesty fuelled by greed. We forget at our own peril that honesty and greed are essentially spiritual and moral issues.In the last few weeks the greed of Wall Street and the City (London financial district) has been under the spotlight. The Archbishop of York recently- and in my view correctly- called some of the traders bank robbers. “We find ourselves in a market system which seems to have taken its rules of trade from Alice in Wonderland”, the Archbishop remarked. The Archbishop of Canterbury has also criticized “trading of the debts of others without accountability” and compared unfettered belief in the market with fundamentalism. This last word “fundamentalism” used by the Archbishop means a lot to me. It is the fundamentalism of economics, its teaching and MBA programmes that is, in my view, the shifting sand upon which we have built this house of cards, called economic globalisation, which has now come home to roost.

The Chicago Boys school of economic thought has proven to be an Emporer with no clothes!  As long as this curse persists, there will be no possibility of reaching the Promised Land: where we can have justice, peace, happiness and contentment.


The Curse of The Chicago Boys

As it has been noted, the so-called “famous school of economics at the University of Chicago led by the late Milton Friedman spread its market fundamentalism worldwide.  Greed, selfishness, individualism and short-termism were conflated with freedom and democracy and elevated to the status of moral philosophy.  The fatal flaws of this ideology has fueled the reckless risk-taking, greed and arrogance that led to Wall Street’s downfall, and the loss of confidence in financial/banking sectors the world over”.

The Chicago Boys and their clones inspired the Reagan and Thatcher era and the Washington Consensus of deregulation, privatisation, driving today’s form of economic globalisation.

Let us recall Milton Friedman’s infamous single bottom line: the only purpose of private enterprise and corporations is to make as much money as possible for shareholders. In the last few decades academics created “free market” curricula, and business schools reaped grants from corporations and from conservative and gullible liberal foundations.  Media joined in promoting the “animal spirits” of individual entrepreneurs, the glorification of business leaders and the “wealth” of Wall Street raiders, hedge fund titans and private equity kings.  Money was seen as the only form of wealth”.
I believe this must be highlighted, as without this understanding we cannot provide any solution or an alternative. It is immoral and an affront to humanity to spend the tax payers money on this bail-out, without admitting what has caused the calamity to begin with. After Enron and WorldCom we were told never again, how wrong they were and how naive we were. For the last few years I have been arguing against economic/money-driven/fundamentalist/neo-liberal globalisation. As Albert Einstein has reminded us,“The world cannot get out of its current state of crisis with the same thinking that got it there in the first place”. Therefore, we must change from the ideas and values of the Chicago Boys, currently the dominant or the only philosophy used in the teaching of economics and MBA programmes the world over, to a sacred and spiritual teaching of economics, rooted in ethics, morality, spirituality and the common good.

The focus of economics should be on the benefit and the bounty that the economy produces, on how to let this bounty increase, and how to share the benefits justly among the people for the common good, removing the evils that hinder this process. Moreover, economic investigation should be accompanied by research into subjects such as anthropology, philosophy, politics and most importantly, theology, to give insight into our own mystery, as no economic theory or no economist can say who we are, where have we come from or where we are going to. Humankind must be respected as the centre of creation and not relegated by more short term economic interests.

‘Economic rationality’ in the shape of neo-liberal globalisation is socially and politically suicidal. Justice and democracy are sacrificed on the altar of a mythical market as forces outside society rather than creations of it. However, free markets do not exist in a vacuum. They require a set of impartiality in government, honesty, justice, and public spiritedness in business. The best safeguard against fraud, theft, and injustice in markets are the cardinal virtues of justice, temperance, fortitude, and prudence, and the theological virtues of faith, hope, and charity. 
If you have a moment have a look at the lecture I recently gave at Oxford: http://www.globalisationforthecommongood.info/wp-content/uploads/2008/06/june-2008-oxford-lecture.pdf  Moreover, if you wish to learn more about our project, or wish to contribute to the ongoing debate on Globalisation for the Common Good, please consider joining us at our 8th Annual International Conference, which will be held at Loyola University in Chicago:( http://www.gcgchicago2009.info/)

Kamran Mofid PhD (ECON)
Founder, Globalisation for the Common Good Initiative
Co-editor, Journal of Globalisation for the Common Good
Globalisation for the Common Good, Chicago 2009

Dr. Joseph Stiglitz, a Nobel Prize–winning economist, is a professor at Columbia University.  The following comments are excerpts from an article in Vanity Fair: “The Economy.”

Dr. Stiglitz agrees that dishonesty and greed are at the root of the current financial crisis and that John McCain’s past and present policy positions are the opposite of what we need to address the current crisis and prevent future economic disasters.

Here are some of Dr. Stiglitz’s comments from the Vanity Fair article:

The federal government needs to give a hand to states and localities—their tax revenues are plummeting, and without help they will face costly cutbacks in investment and in basic human services. The poor will suffer today, and growth will suffer tomorrow. The big advantage of a program to make up for the shortfall in the revenues of states and localities is that it would provide money in the amounts needed: if the economy recovers quickly, the shortfall will be small; if the downturn is long, as I fear will be the case, the shortfall will be large.

These measures are the opposite of what the administration—along with the Republican presidential nominee, John McCain—has been urging. It has always believed that tax cuts, especially for the rich, are the solution to the economy’s ills. In fact, the tax cuts in 2001 and 2003 set the stage for the current crisis. They did virtually nothing to stimulate the economy, and they left the burden of keeping the economy on life support to monetary policy alone. America’s problem today is not that households consume too little; on the contrary, with a savings rate barely above zero, it is clear we consume too much. But the administration hopes to encourage our spendthrift ways.

What has happened to the American economy was avoidable. It was not just that those who were entrusted to maintain the economy’s safety and soundness failed to do their job. There were also many who benefited handsomely by ensuring that what needed to be done did not get done. Now we face a choice: whether to let our response to the nation’s woes be shaped by those who got us here, or to seize the opportunity for fundamental reforms, striking a new balance between the market and government.

The new populist rhetoric of the right—persuading taxpayers that ordinary people always know how to spend money better than the government does, and promising a new world without budget constraints, where every tax cut generates more revenue—hasn’t helped matters. Special interests took advantage of this seductive mixture of populism and free-market ideology. They also bent the rules to suit themselves. Corporations and the wealthy argued that lowering their tax rates would lead to more savings; they got the tax breaks, but America’s household savings rate not only didn’t rise, it dropped to levels not seen in 75 years. The Bush administration extolled the power of the free market, but it was more than willing to provide generous subsidies to farmers* and erect tariffs to protect steelmakers. Lately, as we have seen, it seems willing to write blank checks to bail out its friends on Wall Street. In each of these cases there are clear winners. And in each there are clear losers—including the country as a whole.  (*Note:  I assume from reading other work by Dr. Stiglitz that his reference to “farmers” he mean corporate farms not small, family-owned farms).

As America attempts to work its way out of the present crisis, the danger is that we will listen to the same people on Wall Street and in the economic establishment who got us into it. For them, our current predicament is another opportunity: if they can shape the government response appropriately, they stand to gain, or at least stand to lose less, and they may be willing to sacrifice the well-being of the economy for their own benefit—just as they did in the past.

Our tax policies need to be changed. There is something deeply peculiar about having rich individuals who make their money speculating on real estate or stocks paying lower taxes than middle-class Americans, whose income is derived from wages and salaries; something peculiar and indeed offensive about having those whose income is derived from inherited stocks paying lower taxes than those who put in a 50-hour workweek. Skewing the tax rates in the other direction would provide better incentives where they count and would more effectively stimulate the economy, with more revenues and lower deficits. 

We can have a financial system that is more stable—and even more dynamic—with stronger regulation. Self-regulation is an oxymoron. Financial markets produced loans and other products that were so complex and insidious that even their creators did not fully understand them; these products were so irresponsible that analysts called them “toxic.” Yet financial markets failed to create products that would enable ordinary households to face the risks they confront and stay in their homes. We need a financial-products safety commission and a financial-systems stability commission. And they can’t be run by Wall Street. The Federal Reserve Board shares too much of the mind-set of those it is supposed to regulate. It could and should have known that something was wrong. It had instruments at its disposal to let the air out of the bubble—or at least ensure that the bubble didn’t over-expand. But it chose to do nothing.

Throwing the poor out of their homes because they can’t pay their mortgages is not only tragic—it is pointless. All that happens is that the property deteriorates and the evicted people move somewhere else. The most coldhearted banker ought to understand the basic economics: banks lose money when they foreclose—the vacant homes typically sell for far less than they would if they were lived in and cared for. If banks won’t renegotiate, we should have an expedited special bankruptcy procedure, akin to what we do for corporations in Chapter 11, allowing people to keep their homes and re-structure their finances.

If this sounds too much like coddling the irresponsible, remember that there are two sides to every mortgage—the lender and the borrower. Both enter freely into the deal. One might say that both are, accordingly, equally responsible. But one side—the lender—is supposed to be financially sophisticated. In contrast, the borrowers in the subprime market consist mainly of people who are financially unsophisticated. For many, their home is their only asset, and when they lose it, they lose their life savings. Remember, too, that we already give big homeowner subsidies, through the tax system, to affluent families. With tax deductions, the government is paying in some states almost half of all mortgage interest and real-estate taxes. But many lower-income people, whose deductions are meaningless because their tax bill is too small, get no help. It makes much more sense to convert these tax deductions into cashable tax credits, so that the fraction of housing costs borne by the government for the poor and the rich is the same.

About these matters there should be no debate—but there will be. Already, those on Wall Street are arguing that we have to be careful not to “over-react.” Over-reaction, we are told, might stifle “innovation.” Well, some innovations ought to be stifled. Those toxic mortgages were certainly innovative. Other innovations were simply devices to circumvent regulations—regulations intended to prevent the kinds of problems from which our economy now suffers. Some of the innovations were designed to tart up the bottom line, moving liabilities off the balance sheet—charades designed to blur the information available to investors and regulators. They succeeded: the full extent of the exposure was not clear, and still isn’t. But there is a reason we need reliable accounting. Without good information it is hard to make good economic decisions. In short, some innovations come with very high price tags. Some can actually cause instability.

A unique combination of ideology, special-interest pressure, populist politics, bad economics, and sheer incompetence has brought us to our present condition.

Read Dr. Steiglitz’s full article at the link below: