U.S. News

Yale Economists Discuss The Financial Crisis (VIDEO)

In front of an audience of Yale alumni, university president Richard Levin hosted a fascinating discussion Tuesday on the financial crisis with John Geanakoplos (James Tobin Professor of Economics) and Robert Shiller (Arthur M. Okun Professor of Economics).

All three professors challenged the Obama administration's approach to fixing the crisis, with Geanakoplos and Levin laying out the most withering critiques.

According to Geanakopolos, the premise behind Treasury Secretary's Tim Geithner's plan is fundamentally wrong. Alluding to the famous "pound of flesh" loan in Shakespeare's "Merchant of Venice," the fast-thinking economist emphasized that the solution to the foreclosure crisis is not to reduce mortgage interest rates but to write down the principal. If a homeowner's principal is reduced, "he's going to find a way to pay... It's common sense to me and it's frustrating to me that they're not doing it."

In addition, he emphasized that the government needs to "re-leverage" the system, explaining that one of the causes of the crisis was the high level of leverage in recent years, which alarmingly grew to 16 to 1 with toxic securities.

"Warren Buffett and Bill Gates could have put $150 billion down and bought every single toxic security (totaling $2.5 trillion) in the country." Wealthy optimists end up holding most of the assets and lose their money when the assets crash, explained Geanakoplos. "Once the optimists disappear, activity stops" because the general public isn't buying or selling assets.

"You should never let leverage get so high in normal time. The Fed should be monitoring leverage and preventing people from putting only 3% down on a house."

The TARP program failed to re-leverage the system, argues Geanakoplos because "they just gave the money to banks but the banks aren't lending the money. They just sat on the money." He proposes that the government goes around the banks, which the recently proposed TALF (Term Asset-Backed Securities Lending Facility) plan may accomplish.

"It's shocking to me that we just keep pouring money into banks considering how insolvent they are."

Levin agreed that subsidizing the interest rate doesn't make sense and that it makes more sense to write down the value of the loan, blaming the political atmosphere in Washington for the current housing crisis solution.

"There is an ideological aversion to doing the right thing here," he said, lamenting that his advice was "roundly rejected by everyone in Washington I've talked to."

Then, Levin blasted the stimulus package, "the biggest pork barrel opportunity ever," for containing billions in tax cuts rather than focusing on job creation projects. "Temporary tax cuts enacted are essentially worthless," he said, explaining that they have very little effect at creating jobs or turning around businesses because people use them to pay off their down debts.

"The stimulus program should have been job creation, not tax cuts. The stimulus program was awful, it totally missed the boat. Congress saw the stimulus program as pork projects, all pork; there could have been great ongoing public works projects - they should have doubled and tripled the number."

"It should have been all direct job creation but it was a political idea.. bring the GOP along and get a consensus bill but of course, they got three Republicans... I am as incensed about that idea as John is about the mortgage value thing."

Finally, Levin said temporary bank nationalization is preferable to the Obama administration's toxic assets program. "It's highly unlikely that plan will succeed," Levin said, because the banks don't have enough incentive to get rid of their toxic assets and because the government is "shareholders who took all this risk."

"What do we need as taxpayers? We need credit to flow... the banking system working. Seize the banks, split them along Glass-Segal lines... take the normal commercial assets and then spin them right back." As for the toxic assets, "pretend it's the RTC and take time unwinding all those claims... Now the government is selling the junk instead of buying it at too high a price."

Robert Shiller pointed out that economists failed to predict the problem by not considering the psychology behind the housing bubble and Wall Street excess. "We've gotten very speculative in our thinking. There was a psychology that developed... You still have these economists that say it can be explained by building costs, population and interest rates but we say it's more about the culture."

In addition to "real solutions," Shiller proposed "national psychotherapy" to get the country out of the crisis and to avoid a repeat.

Watch the discussion: