Wharton Faculty Discuss Financial Crisis

I would like to call attention to four videos which I showed in my risk management course this morning at Baylor University (in the order in which they were presented):

1. Jeremy Siegel: On the Resilience of American Finance

2. Joseph Gyourko: Fannie, Freddie, and the Housing Bust

3. Franklin Allen: Lessons from the Subprime Crisis

4. Richard Herring: What’s Next for Investment Banks

All four of these lectures were delivered at Wharton on Tuesday afternoon, September 16 at a Wharton “Teach-In” (see http://www.wharton.upenn.edu/teach_in_09_16_08.cfm). I also recommend viewing a panel discussion from that same day featuring Wharton professors Franklin Allen, Richard Herring, and Susan Wachter entitled “Wall Street’s Day of Reckoning: Turmoil in the Global Market”.

After viewing these videos, I now feel like I have a rough idea of how this (the so-called credit crisis) all came about. It’s really all about (perverse) incentives. I hope we can figure out a way to sunset (that’s a politically correct way of saying “get rid of”) Fannie Mae and Freddie Mac. We also need to think seriously about reforming public policy toward real estate; e.g., by abolishing the tax deductibility of mortgage interest. During the bubble we were encouraging consumers to make highly levered bets on a risky asset class (i.e., residential real estate), and it was funded by the likes of investment banks like Bear Stearns who had only had $1 of their own money and $32 of other people’s (creditors’) money at risk.

Also, according to the Wharton professor Joseph Gyourko, it now appears (after the fact) that the rating agencies probably relied too much upon historical US real estate market price data which showed that prior to the crisis, the national average price for residential real estate had never declined during the course of the postwar (WWII) period. The rating agencies incorrectly inferred from these data that real estate isn’t all that risky, and this helped to feed unrealistic expectations concerning real estate as an asset class (specifically that unlike all other asset classes, real estate “always” goes “up”!).

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