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The Humphrey Institute is hosting a panel of experts to address the current financial situation.
Download the MP3 audio recording of the panel discussion (1 hr 29 mins) or subscribe to the Humphrey Institute's Special Events and Guest Speakers podcast in iTunes:
Panelists include V. V. Chari, professor of economics at the University of Minnesota; Tim Kehoe, professor of economics at the University of Minnesota and advisor to the Federal Reserve Bank of Minneapolis; Arthur Rolnick, senior vice president and director of research for the Federal Reserve Bank of Minneapolis; and Thomas Stinson, state economist for the State of Minnesota and professor of applied economics at the University of Minnesota. The panel will be moderated by Jay Kiedrowski, a senior fellow at the Humphrey Institute of Public Affairs and former Minnesota Commissioner of Finance. A live-blogged account of the event is after the jump.
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3:50pm the Cowles auditorium is filling with people both from the University and wider community. Stay tuned here. The event will begin shortly.
4pm Prof. Robert Kudrle offers his welcome to the assembled group on behalf of the Humphrey Institute and Dean Brian Atwood. A recent poll indicates that "88% of people are alarmed about American economy." Until recently, crisis limited to American institutions--recently, however, coordinated global responses necessary. Asks panelists to consider four questions:
4:15pm Jay Kiedrowski, moderator: signs of the crisis are everywhere. Short term T-note interest near zero. Stock market hit 5-year low last week. Consumer confidence low. Iceland defaults.
Introducing panel, Art Rolnick, V. V. Chari, Tim Kehoe, and Thomas Stinson (see credentials above).
4:20pm Q: What are we doing to alleviate this crisis?
Art Rolnick (AR): On record as being an optimist. Even through prior crises, American economy has proven resilient. Virtually every decade since Civil War has seen bank panic. Federal Reserve is "lender of last resort" to banks, but also authorized to lend into the whole system. Fed has acted appropriately to lend against good assets at penalty rate--"not a bail out." Significant expansion of what Fed has done in past, but believes it will recapitalize system and bring liquidity to healthy institutions.
4:28pm V.V. Chari (VVC): "Remarkable, and remarkably unwise" legislation passed by Congress and signed by President a week ago. Fed is now lending under two conditions: "either you are breathing and alive, or you are not breathing and dead" [laughter]. Great number of policy responses in last month mean some of them must be right, but vast bulk are wrong. Asks whether policymakers believe capitalism rests on a "thin skin of confidence." Policymakers tell financial markets that transparency is of utmost importance, but themselves have acted in opaque ways through this crisis. Federal Reserve's own weekly data (as of Oct 1) indicate that interbank lending market is healthy. However, price of lending has increased. His analysis: either policymakers see something the rest of us don't, or they are panicking in the same way that others are.
4:35pm AR: Chari raises good question: why does message from policymakers seem to not match the data?
JK: Last week, we saw 3-mo Treasuries selling at premium. Commercial paper market tight. Last week, some troubling signs.
VVC: But in case of GE seeking overnight paper, not clear that GE is not a financial institution.
4:40pm Q: What are the causes of this financial crisis?
Tim Kehoe (TK): We've decided that some financial institutions are too big to fail (but not all). If institutions are "too big to fail," we should be regulating them. Bond rating agencies did not fully understand the "bets" that housing prices expected to rise. In Oct 1987, Dow Jones fell 34(?)% -- larger than stock drop in current crisis. "...You all remember the great depression of 1987?" [laughter] Stresses importance of asset allocation relative to expected retirement date.
TK: Echoes Chari's worries--what will "overreaction" in Washington do for future? In a well-functioning financial system, risk-takers should reap rewards. Not clear to TK that taxpayers will reap future gains. $8 trillion in mortgages outstanding in US. Back of envelope, TK estimates $320 billion losses. Is that a huge amount? Not unless we also bail out "bets" on bad mortgages. Agrees with AR, current situation does not share many similarities with Great Depression. More like Mexico '82 or Japan '91.
4:50pm Q: What are implications for Minnesota economy?
Tom Stinson (TS): "Short answer: I don't know." Part depends on what happens in larger US economy. Many policy initiatives put in place over last few weeks, will have to give these time to take action. We don't yet know whether there has been any real change. Many forecasters finding similar conclusions: policy actions of last weeks unlikely to prevent recession, though make it less deep; Minnesota economic growth likely to be negative in Q4 2008, also in Q1 2009; recently-lower energy prices will help. Each $0.01 increase in gasoline costs reduces aggregate discretionary spending by $1 billion. Expects acceleration of spending in Q4 2008 that will reduce depth of recession. Fewer housing starts than any year since WWII. U.S. employment figures very discouraging--have not yet hit bottom--expects unemployment rate to reach 7%+. Another rule of thumb: 1 point on the Dow equals ~$1.2 billion in wealth. To start recovery, must rebuild "thin veneer of confidence" that Chari noted.
5:01pm AR: So what is cause of crisis? (Cites article from 1999, didn't catch author's name) Root cause may be Fannie Mae easing standards for buying mortgage loans from banks. Not that expanding home-ownership is not well-intentioned, but the arrangement rested on rising prices. Turned out to be house of cards.
5:05pm Q: What is role of reregulation re: this crisis?
AR: If institutions are too big to fail, we must do better job of regulating these industries.
TK: Moral hazard is problem. Why does Wells Fargo want to buy Wachovia if Wachovia is in such trouble? Wells betting on government bailout?
5:08pm Q: Crisis has seen other nations taking lead on finding solutions to crisis. How does this affect U.S. ability to lead in future?
AR: Europeans facing same problems. Not sure of direction they are leading. Hopes U.S. can return to capital markets where investors who take risks have to pay on the downside.
TS: Is there an institutional structure sufficient to manage global economy? Do we need a fundamental restructuring of global institutions?
VVC: Financial institutions by design and nature highly leveraged. We have developed a peculiar attitude toward debt. We need provisions for debt to be converted to equity without having to go through bankruptcy--debt into preferred stock, of sorts.
TK: Chari is right about problem. Upside-down mortgages not the problem--huge costs come from bailing out those who "bet" on home prices. Must be willing to let those who took bad bets lose money.
5:15pm Q: How is political situation (unpopular outgoing president and closing weeks of campaign) affecting policy response?
VVC: Actions of policymakers in crisis "exactly the same" as that of administration--i.e. "we [the administration] have the information, you don't." Very concerned about asymmetry of information between Washington and rest of us.
TS: But these financial measures are not easily manipulated--spread between Treasury and LIBOR.
TK: For every thousand of those who sell low, there is one Warren Buffett who is buying to make billions.
5:21pm Q: How will crisis affect developing countries?
TK: For example, Mexican peso has depreciated 30% against dollar in last couple weeks. Uncertainty is hurting developing countries.
AR: Many will use this crisis to rail against globalization--believes this to be destructive to development. Must find true causes so that responsible policy responses can be undertaken.
5:24pm Q: What are signs that indicate crisis is lessening? What should we be looking for?
VVC: Look for narrowing TED spread -- indicating that inter-bank borrowing market growing more healthy.
AR: Stabilizing home prices. Sees lower home starts as appropriate corrective response.
TK: We'll see improvement when policymakers quit "running around like chickens with their heads cut off."
5:27pm Q: What is the one thing you'd like to see re-regulated to improve financial system?
AR: Commitment that "all investors must take a hit"--should be written in law.
VVC: In addition to what already noted, concerned that credit default swaps are simply an attempt to avoid capitalization requirements. These instruments should prompt greater regulatory scrutiny.
TK: Make it clear that, when institutions are not too big to fail, they must bear the risk of their actions. Avoid moral hazard.
TS: Rating agencies did not fully understand risks of credit default swaps, among others.
5:35pm JK: Thanks panel and audience. Podcast of this session available from Humphrey Inst home page.