Stiglitz’s ideas about how economic actors screen for risk found their most recent illustration in the subprime-mortgage mess.”Banks are very important institutions for screening creditworthiness. But the system of securitization of mortgages distorted their incentives,” he explains. “The lender who originated a mortgage had no intention of holding it, so the risk of default was neither accurately calculated nor adequately protected against.”
These circumstances constituted what economists call a moral hazard, another idea on which Stiglitz did important work–and one that’s been much discussed since the government’s bank bailout. “If people don’t bear the full consequences of their risks, they have a tendency to take excessive risks,” he says. “The big banks knew that if they took big risks and lost, the government would pick up the pieces. Classic moral hazard: they knew they were too big to fail.”
Stiglitz established a reputation early in his career, winning Fulbright and Guggenheim fellowships in his 20s and teaching economics at MIT, Yale, Stanford, and Oxford before he turned 40. After nearly a decade as a tenured professor at Princeton in the 1980s, he served as a policy advisor in Washington before being appointed a University Professor at Columbia. Stiglitz has written, cowritten, or edited nearly 40 books, in addition to scores of articles on an array of economic subjects, and his work has been translated into 35 languages.
His interest in economics took root early, he says, during his childhood in postwar Gary, IN. “There must have been something in the air,” Stiglitz says, for in addition to its countless tons of steel, Gary produced more than its share of economists. (Gary native Paul Samuelson, Stiglitz’s MIT mentor, won the Nobel in 1970.) The son of a New Deal Democrat mother and a small businessman who believed in the virtue of self-reliance, Stiglitz grew up immersed in political debates in a family with high ideals and even higher expectations. And the social and economic anomalies he observed in his own backyard provided plenty of fodder for discussion. What accounted for the poverty, unemployment, and racial discrimination that persisted in Gary through booms and busts? It defied the prevailing economic theory that declared labor markets efficient.
Stiglitz studied physics as an undergraduate at Amherst College but was enthralled by the challenge of understanding and modeling the imperfection of markets. Before even completing his bachelor’s degree, he left to do graduate work in economics at MIT, where he would study with such giants as Samuelson and Robert Solow.
“In the 1960s, MIT had become the center of a revolution in economics,” Stiglitz recalls. The department placed mathematics–not philosophy or ideology–at the heart of policy analysis. But it aspired to “an interface of careful mathematical models and the practical problems of the economic world,” he says.
Rigorous, quantitative, yet hardly abstract, that hybrid approach suited Stiglitz, who had marched on Washington with Martin Luther King and journeyed to Kenya in the late 1960s to study economic development.
Confronted in Africa with widespread deprivation as well as what he calls “massive discrepancies between the models I had been taught and what I saw,” the young Stiglitz strove not just for practical solutions but for theoretical understanding. Conventional wisdom offered little explanation for Kenya’s mass unemployment or the persistence of dysfunctional institutions such as sharecropping. What he saw reinforced his desire to build better, richer, more accurate economic models that could bring mathematical precision to the task of eliminating poverty.