Day of Reckoning in the US Glasshouse

Linked with Share The World’s Resources STWR.

Published on Share The World’s Resources STWR, by Jospeh Stiglitz, January 22, 2008.

There is a growing consensus: America is going into a marked slowdown, if not a downright recession. There will be a large gap between potential growth – usually estimated at 3 per cent to 4 per cent – and actual growth, meaning lost output of hundreds of billions of dollars. America actually faces three separate but related problems; a credit crunch, a debt crisis and a macroeconomic problem. A decade ago, America roundly criticised the countries of East Asia for their lack of transparency and inadequate regulation. But, as the old aphorism goes, people in glass houses shouldn’t throw stones.

Money was lent to hundreds of thousands of Americans beyond their ability to pay. What was called financial innovation meant that borrowers didn’t even have to pay the accrued interest; at the end of the year, they owed more than at the beginning. Liar mortgages had been invented, requiring no evidence of income or ability to pay.


Borrowers were told not to worry about their mounting debt. With prices going up year after year, the more they borrowed, the more they made. What was true was the more they borrowed, the more the mortgage brokers and the banks made. It was, in a sense, an old-fashioned pyramid scheme: prices simply couldn’t go on rising, especially as the real income of most Americans was actually declining. Low interest rates fed the bubble, but that was not enough: the Chairman of the Fed actually encouraged people to take out variable rate mortgages (where payments would go up as interest rates increased), just when interest rates were at an all-time low. They had only one way to go, and that was up.

Then these toxic mortgages were sliced and diced, bundled and rebundled, in complex securities. The bankers seemed, for a moment at least, to believe in financial alchemy. Take a bad mortgage, blend it with an A-rated security and the mix got an A rating from the credit agency … (full text).

(Joseph Stiglitz is University Professor at Columbia University. He was chairman of the US Council of Economic Advisers and Cabinet member in the Clinton Administration. A former chief economist of the World Bank, 1997-2000, he won the Nobel Prize for Economics for his work in information asymmetries and is author of three global bestsellers; Globalization and its Discontents, Making Globalization Work and The Roaring Nineties. His latest, with Linda Bilmes, of Harvard, is on the mounting costs of the Iraq war. It is published in late February, in commemoration of the fifth anniversary of the war, by Penguin/Allan Lane).

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