A Nobel Laureate Takes on Financial Reform

This Wednesday, the United Nations Conference on the World Financial and Economic Crisis and Its Impact on Development" opens in New York City. We have been following the run up to the conference and Joe Stiglitz, the Nobel Laureate in Economics, has written a very interesting working paper on a new global financial architecture for the post-crisis world.

The Obama Administration's empty box of a plan for regulatory reform contrasts sharply with a number of good ideas presented in the Stiglitz paper. I took a graduate seminar from Professor Stiglitz when he visited Johns Hopkins from Yale. Although he takes on a whole host of issues in the working paper, he raises lots of good points and has a number of sharp observations.

For starters, Stiglitz points out financial markets are not an "end in themselves but a means---they enable the economy to be more productive." If this is true, which I believe it is, then the financial sector cannot and should not be the foundation for employment and income for the United States. As such, it follows that our financial sector, post crisis, should be smaller than it is now.

He points out the toxic combination of rolling back Glass-Stegall and the adoption of Basle II, based on a system of self-regulation that Stiglitz rightly calls "an oxymoron." Other market observers like Professor John Coffee of Columbia Law School have pointed out the folly and the unfortuitous timing of both these regulatory changes in their writings.

Many hundreds of puff pieces were written about the need to preserve the United States' lead in "financial innovation." However, as Stiglitz points out financial innovation meant nothing more than confusing, opaque products that created rather than managed risks and did little other than generate huge fees to investment banks, law firms, and rating agencies. Also, if financial markets are servants of the economic system rather than its master, financial innovation is not equivalent to fundamental scientific innovation, which has positive social externalities. He expresses his frustration and a blind wish when he writes, "Wall Street has polluted our economy with toxic mortgages. It should now pay for the clean up." Nice idea, but unlikely to happen for many reasons.

We will be following the progress of the conference through some of our old friends in the international community, and we hope that some useful principles will be adopted by the international group, although we're not optimistic because of the traditional split between the political interests of the developed countries and what was called the G-77.