A review by inquiry_from_an_anti_library
Freefall: America, Free Markets, and the Sinking of the World Economy by Joseph E. Stiglitz

informative reflective fast-paced

4.0

Is This An Overview?

The financial industry is meant to manage risk, allocate capital, and mobilize savings, all while keeping transaction costs low.  But the financial crisis in 2007 showed that the financial industry failed their function.  They mismanaged risk, misallocated capital, and indebted people, all while imposing high transaction costs.  The crisis was made by the financial industry, something that was done to the financial industry and everyone. 

Financial markets focused on maximizing returns, no matter the risks involved for the borrower.  Mortgage companies generated many inappropriate mortgages, and gave them to people who did not understand their effects with the assumption that housing prices would keep rising.  The mortgages were repackaged into financial instruments by banks, which made the securities products more complex.  An attempt to reduce the risk, but in practice just shifted the risk.  The rating agencies did not check the risk of the securities, but still gave the securities approval as the rating agencies were paid when they provided favorable ratings.

The financial industry analysts deceived themselves and their clients about the worthiness of the products.  Having purchased many of the toxic assets themselves.  When the crisis occurred, banks did not know the value of their own assets, nor those of other institutions.  Therefore, could not lend.  The government bailed out the banks, but that did not stop the banks from blaming the government.  The Federal Reserve has historically been willing to bailout banks, which created moral hazard as the banks took greater risks with a high expectation of being bailed out again.  While banks were being bailed out, banks used the money to pay dividends and bonuses, while denying government assistance to the rest of society because it would have created moral hazard.  In effect, the government had rewarded the people responsible for the financial crisis rather than seek accountability. 

 

What Did The Financial Industry Do? 

Securitization process repackaged mortgages and bundled them.  The innovative financial products were designed to shift risk from banks, while generating fees.  They were designed to avoid accounting and regulatory restraints.

The financial sector used their profits to buy political influence, that gave them deregulation and bailouts.  Banks had actually successfully lobbied the government for deregulation.  Regulators got captured by those they were supposed to regulate.  Giving financial markets a lot of influence as to how they are regulated.  Giving subsidies to wealthy companies has become known as corporate welfare.  Even with the government assistance, banks blamed the government for the crisis anyway.

 

How Was The Crisis Handled And Resolved?

Rather than hold accountable the people who were responsible for the crisis to pay for the crisis, the government rewarded the banks for their efforts in ruining the economy.  It was thought inappropriate to have taxpayers who did not contribute to the housing boom, to pay for those who did.  Therefore, the lenders should have paid, because the lenders failed to do their job and assess risk.  The banks claimed that paying for the damages would have impeded the recovery.  Also, the people responsible for the crisis, were put in charge of the repair.  They applied the same ideas that got them into trouble.

The government gave banks money, to enable banks to lend the money out.  But the banks did not lend.  The money was used by banks to pay dividends and bonuses rather than restart lending.  As the banks knew that they might not survive, they just took the money for themselves.  The Federal Reserve even started paying banks interests on their reserves, thereby dampening lending further.

The government did not help the rest of society such as homeowners, unemployed, or alternative ways to stimulate the economy.  Banks claimed to not want to give homeowners bailouts because that would disincentive replaying loans, while at the same time were asking the government for money for themselves.  For an effective stimulus package, it should have been responsive and supported investments to increase jobs.

The government took over various bank assets.  But shifting toxic assets to the government, does not get rid of the toxic assets.  The mortgages were restructured, which stretched payments for which they got more fees.  But this just delayed the consequences. 

 

Caveats?

Book provides an overview of what happened.  Many popular criticism are made about the financial system, and the arguments are consistent, but there seems to be information missing. 

The author notes various hypocritical contradictions within the claims being made by banks.  Consistent logic, but the claims are being referenced as the financial system rather than the individuals.  As in different people within the financial system can make different and opposing claims, but does not mean that the individuals are making the contradictions.

The proposed solutions would have had their own consequences, and needed to be developed further to be applicable. 

Uses popular assumption because they appear credible, such as claiming that financial services were free and unfettered markets.  Although there were products that did not have appropriate regulations, financial services had been one of the most regulated industries.