Lessons from the meltdown4 min read . Updated: 11 Dec 2008, 11:39 PM IST
Lessons from the meltdown
Lessons from the meltdown
New Delhi: Dr. James R. Barth, Lowder Eminent Scholar in Finance, Auburn University and a Senior Finance Fellow, Milken Institute, Santa Monica, CA recently gave a presentation on “Global Financial Meltdown: Causes and Lessons for the Future" at a seminar in Delhi. Mint’s Rahul Sharma had a Q and A session with Dr. Barth. Edited excerpts:
In your view, who are the real culprits behind the global financial meltdown– the regulators or the bankers?
I think there is enough blame to go around everybody, including the US congress. You can say some lending institutions got a bit too carried away, reaching the high yield. And that’s the regulatory authorities have admitted that they should have been more on top of the issues in preventing such a terrible crises from striking the US.
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/Content/Videos/2008-12-12/Mint TV/1112_Dr Barth_Financial meltdown_MINT_TV.flv7138f67a-c798-11dd-9cc3-000b5dabf636.flvIs it a systemic failure or institutional failure?
I think it was the systemic crisis that spread through the entire financial system. It’s like a perfect storm; too many different things came together at one time causing havoc in the financial sector. It started in the home mortgage market area particularly some sub-prime borrowers people who were with greater credit risk than many others. Then spread not only throughout the United States but also other parts of the world. So it is a systemic failure basically but also had institutional elements in which we allowed institutions and financial players to do too many things they shouldn’t have done with too little money at risk.
Should there be a fresh look at credit agencies?
Oh yes! I think the credit rating agencies are receiving a lot of scrutiny today because they seem to have rated a lot of financial instruments, if not even companies, as AAA or high investment grade that turned out not to be so. I think they have some soul searching to do. Also, it turns out that I think we have to not so much bless these agencies. Governments have to be much more careful and warn investors.
If you buy financial instruments, do your own due diligence. Ratings by rating agencies are no good substitute for due diligence on the part of investors if they have lots of money at stake.
What is the remedy now?
The remedy is that home prices have to stop sliding because what we have is that as long as home prices are falling a lot of buyers hold off buying a home thinking, “I’ll wait till prices go still lower". We also have lots of builders who built too many homes. We have an excess inventory of unsold homes. So what we have to do is to wait until credit becomes more available, the real economy stops declining, then we have to see people go back buy homes. Home prices stabilize, start to go up. And we have to see that excess inventory of these unsold homes starts to go down, get back to more normal levels, then things should happen. The unfortunate thing, it’s going to take a year or two for that to happen. There is no quick solution when you’ve had such major problems in a country like United States.
What are the lessons for India?
Lesson is clearly, you don’t let people borrow without putting any money down. You know that people borrow the full value of a home. If they put money down, they have something at risk. If home prices were to stop rising, go down a bit, they don’t feel perhaps that now they got to walk away from that home because they basically own a home that’s worth less than the mortgage loan. So, you also have to have institutions that don’t become excessively leveraged, have too little capital. So capital is important and also borrowers have to be more aware as to what it is that they are borrowing and not borrow more than they can afford to repay. Those are the lessons and India has done a better job, so far at least than the United States.
About Dr. Barth
Dr. James R. Barth, Ph.D. in Economics from Ohio State University is the Lowder Eminent Scholar in Finance at Auburn University and a Senior Finance Fellow at the Milken Institute, Santa Monica, CA. His research has focused on financial institutions and capital markets, both domestic and global. Most recently, he served as leader of an international team advising the People’s Bank of China on banking reform.
Barth was an appointee of Presidents Ronald Reagan and George H.W. Bush as chief economist of the Office of Thrift Supervision until November 1989 and has previously served as the chief economist of the Federal Home Loan Bank Board. He has also held the positions of Professor of Economics at George Washington University, Associate Director of the Economics Program at the National Science Foundation and Shaw Foundation, Professor of Banking and Finance at Nanyang Technological University. He has been a visiting scholar at the U.S. Congressional Budget Office, Federal Reserve Bank of Atlanta, Office of the Comptroller of the Currency and the World Bank. He is a member of the Advisory Council of George Washington University’s Financial Services Research Program.