April 17 (Bloomberg) -- The Obama administration’s bank- rescue efforts will probably fail because the programs have been designed to help Wall Street rather than create a viable financial system, Nobel Prize-winning economist Joseph Stiglitz said.
“All the ingredients they have so far are weak, and there are several missing ingredients,” Stiglitz said in an interview yesterday. The people who designed the plans are “either in the pocket of the banks or they’re incompetent.”
The Troubled Asset Relief Program, or TARP, isn’t large enough to recapitalize the banking system, and the administration hasn’t been direct in addressing that shortfall, he said. Stiglitz said there are conflicts of interest at the White House because some of Obama’s advisers have close ties to Wall Street.
“We don’t have enough money, they don’t want to go back to Congress, and they don’t want to do it in an open way and they don’t want to get control” of the banks, a set of constraints that will guarantee failure, Stiglitz said.
The return to taxpayers from the TARP is as low as 25 cents on the dollar, he said. “The bank restructuring has been an absolute mess.”
Rather than continually buying small stakes in banks, the government should put weaker banks through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said.
Nobel Prize
Stiglitz, 66, won the Nobel in 2001 for showing that markets are inefficient when all parties in a transaction don’t have equal access to critical information, which is most of the time. His work is cited in more economic papers than that of any of his peers, according to a February ranking by Research Papers in Economics, an international database.
Financial shares have rallied in the past month as Goldman Sachs Group Inc., JPMorgan Chase & Co., Citigroup Inc. all reported better-than-expected earnings in the first quarter. The Standard & Poor’s 500 Financials Index has soared 91 percent from its low of 78.45 on March 6.
The Public-Private Investment Program, PPIP, designed to buy bad assets from banks, “is a really bad program,” Stiglitz said. It won’t accomplish the administration’s goal of establishing a price for illiquid assets clogging banks’ balance sheets, and instead will enrich investors while sticking taxpayers with huge losses, he said.
Bailing Out Investors
“You’re really bailing out the shareholders and the bondholders,” he said. “Some of the people likely to be involved in this, like Pimco, are big bondholders,” he said, referring to Pacific Investment Management Co., a bond investment firm in Newport Beach, California.
Stiglitz said taxpayer losses are likely to be much larger than bank profits from the PPIP program even though Federal Deposit Insurance Corp. Chairman Sheila Bair has said the agency expects no losses.
“The statement from Sheila Bair that there’s no risk is absurd,” he said, because losses from the PPIP will be borne by the FDIC, which is funded by member banks.
Andrew Gray, an FDIC spokesman, said Bair never said there would be no risk, only that the agency had “zero expected cost” from the program.
Redistribution
“We’re going to be asking all the banks, including presumably some healthy banks, to pay for the losses of the bad banks,” Stiglitz said. “It’s a real redistribution and a tax on all American savers.”
Stiglitz was also concerned about the links between White House advisers and Wall Street. Hedge fund D.E. Shaw & Co. paid National Economic Council Director Lawrence Summers, a managing director of the firm, more than $5 million in salary and other compensation in the 16 months before he joined the administration. Treasury Secretary Timothy Geithner was president of the New York Federal Reserve Bank.
“America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street,” he said. “Even if there is no quid pro quo, that is not the issue. The issue is the mindset.”
Stiglitz was head of the White House’s Council of Economic Advisers under President Bill Clinton before serving from 1997 to 2000 as chief economist at the World Bank. He resigned from that post in 2000 after repeatedly clashing with the White House over economic policies it supported at the International Monetary Fund. He is now a professor at Columbia University.
Critical of Stimulus
Stiglitz was also critical of Obama’s other economic rescue programs.
He called the $787 billion stimulus program necessary but “flawed” because too much spending comes after 2009, and because it devotes too much of the money to tax cuts “which aren’t likely to work very effectively.”
“It’s really a peculiar policy, I think,” he said.
The $75 billion mortgage relief program, meanwhile, doesn’t do enough to help Americans who can’t afford to make their monthly payments, he said. It doesn’t reduce principal, doesn’t make changes in bankruptcy law that would help people work out debts, and doesn’t change the incentive to simply stop making payments once a mortgage is greater than the value of a house.
Stiglitz said the Fed, while it’s done almost all it can to bring the country back from the worst recession since 1982, can’t revive the economy on its own.
Relying on low interest rates to help put a floor under housing prices is a variation on the policies that created the housing bubble in the first place, Stiglitz said.
Recreating Bubble
“This is a strategy trying to recreate that bubble,” he said. “That’s not likely to provide a long-run solution. It’s a solution that says let’s kick the can down the road a little bit.”
While the strategy might put a floor under housing prices, it won’t do anything to speed the recovery, he said. “It’s a recipe for Japanese-style malaise.”
Even with rates low, banks may not lend because they remain wary of market or borrower risk, and in the current environment “there’s still a lot of risk.” That’s why even with all of the programs the Fed and the administration have opened, lending is still very limited, Stiglitz said.
“They haven’t thought enough about the determinants of the flow of credit and lending.”
To contact the reporter on this story: Michael McKee in New York at mmckee@bloomberg.net; Matthew Benjamin in Washington at Mbenjamin2@bloomberg.net
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