UCSD Experts Analyze Nation’s Financial
Crisis, Assess Prospects for U.S. Economy
Barry Jagoda | Oct. 6, 2008
Moderated by Professor Richard Attiyeh, the Financial Crisis Panel, L to R, Professors Ross Valkanov, James Hamilton, Allan Timmermann, Ross Starr and Harry Markowitz took a variety of questions from the audience.
It’s not clear whether the $700 billion government bailout of the financial industry will solve the economic crisis the country faces, but five UC San Diego economists and finance scholars said they hoped the economy will improve after several quarters of recession. They spoke on the U.S. financial crisis before overflow crowds Friday night at the Institute of the Americas on campus.
The five scholars unanimously agreed that faulty mortgages are the source of what Professor of Economics Ross Starr called “the worst economic conditions in America since the Great Depression.” All five experts also said they supported the economic bailout legislation that had been signed earlier in the day by President Bush, although Rady School of Management Finance Professor and Nobel Laureate Harry Markowitz said he favored a package with different content.
More than 600 audience members crowded into Hojel Auditorium or viewed the program on television in the nearby Weaver Center. The event also was webcast. The discussion, co-sponsored by the Rady School of Management and the Division of Social Sciences’ department of economics, was introduced by Chancellor Marye Anne Fox. “Whether you call the events a bailout or a rescue, it is certainly a crisis and underscores the importance of social science contributions in helping our understanding,” Fox said.
Participants and organizers of The Financial Crisis discussion, from L to R: Finance Professors Ross Valkanov, Allan Timmermann and Harry Markowitz; Economics Professor James Hamilton; Rady School of Management Dean Robert Sullivan; UC San Diego Chancellor Marye Anne Fox, Social Sciences Dean Jeff Elman and Economics Professor Ross Starr. (Photos / Nick Abadilla)
James Hamilton, professor of economics, spoke first and outlined in a plain narrative a history, since about 2004, of the residential mortgages provided by banks, savings and loans, government-sponsored providers and private institutions. These loans, Hamilton said, were granted even when there was no clear evidence that borrowers could pay them back. Many were in a category Hamilton dubbed “NINJAs,” for “no income, no job and no assets.” Soon, many homeowners had larger mortgages than the actual value of their homes. The crisis deepened when larger financial organizations took over the debt and found that they too had acquired properties with less value than the cost of the debts.
A way to avoid such future entanglements was presented by Markowitz, the Nobel laureate, who said there was a need for more information that would permit buyers and sellers to value the mortgage instruments. He presented a four-point plan for transparency in such future transactions, including a careful census of every financial transaction from original loan through various sales and additional ownerships.
Professor Harry Markowitz has developed a plan for transparency in mortgage transactions.
Finance Professor Ross Valkanov offered an explanation of why no one saw the financial crisis coming. The nation had experienced previous declines in the value of homes, but, never before, had the entire country been affected at once, he said. “Even if you had a 20 percent decline in certain parts of the country, financial institutions would not have been affected to such a degree because the toxic real estate assets on their balance sheets are mitigated by geographic diversification—their lower value is compensated for by better real-estate markets elsewhere. But when there is a sudden national plunge, banks cannot escape severe losses,” Valkanov said. He suggested the widespread national occurrence pointed back to the unhealthy mortgage dealing across the country.
"We are in the worst economic crisis since the Great Depression," said Economics Professor Ross Starr.
Liquidity has been the “common risk factor” for the entire crisis, said Allan Timmermann, also a professor of finance. “While people and institutions have to be willing to invest their money, in a crisis like the current one, there is a lack of funds for investment even in normally safe commercial paper issued by reputable firms, including among banks, where the cost of borrowing short-term funds has gone up dramatically, reflecting investors flight to the mattresses,” he explained. “As banks collectively attempt to sell off their risky assets—a process known as de-leveraging—prices are at risk of dropping even more, causing even more liquidity trouble for the banking sector.”
One test of the current bailout is if enough money has been set aside for the banking system to recover. “Does the current plan simply postpone the inevitable consolidation, which can be expected in banking as the crisis unfolds?” Timmermann asked. “In all cases, uncertainty about underlying asset values and future economic growth has to be resolved to a point where hedge funds, private equity, sovereign wealth funds and mutual funds are again willing to invest in risky assets,” he later concluded.
Meanwhile, economist Starr noted that the rescue plan is “a work in progress not only in its suitability to restore the system, but also as a vehicle to overcome the contagion of fear, with which we are victimized.” Starr said that if the plan is successful, we’ll end up with a couple of quarters of recession and get back on track. “If it doesn’t work, we will be in a serious crisis of liquidity that will last a long time and cause lots of danger,” he added.
The audience spilled out of Weaver Center where television was set up to handle the overflow crowd at the Financial Crisis Briefing.
Members of the audience raised many questions on diverse aspects of the crisis, which were fielded by the moderator for the program, Richard Attiyeh, professor emeritus of economics at UCSD. Members of the panel were asked whether they would have voted for the day’s plan. An audience member wondered which political party had the best advisors to follow up on the economy (answers were divided between the Democrats and the Republicans). Other questions included why the bailout didn’t go to individuals instead of institutions (it would take too long to be effective); what was the role of the news media (this was more about fundamentals than about perceptions), among many inquiries.
The idea for the discussion on the financial crisis came up in a conversation just over a week ago between Jeff Elman, dean of Social Sciences, and Robert Sullivan, dean of the Rady School of Management. “It is such a big problem and we have so much expertise on the faculty that it just seemed like the right thing to do,” said Elman.
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