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Turmoil on Wall Street Is Affecting Main Street

A comprehensive study that pinpoints the extent and impact of the subprime lending crisis was called “one of the most exhaustive efforts to date” by the Wall Street Journal.

Funded by the Initiative on Global Markets, the research drew on the expertise of Wall Street economists and faculty from Princeton and Chicago GSB, including Anil Kashyap, Edward Eagle Brown Professor of Economics and Finance.

Released March 9 in New York at the second annual U.S. Monetary Policy Forum, the report was discussed by Federal Open Markets Committee members Frederic Mishkin and Eric Rosengren and was covered by media including live broadcasting on CNBC and Bloomberg television.

“The depth of the crisis hasn’t been hit yet if a new study by several prominent economists is correct concluding that unless financial markets can quickly recapitalize, banks are likely to cut back their lending to consumers and businesses by nearly $1 trillion,” Reuters reported.

Kashyap said, “The report gives a brief but comprehensive study of what’s happened, and it provides a framework for thinking about how the turmoil on Wall Street would spread to Main Street—what to watch to figure out whether it’s finished, and what it’s going to take for the stress to end.”

The report combines academic insights from Kashyap and Hyun Song Shin, professor of economics at Princeton, with the Wall Street perspective provided by David Greenlaw, managing director and chief U.S. fixed income economist at Morgan Stanley, and Jan Hatzius, chief U.S. economist at Goldman Sachs.

“We addressed two common views that are wrong,” Kashyap said, including the idea that this stress affects a few investment and commercial banks and won’t ever matter to Main Street. “We look at past episodes where this kind of stress was present and showed that it spilled over and affected the economy,” he said.

A second mistaken view is that banks experienced losses but raised enough money to cover them; in fact, several banks announced they intended to raise little more. But Kashyap said, “The recapitalization to date remains incomplete by our calculations.  If more financing is not found a large reduction in credit is likely.”

Launched with a founding grant form the CME (Chicago Mercantile Exchange) Trust, the IGM is supported by funding from AQR Capital Management, Barclays Bank, Northern Trust, and Deere & Company, which recently joined the list of corporate donors.

– Patricia Houlihan