Ask an Economist: Breaking Down the Financial Crisis

wharton.upenn.edu)

(source: wharton.upenn.edu)

 

It has been a jarring September for Wall Street. It is just the middle of the month and some largest financial institutions have met an unflattering demise. Bernard Anderson, Professor at the Wharton School of Business in Philadelphia and a member of the Black Enterprise board of economists weighs in on the crisis, the economy, and which candidate is best prepared to rescue Wall Street.

 

BlackEnterprise.com: In March, securities institution Bear Stearns was purchased by J.P. Morgan Chase. Just last week the government took over loan giants Fannie Mae and Freddie Mac, and yesterday the federal government agreed to loan AIG $85 billion. Today Lehman Brothers was acquired by Barclays and on Monday Merrill Lynch was acquired by Bank of America. There’s a lot of flux in the financial services industry, what’s causing these financial institutions to flounder?

 

Bernard Anderson: There was a common problem with each of the financial institutions, and that was rooted in their heavy investment in financial instruments called collateralized debt obligations. A CDO is a debt instrument that companies invest in with the expectation that instrument will generate quarterly revenue. In this case they were mortgage backed securities. Now when you write off the value of those securities in order to balance in your portfolio, you have to raise more capital. Banks raise capital by selling shares, but in this case no one wants to buy the shares. The share price of the companies plummet, which means they face a capital shortage. They are running out of money to meet their financial obligations and that drives them near bankruptcy.

 

Fannie Mae and Freddie Mac were taken over by the government, how will this affect the way these companies will run now?

 

You will have government appointed officials running the companies. Those officials will technically be political appointees, but will have extensive experience in the private sector. They will be able to reorganize Fannie Mae and Freddie Mac and bring them back online as successful mortgage companies. Fannie Mae and Freddie Mac will be subject to far greater regulatory scrutiny. The federal government, probably through the Federal Reserve Board, will have new authority to regulate. Also, the treasury will have new authority to regulate and will be more attentive to regulating Fannie Mae and Freddie

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  • gary

    How is the Bush/McCain leadership responsible for the abuses of the private investment banking system by those within the system? It seems to me the real issue is not regulation but performance and integrity starting with the factual data: Clinton’s repeal of Glass-Steagal; the failure of both Fannie Mae and Freddie Mac under the leadership of Raines and Johnson respectively (both key Democratic contributors who netted tens of millions in bonuses for bogus balance sheet performance); and, the huge donations to key Dem leaders like Frank and Dodd.

  • Keith Williams

    I am watching the hearings and am mortified that Secretary Paulson wants the government to buy junk that he himself would not buy. I have been living in this country for 28 years and have seen the finance industry bailed out many times. I have issues with Mr. Paulson’s assertion that the world will end if it is not bailed out again. He was the number one hedge fund trader last year making billions by betting on the mortgage meltdown. The truth that will probably come to light is that he is simply trying to save his own skin at the expense of U.S. taxpayers. Furthermore, why bail out the finance industry after repeated accounting improprieties and restatements? The truth is that they are too smart for their own good and should not be trusted. Why not bail out automakers who have not “cooked the books” and are asking for what they need instead of what they want. Let AIG fail and allow their retirement accounts and annuitiestransfer to better run finance companies. Americans deserve a better deal.

    I also have issues with Mr. Bernanke and by extension, Mr Greenspan. The last thing this market needs is more cheap money. Propping up the finance markets with cheap money has exacerbated the financial industry’s calamity. Raising interest rates would narrow Wall Street’s profit spread and would naturally cause everyone to tighten their fiscal belts. Banks would not lend to unsuitable borrower and personal accountability would increase.

    Lastly, I have issues with wall street practices such as short selling which I believe is unethical and should be banned. I believe it is unethical to sell someone elses property and pocket the money and then hand back to that person a loss. Small investors like me need protection from this abusive practice. I think Mr. Cox should ban it outright or resign.

    The economy could be stronger if we:
    1. Refuse to bail out Wall Street
    2. Force Secretary Paulson to resign due to conflict of interest
    3. Raise interest rates
    3. Ban all short selling

    Get a backbone and grow some balls and stand up to Wall Street!

  • Keith Williams

    How is the Bush leadership responsible for the abuses of the private investment banking system by those within the system? No leadership on issues such as cheap money and abusive market practices like short selling. Bernanke has failed the nation by providing cheap money for Wall Street by keeping interest rates artificially low and creating a climate of fiscal irresponsibility. Higher interest rates would have ended this era of cheap money for Wall Street and caused everyone else to naturally tighten their belts. Shortsellers hurt small investors and institutional investors alike and the practice is unethical.

  • NIA-New Mexico

    Ok, I’m not the best when it comes to my own finances, however, this whole Wall Street thing seems very easy to me to solve. All those CEO’s and Wall Street “Giants” liquidate their assets (the many homes, cars, jewelry, and extra’s you know they have) to cover the debt.
    Have a random pick of 50 Americans (one from each State) join the “Americans from Main Street Program” help with the liquidation and over sight of paying the “HUGE” debt owned back to “US” and Wall Street. I’m sure with the average American helping with this “Americans from Main Street Program” this would pull America into the “BLACK” and out of the “RED”.

    Oh, and all those CEO’s and Wall Street Giants, NO JAIL TIME, put them to work with us. They can own only “ONE” home, one vehicle per family member living in that home. Performing 10,000 community work hours “hands-on help with the average Americans teaching effective work skills, help rebuild Americas neighborhoods, tutoring young American children and teens, working with the elderly. Helping with reading programs in own local Libraries. Work in a local hospital, ER, Urgent Care. Of course have some in the billing department where the clients have lost their health care and need to pay.

    Well you get the idea. Bring those CEO’s and Wall Street Giants back to
    American Main Street. Help some of them remember where they came from. And the other ones that didn’t come from “Main Street”, learn what it really means to be a “TEAM PLAYER” and a “TRUE AMERICAN”!!!!

    But then again I could be wrong………….

  • Henry Singleton

    This is an interesting Theory.

    I don’t know enough to determine if it would really work this way but I’m willing to give it a try. I’m against the $85,000,000,000 bailout of AIG. Instead, I’m in favor of giving $85,000,000,000 to America in a “”We Deserve It Dividend”".

    To make the math simple, let’s assume there are 200,000,000 bonafide U.S. Citizens 18+.Our population is about 301,000,000 +/- counting every man, woman and child. So 200,000,000 might be a fair stab at adults 18 and up..

    So divide 200 million adults 18+ into $85 billon that equals $425,000.

    My plan is to give $425,000 to every person 18+ as a “We Deserve It Dividend”.

    Of course, it would NOT be tax free.

    So let’s assume a tax rate of 30%.Every individual 18+ has to pay $127,500.00 in taxes. That sends $25,500,000,000 right back to Uncle Sam.

    But it means that every adult 18+ has $297,500 in their pocket.

    A husband and wife have $595,000.

    What would you do with $297,500 to $595,000 in your family?

    Pay off your mortgage – housing crisis solved

    Repay college loans – what a great boost to new grads

    Put away money for college – it’ll be there

    Save in a bank – create money to loan to entrepreneurs

    Buy a new car – create jobs

    Invest in the market – capital drives growth

    Pay for your parent’s medical insurance – health care improves .

    Enable Deadbeat Dads to come clean – or else

    Remember this is for every adult U S Citizen 18+ including the folks who lost their jobs at Lehman Brothers and every other company that is cutting back. And of course, for those serving in our Armed Forces.

    If we’re going to re-distribute wealth let’s really do it…instead of trickling out a puny $1000.00 (“vote buy”) economic incentive that is being proposed by one of our candidates for President.

    If we’re going to do an $85 billion bailout, let’s bail out every adult U S Citizen 18+!

    As for AIG – liquidate it.

    Sell off its parts

    Let American General go back to being American General.

    Sell off the real estate.

    Let the private sector bargain hunters cut it up and clean it up.

    Here’s my rationale. We deserve it and AIG doesn’t.

    Sure it’s a crazy idea that can “never work.”

    But can you imagine the Coast-To-Coast Block Party!

    How do you spell Economic Boom?

    I trust my fellow adult Americans to know how to use the $85 Billion “We Deserve It Dividend” more than I do the geniuses at AIG or in Washington DC.

    And remember, The Family plan only really costs $59.5 Billion because $25.5 Billion is returned instantly in taxes to Uncle Sam.

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