Interview with Marty Finkler, Professor of Economics and John R. Kimberly Distinguished Professor in the American Economic System.For those of us who do not know much about the economy:
What has happened in the last few months to cause the current economic situation?
Two things have happened that changed the situation. One is we have built ourselves a huge amount of debt. The ratio of the total amount of debt in the whole society to the GDP [gross domestic product] has tripled essentially in the last several years. That always puts us at risk. The specifics of the situation are that we have encouraged debt since 2001 to buy housing, whether or not people had the wherewithal to own those houses. Mortgage brokers sometimes give out NINJA loans, meaning no income, no job or assets. The reason they do this is because their interest is in completing the deal, whether or not the deal is a good deal.
Now when those mortgages got sold off to other banks and entities, they got sliced and diced and collected and put together in ways that nobody had any idea what was in them, and many of them were no good anymore. There may have been strong incentives up front for home-buyers to get the loan, such as low interest rates for two years, but now we’ve passed the two-year mark. The interest rates are now much, much higher, and those loans are not very good, or nonperforming.
The second thing that has built up recently is something called a credit default swap. What happened here was that the banks and investment outfits that bought and held these collections of mortgages were told by other organizations that they could purchase the equivalent of insurance. These came in the form of CDSs, which essentially said that if these loans go bad, then this other entity will help insure them. The problem, of course, was that none of this was real insurance and the loans did go bad. The investment banks didn’t have to hold any money and now we have an unknown number of these CDSs, estimated at being worth $62 trillion. This means that as these loans become nonperforming, the investment banks can’t pay what they owe.
The final kicker in the story that has happened in the last three weeks was the bankruptcy of the Lehman Brothers. A lot of the Lehman Brothers stocks, bonds or commercial papers were held overseas, and by allowing the company to go bankrupt, our institutions have created huge spill-on effects that we’ve seen in the last three weeks. And we now have a situation where no one wants to lend to anybody else, including banks to banks.
How does this affect daily life, for the greater population and for us as students?
Well, companies can’t get money to make payroll or to purchase their inventories. Everybody’s sales occur after they put in their effort to develop a product or service, and you have to have a working capital beforehand to do that. What’s happening, when the commercial paper market dried out, is that big companies have to go to banks to borrow money, and banks are worried about lending. So they’re only going to loan to the best of those companies, meaning that other folks are not going to get loans. The smaller you are, then, the more constrained you are in your options to get funding.
Students who are looking to invest in the stock market for three years, or maybe even five years are rolling the dice. It’s no different than going to Las Vegas. But presumably many of you are looking into the future and can take advantage of compound math and compound interest. In that case, there are a number of deals in the marketplace; the opportunity for good returns on your long-term money could be pretty good.
Congress finally passed a $700 billion bailout package. What is it supposed to do?
The primary objective is to recapitalize the banks, which is to say provide funding that the banks will then be willing to lend, in order to restart this cycle. The bailout package as it first came out was a two page memo from Secretary Paulson saying, “Trust me with your $700 billion, and I will take care of the problem.” That didn’t go over all that well. So it got amended in a variety of ways with some good oversight and some specific directives as to where it ought to go. Most of its focus is on attempting to buy up distressed assets. The problem with this so far is deciding which assets to buy and at what price to buy them. That’s not yet resolved, but in the meantime the economists are suggesting that we do as Britain did last week and buy shares in the banks that are going to restart the lending process. That way we don’t have to go through the tedious, dangerous process of deciding which assets to buy. That’s all to be negotiated, but that’s the route we’re taking.
Do you think it will work?
I think it’s the only route we have that will work relatively quickly. What we have to find is something that convinces folks who are sitting on the sidelines with their money that they can lend. How all these things work out it is unclear, but the primary event that will turn things around is the folks who are sitting on cash realizing that the deals are too good and that they should take some of the money they have and put it back in the market.
Do you think the outcome of the election will affect what happens with the bailout package come January 2009?
Probably not. It may depend on who the treasury secretary is, how credible that person is and whether or not they can put together the right kind of policy. I think we’re at the stage where everybody recognizes that this has to be above politics.
What advice do you have to give to students, especially those who are graduating this spring?
Educate yourself. Read a lot. Read ****The New York Times****. Read ****The Wall Street Journal****. Read ****The Economist****. Try to become informed. Don’t make quick decisions. Certainly don’t get in over your head borrowing, but that doesn’t mean you should ignore the stock market. Do your homework. Like anything else, if you want to do well in something you need to understand it; you need to understand the weak points and the strong points and where the opportunities are. What’s the job market going to be like come June? I haven’t the faintest idea. But if we act reasonably quickly, we’ll probably have a short, sharp downfall, meaning somewhere in the middle of next year, we’ll be on the upside. Hopefully, before June, but we’ll see.
Economy Q&A with Professor Marty Finkler
