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Credit markets have recovered, although they still reflect massive government financial intervention. The financial panic of 2008 and 2009 has passed, though now bank failures are notably increasing. The net worth of the Federal Deposit Insurance Corporation is dropping, and estimates for its deficit are growing, but its obligations are
Download Audio as MP3 ultimately U.S. Treasury obligations. Average house prices seem to be stabilizing, but commercial real estate prices are dropping. Huge losses from the deflation of the great twenty-first-century bubble have been recognized or realized, and though more remain, financial markets have regained their appetite for risk.
At this event, our expert Deflating Bubble panel will define the lessons of the whole twenty-first-century financial experience and make related recommendations for future financial policy. Speakers will include AEI economists Desmond Lachman and John H. Makin; New York University professor of economics Nouriel Roubini; R. Christopher Whalen, managing director of Institutional Risk Analytics; and Thomas Zimmerman, managing director at UBS Investment Bank. AEI resident fellow Alex J. Pollock will moderate.
||Panelists:||Desmond Lachman, AEI
|John H. Makin, AEI and Caxton Associates
|Nouriel Roubini, New York University
|R. Christopher Whalen, Institutional Risk Analytics
|Thomas Zimmerman, UBS Investment Bank
|Moderator:||Alex J. Pollock, AEI
WASHINGTON, D.C., OCTOBER 22 -- At an AEI event, "Deflating Bubble, Part VI: The Lessons of the Bubble and the Crisis," panelists identified many lessons that policymakers should learn from the current crisis, and several affirmed their well-known pessimistic perspectives on the outlook for financial and economic recovery.
Prognosis for the Future
Organizer and AEI resident fellow Alex J. Pollock suggested we should "learn something useful from a painful experience." At this sixth installment of the three-year-old Deflating Bubble conference series, Nouriel Roubini, a professor at New York University's Stern School of Business, explained the three potential economic trends going forward: a "V" if the economy recovers quickly, a "U" if the economy grows below trend for the next few years before finally recovering, or a "W" if we experience a "double-dip" recession--a second downturn before a final recovery.
Roubini discussed his hope for a U-shaped recovery, suggesting that this scenario is more probable than a V. He explained that several economic indicators suggest that a steady recovery is unlikely to happen. Unemployment is rising, and income and consumption are falling. The damage to the credit system is severe, and even when credit growth becomes positive, it will not be as robust as in the bubble years. There is little possibility of growth in business investment; capacity utilization is only at seventy percent, and firms will not resume investing until capacity is fully utilized. Furthermore, now that the American "overspenders" are not spending, if our thrifty international counterparts, the "oversavers," do not compensate, there will be a global glut of capacity.
Roubini and AEI's Desmond Lachman and John H. Makin all agreed that the W scenario is the most likely. Roubini noted that a severe policy mistake could send the economy back into crisis, and Makin suggested such a scenario could already be happening. He observed, "If Congress was really concerned about not letting this crisis happen again, and this crisis was started by lending to people who can't afford homes, then [why is] the solution… $8,000 tax credits for people who can't afford homes?" Roubini also suggested there is a no-win exit strategy from the stimulus package; if it is taken away too soon, the weak economy will falter, and if it is taken away too late, there will be a runaway deficit. Roubini also worried about the impact of rising oil and asset prices and suggested that we may be "creating a huge asset bubble through monetary policy. . . . We've addressed one bubble by creating another, bigger one."
Given this grim outlook, will more regulation prevent another financial crisis? Not so, said Pollock. "If you think that regulation will save you, it won't." He noted that many of the problems that contributed to the crisis stemmed from "intensely regulated" commercial banks. Thomas Zimmerman, a managing director at UBS, agreed with Pollock, saying "regulation is necessary but not sufficient." Zimmerman argued for keeping several different regulators in the banking industry instead of consolidating supervisory powers into one agency, saying that he preferred to get several different perspectives from the government. Lachman pointed out two areas where regulation could be improved to realign incentives with the public interest: rating agencies and executive compensation. However, he noted, "there is no silver bullet on financial reform."
Both Lachman and R. Christopher Whalen, the managing director of Institutional Risk Analytics, highlighted the moral hazard that the government-sponsored enterprises (GSEs) created. Unfortunately, Whalen noted, the list of GSEs is growing rather than shrinking, and it now includes formerly-private companies like AIG and Citibank. The former was explicitly bailed out by the federal government, and the latter is receiving subsidies from the Federal Reserve and the Treasury Department, making it difficult, if not impossible, for the private market to compete. Makin elaborated on Whalen's point, saying that the number one lesson that firms have learned from the crisis is that "it's best to be too big to fail. . . because then you will get bailed out."
According to Lachman, economists have also learned that "housing and the economy are joined at the hip. . . . Housing is consumers' wealth collateral." Makin also emphasized this point, explaining, "the disruption in the financial sector had a devastating effect on the real economy. . . [and] almost created a global depression. . . . Last fall was a near-death experience." Zimmerman concluded with an old lesson about the financial sector, "When things are too good to be true, they aren't true."
Desmond Lachman joined AEI as a resident fellow after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy and Review Department and was active in staff formulation of IMF policies toward emerging markets. Mr. Lachman has written on topics such as economic policy, fund arrangements, monetary reform, import restrictions, and exchange rates. At AEI, he studies major emerging market economies and the role of multilateral lending institutions.
John H. Makin is a visiting scholar at AEI. He is also a principal at Caxton Associates. Mr. Makin has been an adviser to numerous U.S. government agencies, the Federal Reserve System, and the Bank of Japan. He is a member of the Council on Foreign Relations and the Economic Club of New York. Mr. Makin joined AEI in 1984 after a distinguished career in academic research. He is the author of numerous books and articles on financial, monetary, and fiscal policy, and he writes AEI's monthly Economic Outlook.
Alex J. Pollock has been a resident fellow at AEI since 2004, focusing on financial policy issues, including housing finance, government-sponsored enterprises, retirement finance, corporate governance, accounting standards, and the banking system. Previously, he spent thirty-five years in banking, including twelve years as president and chief executive officer of the Federal Home Loan Bank of Chicago. He is the author of numerous articles on financial systems and the organizer of the "Deflating Bubble" series of AEI conferences. In 2007, he developed a one-page mortgage form to help borrowers understand their mortgage obligations. He is a director of Allied Capital Corporation, the Chicago Mercantile Exchange, the Great Lakes Higher Education Corporation, the International Housing Union for Housing Finance, and the chairman of the board of the Great Books Foundation.
Nouriel Roubini is an internationally known expert in the field of international macroeconomics. He is a professor of economics at New York University's Stern School of Business and the cofounder and chairman of Roubini Global Economics LLC, an innovative economic and geostrategic information service that was named one of the best economics websites by BusinessWeek, Forbes, the Wall Street Journal, and The Economist. Mr. Roubini has served as a senior adviser to the President's Council of Economic Advisers and the U.S. Treasury Department, has published numerous policy papers and books on international macroeconomic issues, and is regularly cited as an authority in the media. He has also been a faculty member at Yale University.
R. Christopher Whalen is the cofounder and managing director of Institutional Risk Analytics, where he is responsible for sales, business development, and editorial activities. He has worked as an investment banker, research analyst, and journalist for more than two decades and has covered a variety of industry sectors, including technology and financial institutions. In addition to editing The Institutional Risk Analyst newsletter, Mr. Whalen contributes regularly to publications such as Barron's, The International Economy, and American Banker. He is a member of Professional Risk Managers International Association and volunteers as a regional director of the association's Washington, D.C., chapter and chairs its speakers committee.
Thomas Zimmerman is a managing director at UBS AG. He has been involved in managing the firm's asset-backed and mortgage-backed securities research efforts for the past eleven years. Before joining UBS, Mr. Zimmerman managed the asset-backed and mortgage-backed securities research groups at Prudential Securities and Chemical Bank. Mr. Zimmerman started his research career as a vice president in the mortgage research department at Salomon Brothers. His research has appeared in numerous fixed-income publications and industry reference works. He was a member of the UBS research team that consistently ranked first in the annual Institutional Investor survey of fixed-income analysts.