# Joseph Stiglitz: The financial crisis was a market failure

https://www.youtube.com/watch?v=g_W9SsstO9Y

[00:00] 2008 was a traumatic experience for homeowners, workers, and for economic theories that markets worked well.
[00:09] Literally millions of people lost their home.
[00:17] Tens of millions of people lost their jobs.
[00:23] The regulators had such belief in the efficiency of the financial markets–in being good for the bankers, they will be good for all of our society.
[00:29] That, too, turned out to be wrong.
[00:36] The very idea that the markets were efficient and stable was totally devastated.
[00:43] Before the crisis, scarce capital was allocated clearly to uses that were not good.
[00:49] Building shoddy homes in the middle of the Nevada desert that will shortly remain empty and be destroyed.
[00:56] Afterwards, the shortfall between the economy’s potential to produce and its actual production is in the trillions and trillions of dollars.
[01:02] No government has ever wasted money on the scale or the consequences of the US financial crisis.
[01:09] Our belief, our understanding that markets are efficient is based on a very simple model–perfect competition, perfect information.
[01:18] A kind of rationality that people really think through the consequences of their actions and another very important assumption is no externality;
[01:31] there is nothing that I do that has effects on others that is not already taken into account by the market.
[01:38] All of those assumptions were wrong and were proven wrong by the crisis.
[01:47] Economists usually begin by thinking about incentives, that people have incentives to behave badly and the answer is yes.
[01:53] What were those incentives and why were there those incentives?
[02:01] And in fact they had incentives to create incentive structures that were bad.
[02:06] In the late 90s we formed these mega mega banks.
[02:09] These banks became ‘too big to fail’.
[02:14] If you take a risk and you win you walk off with the profits but if you gamble and lose the government picks up your losses.
[02:21] There is an innate incentive to undertake excessive risk, exactly what they did.
[02:28] When you have an economic system like that the ‘too big to fail’ banks can get access to capital to lower interest rate.
[02:34] Because those who lend out money say there’s no risk because the big government will bail it out if they make a mistake.
[02:40] So, the ‘too big to fail’ banks get bigger and bigger, so the system has a dynamic instability to become even more distorted.
[02:51] Inside the firm you look at the incentive structures; managers of the banks got a large percentage of the profits if things did well.
[02:56] If, as a result of those gambles, the next year they lost, they didn’t have to bear the consequences.
[03:02] As an economist.
[03:07] I looked at the incentive structures and predictably they led to bad behaviour.
[03:12] Many of us believed before the crisis you needed good regulation.
[03:20] Those who were caught up in the euphoria of the pre-2008 world pretended that there were no externalities.
[03:27] We’ve had economic fluctuations before.
[03:27] When banks go down many people suffer and that’s especially true when we have ‘too big to fail’ banks.
[03:34] The reason they’re ‘too big to fail’ is because there are these macroeconomic consequences.
[03:40] So, we have this vocabulary that recognizes that there are macroeconomic consequences and we had regulators that pretended that there weren’t.
[03:55] It was what you might call a perfect storm, perfect recipe, for a massive market failure.
[04:02] The basic lesson that I think should be taken away from the crisis of 2008–markets
[04:09] On their own are not efficient or stable.
[04:14] We realized that there are these externalities, there are things that one person can do, one organization can do, that affect others.
[04:20] We’re never going to get to what we would say is a perfect working system but we can get something much better than we are now.
[04:25] We’re always trying to strive to get the right balance.
[04:29] We know that a system in which the state does everything doesn’t work.
[04:35] The big lesson of the crisis of 2008 was that we could lose balance on the other side too.