I went to a panel discussion tonight at Harvard on the current economic crisis. I figured the topic was important enough for me to skip out of work early (I was in a training class in Waltham) although the session did nothing to calm my anxiety about the current situation.
My notes on the discussion:
Jay Light, dean of the Business School
There are three main issues in the crisis at the moment:
Traditionally, home prices in the US have been 2.8 to 3.0 times income but it’s gone to 4.0 in the US and even higher elsewhere (6.0 in the UK, for example.) Short term credit markets have seized up. It’s been like a slow-motion train wreck, although the wreck has speeded up in the past 10-12 days. To resolve it we need the $700 billion to stop the patient from bleeding to death in the operating room. Next, we need to stablize the patient over the course of the next few months and then in the long term go through some process of rehabilitation, undoubtedly including regulatory reforms.
Rob Kaplan, professor of management and former vice-chairman of Goldman Sachs
The real problem that the economy is facing is that it’s engine of growth, the middle-American family, has slowed. The middle class, he said, is disappearing. Over the past ten years, middle class wages have stagnated but costs — including food, energy, and especially health care costs — have been rising rapidly,. This gap has been financed by tapping the equity in homes, a perfectly rational economic choice.
Like Jay Light, Kaplan believes the $700b plan is good and necessary but alone it is not enough. We as a country need comprehensive policy reforms to support the engine of the US economy, the middle class.
Elizabeth Warren, law professor
First of all, let’s be clear that this isn’t the fault of poor people; we hear about subprime loans and we think about poor people getting into houses they couldn’t afford but 80% of subprime loans were existing homeowners re-financing. It turned into a giant Ponzi scheme that inevitably came crashing down.
We have a new home finance industry that was never tested by a bubble and it’s clear that it didn’t survive its test.
One problem is that we don’t have a one-to-one correspondence between the debt owner and the debtor. Because mortgages were divided up and bundled you can’t work out specific situations between the lndor and the borrower like you could in the past. Instead, what we have is a zillion fractionalized shares. Ten percent of what the government will buy will be actual whole mortgages.
Her recommended solution is a Financial Product Safety Commission because at the base of it we’re dealing with a dirty faulty product. It doesn’t meet basic ‘safety’ requirements; if it was a toaster, you wouldn’t be able to sell it (no matter what the price) in the US; why don’t we have similar regulation over financial instruments, which have proven to be very very dangerous?
Kenneth Rogoff, Professor of Public Policy
The financial sector is too big; as a sector it’s 3%-4% of the economy but in recent years it’s represented 30% of corporate profits, and because of all of the outsized pay packages, 10% of the wages in the country. The sector needs to shrink, which is what’s happening now. Why should we prop this sector up? What makes them more special than say the auto industry? This is especially true since we don’t know how much these investments are worth and the people that are going to *try* to price them for us are the same (unemployed) investment bankers who couldn’t do this before and created this whole mess in the first place.
Greg Mankiw, Professor of Economics
Falling housing prices, not bad underwriting, are the core of the problem; there was bad underwriting, for sure, but that isn’t all of it.
Everyone has known that the GSE (government-sponsored entities, i.e., Freddie Mac and Fannie Mae) were a problem but the politicians, on both sides of the aisle, didn’t wan to touch it. He served on a Bush-sponsored committee to review the GSEs and they made the same recommendations that a similar panel had made to Clinton but neither was acted upon.
As far as the presidential candidates’ responses, neither of them has done a stellar job of addressing the problem.
Robert Merton, University Professor and Nobel laureate
There has been a real wealth loss in the country, something like $16b to $18b.
There is a strong negative feedback loop going on in the financial markets now.
Need to figure out in the future how to reward innovation and take acceptable levels of risk without imploding the whole system.
(Coincidentally, I had written about Sanders Theatre a couple of weeks ago, so it was a real pleasure to be back there after fifteen years. It’s such a beautiful space.)
See also Larry Summers’ piece in the Harvard alumni magazine