The Finance Industry and Its Impact on the U.S. Economy after the Great Recession

In conversation with Peter R. Fisher, Senior Fellow and Senior Lecturer at Tuck Business School, Dartmouth College, Rana A. Foroohaar, Managing Editor of Time Magazine, John P. Lipsky, Senior Fellow at Foreign Policy Institute, John Hopkins School of Advanced International Studies, and Joseph E. Stiglitz, Professor at Columbia Business School, discuss the effects of the finance industry’s continued growth and assess whether it is helpful or hurtful to the U.S. economy overall. They consider how finance’s growth impacts business development, its effects on income inequality, and whether the financial regulations implemented after the Great Recession have been effective. The panel further reflects on the best ways to regulate and manage risk in the financial industry going forward. 

FISHER: Good morning. I’m Peter Fisher. I teach at the Tuck School of Business at Dartmouth. And when I was invited this morning to preside over this panel, what came to mind was the boyhood experience when my father was on sabbatical in London, and my parents took my brother and I to see the American comedian Danny Kaye conduct the London Philharmonic Orchestra. (Laughter.) It was a one-gag evening, which is, the London Philharmonic is so good, it doesn’t need a conductor. (Laughter.) Now, given who I have up with me on the stage, I feel like Danny Kaye. (Laughter.) But I hope I’ll be as good as he was at getting out of the way.

So, without further ado, you have everyone’s biographies in your book. But, briefly put, we have here Rana Foroohar, the assistant managing editor of Time Magazine and the author of the new book, “Maker and Takers: The Rise of the Finance and the Fall of American Business”; John Lipsky, former first deputy managing director of the—something called the International Monetary Fund—(laughter)—and a senior fellow at the John(s) Hopkins School of Advanced International Studies; and we have Joseph Stiglitz, a university professor at Columbia Business School.

And we’re here to discuss “Is U.S. Finance Hurting Growth?” And I’m going to pose the same question to each of you in sequence—I think Rana, Joe, John. Do we have too much or too little finance? Is it hurting us or helping us? And over what horizon are you thinking about?

Rana?

FOROOHAR: OK, I’ll kick it off.

Well, first of all, let me say thank you for having me here. I’m incredibly honored to be on a stage with all of you. I am a humble journalist and not a trained economist. But I’ve been a business and economic journalist for 23 years, and so my perspective in my book is really built off of that observation and talking to very smart people like the ones on stage about what’s going on in the global economy.

So I began working on my book about three years ago in the wake of the financial crisis because I was trying to understand why there was still such an incredible divide between Wall Street and Main Street, and in particular where the markets were, and where the real economy was, and what was that divide about. I was going and, you know, talking to companies and seeing individuals in various parts of the country, and they just simply were not feeling the recovery in the same way that the markets were perceiving them.

So I began digging into it—the research, essentially, on finance and growth. And what I came to find was that I think the nature of the financial system in the U.S. has changed profoundly over the last 40 years. I actually do in my book a kind of a hundred-year overview, because I wanted to compare the run-up to the Great Depression with the period in the run-up to the subprime crisis.

But I would say that the period of what I call “financialization,” the modern period, started about 40 years ago. And during that time, the size of the financial sector as a percentage of the economy has almost quadrupled. So it’s gone from 2 ½ (percent), 3 percent, to close to 8 percent. But during that time, trend growth, of course, has not grown. And there have been a number of metrics about number of startups falling, entrepreneurial zeal going down by a variety of measures, R&D spending going down relative to, say, share buybacks in companies, that show that business has actually suffered as finance has gotten bigger. And there’s a lot of studies—it’s all cited in the books, so—and there’s smart people who’ve done some of these studies on the—on the stage here, so I won’t go into them. But basically, by a lot of metrics, the size of finance in the U.S. has started to slow growth. And, in fact, there’s some studies, BIS studies and others, that show that that happens actually when finance is just half the size that it is in the U.S. right now.

But then the other thing that I would mention—and I was very interested as I began to speak to different academics about this—is the nature of change in what the financial sector does. So, if you go back to kind of, you know, the original nature of what the capital markets were supposed to do to business, they’re supposed to take everybody’s savings, you put it in financial institutions, the financial institutions lend that money out to business, business grows and creates jobs. Actually, there are some deep academic studies that show about only 15 percent of all the financial flows in the U.S. financial institutions right now are going to business lending. The rest of it is basically trading against existing assets—stocks, bonds, houses, the real estate market being a large part of that, of course. And then so I try and get into the ramifications of this for business in a variety of chapters in my book.

And I’ll just leave one last stat before I pass the baton here. One of the fascinating things that I found—and I explored this through stories of a number of companies—is that business itself has come to emulate finance. So, if you look at the amount of revenue that businesses across all industries are getting now from financial services, from financial tactics like tax optimization, that’s increased fivefold since the 1980s. So it’s almost as though we’ve all become bankers. And finance has become, in my view, the tail that wags the dog for industry, rather than the other way around.

So I’ll stop there.

FISHER: Thank you.

Joe, too much, too little, or the wrong mix?

STIGLITZ: Well, first let me say Rana’s book is fantastic, so I’d encourage all of you—she can’t say that, but I can say that. (Laughter.) So it is really interesting.

The basic perspective that Rana put, that there’s been this enormous increase in the relative size of the financial sector to GDP without any evidence that this has led to any benefit to economic growth, there are actually two other aspects of this that I’d just mention briefly.

Looking across countries, one is that—a study that I did with Bill Easterly when I was chief economist of the World Bank, which showed that, if you look at instability, as you increase, there’s a—there’s a U-shaped curve. Some degree of finance is very important—diversifies risk, so it’s an important function. But if you look across countries, when it gets too big, there’s more instability. And, of course, instability is bad not only for growth, but for a whole other set of effects.

The second thing that—Jamie Galbraith has a nice book that describes, is there’s a systematic relationship between the degree of financialization and inequality. And for a whole variety of reasons, not a surprise.

The real question, though, is, when you start looking at the micro—not the macro, but look underneath—and you ask the question, what is the financial sector doing and, like Rana said, where are they making money? It turns out a very large fraction of their—of their revenues come not from the core activities that we model the financial sector—you know, that lending activity, that risk mitigation, those kinds of things that are core—but from all kinds of, you might say, antisocial activities—(laughter)—like LIBOR manipulation, forex manipulation. I don’t want—you know, hard to quantify. Some of, though, you—has been quantified. You ask questions like using market power over the medium of exchange, the rents they extract in interchange fees are very significant.

And that’s where the big—you know, there’s been a lot—an attempt to curb it a little bit in Dodd-Frank, but the Fed really missed it. And the Dodd-Frank only focuses on debit cards, not—didn’t do anything about credit cards.

Schiller and Akerlof had this very nice book called “Phishing for Phools,” where they use the word—“ph,” picking up on the internet—that a very large part of the revenue comes from trying to find people that they can take advantage of. And there are a lot of fools out there. And you might say, globalization opened up a global market for fools, and they were very good at finding them. You know, a little village in Norway or, you know.

So that contrast with another study that’s cited in Rana’s book, which is that the efficiency of the sector in providing the services that it does, you would have thought the cost would have gone down because it’s basically a tech sector, you know? It’s processing data. And our technology has been—you know, Moore’s Law has brought down that cost—doesn’t show up in the cost that they charge for those kinds of services. So that comes to the question that you posed, Peter, which is, the question isn’t just the size of the financial sector, that it’s doing too much of what it shouldn’t and not enough of what it should do.

And then this comes to the core regulatory issues that we’ve been debating since the financial crisis. Most of what the debate has been focused on is stopping the financial sector from imposing harms on the rest of the society. Very little of it has been addressed to the question, how do we actually make the financial sector do what we hope it’s supposed to do? And which is very important. So, you know, I’m very much in favor of the financial sector. I think the financial sector is really important. The real problem is it hasn’t been doing as much—you know, it’s been diverted from performing those core functions.

And just one closing remark is, you know, there’s a—you might—you may say almost a personal aspect of this, of how it adversely affects our growth. A disproportionately large fraction of our best students, you know, and my best students, wind up in finance, for good reason; it’s where the money is, and they’re reasonably rational. But one would have hoped that there would have been more diversification, more of them would have gone into other areas of inquiry—you know, public service, research, you know. So I think one of the reasons why it has not had the positive effect that you would have hoped, I mean, is that it has distorted the structure of our economies. And not only is the financial sector distorted, there’s a distortion in the whole structure of our—of our economy.

FISHER: Thank you, Joe.

John, too much, too little, what horizon?

LIPSKY: (Laughs.) Well, I’ve chosen to interpret this question a little more narrowly, but before that just say Joe is an old friend and absolutely brilliant, but he obviously doesn’t work in a financial institution. (Laughter.) So he hasn’t had to watch his margins shrink, he hasn’t had to watch the onslaught of new regulation, he hasn’t had to deal with the historically unprecedented monetary policy that has produced a very adverse environment for profitability, and he hasn’t had to worry about all the hotshot young grads heading off to Silicon Valley to join fintech firms that are—certain are going to cannibalizing the evil banks.

And it seems to me, when you’re thinking about this, the—two aspects of this conversation that need to be kept in mind. The last 40 years, or 60 years, since World War II, has seen a dramatic transformation of the global economy that has produced fantastic and unprecedented challenges. And this is an—I tend to, when I hear about this in the financial sector, I don’t think the most powerful forces have been created by the financial sector; I would say have been reflected in the financial sector. Of course, there’s a—this is simultaneous, there’s feedback. But I don’t think that the most powerful forces have come from the financial sector; quite the—quite the other way around.

And in that context, the notion that let’s think about national markets has becoming progressively less relevant. And yet, so much of the discussion has been around national markets, and so much of the response to the crisis has been by national regulators and authorities to try to ring fence their market, such that international markets have become less efficient and less effective over time.

So I’ve interpreted the question, the topic today, to ask, have we—post-crisis, we clearly faced a challenge on, one, restoring global growth; number two, improving financial-sector stability so we never saw another global financial crisis like we just had.

It’s quite remarkable, seven or eight years on from the onset of the crisis, depending on how you want to time it, this regulatory reform is still a work in progress. And some of the most powerful measures have yet to—yet to be enacted. Quite remarkable. Even Dodd-Frank, which has produced about 22,000 pages of legislation and regulation, is still incomplete. And the changes in regulation have forced very costly action on financial institutions that—and I would say, if there’s a criticism, not that there wasn’t—that change wasn’t necessary, but I would say that the—there has been insufficient attention given to the overall impact to a whole series of regulatory and legal measures that were taken in a little bit of a—and I don’t want to sound condescending, but a little bit of a whac-a-mole kind of a manner. Here was a problem, whack. Here’s another problem, whack. Is anybody standing back and saying, what are we doing to the system? I don’t think so.

Here are two little examples. Anti-money laundering, financing of terrorism: we’ve decided that bankers and financial institutions need to also be policemen. Now that’s all well and good—that’s all well and good, but a collateral damage has been of the effort in anti-money laundering to collapse correspondent banking relationships worldwide, and deprived some of the most—some of the poorest nations from access to modern banking. Did the folks designing this think about that? I don’t think so.

Second, when we talk about the wonderful profitability of the banking system, most of the large banks in the U.S. and in Europe trade today below book value. That’s hardly a recipe for producing—for supporting growth, and supporting growth over time. So I would say, have the—if the question is, have the reforms so far hindered growth, which have—has the U.S. financial system hindered growth, I would say, yes, this is true. At the same—relative to what it might have been. Have it—has these changes, at the same time, enhanced stability? I would say, yes, they have. But do we have the tradeoff right? I’m not at all convinced.

I’ll stop there.

FISHER: Let me pick on an early point John made, and press Rana and Joe. Let’s put aside front-running customers and abusing. Yes, that happens. But is it causation, or is it correlation, or is it a secondary effect? We have 40 years of falling interest rates. We squeeze—and the central banks of the world squeezed inflation out of the system from 1982 to 2002. We’re surprised that the value of holding financial assets, it’s a lucrative thing to be in the business of holding these things, asset-based finance. And so we watched the financial sector grow in size while you bring down the discount rate on all those future cash flows. Does that mean it caused the decline in growth? Robert Gordon is pretty gloomy, but I don’t recall—and I read every page of his book—him putting a lot of weight on the financial sector as dragging down productivity. He’s got plenty of other causes he’s pointing to. So I see correlation, and I may see secondary effect, but to say the financial sector got up in the morning and did it, putting aside abusive client, is a little harder for me, even though I sort of see what you’re driving at. Let me press you both on that.

FOROOHAR: Well, so, it’s a really good point. And I would just say, and I mentioned this in my book, that financialization, globalization, and technological job destruction are definitely moving in tandem, and in some ways create snowball cycles with each other. I mean, you know, one of the things I explore is how in corporations, the CFO’s office—I look at this topic culturally as well, just to preface—the CFO’s office, and the sort of way in which corporate management has become very balance-sheet oriented, leads to certain decisions around outsourcing, for example, that a lot of companies are starting to reconsider now. You know, there is—there is a tremendous movement to reshore and rethink the typical Finance 101 teaching of, you know, marshal your capital, you know, cut costs, worry about talent, worry about everything else later. I think that there’s a big shift. And actually I think that that’s for the reason that you’re talking about.

The traditional business school teaching for executives, which is very financially oriented, is actually very out of date for the challenges of the day, in part because we are awash in a world of capital. There’s plenty of money sloshing around. And so making decisions based on that, which is a very financialized way to make corporate decisions, actually doesn’t work as well. And I have some great anecdotes from different corporate leaders in my book about that.

So I think causality is difficult to prove. I’m also struck, though, and I’m remembering Rajan’s comment in his book. The central banker of India used to teach at University of Chicago that “let them eat credit” could be sort of the mantra for the last 40 years.

And this goes along with exactly what you’re saying. Low interest rates, in some ways, policies taken across different administrations, both Republican and Democratic, that mask underlying growth problems with easy money and easy credit, and I see this as part of the process of financialization.

STIGLITZ: So, you know, obviously it’s always difficult to separate causation correlation, particularly there are many factors. So no one will say it is the factor that has caused the slowdown in economic growth; it is one of the factors.

But as one thinks about it, there are several channels by which it has, both by what it’s done and what it’s not done, so let me talk about it.

One of them is I think it’s unambiguous that it has contributed, not only in the United States, but in other countries, to more instability. That most people would say that it did play a role in the buildup in the bubble that led to the crisis.

Now, you could say it was low interest rates. But the financial sector was supposed to manage risk, you know, it was not supposed to be engaged in massive fraud. It was supposed to—you know, securitization was about risk diversification well-managed, OK? It didn’t happen.

And so if you read, like, the report of the Financial Inquiry Commission, very clear that it was some of the things that the financial sector did and didn’t do that played a very big role in the crisis of 2008. And there’s no doubt that crises are bad for economic growth. They have long-term effects. We still are not really recovered from the effects of the crisis. So that’s one example.

A second one is a broader—let me say really the same thing that Rana did, in a slightly different language. What do CEOs focus on? What do corporations focus on? Making a better product or manipulating taxes and deciding where to locate based on tax advantages? You know, that kind of financial management versus innovation, real sector management.

And there’s a, you know, a well-developed theory about managerial attention being limited, and when you focus on one thing you’re not focusing on another.

So the financialization of the economy more broadly I think has diverted the attention of corporate America away from some of the real things that would have increased productivity.

And finally, it goes back, you know, again, to pick up the word that Rana said. If you look at what we model the financial sector as doing, which is taking money from savers, intermediating, and providing it to firms that are going to lead to more economic growth, that’s not what’s been going on in the country.

In fact, there are these studies that show that, on average, money is flowing out of the corporate sector. So its traditional role that we describe in the textbook of intermediating between savers and investors isn’t there.

One strong way of looking at this from a global point of view—you know, we’re at the Council on Foreign Relations, so think about it from a global point of view—is Ben Bernanke remember said that we had a savings glut. And when he said it, you know, from a perch of somebody who does a lot of work in development and a lot of concern about climate change, my reaction was he was living on a different planet than I was, that I looked around the world and I said we need so much money for retrofitting the global economy, for climate change, so much money for infrastructure. Even New York City we know has some problems.

And so you look, say, look, we have a shortage of finance. So you ask the question, how do you reconcile his view with the view, you know, you open your eyes, you say we aren’t financing the investment we need.

And the answer is, between those two is supposed to be a financial sector, and particularly a lot of the savings is long term, pension funds, sovereign wealth funds who are long-term horizon. The investment needs are long-term needs, long-term infrastructure.

But sitting between the two is a financial sector, that is often looking at quarterly, daily, nanosecond, can’t serve that need of intermediating between long-term savers and long-term investors.

So my view has been, you know, that there’s a real dysfunction here in its ability to do what it’s supposed to do from a global perspective.

FISHER: Well, let me push back and then see if John wants to pick up the mantle just for the fun of it. (Laughter.)

Ben Bernanke’s savings glut struck me as the wrong side of the coin.

STIGLITZ: Yeah.

FISHER: We had a glut of consumption and excessive income here, which is how China ended up with a savings glut, and they financed our glut of consumption and excessive income.

It started here. And that was from the accommodative monetary policy, stimulating the interest rate-sensitive sectors of the economy, housing and autos. And when housing and autos collapsed, oh, dear, it wasn’t the fault of monetary policy, it was the fault of something called financial stability in the financial sector and washing its hands of it and saying, what, me, worry, I didn’t do that when, of course, accommodative policy in 2003, ’(0)4 and ’(0)5 did that.

But I want, John—you can jump in after John and then we’ll open it up.

LIPSKY: OK, OK. Look, let’s look at this in a number of ways. If we’re talking post crisis, post crisis there has been a dramatic decline in leverage in the financial sector. Right? In fact, in the U.S. it’s about by half and in Europe nearly by half.

So again, if we come back, have the changes, the latest changes in the economic sector, the financial sector tended to retard credit availability and growth? I would say yes, yeah. It seems pretty clear.

And again, I come back to saying that doesn’t necessarily mean it’s bad, but there certainly has been a tradeoff between stability, enhancing stability, and growth.

The idea about that there hasn’t been—that everybody’s been busy trading and no one’s been paying any attention to the real economy, geez, Joe, you used to be at Stanford. You probably haven’t been out there recently.

STIGLITZ: No, I have. (Laughs.)

LIPSKY: Oh, OK. Well, you go up on Sand Hill Road and you’ll see it’s crawling—

STIGLITZ: Small percentage.

FOROOHAR: Tiny.

STIGLITZ: Small percentage of the financial sector.

LIPSKY: There we go. But it’s—yeah.

STIGLITZ: It’s important.

LIPSKY: Thank you. Thank you.

STIGLITZ: Exactly. But I would like to see a lot more Sand Hills.

LIPSKY: Very good, very good. (Laughter.)

And let’s think about, what does the sector really look like, the financial sector in the U.S.? The U.S. bond market is about $40 trillion outstanding. Equity market’s about 25 trillion (dollars) outstanding. The U.S. investment managers of that control about 45 trillion (dollars), and the banking sector about 18 trillion (dollars). So it’s actually relatively small.

So when we think about what are we talking about in terms of who’s doing what, it seems to me a lot of the discussion focuses on aspects or should say global hedge funds. Globally hedge funds control about 2 ½ trillion (dollars), relatively small, small amount.

So it seems to me a lot of the attention gets focused not on the bread-and-butter and meat-and-potatoes.

So what we’ve been lacking in this economy has been not consumption demand, but investment, right? And right now, the market, not only does the market send a signal to banks to say you are not currently investable, your price-to-book is below 1, so why would I give my money to a bank so they can reduce value-added?

And at the same time, it strikes me when you look at the equity market more broadly, which has nothing to do with the banking system directly, you can see that corporate management is being incentivized to conduct share buybacks because that’s what seems to get valued in the market.

So it seems to me to say so this is a problem that is caused by the financial sector. I’m certainly not trying to say there is no problem that the sector can’t be improved, but I doubt if that is the primary locus of the problems of this economy.

FOROOHAR: Can I just follow up on a couple of point?

FISHER: Yes.

FOROOHAR: I’ve also been really interested in this idea that the largest banks are trading at relatively low valuations.

You know, to me, in some ways, the markets are actually giving a signal about the structure of banking, because if you look at what banking analyst reports say, they would work better and be, you know, more highly valued if they were broken up.

Now, this is not a Bernie Sanders, you know, break up the big banks, it’s a silver bullet for getting rid of risk. We all know that that’s not a silver bullet. And in fact, Joe did an amazing report for the Roosevelt Institute on how there is no silver bullet because this is a 40-year process that’s been tiny, little, incremental changes, each of which require looking at.

But I would also say that in my book and as I think of finance, I’m looking not just at the formal banking sector, but at shadow banking, at all the ways in which risk is moving into places that are even more opaque.

I mean, I totally agree with you. Definitely Dodd-Frank has reduced risk and leverage ratios in the formal banking sector, but risk has gone to many other places.

And what’s really interesting to me is that the corporate sector, I mean, the corporate bond market, the corporate junk bond market has become a place where risk now lies. And big tech companies are underwriting corporate bond offerings the way Goldman Sachs, you know, would, but they’re not regulated in the same way.

So the entire—it is a larger ecosystem. And I do agree with you on the thing that we spend way too much time, I think, in a really siloed conversation about, you know, how much tier-one capital JPMorgan should be holding. We should be looking at a much bigger ecosystem of finance and let’s study where is the risk and what should the system be doing, per Joe’s point.

LIPSKY: Sure.

FISHER: Joe gets the last word before I open it up to questions.

LIPSKY: OK. (Laughs.)

FISHER: I want to get one little bit. I know, you’ll get quite a few. (Laughs.)

STIGLITZ: So one way of thinking about it, you know, go back sort of to textbooks economics. If you lower the cost of capital, you know, monetary policy, the standard economics would be that lower cost of capital, that money goes into more investment that stimulates economic growth.

But between what the Fed does and Main Street is the financial sector. And I’ll use the financial sector in a very broad term, like Rana, not just the banks, but a whole industry, OK, out there and some of it even in the corporate sector when they engage. GE Capital was as much part of the financial sector as any other. So I don’t want to—it needs to be interpreted in a very broad way.

So you would have thought if we had a well-functioning economy and a well-functioning financial sector, the low cost of capital would have stimulated a lot of investment and that would be a period of high economic growth.

There was nothing that said that that low cost of capital would be translated into lots of consumption, you know, a housing bubble. But that’s really where the debate, in some sense, is.

The central role of the financial sector is—two of the central functions are allocating capital to create a productive economy, and managing risk. And I’d say it failed on both. It allocated capital not to this productive use that is part of the textbook, you go down to your investment banker and you have a lot of investment, but to consumption and to existing assets creating asset bubbles.

And that was not the attention in the Fed. I don’t think—you know, I agree with you, very critical of the Fed of its understanding that the translation of credit into productive activities, that chain is a very weak chain and it could actually go the other way. And I think they still haven’t fully appreciated that.

A second aspect of this that you often see, you know, low interest rates, people say that causes more volatility because there’s this reach for yield and people put their money into more risky assets.

In a standard, rational model that underlies most of macroeconomics, that doesn’t happen. You know, just because the interest rate is lowered doesn’t mean you act in a more reckless way. In fact, it should go the other way.

So the bottom line is that our models of behavior are wrong. I agree with you, macroeconomic policy is wrong. But the financial sector has not guided either the allocation of capital or the management of risk in ways that you would have hoped it would have done to promote economic growth.

So that period of low interest rates should have been a period of enormous economic growth and stability, but it wasn’t.

FISHER: All right. I’m going to let the audience get in on the action now, our members.

I was remiss in not saying this is an on-the-record session, but our guests all knew that in advance.

FOROOHAR: Everything is on the record.

FISHER: So now you know this was an on-the-record session. And let me ask you to identify yourself. We have microphones roaming around. Identify yourself, pose your question quickly, and then we’ll try to have a dialogue.

So here, right there, sir.

Q: Thank you very much. Mahesh Kotecha.

My question is regarding, you know, the problem that John raised, which is, are we looking at the bread-and-butter as it were, the shadow banking system versus the real banking system? The banking system relative to the shadow banking system is actually not what it used to be. It is, as you pointed out, it’s smaller. So the regulation typically goes to the regulated side, missing the boat. What do you do about that? And are we successful in getting to the unregulated sector which seems to be the tail that wags the dog?

LIPSKY: That was just the point I was going to make. (Laughter.) So you were—

FISHER: I was right.

LIPSKY: You predicted accurately.

Absolutely, the source of the problem, which also reflected incentives, including government incentives, including a housing sector that is probably the most distorted of any large economy in the world, and the response to the crisis has been to pile more incentive into the housing sector, that the source was not the regulated banking system, but the, let’s call it, shadow banking and nonregulated or more lightly regulated sector.

Back at the IMF, we had five conclusions of what needed to be done with regard to fixing the system. One was more capital, but two was to improve regulations. And the primary problem that we saw with the regulatory environment was a misdrawing of the perimeter of regulation that left systemically important institutions outside the perimeter of regulation. And that has not been largely changed in that almost all the regulation has focused so far on the banking system.

And, Rana, one of the reasons why large banks are poorly valued in the market is because they’re in the process of attracting fantastic capital charges that call into question their viability. It has nothing to do with the underlying business, but has to do with regulatory decisions in which, for example, with TLAC coming up, total loss-absorbing capital charges, the two banks in the world that sailed through the crisis without batting an eye, never worrying for a minute that they were under threat, are going to attract by far the highest charges.

STIGLITZ: Can I say, this is an avenue where John and I agree, it sounds like. (Laughter.)

LIPSKY: I hope we agree on a lot, Joe.

STIGLITZ: We agree. We do agree on a lot.

And I just would raise two or three more points. One of them is, one has to ask the question, why do we have a shadow banking system? And part of it is actually to circumvent the regulations.

And to the extent that that is true, we really ought to be asking, you know, is the issue should we—we really ought to bring it all in in some ways.

It’s a little bit like the question, you know, an easier question is, why do we have offshore banking? You know, is it that finance really does better in the Cayman Islands because of the sunshine? (Laughter.) You know, that makes money grow faster.

Or is there something else going on? And we all know the answer to that. It’s not like, you know, the expertise in New York and in London isn’t up to the expertise that they have in British Virgin Islands. So we know the answer.

So the question is, why don’t we just shut it down?

FISHER: We have a global collective action problem is the answer. (Laughter.)

Another question from the audience, who would like to jump in?

Yes, sir. Wait for the mic and identify yourself and your affiliation.

Q: Sorry. Jim Shapiro from the Tata Group.

I just wonder if any of you would like to comment on the failure of fiscal policy relative to all this. I mean, you mentioned the obvious role of monetary policy, but one of the real failures, it seems to me, in terms of driving the investment, much of which needed to be public investment or at least publicly led investment, is really just a governmental failure in the U.S. and in other countries. And what part—how much does that sort of explain some of what—

FISHER: I’m going to intervene and translate just because I want to see how Lipsky—(laughter)—will respond.

FISHER: I have a shortcut to that. I’ve tried to teach my students at Dartmouth without making them read the entire general theory. Why did Keynes become a Keynesian? Because he gave up on monetary policy. He didn’t just from a vacuum decide the state should do it, you know, because gee I can’t think of anything else. He sat there in 1935 and ’36 and said: Fiddling with the rate of interest in order to simulate private credit to get investment going just isn’t going to do it. So let me see how they respond to that.

STIGLITZ: Oh, I totally agree with that perspective. And the view—so the question, in a way, is it is a failure of fiscal policy. They should have used even louder—they did say this—that they should have used even louder the bully pulpit and said: We can’t do it. It’s really your responsibility. And that was a failure, not—there was a little bit of, I think, a failure to do more about increasing the credit channel. The credit channel was broken and there was more that they could have done to think about why it was broken and what could be done about making it better.

But the next question is, given that the fiscal policy wasn’t working, what should monetary policy have done? The first is making the credit channel work better, but then the question is, say they can’t do that. Should they have lowered the interest rates to the level—are they having a productive or a counterproductive effect? And I think that’s—you know, I think that’s open to debate.

FISHER: Yes, ma’am. Microphone here, please.

Q: I’m Lucy Komisar. I’m Lucy Komisar. I’m a journalist.

And I’ve written for many years about the offshore banking corporate secrecy system. So I’d like to ask Joe, how would you shut it down?

STIGLITZ: Well, in a way I’m—this picks up a little bit on what John said and what we did in the Anti-Terror Act, you know. We did really—we cut off correspondence relationships. It had some adverse effects on some countries, but it had—it worked. The system of financing for terrorism really—I think it was an effective system. So if we had a resolve to do it, and there would be a debate about the collateral damage and John would—(laughter)—I think it would probably—it would be worth doing is precisely things like the correspondence banking. You say, lookit, if you’re not willing to sign up to these standards, you can’t have correspondent relationships.

FISHER: John?

LIPSKY: Look, that’s not really the problem, Joe. The problem is you’re responsible for your correspondents living up to the standards the correspondent said. And you get this tremendous imbalance of risk and reward, namely if your correspondent bank—the guy you’ve trusted actually fail, you’re going to get—you’re going to get a huge—

STIGLITZ: Yeah, but I’m answer his question on how you do it.

LIPSKY: Yeah, yeah, but there’s another aspect that’s actually even more important. And that’s what now goes under the BEPS, base erosion profit shifting, that there is—the big money for tax authorities in governments is not in stopping money laundering or financing of terrorism. It’s really to make sure that you end up with collecting the taxes that you think are due. And that—there’s a big effort—you know this—there’s a big effort on that score.

STIGLITZ: But that has not gone anywhere far enough. I mean—

LIPSKY: But I think the idea of tax havens are disappearing. The notion, for instance, of Swiss bank secrecy is long gone, et cetera, et cetera. So I think that’s changed.

Can I come for just a second to the question on fiscal policy? Two things. I think in the immediate response to the crisis the U.S. did a couple good things in terms of credit. TARP, which started out on a silly idea, the troubled asset, right? They were going to buy back bad assets. In the end, they just said we’re going to recapitalize them. We’re going to guarantee the recapitalization of the banks. And then couple that with stress testing. That did a lot.

What’s missing? The common—the conventional wisdom is infrastructure. OK, yes, but my experience in my career is to watch it. Just because somebody calls something an investment doesn’t mean it’s really a good investment. And you can waste money on bad investments big time—

STIGLITZ: Like housing in Nevada in the desert, like the private financial sector did?

LIPSKY: Yeah. Well, you mean there was no public incentive to—you know, in the housing sector?

STIGLITZ: Nobody told them to invest in the desert.

LIPSKY: No, I’m not trying to say that nobody made any mistakes, I’m just saying that let’s not say just because something’s infrastructure that we should spend whatever.

And then finally interest—I learned in public finance 101, just today’s interest rate is low doesn’t mean you should engage in a 50-year live asset based on today’s rate, because you may actually—if this is distorted by public policy—you may be effectively ripping off savers in the long run, which you may not want to do.

FOROOHAR: Can I—

FISHER: Rana wants to jump in.

LIPSKY: That’s not to say that more couldn’t have been done. And then finally tax reform is long overdue.

FOROOHAR: Oh, yeah. Well, I was going to jump in on that too. I just want to say one thing on fiscal policy. I think it’s worth pointing out that this is a long-standing problem. This isn’t even just a post-2008 problem. I actually looked in the first chapter in my book at the ways in which at many points when there was political contentiousness and disagreement about how to deal with an underlying growth problem—you know, from the 1970s onward, really—that easy money, you know, pushing the ball to the market, saying let the markets figure it out is a way that politicians have always managed these more difficult problems. So I think that’s one important thing.

The other thing—I just wanted to say, just one kind of colorful story that I think speaks to the tax issues—the offshore tax issue, and the tension points between finance and business, and really I think the Kafkaesque way in which the markets have developed. If you just look at Apple, for example. Apple has about $2 billion sitting in bank accounts, many of them offshore. It has made promises and issued I’m not sure how many tens of billions of dollars of debt in the last three years—but it has made promises to issue almost that amount of debt here at home in the bond markets, because it’s cheaper, obviously. And they don’t want to pay the higher corporate tax rate. That money is being paid out to, you know, people—until recently, people like Carl Icahn, activist investors, the top ten percent of the population that owns 80 percent of the stock. Which does to Joe’s point about how financialization increase inequality.

And it’s also just bizarre, because it makes you wonder what are the capital markets for? I mean, corporations are involved in the capital markets more than ever before, at a time when they don’t actually need any capital, you know? (Laughs.) Which is sort of a very question that I think is important to keep in mind here.

FISHER: Yes, Mr. Tempelsman. Here comes a microphone.

Q: Maurice Tempelsman. Thank you very much for a good debate.

One participant absent on this stage, if one looks back at, say, the last 100 to 150 years, in this search for growth—motivation for growth and stability, ranging all the way from state ownership to total laissez-faire, or triumphalism of laissez-faire, the political factor has been totally omitted. And I think the interaction between the political—what if feasible, what is doable—versus what is possibly desirable in an imperfect world is something which is a very important—as we see it in our present political—(inaudible)—with both the left and the right, with different methodology, different—really mining the same political load. Can you comment on that?

FISHER: Yeah. Can you say a word about that?

LIPSKY: Yes. Real briefly. You’ve touched on something I feel very deeply about. It seems to me that when the crisis hit in 2007, 2008, it produced collective action on a scale we’ve never seen before. The principal institutional response to the crisis was the formation of the G-20 at the leaders’ level. And the cooperation shown, for example, between November 2008 and April 2009, the London summit, I think everybody agrees had a tremendously positive effect on ameliorating the downturn and setting the stage for an upturn.

I, for one, hope that that would be a lesson learned that would produce a much more cooperative and collaborative approach to macroeconomic policy setting that was originally established in Pittsburgh in September of 2009 in the formation of what we called the framework for strong, sustainable, and balanced growth—an initiative that I thought showed tremendous progress in the idea of collaboration, not I’ll sacrifice for the greater good, but that if we all work together we can produce, create a superior result that leaves everybody better—at least as well off or better off than before. And how much have you heard about this effort from the political leaders? It’s still going on at a technical level, but there’s just been no political follow through. And I’ve been bitterly disappointed with that.

STIGLITZ: Yeah, and can I just say one word about that? And that goes back to the macro or the fiscal. The view, particularly of Germany, that austerity is the solution has really led to—I think played an important role in undermining the ability to reach a coordinated solution, because there are just very deep political divide—philosophical divide on what is necessary to get cooperative action that would lead to growth for the global economy.

FISHER: Yes, sir. Here in the red tie. Here comes the mic.

Q: Ed Cox, New York State Republican Party and director of Noble Energy.

In the upstream oil—or taking the sand hill argument one step further—in the upstream oil and gas sector, I have seen the availability of equity, bond markets hedging very important recently, doing strategic mergers. The financial sector has really permitted the upstream oil and gas sector to drive innovation and produce cheap oil and gas. That has been really tremendous impact—positive impact for our economy, and frankly the world economy. So where has the financial sector gone wrong with respect to that important area of our economy?

STIGLITZ: OK. Well, let me just say something. It may—

LIPSKY: (Laughs.) About fossil fuels?

STIGLITZ: Well, there are two things—two things where I think there’s a problem. One was the question of did they overinvest in the same way they overinvested in houses in the Nevada desert? And what we now know is that almost surely they did. And there’s a wave of bankruptcies going on. So from that—even from that narrow point of view, there was not management of the allocation of resources. It was important—OK, I know you’ll disagree.

The second one is, the oil and gas market does not reflect the real social cost of carbon—of carbon emissions, which is very, very high. And therefore, there’s been overexpansion of that sector relative to renewable energy. So in my mind—but that, I don’t blame the financial sector.

FOROOHAR: I would—

STIGLITZ: But that is public policy. We should have had a public policy to deal with the social cost of carbon. And they’re responding to—so I don’t blame the financial sector for that at all. They’re just responding to the failure of government to—you know, or collective action to—

FOROOHAR: Also, the commodities sector, one of the reasons it’s so volatile is it’s become one of the most highly financialized sectors. I mean, you know, a lot of—a lot of money has gone into commodities—raw commodities or plays on commodities. And you see that flowing out. And I mean, you know, hedge funders themselves would say that. There’s plenty of Senate testimony on the topic.

LIPSKY: Yeah, although outside of energy the size of the commodity markets is much smaller than people understand it.

STIGLITZ: But let me just raise one question that Mark Carney has raised, who’s the head of the Bank of England, and I agree. And that is, embedded in our current financial market is a contagion risk that we haven’t really, fully taken into account, that if—we ought to be thinking, what will happen if the—we finally do put a price of carbon, or we recognize that, you know, global warming is really serious? Then the price of those carbon assets are going to go down. You know, there will be these calculations that a very large fraction of reserves are going to have to stay in the ground. And if you look at the network—the financial network, firms that own assets that own assets that are related to the financial sector, it is—there is a systemic problem of a very significant order of magnitude that has not been fully incorporated—

LIPSKY: Right, but, Joe, let me say, you can be sure that senior management of large financial institutions that have long-lived assets are thinking hard about this topic, absolutely.

STIGLITZ: Yeah. Yeah.

FISHER: Question in the back? Yes, ma’am.

Q: Bhakti Mirchandani, One William Street. Thank you for a wonderful discussion.

Earlier in the discussion, there was talk of the perimeter of regulation being too narrow. What would you ideally like to see in terms of the systemically important institutions that are outside that perimeter? How would you like to see them regulated?

LIPSKY: Well, without getting specific about how do you regulate the insurance business, how do you—et cetera. But essentially, what we saw was the ability to collect—to create pools of leverage outside of the regulatory system. AIGFP, Countrywide Finance, et cetera. And it seems to me that there needs to—we need two things. We need to find a way to make sure that these sources of leverage are fairly regulated, or else you’ve got exactly what Rana was talking about, is the risk will move to the less regulated spot and it can become excessive and distorted.

Secondly, an aspect I remarked, but I think has been underappreciated, is how much the post-crisis regulation has tended to be based on national boundaries, and how the initial effort to create a level playing field by regulatory reform, I would say, has not succeeded. And as a result, has become a barrier to, I think, the more efficient development of cross-border flows. And hence, it is not the only reason, but it is not so surprising that for the first time since World War II, since the crisis global trade has grown more slowly than global GDP. And I think that’s a sign that shouldn’t be just excused away. And I think there’s some cause and effect here.

STIGLITZ: Yeah. Although, let me just say, from a longer-term perspective, as we move more to a service sector economy, I would have expected that to happen. So again, many factors and it’s correlation versus causation.

FOROOHAR: And digital trade flows are actually exponentially growing. It’s real, you know, physical goods.

So, can I just add one thing to this? Which is, you know, I’m not an expert in regulation, and I won’t pretend to be. But I think an interesting question would be also how to incentivize the behaviors that we want, versus just regulating the behaviors that we don’t want. It has always seemed to me that, you know, the basic question is, is an institution, is a company providing a clear, measurable good? And if they are, let’s reward them for that. Let’s incentivize that. And that might go to some broader conversations about the tax code and how it subsidizes debt and leverage, versus equity and savings.

FISHER: Yes, ma’am. Last question.

LIPSKY: Aww.

Q: Pat Cloherty, venture capitalist.

What would you think of the idea that excessive regulation, in many ways, provides the basis for growth? And having been in this business 45 years, I’ve watched AT&T be dismantled, all kinds of regulation there, and the downstream consequences for innovation in telecommunications were vast, for an unregulated—then-unregulated sector. Likewise, IBM—the breakup of IBM. So we get the downsizing of computers, so there were antitrust, all kinds of regulations. So is it perverse to think that maybe extending the boundary of bank regulation would not be a good idea?

FISHER: Can we ask you each to take a bite at this, and each get a last word in? And then we’ll end. So, John.

LIPSKY: OK. Yes, that is definitely a risk. That I wanted to point out, there’s a big difference, for example, between the Japanese, European economies on one hand and the U.S. economy on the other in terms of the relative role of regulated finance—i.e., banks, commercial banks, as a source of funding—versus more market-driven securities markets. And what you see, and it’s, of course, post-crisis, that the securities markets have driven a cleaning of the balance sheet. It doesn’t prevent mistakes, but when mistakes are made they get recognized and dealt with very quickly, then you move on. Whereas, there has been a tendency in the much more highly regulated commercial banking system, they’re very slow to recognize losses, very slow to create realistic valuations. And that has clearly inhibited growth to the point that the U.S. economy is now—what, GDP’s, what, 10 percent above where it was pre-crisis? And in the European Union, they are just back to pre-crisis levels now. And I—

FISHER: Joe, your last word.

STIGLITZ: Well, the last point, I guess I can’t help—(inaudible)—(laughter)—the main reason for that is the euro—I have a book coming out, and I shouldn’t mention this, but on the devastating effect of the euro. And that’s the real reason for the problems in Europe.

The broader point that you made, which is that there are often, almost always unintended consequences that you can’t fully take into account, when we look at that particular experiment, breaking up AT&T, we have to remember that AT&T was very important in bringing the transistor, a lot of innovations, basic research. It wasn’t very good at bringing the last mile, bringing the goods to the market. But in terms of basic research, it was phenomenal. It had more Nobel Prizes than any country, outside the United States. So the point is that was an unintended consequence. I think there’s been a slowdown of some of the basic research, as a result of that. Nobody intended that.

The broader view—my last word—is just to reiterate what Rana said, that our major challenge is to try to figure out how to make sure that our financial system does what it’s supposed to do. And too much of our discussion has been trying to prevent the problems of the things that it’s gone wrong. You know, we have to do that. You know, we have to stop all the bad things. But in all that discussion, there’s just been two little questions. What are the core functions? What would a banking system—or, not a banking system—a financial system that really fulfills that? There’s been a little bit too much faith, in this discussion between markets and institutions, markets and banks, a little bit too much faith, I think, in markets. I think institutions like banks are really important. They’re good at information, theoretic reasoning for that.

So I think we’ve lost sight of the bigger picture, and that as we begin—continuing our discussion of reform—regulatory reform, I think we ought to put a lot more emphasis on the bigger picture.

FISHER: You get the last, Rana.

FOROOHAR: I will just take a kind of existential step back and just say: I think de-siloing the debate, realizing that making a healthy capital market system is not just about formal banking, it’s also shadow banking, it’s tax policy, it’s housing policy, it’s retirement policy and pensions. We haven’t even gotten into that whole topic. And that it has to really be about all those pieces, because they interact together. And I also think that just changing the narrative—I feel like there’s been a sense that finance was the kind of tippy-top of the services economy pyramid that we’re all supposed to aspire to. You know, after you graduate from being agrarian to a manufacturing economy to a services economy? And I would actually switch it. I mean, it’s called financial services for a reason, because finance is supposed to serve business.

FISHER: Thank my trio, and thank the members for coming. Thank you all. (Applause.)

(END)