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A panel of professors put forth solutions to the economic crisis that varied from a two-year bank holiday on dividend payments to a new type of self-insurance program for banks.
Panelists also debated the affects of a proposed auto industry bailout.
“Supporting zombie companies like GM doesn’t help,” said Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance. Government assistance was important for banks to prevent them from “going down one after another,” Kaplan said at the Myron Scholes Global Markets Forum November 18 on the Hyde Park campus. It was the fifth in a series of panels on the credit crisis presented by the Initiative on Global Markets.
Kaplan said the government’s first Troubled Asset Relief Program (TARP) failed because the perceived worth of banks’ loans and investments in securities did not square with their listed price. The infusion of billions of dollars did not change that perception.
He said the second round of TARP was needed to stop bank runs, but “my guess is TARP 2 will not be enough” to resolve the solvency problem. Banks need to raise more equity, preferably from the private sector, but government sources might have to put still more money into solvent banks. Insolvent banks will need to be restructured, merged, or shut down, Kaplan said.
Kaplan recommended the dividend holiday for two years to “allow the banks to build up solvency.”
Noting three bank crises within the past three decades, Raghuram Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, said more emphasis should be placed on averting the next crisis.
“What we’re going to see is a lot of fighting of the last war,” Rajan said. “We are, I can assure you, not going to have a subprime crisis ever again once we deal with this one, but we’ll have a crisis somewhere else.”
Rajan proposes a program that would automatically recapitalize large banks in a crisis, but be paid for by the banks up front. This would be a form of capital insurance, with the bank paying premiums in good times and the insurer paying out in really bad times, independent of the crisis source, he said.
“Writing ever more fire code to prevent the fire is going to be a little silly,” Rajan said, “because the fire will happen. It makes more sense to focus on creating more sprinklers.” He said currently the insurance was being provided by the taxpayer, without banks paying for it, and this had to change.
In the current crisis, John Cochrane, Myron S. Scholes Professor of Finance, said all that matters is whether or not the system can make new loans. However, what’s leading to a “frozen market” is not “bank lending that gets held on books and is subject to a capital constraint,” Cochrane said. “It’s the securitized lending that’s falling apart. Fixing the banks, which has been done, did nothing to revive this vast supply of risky debt,” he said. His diagnosis: what’s broken is the “middle part” of the financial system — hedge funds, investment banks, money market funds, structured investment vehicles, and other complicated securities. “We’re asking people to dis-intermediate, and hold complex securities directly,” Cochrane said.
A spirited debate ensued on whether banks were that different from industrial firms. . Rajan said it was a matter of degree. If GM were to fail, more than just the company itself would suffer, Rajan said. Spillovers would affect suppliers and workers. “If GM goes bankrupt, a lot of customers go away,” he said. “Clearly there could be an economic loss.”
While Kaplan predicted GM would continue operating if it goes into bankruptcy, Rajan questioned who would buy from GM if it were operating in Chapter 11. While not supporting the bailout, whether a company should be bailed out “really hangs on how big the spillover effects are for each and the possibility of recovery,” Rajan said.
From the audience, Eugene Fama, Robert R. McCormick Distinguished Service Professor of Finance, said, “You’re all missing the main point of a GM bailout: Savings equal investments. When moving capital to an unproductive use, you’re moving it away from productive uses.” Therefore, spillover effects likely will be smaller because new productive investment creates spillover effects as well. Unproductive investment “is really the displacement of productive investment,” he said.
Milos Dedovic, a student in the Evening MBA Program who works for an auto parts supplier, agreed with Rajan and said if GM goes through bankruptcy, customers would be concerned that GM wouldn’t be around to service cars. And since many GM parts suppliers also supply other American automakers, he said, if GM folded, it would impact the others as well.
— Mary Sue Penn