Cenk Uygur: Welcome back to The Young Turks, now the interview we've all been waiting for, Joseph Stiglitz, professor at Columbia University, winner of the Nobel Prize in Economics, the John Bates Clark Medal, Chair of the Council of Economic Advisors between '95 and '97, Senior Vice President, Chief Economist at the World Bank, now joining us on The Young Turks. Professor Stiglitz, it's a pleasure.

Joseph Stiglitz: Nice to be here.

Uygur: All right. Now, there are many things I want to talk to you about, of course including your book, and the book, of course, is "Freefall: America, Free Markets, and the Sinking of the World Economy", and how we did sink that world economy, but a lot of news today that I've got to ask you about. So we have a spending freeze that Barack Obama's administration is apparently going to put into place, it's going to be for discretionary, non-security spending for three years. Now, a lot of economists in the country have not been favorable to this so far today. What are your thoughts on it?

Stiglitz: Well, I think my reactions are that it does reflect a concern about the ballooning of the deficit and national debt and it's good to know that there's concern about that. On the other hand, the economy is very weak, and there's a need for stimulus, and stimulus means spending. The issue isn't the level of spending, in my mind, but how we spend the money. And if we're concerned about the long-run national debt, the implication is, let's make sure that more of that spending goes to high-productivity investments and less to things that don't yield returns like, my own view of it, a war in Afghanistan or Iraq or a lot of defense expenditures which do not increase the productivity of our economy. The other point I'd make is obviously $250 billion out of the expected increase in national debt of around $9 trillion in the next decade is clearly just the beginning.

Uygur: Wouldn't real deficit hawks be more interested in cutting defense spending or raising taxes? That seems like that would be more of a frontal assault on Republican ideology; it doesn't seem like this president has the stomach for it, but what are your thoughts, I mean, do you think there's any chance, one, is that right, and two, do you think the president has any chance of going down that road at any point in his term?

Stiglitz: Well, you're absolutely right that if I were to ask what is the best way of addressing the long-term national debt, it is, as I said, look for the kinds of spending that do not stimulate the economy that much in the short run and do not contribute to long-run productivity, and making weapons that don't work against enemies, for enemies that don't exist, is certainly a prime candidate for cutting. Tax increases clearly should be on the table. The tax cuts that we had in 2001-2003 were clearly beyond our ability to afford, aimed at the people who had done very well over the last 30 years, the people at the very top, and a reversal of that would obviously put us in a much better stead.

Uygur: Now let's move on to the other big news of the last several weeks, which is Ben Bernanke's reconfirmation. Right now, apparently Rahm Emanuel, Tim Geithner, and the rest of the Obama administration putting a lot of pressure on Democratic Senators to make sure he's reconfirmed. Do you think that's a bad idea?

Stiglitz: Well, I... Let me put it as I'm very sympathetic to the critique, to the critics. And the critics point out first that he brought the economy to the brink, so while you can be very thankful that he brought us back from the brink, you have to say that he bears a lot of responsibility for our being there. Secondly, the manner in which the bailout was handled has raised very important questions including questions about transparency that have been increasingly in the limelight, the AIG bailout being the prime example. The third is that the forecasting record is a little disappointing, you know, he said we've had the problem contained, the subprime mortgage problem, contained, don't worry, in 2008, shortly before everything came apart, he said, you know, the economy's on the mend, the recession that started in December of 2007, he said we're, you know, we're on the growth path. Clearly, we were not. The problem is that that forecasting is really important because we have some real problems of managing this ballooning balance sheet of the Fed, worries about inflation, and lack of confidence in the forecasting ability obviously is a source of concern.

Uygur: You're calmer than I am about it, let's put it that way. So I want to challenge you a little bit more on that. We're talking to Professor Joseph Stiglitz, Nobel Prize-winning economist and the author of "Freefall: America, Free Markets, and the Sinking of the World Economy". Now, he claims he didn't see this collapse coming at all, which I would paint in a positive light as gross incompetence. In a negative light, you could say well, maybe he did see it coming, but he's an accommodationist of Wall Street, so he thinks his job is to accommodate the bankers and whatever they would like to do, whatever shenanigans they'd like to do, for as long as possible to retain his job. And it seems that if he was making that calculation, he was fairly correct. Which one do you think it is, gross incompetence or accommodationist of Wall Street?

Stiglitz: I'm leaning a little bit more to the gross incompetence than to the accommodation, but there's a third interpretation, also not one very favorable, which is that he has been very attracted to free market ideology, to the view that Greenspan put forward that bubbles basically don't exist, markets are efficient, the view that even if there were bubbles, there's nothing you can do about it, the Fed doesn't have the tools, it's better to clean up at the end. So if you look at that philosophy, that philosophy of deregulation, non-regulation, is what has got us into trouble, and to me the concern about that philosophy is one of the main reasons why I think some people should have reservations.

Uygur: It sounds similar to what Simon Johnson calls "intellectual capture", Right?

Stiglitz: Exactly.

Uygur: Right.

Stiglitz: Simon is exactly right. And so, I don't think it's... my view is this is not capture in the traditional sense of being in somebody's pocket, but it is intellectual capture.

Uygur: All right. Professor Stiglitz, as I mentioned, you're a Nobel Prize-winning economist, you were the Chair of the Council of Economic Advisors, Chief Economist at the World Bank, it appears that's a resume that might warrant consideration for head of the Fed. If Bernanke were to not pass his confirmation process in the Senate, if they offered you the job, would you take it?

Stiglitz: Well, I don't think they're going to offer me the job, so it's... and as one tends to say, I'll cross that bridge when it happens. Obviously I think that if the president asks one to take a job of that importance in the context particularly of an economy in the current fragile state, I think I'd have to, I'd have to accept it. And particularly, you know, I've been very critical of what the Fed has done, and in my book, "Freefall", I do point out all these mistakes that they've made, and I would actually welcome an opportunity to try to rectify some of those mistakes.

Uygur: Well, and we, a lot of us would welcome an opportunity for you to rectify those mistakes. Whether we can get that past Geithner and Summers and Obama is, of course, a different question. All right, so let's get to those mistakes and what went wrong. So, you know, let me do a quote of a piece you wrote for Mother Jones here called Moral Bankruptcy. You say, "In the finance sector, when performance is high, pay is high; but when performance is low, pay is still high. The bankers knew--or should have known--that while high leverage might generate high returns in good years, it also exposed the banks to large downside risks. But they also knew that under their contracts, this would not affect their bonuses." Now, this is something that I've been saying for well over a year now. Is this the heart of the problem, the wrong incentive structure on Wall Street?

Stiglitz: I think it's one of the hearts of the problem. As I also sort of indicate in that quote, I'm not sure that these masters of the universe really did understand risk, so that some of them did what they did because of perverse incentives, some of them did what they did because of incompetence. The two are interrelated because I think they had incentives not to think too deeply about what they were doing. So as an economist, I look at some of the things and I say this is really absurd, how did this happen? I look at the incentive structures, and I say anybody looking at those incentive structures should really have been worried. And these guys are supposed to understand economics, are supposed to understand incentives, how did they put in place these incentive structures? And then you have to... that's when issues of the kind of, they had incentives not to think too deeply about these issues.

Uygur: Right, because like you, the quote I just read, if they make money either way in the short run, and that's obviously part of the problem. But you say it's one of the hearts of the problem, and you know, I've got a number of things that I think are on the list, and I wanted to basically run it by you and ask you what the order of importance is. So we had the subprime meltdown, and now that caused a bubble, and, but other bubbles have happened before, tech bubble, to some degree, oil bubble, et cetera. Another problem was the overleveraging and the naked credit default swaps that basically just allow casino gambling. I think that amplified the problem, but I want to ask you, again, relative importance. And then, obviously, this wrong incentive structure on Wall Street. So when you take all those factors, and I know there are others, what do you think stands out as the most important?

Stiglitz: If I had to single out one thing, I think I would agree with you, it was the incentive structure. You know, a lot of people have focused on the low interest rates and how that led to the bubble, but the fact is that we've had low interest rates in the period after World War II, and we didn't have these kinds of problems. There was something else, though, we didn't have the peculiar incentive structures at that point, we also had good regulation. And in your list, you didn't mention the absence of good regulation, the deregulation that occurred beginning of the 80s that forgot the fact that banks have repeatedly gotten economies into trouble, have imposed costs on the rest of society, that they have given in to irrational exuberance and irrationalities of all kinds, irrational risk-taking, and they have to be curbed. And we stripped away those regulations and we went back to what we've had repeatedly, bubbles, manias, and crashes.

Uygur: You know, that, in my mind, is part and parcel of allowing leverage to get out of hand and allowing the naked credit default swaps et cetera et cetera, but what I've always wondered and never gotten a really good answer on, that's why I was dying to ask you about this, is, is the main problem, you know, the subprime that triggered this mess or is it the bets that they made on top of it, all the CDSs and with the great leverage that they were able to put behind it?

Stiglitz: Well, I think one way of thinking about this is if they had not had CDSs, these credit default swaps, we still would've had a very serious downturn. The CDSs made the downturn worse and cost the taxpayers plenty, for instance, in the AIG bailout, but I think even in the absence of that the problem that the country is now confronting, the crash of the real estate market, the weak economy, would've been still there. The banking system might have been a little bit, and would have been in better shape, and the taxpayer would've been in a lot better shape. So I put the focus on the bad lending, but I also put a lot of blame on leverage because, again, what the leverage did is it both blew up the bubble, it is one of the things that allowed the bubble to grow so big, and it also meant that when the bubble crashed, it put in jeopardy our financial system.

Uygur: One thing I don't have a good handle on, to go along that route again, is so they say the credit default swap market or derivatives market is $64 trillion, which is an unbelievable number, it's larger than the entire world economy. So for about a dollar in subprime market mortgages, how much did they make in bets? Was it two dollars' worth in derivatives or $10 or $100?

Stiglitz: Well, one of the issues I do raise in my book, "Freefall", is that there's a lot of mystery about what these banks are doing, how they're managing their gambles. One of the things that we do know is that they are using some of this for tax avoidance, tax arbitrage, regulatory arbitrage. We also know that while they claim to be using this for risk management, it actually created risk. And we also know that they have a tendency not to net out these, and what I mean by that is the following: A will bet B on something like the death of Bear Stearns, and then a little bit later, they'll say let's cancel the bet, but rather than canceling the bet, what they do is B will bet A on the opposite direction. It has the net effect of canceling so long as one or the other side doesn't go bankrupt, but it is exposing them to enormous amount of risk, and when Lehman Brothers went down, when AIG had its problems, it was exactly that that almost brought the financial system over the brink. So again, one of the things that I find absolutely amazing and emphasized in my book, "Freefall", is how these guys who were getting paid the gazillions to manage risk did not seem to either understand risk or had incentives that went in the other direction.

Uygur: Yeah. I mean, I definitely lean in the direction of they understood it but didn't give a damn, because their bonuses go up if they take those risks, so they have no incentive not to.

Stiglitz: And they've got bonuses based on fees, and the fees were related more... the more transactions, the more the fees.

Uygur: Right. So even AIG, which made the disastrous bets, the people making those bets made, you know, the head of the London office, if I'm not mistaken, made $600 million off of those fees, so...

Stiglitz: That's right. And that's one of the problems that, as they say, that they pocketed the money and they left the taxpayer bearing the downside risk. And that is one of the reasons why, go back to the things that have been in the news recently, Obama's initiative to do something about the too-big-to-fail banks is so important, because these institutions also have bad incentives because when they gamble and win, they walk off with the profits, and when they lose, we pick up the tab.

Uygur: So let's get to the fixes. We're talking to Professor Joseph Stiglitz, Nobel Prize-winning economist and the author of "Freefall: America, Free Markets, and the Sinking of the World Economy", which, of course, goes a long way towards explaining how we got into this mess. Let's talk about how we can get out, Professor Stiglitz. So first of all, the pure betting. I understand the value of derivatives, you got price fluctuations in corn, oil, whatever it might be, they've been around a long time. But the derivatives with no underlying assets, what I'm calling and what a lot of people call "naked CDSs", do they have any value, and if not, can they realistically be banned at this point or are they just simply too large to get a handle on at this point?

Stiglitz: Well, my view is twofold. They certainly need to be put under better control, and there've been proposals, for instance, to move them to standardized products traded in exchanges, very important that the exchanges themselves be adequately capitalized. The Obama proposals say that they're going to encourage it, but they're going to allow the non-transparent over-the-counter market to continue and that's dominated by the big banks which in effect means that it's underwritten by the taxpayers. To me, that's totally unacceptable. And I suspect that if we said these big banks can't underwrite them, ie, if the taxpayer isn't backing them up, much of this market would disappear and the problem would be much less.

Uygur: All right. Let's talk about other fixes. So that's one, and let me clarify that. I would, again, let me re-emphasize, I would ban them. If you don't have an underlying asset, it just, and correct me if I'm wrong, and that's why I'm asking you, it just seems like an absolute Blackjack bet, you know, bet it on black or red on Roulette. Am I wrong about that?

Stiglitz: It could even be worse than that because I could take a bet on the death of Bear Stearns, for instance, and I have, then, an incentive to make sure that Bear Stearns dies. And so, it's like buying an insurance policy on somebody else that you have no interest in. You don't allow that under laws in the United States, but we allow that kind of thing against corporations. So the problems are very severe. The difficulty is the following: that you may have an interest in what happens to a firm even if you don't own their bond, for instance, you may have an interest because you deal with them and if they go bankrupt, you may lose sales. Overall, though, my judgment is that they are... present more risk than they're worth. Let me just give you one bad argument they sometimes put, they say, well, this enables you to buy a corporate bond and insure against the default of that bond. Well, if you're worried about the default of that bond, buy a Treasury bill. You don't have to buy a corporate bond and then strip out the risk through credit default swaps. If you want a safe bond without any risk of default, buy a U.S. Treasury bill. So a lot of the arguments that are given for these credit default swaps are totally unpersuasive.

Uygur: All right, so that's the credit default swap angle. Now, of course, the Obama administration's nowhere near that, they can barely begin to put together an exchange where we might be able to see some of the credit default swaps. Let's go to point number two: how much do you think it would help to give shareholders more power in determining the board of directors and having more control of their own company?

Stiglitz: Well, I just testified in Congress on this issue. We were talking a lot about incentives and the role that incentives played in the crisis, but when you think about that, and again, one of the points I make in the "Freefall" is you have to ask why were there such bad incentive structures? And one of the reasons is that shareholders do not have adequate say in pay, and adequate control over the managers. So I think reforms in corporate governance are absolutely essential; I don't think they go far enough, though. I think that managers are always going to have a lot of influence, shareholders are not going to be... there will be some active shareholders, but most of them are going to be passive, and that's why as important as I think these reforms in corporate governance are, for the banks which pose such a big risk for our economy, we have to have direct regulation, size, what they do, leverage, and so forth.

Uygur: Professor Stiglitz, let me press on that just a little bit more. What specific reform do you think would help the most in giving shareholders more power over the company rather than the directors... the executives, I should say, which, of course, have an incentive to take as much as they can out of the company without sharing it with the shareholders?

Stiglitz: Well, there are a whole set of reforms in corporate governance that have been discussed. One I just mentioned was called say in pay, so that at least they should have a vote in the pay. I mean, one way of thinking about that is if somebody's working for you, you should have some say in what they get paid. And...

Uygur: Of course!

Stiglitz: And you own a company, you are a shareholder in a company, it seems to me reasonable that you should have some say in their pay. But there are other issues, other... reforms that are very important. One set of reforms is making sure that shareholders can have a more effective role in choosing the board of directors. In some companies, they only allow a small fraction of the board of directors to turn over every year, and that means that it would take a very long time before you can get a turnover of control of the board of directors. There are, as I say, a number of reforms. Another reform, one of the big changes in America's structure, financial structure, in recent years is the increasing role of pension funds and other institutions. They are big shareholders, and typically they vote with management. And one of the initiatives is to say they have to let their constituents know how they're voting, so for instance, I think a lot of unions would be very upset if they knew how their pension funds are voting on a lot of these corporate issues.

Uygur: I know we have... we've taken up a lot of your time, Professor Stiglitz, but I just, real quick, a couple of things here to wrap up, more specifics. And the book, the new book is "Freefall: America, Free Markets, and the Sinking of the World Economy"; we'll of course put that up on TheYoungTurks.com so people can purchase it through there. So on the issue of leverage, you know, it used to be anywhere between 10 to 15 to one, and then 2004 it got lifted, and now some got up as high as 95 to one. Is there a reasonable number for what the leverage should be?

Stiglitz: I think we should go back to the much lower numbers. And one way of thinking about it is the following: When you have 30 to one leverage, and some of them were beyond that, a 3% change in the value of your assets wipes out the net worth. But housing, real estate prices have come down 30%, so you're really exposed to enormous amount of risk. The point is that leverage isn't like it's creating anything, it's just shifting risk from one place to another. It's not really creating value. And unfortunately, we don't want risk to be borne by the pay-mix mechanism, by the banking system, because when you put money into the bank, you want to be able to get it out without government coming to the rescue. So to my mind, it is much better to be conservative on this and to go back to the standards that we had before all this deregulation. Very little benefit came out of it, but enormous costs were imposed on the rest of our society.

Uygur: Is 10 to one a reasonable number?

Stiglitz: 10 to one, 12 to one probably max.

Uygur: 12 to one, OK. And then on the idea of consumer loans, the Obama administration has said hey, you should keep 5% of a loan you make so that you have an incentive to make a decent loan. I think that number should be much higher, maybe as much as 50%, but I'm just guessing. Is there a reasonable number?

Stiglitz: Well, what you're pointing out here is the problem posed by securitization, that really was based on what I call the "greater fool" theory. You manufacture these pieces of paper and you hope that there's some fool around somewhere that will buy this piece of paper. Globalization meant that there was a global marketplace for fools, and we found a lot of them, about 40% of our subprime mortgages, for instance, were sold abroad. It's, you have to deal with this problem of what we call moral hazard, asymmetric information, the fact that in the old days, when you originated a loan, you kept it, and you therefore had an incentive to make sure that the borrower was capable of repaying it. I think 5% is clearly not enough. I don't know exactly what the right number is, but at a minimum, I think 10% is what we should be going for. Again, what I think we really need is to have much closer monitoring of the standards of lending, and that's why one of the proposals Elizabeth Warren from Harvard of Consumer Financial Products Safety Commission to make sure that these loans really are appropriate is absolutely essential. And unfortunately, while Congress seems to be moving forward with this initiative, they've gutted it, exempting about 84% or more of the banks, all the small banks, from these provisions.

Uygur: Shocking. And finally, a financial transaction tax. The rest of the world seems to be pushing us in that direction, and yet again, of course, Geithner, Summers, Obama are resisting. What do you think about the value of a financial transaction tax?

Stiglitz: Well, the first point, and one that Gordon Brown just raised, emphasized, in the last couple of days was at least the United States was beginning to realize that the financial sector was overbloated, that it had imposed costs on the rest of our society, and that they ought to pay some of the cost for the damage that they inflicted, and backs, you know, an initiative to impose taxes on the big banks related to their leverage. I think that was a move in the right direction. It's not just a matter of paying back the costs they've imposed in the past, it's trying to prevent these problems in the future. The basic idea of the financial transactions tax is that it recognizes that there've been a lot of excessive transactions, these transactions contribute to volatility, this volatility imposes a high cost in our economy, it makes a lot more sense to tax things that are bad than to tax good things that are good like work and savings, and that therefore our system as a whole would be more efficient if we shifted the burden of taxation towards things like pollution and towards things like a financial transactions tax. I think that that argument is compelling. The only reservation I have is that some people believe that the financial sector, with all its ingenuity, will evade it. And another principle of taxation is that taxes that are easily evaded and avoided are also very distorting. A big controversy, some of my friends in the financial sector tell me that they believe they can design one that is very hard to circumvent, others say that they believe they can circumvent. I tend to believe that at the current time, we've made sufficient strides that we could implement it, and I actually think if we did it through, for instance, a tax on short-term capital gains imposed in the United States on American citizens, but imposed worldwide, wherever they made the transaction, it would be a step in the right direction and that we could do that even without coordination with the rest of the world because it would discourage Americans from engaging excessive transactions and that, by itself, would enhance the stability of our economy.

Uygur: All right. Professor Joseph Stiglitz from Columbia, Nobel Prize-winning economist and the author of "Freefall: America, Free Markets, and the Sinking of the World Economy", and that's going up in The Young Turks' library, of course, where you can purchase it. Professor Stiglitz, thank you so much for joining us.

Stiglitz: Well, thank you. Great conversation.

Uygur: Thank you.