Joseph Stiglitz emphasises that there is a battle of ideas at the heart of the financial crisis. In the 75 years since the Depression, people had forgotten the lessons they should have learnt, and came to believe that markets were always self-correcting. This simply isn’t the case – all too often, the beloved “invisible hand” wasn’t actually there. The reason that the financial markets failed is because they were designed to encourage bad, short-sighted behaviour. With big incentives to undertake excessive risk, the 2008 economic collapse was an entirely logical result. Of course, market economics should provide good incentives, but they didn’t because of a combination of poor corporate governance, inadequate regulation, and politics.
The US response to the crisis – Barack Obama’s stimulus plan – was badly designed and too small. With unemployment up to 10%, and a quarter of American homeowners in negative equity, America was still suffering. Stiglitz predicts that there will be a massive wave of 2.5-3 million foreclosures in 2010. This will have serious social consequences. In 2009, 140 US banks had shut down, but these were the small ones which were lending to businesses and serving a beneficial social purpose. All this had happened while bailout money was poured into the casino banks, and the end result was a less competitive industry.
Whereas before the collapse American consumers were living beyond their means, now they were saving and not spending. With this happening around the world, there was reduced aggregate demand. Consequently, Stiglitz feels that the crisis may well be prolonged.