Wharton prof examines ‘bailout’
The U.S. economy is enduring its greatest upheaval in nearly a century.
A financial crisis that began with a housing bubble and too-easy-to-get credit has since exploded into a full-out economic nightmare, with lending at a near standstill, storied Wall Street financial institutions falling apart and, most recently, the federal government stepping in with a proposal to bail out not only insurance giant AIG, but also, essentially, the entire banking industry.
Though details of the plan were still being worked out as of this writing, it appeared the Bush administration, Congress and top economic officials were working on an agreement that could see the U.S. government buy up to $700 billion in bad debt from troubled financial institutions. Bush administration officials say the plan—which comes on the heels of the government’s earlier bailouts of Fannie Mae, Freddie Mac and AIG—could finally get the U.S. economy moving again after it nearly ground to a halt last month.
In short, there’s been plenty of bad news to go around of late.
There’s likely more to come.
But Joseph Gyourko, the Martin Bucksbaum Professor of Real Estate and Finance at the Wharton School, says while the economy may be tanking, he would be lying if he didn’t admit this much: It’s certainly an interesting time to be an academic.
Because what we are witnessing today, says Gyourko, is truly historic.
“It is probably the biggest financial crises we’ve seen since the Great Depression,” says Gyourko, who serves as director of Wharton’s Zell/Lurie Real Estate Center. “There’s a lot of interesting stuff going on. But it’s not a happy time. It’s tough.”
And just how tough was made clear earlier this month, when the government announced that, because its piecemeal bailouts weren’t having any impact on the downward spiraling economy, it would push forward on the massive bank bailout—a plan the likes of which Wall Street has never seen.
The proposal came about, Gyourko says, because of two factors: First, a massive run on money-market funds; second, a huge influx of new investments into U.S. Treasury bonds, even though those bonds were delivering almost no return at the time. “People were willing to lend their money to the U.S. government for almost no return,” Gyourko says.
“And they were willing to do that because they weren’t convinced they could lend it to anyone in the private sector and actually get it back. At least with the government, they knew they would get it back.”
That created a problem, Gyourko explains, because the economy simply doesn’t work if banks are only lending to the government. Private enterprise relies on bank funding to grow.
So when government officials realized just how bad the situation was—and that all lending, across all sectors, was at risk of grinding to a halt—they felt they had no choice but to propose the bank bailout, which would take bad loans off the books of major institutions and, in theory, get economic activity moving again. Gyourko says it could do just that.
But he says it likely won’t do much else.
“It’s everybody’s hope that this plan will cure that one problem—the incredible liquidity crisis, where banks were hording money, or were only willing to lend to the government but not anybody else,” he says. “I suppose this plan will solve that problem. But will this mean that housing prices will stop dropping, or that the real economy will start growing again? No. This plan does not solve those fundamental issues.”
As for the housing market—the sector that may be most responsible for this entire mess? Gyourko warns that it’s not likely to rebound anytime soon. While he points out that the housing market can be very regional—housing remains strong in areas such as Dallas, Houston and even Iowa, where local economies are propped up by high commodities prices—he also says several markets that have already taken a hit, including those in Florida and California, may see prices fall even further. “In San Jose, where the economy is very tech-driven, the market is still doing pretty well,” he says. “But in a financial center like New York, you might see prices drop a lot.”
Originally published Oct. 2, 2008.
