 Carmen Reinhart is a Professor of Economics at the University of Maryland, and co-author, with Kenneth Rogoff, of the paper “Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison,” which was discussed in a previous article in Advisor Perspectives. Professor Reinhart is a Research Associate in the National Bureau of Economic Research and serves on the editorial board of the American Economic Review. She has held positions as Vice President at the investment bank Bear Stearns and more recently, as Deputy Director at the Research Department of the International Monetary Fund. Her areas of academic research include capital flows to developing countries, capital controls, inflation stabilization, balance of payments and banking crises, and contagion. She recently testified before Congress on the causes and cures for the sub-prime crisis.
We spoke with Professor Reinhart on March 19, 2008.
Your paper makes a strong case for a two- to three-year period of economic recovery from the sub-prime crisis, based on historical precedent. Have any of the recent events, including the failure of Bear Stearns and the most recent Federal funds rate cut, changed your opinion about the severity of the crisis or the projected recovery period?
The idea that it takes two to three years to recover is not unique or new. After gong through a crisis of this order of magnitude, you do not have willing lenders. Lenders are reluctant to make loans of any kind, irrespective of quality. That is the definition of a credit crunch, and it is not overcome in three to four months; it takes a while. The good news, if it can be considered good news, is that we are six months into the crisis period.
None of the historical examples cited in your paper involved the securitization of debt, which spread the risk of default across a wide range of holders of debt. How important a role does securitization play in differentiating the US crisis from your historical examples?
This is a very sophisticated question. The securitization that took place with Brady bonds was similar. [Editor’s Note: Brady bonds were created in 1989 as a mechanism for mostly Latin American countries to securitize their debt that had gone into default in the 1980s.] Most run-of-the-mill crises do not involve securitization, except in the case of Brady bonds. The current crisis is more unique. As I noted in my testimony to Congress, these sub-prime loans are no better than what would be made to a banana republic. The borrowers were not credit worthy.
I wish I could offer a better answer to this question. It could be that sub-prime debt ends up being repackaged through another round of securitization.
Do the actions taken by the Fed resemble the ways other governments (especially the “big five”) dealt with their crises? What regulatory actions, both in the short term and the long term, have proven to be most successful in dealing with the historical crises you have studied? Should the Fed have let Bear Stearns go bankrupt – and avoid the “moral hazard” dilemma?
The Fed has been really good in terms of how quickly it has acted, but really bad in the way it has acted. The Fed had to reduce interest rates in a hurry, and it acted perfectly in this respect. But doing it in “panic mode” does not instill confidence. One of the big problems Japan had was that it dragged its feet, mostly through indecision with respect to dealing with inflation versus easing credit. We should not worry about inflation now; we can worry about that later. As long as the Fed acts symmetrically, and raises interest rates as swiftly as it has lowered them, it will stem inflation. Our first concern is mitigating the recession associated with the credit crunch.
My opinion of the fiscal stimulus package resembles that of our monetary policy. It is good that we are doing it. It will minimize extent and severity of the crisis, but it will not avoid it.
Display article as PDF for printing.
Would you like to send this article to a friend?
Remember, if you have a question or comment, send it to
. |
