Gustavo Ballvé on January 4th, 2010
Food for thought, Home, Mental models, Portfolio Management, Risk management

Prof. Joe Stiglitz has been on a tear recently. He wrote a Dec. 31st ’09 article on China Daily about the 5 lessons we should learn from the crisis and two days later presented a tough message at the American Economic Association’s annual meeting (here’s the Bloomberg link in case you don’t subscribe to the Wall Street Journal). The bulk of the message: Wall Street ain’t that smart, and it failed miserably to perform on its purpose, which is to “manage risk and allocate capital at low transactional costs”. And before the reader thinks “well academe didn’t do much better”, he also blames economists for continuing to rely on “rational player” models.

The issue here is not exactly what he said, since the reports that came in so far are rather sketchy and we haven’t yet gotten our hands on his presentation slides, speech transcript and so on. So based on the snippets that did come out, it’s easy to criticize and a cynical blog writer even argued that perhaps Wall Street was acting rationally because…

“(…) who says the purpose of the financial system is ‘to manage risk and allocate capital at low transaction costs’?  Surely that is not the lesson of the last 10-12 years, where allocating capital in magnificently stupid ways has lead to great reward – or at least the lack of any real negative consequence — for those involved.  Creating large amounts of risk leads to a ‘too big to fail’ institution… and then there is nothing greater, since you will be ensured limitless life support. In short –  he is right, but he is wrong.”

And still others will remember that Mr. Stiglitz co-authored a paper in 2002 basically stating that the risk of Fannie Mae or Freddie Mac defaulting was zero. But the point is that he’s trying to focus on the lessons that we should already have learned – because now we have another “golden opportunity”. We’re skeptical because one has to take incentives into consideration, and this seems to always get lost in translation.

Mr. Stiglitz has a book coming out in January, so until then we’ll have to make do with the links to a few of his latest articles below. He’s definitely in a somber mood.

LINKS:

Wall Street’s toxic message – Vanity Fair, July ’09 – Can the crisis in the US financial system lead other nations to follow other models, thus potentially creating threats to global stability?

Capitalist fools – VF, January ’09 – The title is a great summary.

The US$ 10 trillion hangover – Harper’s Magazine, January ’09 – “Paying the price for eight years of Bush”

James Surowiecki (author of “The Wisdom of Crowds“) interviews Joe Stiglitz for the New Yorker, Sept. 28th ’09:

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