Experts Explore Global Credit Crisis Causes, Cures

February 19, 2009

Though it took most of the world by surprise, there were indicators that predicted the recent global economic crisis, according to panelists at the Virginia Law & Business Review Symposium's practitioner panel.

From left: Franklin Edmonds, Robert Bruner and Paul Mahoney

The symposium, "Global Credit Crisis: The International Role of the United States," examined the causes and effects of the crisis, and explored possible ways to revitalize the world market.

Robert F. Bruner, dean of the University of Virginia's Darden School of Business, said complexity and an information problem were among the principal causes of the U.S. subprime mortgage crisis.

Mortgages with a series of attached options were bundled into securities, securitized in portfolios, purchased and aggregated into whole trading positions, he said.

"By the time you get up to a sufficiently high level, no decision maker can have a real, clear idea of what is going on," Bruner said. "I submit at that the heart of every crisis is that complexity problem. The lack of transparency is the core issue, and when you bundle that with the high degree of leverage, which reduces the flexibility that individuals and firms and whole markets might enjoy, you have the tinder for an amazing bonfire, a big problem."

Panelist Franklin S. Edmonds Jr. '96, a senior research analyst and member of the investment committee of King Street, said the recession has been made worse by the Sept. 11, 2001, terrorist attacks, because the event likely postponed a recession that would naturally have occurred early this decade.

Over-optimism and short-sightedness were also blamed for the economic downturn, according to Chip MacDonald '79, a partner in Jones Day's Atlanta office. MacDonald said much of the population was acting as though home prices would continue to dramatically rise forever.

"In the housing market, you had people doing all kinds of things. You had people who were basically day-trading with their houses, and refinancing periodically," he said. "They were using exotic instruments like option ARMs where you pay this much this month but not next month, you pay interest only with no amortization. You had all this cash to spend, and people spent it rapidly."

Now, as financial institutions struggle to recover or, in some cases, survive the crisis, Edmonds said it is of the utmost importance that they lend scrupulously.

"Nobody is building a new factory, nobody is growing in any way. There are no new capital needs there — so who would you lend to? You would lend to companies that are struggling and might go bankrupt anyway; they're not growing, they're just in trouble. They're burning cash," Edmonds said. "I don't think there's an easy fix in lending more money to borrow money. Do we want to lend more money to that, or do we have to be patient and allow for people to fix their financial situations?"

The panelists said there is no easy or quick fix for the world's financial troubles, but Bruner said there are steps that can be taken to address the issue.

"How do you fight this? You address the complexity by means of transparency. You help explain to people what is going on. You help to reinstitute the safety and soundness of balance sheets in the financial system, " Bruner said. "Second, you flood the market with liquidity. Boy are we flooding the market with liquidity. And, generally speaking to build confidence, you address the issues of investor fear with assurances, with the intervention of tools of rescue."

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