Money misery made plain
College professors take a hard gander at economic woes
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By Gordon Dritschilo Herald Staff - Published: October 2, 2008
MIDDLEBURY — David Colander said his students have been coming to him, asking him to explain what's happening to the economy.
"Since no one person understands what's going on, we thought we'd have four of us explain it," the Middlebury College economics professor said Wednesday from the stage at Dana Auditorium.
People packed the auditorium, with students sitting in the aisles, to listen and put questions to Colander and fellow economics professors Scott Pardee, Peter Matthews and Robert Prasch.
Pardee gave a brief history of the crisis, describing how the federal government relaxed mortgage terms and a new industry, mortgage bankers who did not lend money themselves, but helped people get loans, appeared.
Among these mortgage bankers, Pardee said, were some "bad apples" who ignored the income of home-buyers, helping them into mortgages they could not afford. At the same time, mortgages were packaged together and sold to other investors.
The questionable loans wound up bundled in among the safer ones. The mortgages were analyzed using mathematical models, but many sub-prime mortgages were not actually what they were advertised as. When investors found out what they really had, they began selling and the markets collapsed.
Prasch said the crisis illustrated a shortcoming in how economics is taught. He said textbooks frequently start with an analogy along the lines of one child with a lemonade stand trading product with another child selling cookies, each getting something and each being happy.
The problem, Prasch said, is that the lemonade merchant can examine the cookie, see how many chocolate chips it has and how big it is and decide whether to buy it. Finance, he said, doesn't work that way — a buyer often does not learn the value of an investment until later.
"As a result, what we really trade are our expectations of how we're going to do," he said. "This is very different time from a long time ago."
Once upon a time, Prasch said, a local banker knew all about the people he was loaning to. Now, he said, loans are handled and traded without much real knowledge of the investment, just statistical probability models.
Matthews said the current crisis had a number of similarities to major financial crises in five other countries since the late 1970s, including being preceded by a run-up in housing and real estate prices and borrowing from other countries just before the crisis.
"The good news is that all our predecessors managed, somehow, to muddle through," he said. "Even the Lost Decade in Japan pales in comparison to the Great Depression."
So how can America muddle through?
"One of the ways not to do it is to give a whole lot of money to a whole lot of banks and a whole lot of rich people," Prasch said. "People with a lot of money tend not to spend it. Donald Trump has everything he needs."
On the other hand, Prasch said, students and poor people tend to have "unmet needs."
"If you give a whole lot of money to students, you can bet they'll spend it," he said. "Give it to poor people and students or spend it directly."
Matthews also advocated direct government spending, saying the government ought to invest heavily in infrastructure. He said crumbling infrastructure is one of the biggest impediments to growth, and infrastructure repairs could stimulate the economy while helping business.
Colander proposed vouchers for people below a certain income level for use on housing or mortgage payments. He also stressed the need for both short-term and long-term solutions.
Colander compared the economy to a car with a bad engine whose oil light suddenly comes on. You need to add oil, he said, but doing so does not solve the engine's other problems. An immediate bailout is the oil, he said, but the economy needs an engine overhaul in the form of continued stimulus.
Prasch suggested the Carter administration's bailout of Chrysler in 1979 as a model. He said the government guaranteed Chrysler's loans in exchange for stock it could sell in five years, setting the CEO's pay at $1 a year for those five years.
"They're not going to like this, but they'll like it well enough," he said.
Prasch also pointed out that whenever banks became involved in bailouts of other countries in the 1980s and 1990s, they would have long lists of conditions on their involvement.
"They're accustomed to conditions," he said. "They're going to like them now."
If he had his way, Prasch said he would forbid any bank receiving aid from lobbying the government in any form and that prosecutions would play a part in the recovery.
"They're begging for a bailout," he said. "They're going to get one. They're also finally going to feel my boot."
The idea was met with rigorous applause.
Contact Gordon Dritschilo at gordon.dritschilo@rutlandherald.com.
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