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UCSD Economists Address Crisis
Last night UCSD held a forum on the financial crisis. Here are some of my rough and scattered notes about what each of the panelist had to say.
James Hamilton, a professor of economics. He is an expert on monetary policy, oil, prices and asset markets.
Hamilton presented on “How We Got Here”.
He pointed out that GSEs expanded greatly since the 1980’s and this was followed with an expansion of mortgage securitization. The GSE’s are government backed and the securities were opaque. Investors didn’t really know what the risks were and/or didn’t care (… oh, and the rating agencies failed again).
People issuing mortgages were making their money by completing transactions, not by holding on to the mortgage. They didn’t care if borrowers were going to pay back the loans. Borrowers didn’t think they would have to pay the high payments after their rates adjusted because they expected to have more equity in their homes by that time.
Between 2004-2008 there was $1.7 trillion worth of subprime loans issued. Many of those loans have, or will, see monthly payments jump by 20-45%. In 2007 there were 8 million households upside-down on their loans. They owed more than their house was worth. In 2008 there are 15 million. When housing drops 35% from its peak 24 million will be upside-down.
Hamilton publishes a blog called econobrowser.
Harry Markowitz, a Nobel Laureate and distinguished professor of finance at the Rady School. He is an expert on financial markets and investment theory.
Markowitz started by making the point that liquidity is not the problem. “Ignorance is the problem.“
He noted the lessons from the Japanese economic fiasco. If something is structurally wrong it needs to be corrected. In our economy the problem is that we don’t know the value of mortgage securities.
He suggests that efforts should be made to regularly estimate the value of financial instruments like those that are now causing Wall Street grief.
Ross Valkanov, associate professor of finance at the Rady School. He is an expert on asset prices and real estate finance.
Valkanov started by providing evidence that there was, and is, a housing bubble. Price appreciation was way beyond fundamentals.
What got us into this bubble? “Large bets on residential and commercial real estate by homeowners, GSEs, banks, and insurance companies.” Their bets were worsened by magnified leverage, and the extra leverage is why a 20% drop in real estate can “wipe out the whole system.”
He said the whole thing was , “almost a Ponzi scheme”.
Did we need a bailout? “Maybe not”
He also said, “Nobody expected such a large drop in the real estate market.”
He did mention Shiller’s 2002 paper on the housing bubble, “it was seen as a curiosity.”
What to expect from real estate values? The futures market is betting on the drop going back to 01-02 values. When would it return to 06 values? Many many years. I take that to mean, don’t even think like that.
He ended on the question of how long it would be before you could buy a La Jolla house for a Claremont price? He said, “I don’t know, maybe a year.”
I found it troubling that Valkanov would use data that has been widely available as evidence of a current housing bubble and then turn around and act as if it had been reasonable to dismiss people like Shiller who had been using evidence based arguments to point out real estate was in a bubble. Others have been noting the same thing and pointing out that our economy is tied into this bubble. That evidence was conspicuously ignored or dismissed by the mass media and countered by the National Association of Realtors and BIA economists(aka cheerleaders), who constantly told the public it was always a good time to buy, even if it wasn’t. What I had not realized was that the evidence and implications had also been ignored by most academic economists.
Allan Timmermann, the Atkinson/Epstein endowed chair and is a professor of finance at the Rady School. He is an expert on stock markets and asset management.
He pointed out that there is a real risk of a negative feedback loop firing up and shutting down the credit markets to a point where no one can get a mortgage.
The housing price decline still had a ways to go.
There is a lot of liquidity waiting to enter the market. Hedge funds, private equity, and sovereign funds could/will return.
Ross Starr, professor of economics. He is an expert on liquidity of financial markets and monetary economics.
Although this is the worse financial crisis in the USA since the 1930’s, it is not all that unusual in modern times. It is just unusual for the USA.
The government bailout can help to break the cycle of contagious fear in the market. The fear of being the final greater fool buy lending to an entity that won’t be able to repay. Many financial institutions have balance sheets that look bad or might be bad because of all their “toxic waste” assets. Those assets are mortgage securities.
The bailout plan will allow the government to come in and buy the “toxic waste” and substitute US Dollars on these firm’s balance sheets.
Starr started to address the question, “Is this [bailout] a gift to the financial institutions?” The answer wasn’t well developed, but Starr did make a suggestion for reducing that risk. He suggested that the “toxic waste” should be put to a competitive auction. He acknowledged that there is a private market that might start buying some of these assets after the government gets the auctions going.
So what if the bailout works? Best scenario is a mild recession. Worst scenario is a 1981-82 style recession.
On the Bailout
All the panelists were asked if they would have voted for the bailout bill. Four said they would have and Harry Markowitz said he would have voted against it. He said he would have voted for a bailout plan, “just not that rescue plan.”