Columnists - Joseph Stiglitz;Paulson putting banks first

Joseph Stiglitz



Unlike the U.K. plan, the revamped American bail-out puts banks first and taxpayers second.

The U.K. Prime Minister, Gordon Brown, has won plaudits over recent days for inspiring the turnaround in Hank Paulson’s thinking that saw him progress from his “cash for trash” plan — derided by almost every economist, and many respected financiers — to a capital injection approach. The international pressure brought to bear on America may indeed have contributed to Paulson’s volte-face. But Paulson figured he could reshape the U.K. approach in a way that was even better for America’s banks than his original cash strategy. The fact that U.S. taxpayers might get trashed in the process is simply part of the collateral damage that has been a hallmark of the Bush administration.

Will this bail-out be enough? We don’t know. The banks have engaged in such non-transparency that not even they really know the shape they are in. Every day there are more foreclosures — Paulson’s plan did little about that. That means new holes in the balance sheets are being opened up as old holes get filled. There is a consensus that our economic downturn will get worse, much worse; and in every economic downturn, bankruptcies go up. So even if the banks had exercised prudent lending — and we know that many didn’t — they would be faced with more losses.

Britain showed at least that it still believed in some sort of system of accountability: heads of banks resigned. Nothing like this in the U.S. Britain understood that it made no sense to pour money into banks and have them pour out money to shareholders. The U.S. only restricted the banks from increasing their dividends. The Treasury has sought to create a picture for the public of toughness, yet behind the scenes it is busy reassuring the banks not to worry, that it’s all part of a show to keep voters and Congress placated. What is clear is that we will not have voting shares. Wall Street will have our money, but we will not have a full say in what should be done with it. A glance at the banks’ recent track record of managing risk gives taxpayers every reason to be concerned.

For all the show of toughness, the details suggest the U.S. taxpayer got a raw deal. There is no comparison with the terms that Warren Buffett secured when he provided capital to Goldman Sachs. Buffett got a warrant — the right to buy in the future at a price that was even below the depressed price at the time. Paulson got for the U.S. a warrant to buy in the future — at whatever the prevailing price at the time. The whole point of the warrant is so we participate in some of the upside, as the economy recovers from the crisis, and as the financial system starts to work.

The Paulson plan responded to Congress’s demand to have something like a warrant, but as a matter of form, not substance. Buffett got warrants equal to 100 per cent of the value of what he put in. America’s taxpayers got just 15 per cent. Moreover, as George Soros has pointed out, in a few years time, when the economy is recovered, the banks shouldn’t need to turn to the government for capital. The government should have issued convertible shares that gave the right to the government to automatically share in the gain in share price.

Whether we were cheated or not, the banks now have our money. The next Congress will have two major tasks ahead. The first is to make sure that if the taxpayer loses on the deal, financial markets pay. The second is designing new regulations and a new regulatory system. Many in Wall Street have said that this should be postponed to a later date. We have a leaky boat, some argue, we need to fix that first. True, but we also know that there are really problems in the steering mechanism (and the captains who steer it) — if we don’t fix those, we will crash on some other rocks before getting into port. Why should anyone have confidence in a banking system which has failed so badly, when nothing is being done to affect incentives? Many of those who urge postponing dealing with the reform of regulations really hope that, once the crisis is passed, business will return to usual, and nothing will be done. That’s what happened after the last global financial crisis.

There is a hope: the last financial crisis happened in distant regions of the world. Then it was the taxpayers in Thailand, Korea and Indonesia who had to pick up the tab for the financial markets’ bad lending; this time it is taxpayers in the U.S. and Europe. They are angry, and well they should be. Hopefully, our democracies are strong enough to overcome the power of money and special interests, and we will prove able to build the new regulatory system that the world needs if we are to have a prosperous and stable global economy in the 21st century.

(NOTE: Joseph E. Stiglitz is university professor at Columbia University and recipient of the Nobel memorial prize in economic science in 2001. He was chief economist at the World Bank at the time of the last global financial crisis.)
— © Guardian Newspapers Limited, 2008