UC San Diego Experts Examine Causes, Suggest Fixes for Economic Crisis

Ioana Patringenaru | March 23, 2009

The federal government should conduct a thorough survey of banks to uncover bad assets. The Federal Deposit Insurance Corporation should take over insolvent banks. But tax cuts and tax rebates probably won’t do much to solve the economic crisis the country is experiencing.

Chancellor Marye Anne Fox introduces Friday's panel discussion.

Those were some of the insights five UC San Diego researchers shared Friday during a panel organized by the department of economics and the Rady School of Management. Getting out of the crisis will require a dramatic overhaul of the country’s financial system, they all agreed. During the 90-minute discussion, the four economists and one psychologist also went over why the crisis happened in the first place; potential signs of recovery; and how to try and fix it.

“The key is finding a solution to the financial crisis,” said UC San Diego economist Roger Gordon.

UCSD professors first came together for a panel last year to discuss these issues and more than 600 people turned out for the occasion, said Chancellor Marye Anne Fox. “Once again, we’ve assembled some of the top experts in the world to discuss the global economic crisis,” she said.

Audience members who turned out included former UC President Richard Atkinson and Qualcomm co-founder Irwin Jacobs.

Some prescribed solutions. Others analyzed the crisis itself. Cutting back interest rates will have little effect, said Nobel Laureate Harry Markowitz, who is on the Rady faculty. “It’s an information crisis,” he said. “No one knows where the bad paper is.” As a result, the government should conduct a thorough survey to find out where banks’ bad assets are, and their direct and indirect impact. Government agencies, including Fannie Mae and Freddie Mac, need to get a clear message that financial safety has to come before low-cost housing, he added.

Many banks may be insolvent and the solution here is to have the Federal Deposit Insurance Corporation take over, said Gordon. Getting toxic assets off the balance sheet of banks also will be necessary. Even without the toxic assets, many financial vehicles that institutions use today are so opaque that determining the real value of a bank can be difficult, Gordon said. The solution is to have the government conduct an audit of banks, a process that has already started, Gordon pointed out.

Dean Robert Sullivan, of the Rady School of Management, points out that the stock market is in much worse shape now than when panelists first met last year.

In addition, the current crisis is a crisis of confidence, said Craig McKenzie, an experimental psychologist who is on the Rady faculty. To get out of it, trust in government and the banking industry’s leaders needs to increase. The system needs more transparency, more accountability and more emphasis on ethics and social responsibility. “The more trust people will have in these institutions, the more wealth will be created,” McKenzie said.

It’s unclear whether the stimulus package recently approved by Congress will help, economist Valerie Ramey said. Tax cuts and rebates very likely won’t do much, she added. Ramey studied the effect on the economy of the 2008 tax rebate, which taxpayers received between May and July of that year. Consumption didn’t budge, but savings did. So people didn’t spend the money. They used it to pay down debts or simply saved it, she said.

Meanwhile, Ramey also surveyed research investigating the effect of government spending on retail sales. There, the evidence is mixed, she said. During the Great Depression, spending on public works and infrastructure led to a rise in retail sales. But during World War II, it didn’t. “The only certain effect of the current stimulus package is that it will leave us with huge deficits,” Ramey said.

Nobel Laureate Harry Markowitz outlines some measures the federal government could take.

All agreed that the current crisis is unprecedented and was extremely difficult to predict. A nationwide drop in real estate values had never occurred before, Gordon pointed out. Also, the exotic financial vehicles banks used were of an unprecedented complexity, he said. Ramey echoed his comments.

“I had no idea it was so national and that the financial system had such exposure,” she said.

The stock market and consumer sentiment index will help predict whether a recovery is actually on the way, Ramey said. Historical data shows that stock prices turn around three to six months before the country’s gross domestic product stops declining, she said. Consumer sentiment turns around two to seven months before. By contrast, the unemployment rate continues to rise for several months, she said.

Recovery could take years, as individuals, companies and agencies try to get rid of their bad debts, said economist Allan Timmerman. But the crisis did bring about some benefits, he added. Energy prices have come down. The personal savings rate in the United States is increasing after falling for years.

“In the future, we’ll be seeing fewer Starbucks lattes and fewer flat-screen TVs,” Timmerman predicted.