Harvard Panel on the Economic Crisis

I went to a panel of Harvard professors discussing the current economic crisis. Here is the scoop:


Jay Light, Professor of Business Administration and Dean of the Faculty of Business Administration

Problem has three parts: leverage, liquidity and accountability. Comes from the failed new economic structure where “securitization”, or spreading out the risks, made values intractable. Bailout will help determine the value of these.

Robert Kaplan, Professor of Management Practice

Weak middle class took other mortgages to survive. They defaulted, and the de-leveraging got passed on and on. The Bailout is necessary to stabilize institutions, but not sufficient.

Elizabeth Warren, Professor of Law

Housing used to be THE way the middle class invested their money. The problem came from de-regulation. Investor started making weird deals to promote people to get more mortgages. These included “teaser fees for two years”. On the 25th month, people could not pay for them anymore. Greenspan promoted remortgages, this raised property values, and people bet on them, which raised them on more. It was a pyramid scheme passing the risk. Risks were “securitized”, a procedure that splits, shares and reframes risks trying to spread out the risk, but really making untractable what is being bought.

The Bailout is grabbing “the wrong end of the dog”. Buying untractable papers doesn’t make them tractable. Bailout tries to prevent the market from reaching the bottom by providing a temporary lift.

Solution: change bankruptcy laws to allow for renegotiation of mortgages. This will let the real estate market to find the bottom, their real values of the property. People will pay for that, and start from there. There will be loses, but people will keep their houses.
More regulation is needed. How can any company sell toasters that 1/5 catch fire?

Gregory Mankiw, Professor of Economics

He was in the republican panel evaluation the crisis 3 years ago. Their proposals agreed with what a similar democratic panel proposed: more regulation. This didn’t pass congress, guess who was lobbying against it?
People bet that housing would never fall, ignoring the great depression and Japan. Lots of people made that bet.

Bailout presumes this: “People are too pessimistic. The trash is worth more than the market value is now. Let’s buy it, market will get confidence, and buy it back.” Economists say: Treasury will overpay for the trashy paper. Treasury says: We will have auction to buy the trash. Econs say: This gives liquidity, but not capital. Treasury says: liquidity will fix everything. Econs: Give more capital to banks OR force banks to give capital.

The problem with forcing banks is that there is no mechanism for enforcing this. Mankiw described a situation where a regulator that goes to the bank and says (with italian accent): “Nice bank you have here… it would be too bad if something happened to it…” that made the whole theater laugh.

He stressed that politics and greed prevented regulation, and made fun of McCain’s ideas on how to solve the problem.

Is there another great depression around the corner? There are no tools to predict that. They are just trying to scare the public into giving them money. There will be problems, but no one knows of what kind. Treasury doesn't know better.

Kenneth Rogoff, Professor of Public Policy

What is happening at Washington now is incredible. “Give me money, with no oversight, or the world will end.” The financial sector is bloated, look at the bonuses they give each other. It needs to shrink even MORE that it has right now. The Bailout will end up in better salaries and bonuses to the people that started this mess. A smaller financial sector might be healthier, unlike in the great depression. Reverse auctioning the trash wouldn’t work, because nobody knows how much the trash is worth. The plan is to give 700B$ to Treasury. He will buy the trash. No one knows how much the trash is worth. Who will Treasury hire? The same investors that just lost their jobs for not knowing how much the trash was worth to start with! They will funnel the money to get their old jobs back, and the public will pay for all that. That is the bailout plan.
We borrowed too much. We screwed up, and to fix it we want to borrow from Beijing so we can get back to how things where for the people that made mistakes?
Recall that the Technology Sector fell apart, and it came back. Now the same should happen. Some regulation is necessary, but not too much, so it can rebound back.

Robert Merton, Economics Professor, Nobel Laurate

We have a liquidity crisis and a financial mess. But we also have a real wealth loss due to falling house prices. People lost money. Nothing can resurrect that, nothing will come back. He made fun of the financial sector, calling them complete idiots that don’t connect their math to their behavior. This led to a risk feedback loop. This was understood and ignored.

Also, keep in mind that you have to be careful with too much regulation, substituting too much administration for the market brings unforeseen problems. Global solutions are needed. Boards of directors of the financial companies don’t understand the technical aspects of their businesses. Bailout is NOT good. But, he doesn’t know what to do. It is not easy now for the people that have to decided on this.

Questions Section – An investor in the real estate market agreed fully with Prof. Warren. That was exactly how the real estate market thought and worked.

Another person asked where does the real losses will fall now?
Merton – will fall between homeowners and financial institutions. The trade off will be a political decision, not a technical one.

Mankiv – mitigate the losses by creating mechanisms to renegotiate the mortgage preventing foreclosure.

Warren – How are the guys that caused this now in Washington DEMANDING that we congress does not give mechanisms for renegotiating the mortgage? They should be kicked out of there.

Rogoff – This situation is bad. There are losses. It will be a while before the lending market works again. But, keep in mind that there can be winners. Young people will face low house prices when getting their first homes.