John Duca, Thomas Fomby and Charles Ruscher all agree the biggest factor that led to the current financial crisis was excess leverage.
“Too many people got loans,” Duca said.
Duca, Fomby and Ruscher were the panelists at the undergraduate economics club’s annual academic panel. This year’s topic was “2008: Financial Meltdown.”
John Jose, undergraduate Economic Club treasurer, said the group is always striving to have varied viewpoints for each panel.
All three panelists are SMU faculty. Duca is an adjuct lecturer who is also the vice president and senior policy advisor of the Federal Reserve Bank of Dallas. Fomby is a professor of economics, and Ruscher is a senior lecturer in the finance department of the Cox School of Business.
The panelists discussed the lead-up to the crisis, as well as the current plans to solve it.
“This is not the first credit crisis, financial crisis,” Ruscher said. “We seem to have credit crises, financial crises every few years. The root problem is… we fail to learn from the past.”
Ruscher believes there are three primary reasons for the current problem. One is that the environment was conducive to moral hazard. Ruscher said since the government would bail out institutions, this lead to institutions believing that the government would bail them out again. In turn, the institutions took more risks.
Another factor was the complexity of the current financial instruments.
The last reason is “it seems like institutions were too large to fail,” Ruscher said. “This creates the need for government to bail them out.”
Fomby also discussed his thoughts on how the crisis came about.
“Our weaknesses began after the dot com bubble burst,” said Fomby. Added to that was the events of 9/11 and the uncertainty that followed. According to Fomby, this uncertainty caused the Fed to “act proactively” by lowering interest rates. Lower interest rates are conducive to borrowing money.
In addition, Fomby said that Congress wanted to get more people into homes. “There was a desire for everyone to have a home.”
In 2004, Fomby stated that the Securities and Exchange Commission allowed the five largest banks to self-regulate themselves. He noted the debt to equity rate increased from 15 to one to 30 to one. He said this was “outlandish.”
Duca discussed a “false sense of protection” that many investors got from innovations. But as the “loans went sour, people’s assets went bad.” Furthermore, Duca noted there was a lot of lending occurring between institutions. This created “a tremendous amount of distrust.” This led to a seizing up of banking and finance.
“You didn’t know if people who were going to pay out were going to pay out,” Fombey said, describing it as like an insurance company who didn’t pay claims even though customers paid the premiums.
Both Fomby and Duca said they prefer the idea of injecting capital directly into banks to solve the problem. Duca explained that this would allow taxpayers to invest in non-voting shares of an institution. These capital injections would buttress an institution’s capital base.
Ruscher agrees that capital injections were appropriate for some institutions that were viable, but he favors a resolution trust corporation (RTC) approach. He said this has proved to be more effective in past crises. This method allows some institutions to fail, which Ruscher said has to happen.
All three panelists agreed that a degree of regulation within the economy was needed.
Duca said there were three reasons to be optimistic about the future of the economy. One is that we have a flexible market system. Another reason is that “we’ve learned a heck of a lot,” from modern macroeconomics. The last reason? Duca said his generation grew up with stories about the Great Depression.
“We’re resolved not to let the happen to you,” he said. “We’re going to come back. It’s going to get nasty, and we’re going to have a slowdown, but we still have our financial system core.”
