Columbia University economist Joseph Stiglitz weighed in on the regulatory reform discussions in Congress this week. American Banker followed up with him for some additional comments. Here are his thoughts on the priorities of regulatory restructuring:
AB: You said during your testimony to the House Financial Services Committee on Tuesday that some reform has to happen now, before the markets can stabilize. What are the priorities for regulatory reform, as you see them?
Joseph Stiglitz: JS: Obviously a thorough reform of the financial regulatory system is going to take a while, but what I think has to be done at this juncture is a strong commitment to the process of beginning a reform. There are two reasons I think that´s important. I think a lot of people believe that Wall Street doesn´t want reform, that they´ve done very well by the old system, even now when you look at the terms of the bailout they´ve done very well, it´s sort of like a big gift to them. I think I a lot of people are worried that there aren´t going to be reforms. Secondly, just giving banks more money obviously is not going to solve the problem if they spend it in the same reckless way that they spent it in the past, and they haven´t´ changed incentives, they haven´t changed constraints on spending this money.
AB: What could Congress do before the end of the year to advance this process?
JS: This congress really needs to make a commitment that it will make significant reforms. Perhaps outlining to a select committee what kinds of things they ought to be fleshing out. One of the other people giving testimony also argued for the need for a select committee-in my mind it´s not a question of investigating the past so much as anticipating the problems of the future. You don´t tend to make the exactly same mistakes twice. Most economists recognize that the exiting structures of financial institutions had a built-in incentive for risk-taking, which must be altered.
AB: What can regulators do in the meantime?
JS: I think right now what they can do is recognizing that with all of this public money there´s more at risk, with many people, many financial institutions struggling to remain above water and with bad accounting structures as an incentive to behave badly-it´s like every embezzlement case when things get bad it´s when the worst behaviors occur-they can act as supervisors. In the past they didn´t use all of the roles that they had-that´s clear. I think people would feel a little bit better if they knew the bad processes have stopped, because regulators saw to that.
We need good monitoring of the lending so we know the banks that are getting the money [from the government] are using it to expand lending capacity. If buying the other banks functions to expand credit then that´s another story but if they´re buying a bank that´s a perfectly functioning bank, that´s not the correct use of the money. It´s sort of another version of trickle down economics that we give the money to the big banks and it will trickle down to the small banks.
AB: What will the long-term effects be of consolidation?
JS: The problem of bank consolidation is worrisome. We have only two courses: either we have much much more intensive supervision and circumscription of what they can do or we break them up. They are too big to fail-we´ve now said that-and so they have a license to gamble, so we can´t avow that. And some of them have behaved better than others but you can´t trust them structurally. We haven´t changed their incentive structures. We are actually making their incentive structures worse implicitly because we´ve announced that `you´re too big to fail and we´re letting you get bigger.´
It´s very hard in the middle of the crisis where you´re trying to rescue the banking system it´s very understandable that that´s the first priority. On the other hand it´s also true that we´re making problems for our future and I think you can almost-what we are doing is we are forcing ourselves into the direction of very, very tight regulation because we are creating these too big to fail institutions. It appears as if we´re choosing a particular path of very very tight regulation but I think there ought to be some congressional discussion: Is this what we want?
Another point is that Goldman Sachs and Morgan Stanley converted themselves into commercial banks. One doesn´t know all the details of that but the old principle was that commercial banks are to be conservatively managed because they are trusted with the basic payment system of the economy. The worry is that they converted themselves into a commercial bank to have greater access to the advantages of commercial banks, but does that mean they´re willing to take the restrictions of commercial banks? Is there any confidence that there´s been adequate ring-fencing of their more risky behaviors from their more conservative operations.
AB: What can come out of the November 15 G20 meeting the White House announced yesterday?
JS: What we can hope is a discussion-to begin a discussion. And that can happen. I think beginning a discussion can happen, maybe outlining some issues, setting ups some working groups, beginning the process that doesn´t happen overnight. The hopeful sign of this is that this will begin a process that will eventually lead to some changes.
