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Finance professors dissect financial crisis and the government’s response
Published: 2009-04-17
Three finance faculty who spoke at a workshop on “the Financial Crisis and the Economy” echoed a common theme: federal monetary policy alone can’t fix the U.S. economy.
Stephen Buser, René Stulz and Ingrid Werner provided analysis from three perspectives—macroeconomics, the role of risk management and derivatives and the role of short selling.
Professor René Stulz discussed how banks, investment firms and hedge funds were exposed because of their holdings in bad securities and derivatives that were tied to subprime mortgage defaults. The losses in those holdings led to downgrades and a slowdown in securities that resulted in a lack of solvency at some financial institutions, according to Stulz, the Everett D. Reese Chair of Banking and Monetary Economics and the Director of the Dice Center for Research in Financial Economics.
Buser, professor emeritus, looked at the crisis from a macroeconomic view. He discussed why the economy went from being “fundamentally strong” to one that was the “worst financial crisis since the Great Depression.”
Buser pointed to the messy combination of circumstances and business relationships that led to the economic crisis. The domino effect of the glut in housing stock, subprime mortgage market, re-packaging of risky mortgage loans that were sold to hedge funds and other investors (Merrill Lynch, Bear Stearns, AIG), he said, fueled the housing bubble burst.
When the housing bubble burst, the government’s response was the creation of the Toxic Asset Relief Program. That financial bail-out plan was the result of a collision of bubble economics and political economics, Buser said. However, he said there is a fundamental lack of understanding of exactly where all the toxic assets are to justify what institutions qualify for TARP funds.
“How much of the toxic assets have we’ve actually bought with that $700 billion,” Buser asked. “None. There’s a lack of transparency. In the good old days if you were a mortgage lender, you would make a loan and you would hold the paper. Now you make the loan and you sell it to somebody else and they package the loan with a bunch of other loans and that continues on down the line. So, we have no idea who these investors are.”
Yet, Buser maintains the vast majority of banks and their mortgage loans are performing well. The problem lies with the wide use of mortgage derivatives, which were side bets on bank mortgages, he said. So companies such as Merrill Lynch, Bear Stearns and AIG, which bought re-packaged subprime mortgage loans through investments, lost their bets on those derivatives. Now, those are the companies that TARP is actually bailing out.
In the meantime, the government has a one solution fits all approach to trying to fix the problem, Buser said. “The government is trying to throw a ‘TARP’ over the financial crisis. But it’s making it harder for the private sector to figure out what is going on.”
In her discussion on short-selling, Professor Ingrid Werner, the Martin & Andrew Murrer Professor of Finance, agreed that the reaction by policy makers, which halted stock short-selling in response to the financial crisis was a knee-jerk reaction that would not fix the real problems in the economy.
“Regulation, in my mind, was ill conceived,” Werner said. “The SEC (Securities and Exchange Commission) was caving into political pressures.”
