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12 Pages
Session2B
Course: CEF 14507, Fall 2009School: Findlay
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Word Count: 959
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Wherearewe,howdidwegethere, OneInequalitywemustmaintain howdoweescape? Rememberthosemathformulaswealllearned inmiddleschool? Itboilsdowntoaseriesofsimpleinequalities WhereAreWe? Howdoyoufigureoutwhereweare?Howdoyoutakeourpulse? CNBCofcoursewhosontheairthesedays?Retiredgenerals? RetiredCEOs?CentralBankers,TreasurySecretaries,Economists, BeleagueredCEOs Weareinthedeepestrecessionthecountryhasfacedinthelast5060...
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Wherearewe,howdidwegethere, OneInequalitywemustmaintain
howdoweescape? Rememberthosemathformulaswealllearned inmiddleschool? Itboilsdowntoaseriesofsimpleinequalities
WhereAreWe?
Howdoyoufigureoutwhereweare?Howdoyoutakeourpulse? CNBCofcoursewhosontheairthesedays?Retiredgenerals? RetiredCEOs?CentralBankers,TreasurySecretaries,Economists, BeleagueredCEOs Weareinthedeepestrecessionthecountryhasfacedinthelast5060 years Nameapartoftheeconomythatisnttroubled.Healthcare,Energy, Housing/RealEstate,Transportation,Food,FinanceAllareinrough shape Consumerconfidenceisaslowasitsbeensincethemeasure wascreated
Whyiseveryonesoglum?Whatare thefacts?
TwothirdsofthecompaniescoveredbyS&Phavespeculativegradeorjunk rateddebt Homevalueshavefallenbyatleast25%.Manythinktheywillfallbyatleast another10% Whileweveapproveda$700billionTARP,someestimateshavethe potentialcreditlossesat$2trillion Investors,luredtotakerisksbythelustofnoncorrelatedreturnsdiscovered thatnearlyeveryassetclassbecamecorrelatedin2009
Howdidwegethere?
Heresthepublicstory:
SheilaBair(FDICChairman): Trillionsofdollarsofinvestormoneyfundedmillionsofmortgagesthat borrowershadlittlechanceofrepaying.Investorsreliedheavilyonratings agencies,whichinturnreliedtooheavilyonmathematicalmodelsinstead ofanalyzingtheunderlyingloans...theproblemwascompoundedbythe factthatthoseultimatelyholdingtherisktheinvestorsdidnotlook behindtheirinvestmentsatthequalityofthemortgagesthemselves GeoffColvin,Fortunebusinesswriter: Financialgeniusescookedupnewwaystobuy,slice,dice,reconstitute, andsellmortgagesasnovelsecuritiesthatnoonereallyunderstoodbut thatinvestorswerewillingtobuybecauseratingagenciesclueless, conflicted,andunregulatedsaidtheyweresolid.
Whatreallyhappened?
WallStreetgetssomeblame,butitcertainlyisnttheonlyonetoblame: Somewhereonthewaytoworkandpleasure,wegotintoxicatedasa country.Wethoughtthatmakingmoneywitheasymoneywastheright waytomakealotofmoney Wecametoprizefinancialengineeringmorethanmechanicalor computerengineering(anotherinequalitywegotwrong)whenthebest mindsinourcountrygotowallstreetandnotmainstreet NamethelastentrepreneurwhocreatedsomethinglikeSamWalton created
Whatreallyhappened?
TheMainStreetInequality BasicMacroeconomics
I C>=0;otherwiseyoutakeondebt
ButConsumersredidtheinequalityandthenbarelykeptitinbalance
I+Debt C>=0;toomuchdebt,what happens? Thefamiliarphrase:whenyouroutflow exceedsyourincome,yourupkeepbecomes yourdownfall
Howdoweescape?
ThePleasehelpmepath: Clearlythepathweareonisoneofincreasedgovernmentinvestmentand intothelargestbanks,mostofitto5particularbanks activism.Bytheendof2008,thegovernmenthadinjectednearly$200Bil Policyresponseshavebeenveryaggressive,intheU.S.,andinother countries Largedeficitspendingisnotanoptionlongtermbecauseoftheimpactto ourcurrencyandinterestrates(needtoraiseratestomakethedebt attractivetoinvestorswhenthatdebtisboughtbyoverseasinvestors, thatpropsupthe$,makingourexportslessattractive)andoptionsto workthroughfuturecrisesthatarentevenvisibletoday Moralhazardofthisapproachisrisky
Howdoweescape?
Thebesthelpisselfhelppath: Thebrutalbutsustainabletruth(thebestsustainablesolutionifthese werenormaltimes):
Weneedtogettheinequalityright Weneedtoproducesavings,notdebt Toproducesavingsweneedtodeleverourpersonalandcorporatebalance sheets Increasedsavingsisgoodmediumandlongterm,butdeepenstheeconomic contractionintheshorttermasconsumersandcorporationsceasespending
Howdoweescape?
Therealisticpath(becausethesearenotnormaltimes): Layingoutthetwoextremesmakesthepoint:Youneedboth:
Weneedincreasedgovernmentspending,investmentandbailoutintheshortterm Buttohaveonlygovernmentspendingwithoutsolvingthefundamentalproblemofthe inequalityonlyresultsinanintergenerationalinequalityofthegreatestproportionwe couldimaginesaddlingourchildrenandgrandchildren Aswebegintorecover,weneedtocorrecttheinequalityandmotivatepeopleto save.Thiswillrighttheinequalityandenableustorepaywhatweveborrowed. Goodnews:asofOctober,2008USsaved$260bilfrompersonaldisposableincome,up almostfourfoldfromayearea...
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