Distinguished Speaker Seminar: Michael D. Intriligator - The Current Worldwide Financial and Economic Crisis

Michael D. Intriligator, Professor of Economics, Political Science, and Public Policy at the University of California, Los Angeles, and Senior Fellow at the Milken Institute delivered a lecture on “The Current Worldwide Financial and Economic Crisis” at an ADBI distinguished speaker seminar on 25 March 2009 in Tokyo.

Professor Intriligator started his presentation with an overview of the current crisis. He said that according to the National Bureau of Economic Research, the crisis started in December 2007 with the collapse of the subprime mortgages in the United States (US), and the contagion spread throughout the whole economy and globally, severely affecting transition and developing economies. He likened the global financial system to a “house of cards”—pulling one card out triggered the devastating collapse, with staggering effects reminiscent of the 1930s Great Depression.

Yet, the current crisis was not without systemic warning, such as the collapse of Icelandic banks, whose attractive premium rates previously attracted myriad European investments. In the US, despite the urgings of Governor Ned Gramlich to the Board of Governors of the Federal Reserve System and to his fellow governors to act on the subprime mortgages, nothing was done. Nor was this crisis without precedents. He noted Japan's “lost decade” of the 1990s after the bursting of the real estate and economic bubble. A similar fate may await the US and possibly the world. Based on historical experience, the current economic collapse would likely not correct itself quickly. Instead of a V-shaped recovery with a quick turnaround, it may follow a “U-shaped” curve with long economic malaise or worse, an “L-shaped”, taking perhaps 6-8 years to recover.

For Professor Intriligator, a single dominant cause for the crisis would be difficult to pin down in the US. Rather, it is a convergence of several factors notably: (1) deregulation of the financial markets through the repeal of the Glass-Steagall Act in 1999 allowing a financial institution to engage in commercial banking, investment banking, and insurance products; and (2) the Federal Reserve Bank's low interest-rate policy under Chairman Alan Greenspan. This lax regulatory framework paved the way for the excesses of the financial system leading to the astronomical growth of new and risky financial products, and highly leveraged financial institutions with unworthy debtors. Lax reviews by credit rating agencies exacerbated the situation. It did not help that regulatory bodies were ill-equipped to render sound judgment on the health of these financial institutions and apply necessary actions, resulting in a vicious circle of losses leading to a financial meltdown, and even the possibility of debt deflation that would have devastating results.

The rescue plan starting with the Troubled Assets Relief Program (TARP) bailout of US$700 billion under President Bush failed to increase much needed commercial bank lending, drying up liquidity for producers. The collapse of a large investment bank, Lehman Brothers, in September 2008 only exacerbated the liquidity crisis.

Currently, credit markets are paralyzed. Most major corporations are at the brink of failing while hedge funds and private equity funds are unwinding. Unless financial institutions resume lending, Dr. Intriligator believes that the economic stimulation plan (American Recovery and Reinvestment Act (ARRA)) under President Obama, as well as the US Treasury's trillion dollar private-public partnership plan to buy “toxic” assets will be insufficient to stop the downward economic spiral.

Finally, Professor Intriligator offered policy recommendations to hasten economic recovery, which included: (1) requiring greater banking transparency and leverage caps for financial institutions, (2) rethinking bank recapitalization for the remainder of TARP, (3) doing both economic stimulation and greater regulation simultaneously, (4) setting up a task force to follow through international finance restructuring started at the G-20 meeting, (5) providing government guarantees for a portion of bank loans, (6) applying closer supervision of banks by the Federal Reserve if banks do not start providing credit, with their restructuring via receivership or nationalization as a last resort, (7) recreating investment banks, perhaps starting with ones run by the Federal Reserve, then spinning them off to the private sector; (8) forging international cooperation to rethink international finance, and (9) providing special assistance to highly vulnerable economies, including transitional and developing ones.

Another interesting proposal mentioned by Professor Intriligator is patterned after the creation of the 1947 Marshall Plan or the European Recovery Plan, which was arguably the most successful foreign aid program in history. After the Second World War, previously warring European states were required to work together and submit one common proposal to the US Government that would determine the amount, the form, and the way American aid would be divided. Similarly, in the current crisis, banks seeking funding would be required to submit proposals on how funds would be used and have these banks review the proposals of each other, and submit a unified proposal to a national or international authority. As history had shown, this due diligence process proved successful in reconstructing a war-ravaged Europe and is worthy of replication. He also proposed setting up an international financial authority, or reforming and expanding existing ones, including the World Bank and the International Monetary Fund, to consider proposals for support by national and international institutions.

His last proposal was again inspired by past successful experience, specifically the development of the first atomic bomb by the Manhattan Project (1942-46), where a top-notch international and interdisciplinary group of scientists at that time confined to the research site at Los Alamos, New Mexico, devoted their energies to accomplish the task at hand. Likewise, he proposed the gathering of world-class experts to identify 50 pressing contemporary issues (hence dubbed “50 New Manhattan Projects”), be it in environment, energy, transportation, terrorist attacks, pandemics, recovery from natural disasters, and others; and then channel their focus to develop innovative approaches to these challenges. Another example of such an approach to addressing major global challenges was the Green Revolution which created new basic foodstuffs in the form of hybrid corn, rice and wheat and thus helped stave off a possible global famine. In the same way, one such new Manhattan Project would involve solving the current economic and financial crisis. The world's best experts, including political leaders, economists, finance experts, bankers, and other specialists could come together and develop approaches that would effectively deal with the crisis.