The Flash recording is right here.
Unfortunately, this is the last webcast for now; the final class on December 9 will not be recorded. For previous classes and class-related materials, use the Classroom category.
Thanks to all of the participants on the Internet.
The Baseline Scenario 
It’s a sobering discussion of the situation.
I have a radical idea, and aside from it’s political feasibility, I’d like some economic thinking about this:
If banks are not lending, even with the massive injection of money into their coffers, why not have the gov’t take on the role of the banks directly. For the amount of $500 billion, the U.S. gov’t can in effect nationalize (or purchase) several banks and lend directly – directly stimulate the economy without the “middle men” sort of speak. This is partly rhetorical, but if the scale of this crisis is unprecedented, then so too should the solution.
Thank you for these webcasts. The discussions were helpful and the students were very impressive.
To some extent, the government is playing the role of a bank. For example, when the Fed buys commercial paper directly from companies, it is in effect loaning them money for short periods of time.
The most common argument against simply nationalizing the banks (as you suggest, by buying all the shares, as opposed to seizing them) is that the government should not be in the business of running banks. People worry both that the government doesn’t have the right skills and that the potential for improper political interference is too great. I’m not saying that’s an unbeatable argument, but that’s the conventional wisdom. That’s why, for example, Treasury only bought non-voting, non-convertible preferred shares in banks – to avoid any measure of government control. (Yes, I know it sounds weird – on the one hand, explicitly avoiding control and, on the other hand, complaining when the banks don’t do what you want them to do.)
Very appreciative of the Webcast and the Web site – thank you.
W.R.T. the Webcast: Regulation can’t force risk management to the C-level, but for global banks, can’t risk be constrained via two regulations at the national level: 1) limit the business areas that a bank can engage in; and 2) restrict leverage so that a bank is more likely to be able to bail itself out from its own excesses or (innocent) mis-calculations?
I agree with you that there are things that make it politically infeasible for the gov’t to run banks, both from the “front” – the decision to do so- and “back” – the possibility that political influence may negate any positives- ends.
But, it appears that the bottleneck for moving the stimulus into the “real” economy is very much the finiancial system itself; which in normal times is the nexus of efficiency. But now, that nexus is operating on fear and is interested mainly in self-preservation.
Assuming that a governance structure can be created to isolate gov’t banks from undue political influence; gov’t run banks may in concept:
1) bypass bottleneck financial system by directly affecting the stimulus in the economy
2) stop the ineffective “bailout” of the organization that created the problem in the first place
3) potentially be investment opportunitie for private equity – a multiplicative effect of bailout dollar?
4) the gov’t has already in effect guarantee many private businesses (banks, auto…what else?)
5) the gov’t could potentially profit by eventually selling the banks when the crisis is over
But of course other GSE’s (Fannie and Freddie) hasn’t done all that well….
Thank you for the excellent webcasts and blog. This is a great public service and I hope you will consider doing more webcasts in the future.
Thank you for sharing your class with us.
You conclude with:”The world economy won’t go out of business but will come back with the same structural flaws and same tendency to crisis. If you’ve got a way to change the incentives of the financial system, tell me, I’ve got a minute”.
OK. Here goes…
First, I don’t think you should be so coy about sharing next week’s discussion on the downside scenario if you think it so improbable. Personally, I think we are looking at the collapse of the world financial system as we know it.
Second, “how do you change the incentives of the same old structurally-flawed world economy?” seems to me to be framing the question too narrowly; in the corny old words of Einstein: “we can’t solve problems by using the same kind of thinking we used when we created them”.
Third, there is a solution.
If we let people like Robert Rubin absolve themselves of all responsibility, then they are certainly right the problem is society’s, and the answer must be societal, too.
The Financial Times agrees with you:
“What makes the management of this crisis so difficult is the opacity of the modern financial system. So much business in new markets has been screen-based, not on organised exchanges. Property has been packaged into obfuscating structured products. It is a truism that regulators and supervisors are always a step behind practitioners in understanding financial innovation. In the current debacle they have been several steps behind. Opacity is partly to blame. Even bank boards and top executives have been woefully ignorant about the financial plumbing of their organisations.”
Greenspan hints at a solution (pages 489-492 of “The Age of Turbulence”): “Only belatedly did I, and I suspect many of my colleagues, come to realize that the power to regulate administratively was fading. We increasingly judged that we would have to rely on counterparty surveillance to do the heavy lifting.”
Research on highly reliable organizations (such as nuclear aircraft carriers and hospital emergency departments that do risky work but remain relatively free of accidents) shows that their success depends on a culture of collective mindfulness. Weick and Sutcliffe in “Managing the Unexpected: Assuring High Performance in an Age of Complexity “(2001) observed that these organizations have five priorities.
1. They are preoccupied with the possibility of failure and so encourage error reporting, analyze near misses and resist complacency.
2. They seek a complete and nuanced picture of any difficult situation.
3. They are attentive to operations at the front line, so that they can notice anomalies early while they are still tractable and can be isolated.
4. They develop capabilities to detect, contain and bounce back from errors, creating a commitment to resilience.
5. Finally, they push decision-making authority to people with the most expertise, regardless of rank.
So, how do you foster such a needed “culture of collective mindfulness”? Margaret Wheatley supplies the answer: “To bring health to a system, connect it to more of itself. The primary change strategy becomes quite straightforward. The system needs to learn more about itself from itself.”
Precisely how you do that is the subject of my book “Yala: How to Manage Complex Relationships” (David Schmittlein and JoAnne Yates have copies). About which, Christopher Gibson-Smith, Chairman of the London Stock Exchange, wrote:
“Geoffrey Morton-Haworth’s book, Yala, presents the challenges of managing complex relationships with rare clarity. This will help everyone, from those who tried and inexplicably failed, to those who succeeded and want to do more.”
See also www. yalaworld.net and http://www.yalaworld.blogspot.com.
We all see it, the lawyerese at the bottom of the prospectus. Past performance is not an indication of future returns. Why is that? In a lot of ways, Rubin is right in saying it is not his fault. Risk mitigation is inherently done by model and the models are not designed to predict exogenous events.
As with any innovation, people were initially cautious of securitization and it was used without incident. But if something mints money, competition drives excess profit out of the system. As long as there is no exogenous event, risk premiums will be driven down, risk is mispriced, and a bubble will form. Humans just do a poor job of discounting outlier events and this is magnified in the market because lowest price wins (ie, the person who under prices the risk most gets the business).
So were the profits really excessive (or is the market too successful at driving out shock related costs)?
Maybe we should just not make shocks an outlier. The government should manage the economy so that dislocations happen on a more frequent basis to maintain a healthy level of fear. Reward the people who are conservative and make bullet-proof businesses. A financial Darwinism.
The people who design mission critical systems are certainly paranoid. They live in fear that they missed something and build in huge margins of safety to make sure that they can deal with issues that were not considered. If the financial system is mission critical, then the same factor of safety must be applied. But just like in the physical world, if you engineer something to be mission critical the costs are high (maybe too high).
Just finished watching this online and it was a great class. Have a request for you, PLEASE make your next class available online as well. Thanks
Your very gracious recording and sharing of the lecture series as a webcast will be sorely missed.
Truly the best economic discussion and information available on the net.
Please bring them back. I’d be willing to help if there is anything at all that I can do.
-Bill
I’ve read many articles about this crisis, listened to reports on NPR, viewed the classes on this website, etc. and what strikes me as odd is the lack of prosecution and civil law suits for those involved. For the executives at the top that made the huge profits from either: making the mortgages to unqualified borrowers, bundling the bad mortgages into CDO’s, rating the CDO’s AAA, creating credit default swaps on the resulting toxic products, etc. there needs to be a day of reckoning with our legal system. The profits from this conspiracy of silence must be reclaimed / disgorged. It’s beyond belief that the heads of these businesses did not realize the towering house of cards they were creating. They put the global economy at risk and then float away to safety in their golden parachutes.
Observer…
Yup, that about wraps up the situation. Very well said.
And now we have a completely dysfunction financial system, zombie companies (and countries) and destroyed family finances.
The ex-CEO of Merrill Lynch is the poster boy of this; destoyed a 94 year old company (in just a few quaters,) and left with $160 million… fading into the sunset not to be heard from again.
Please reconsider posting the last class. Hearing an unedited conversation about the worst case scenario of the situation is important.
I think an effective bank regulation reform should include criminal penalties for managers of banks and rating agencies for certain types of behaviour… including not having/following adequate risk managment policies.
The US should be locking up both “the folks who steal the goose from the common, and the folks that steal the common from the goose.”
Thanks for making the classes avilable. Excellent discussions. I noticed, though, the low attendance in the class. I undertstand that this might be due to the time of the year (end of classes, last assignments, etc., but it makes me wonder if his isn’t a trait of MBA students. They devote a lot of attention to the mechanics of finance and company management but then seem to overlook (or unable to understand) the importance of the broader environment and conditions under which they (will) operate. Rather at odds with their own self image as strategic thinkerrs and future leaders of the business world.
PLEASE — If you cannot webcast the last class post some sort of transcript and sell it to me.