The Subprime Of A Columbia Economist

When we first encountered Nobel Prize-winning economist Joseph E. Stiglitz’s assertion that the Iraq War led to the sub-prime mortgage crisis, we found the assertion a bit of a reach. It turns out that there may have been more to it than met the eye.

“Some might argue that these problems are not the result of the Iraq war as such, but of the way the war was financed, and of accompanying monetary and fiscal policies,” Stiglitz wrote in the notes of his book, The Trillion Dollar War, which was published in 2008. “Earlier, we encountered a similar argument in discussing the deficits, and said that similar points could be raised about many other aspects of the war: they are not the inevitable result of the war but of the particular way in which it was conducted.”

“But the analysis of this chapter shows that any way the war was financed would have had adverse macroeconomic consequences. Different ways of financing the war affect the timing of the impact. The monetary policies may have hidden the impacts in the short run and shifted the burden to later years. Had the United States not confronted, for instance, the dampening effects of higher oil prices, the Fed would not have been able or willing to lower interest rates as much as they did, and there would have been less profligate borrowing. “

Nevertheless, the Government Sponsored Enterprises (GSEs) which guaranteed the loans—namely Fannie Mae and Freddie Mac—would seem to be more likely culprits. As it happens, Stiglitz gave both a clean bill of health in a paper he co-authored with Obama Administration budget director Peter R. Orszag in 2002. That analysis was commissioned and published by none other than Fannie Mae itself.

“This analysis shows that, based on historical data, the probability of a shock as severe as embodied in the risk-based capital standard is substantially less than one in 500,000 – and may be smaller than one in three million,” the authors claimed. “Given the low probability of the stress test shock occurring, and assuming that Fannie Mae and Freddie Mac hold sufficient capital to withstand that shock, the exposure of the government to the risk that the GSEs will become insolvent appears quite low.”

“Given the extremely small probability of default by the GSEs, the expected monetary costs of exposure to GSE insolvency are relatively small—even given very large levels of outstanding GSE debt and assuming that the government would bear the costs of all GSE debt in the case of insolvency. For example, if the probability of the stress test conditions occurring is less than one in 500,000, and if the GSEs hold sufficient capital to withstand the stress test, the implication is that the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million.”

We asked Dr. Stiglitz whether he would, in light of subsequent events, care to revise his conclusion. He has yet to respond to our inquiry.

How much of a role did ideology play in Stiglitz’s analysis? Thanks to RateMyProfessors.com, we can get an idea of how ideas drive the economist’s classroom lectures:

• “Pretty much a waste of your time,” one reviewer wrote. “Just read your favorite left wing blog and you have discovered the extent of this man’s knowledge.”
• “Easy A.” Another reviewer more impressed with the professor nonetheless wrote that “This guy is brilliant, yet he should leave his cynical politics out of the classroom as he obviously hasn’t got a clue!”

By the way, according to Dr. Stiglitz’s vitae, he is the Chair of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System.

Malcolm A. Kline is the Executive Director of Accuracy in Academia.

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