Perspectives on the Global Financial Crisis From
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Perspectives on the Global Financial Crisis From Emerging Managers and Public Policy Makers Abridged Version James L. Grant PhD Associate Professor of Accounting and Finance University of Massachusetts Boston And President, JLG Research August 25, 2014 ______________________________________________ FINANCIAL SERVICES FORUM COLLEGE OF MANAGEMENT UNIVERISTY OF MASSACHUSETTS BOSTON _________________________________________________ Perspectives on the Global Financial Crisis From Emerging Managers and Public Policy Makers Abridged Version James L. Grant PhD Associate Professor of Accounting and Finance University of Massachusetts Boston And President, JLG Research With Special Contribution from: Richard T. Selden, PhD Carter Glass Professor of Economics Emeritus University of Virginia August 25, 2014 For full-text version of Edited Manuscript: (38 Chapters, 652 pages) Dated February 25, 2014 See: http://jlgresearch.com Or: http://www.umb.edu/financial_services_forum © 2014 All Rights Reserved Worldwide Perspectives on the Global Financial Crisis from Emerging Managers and Public Policy Makers, James L. Grant, Edited Manuscript, February 25, 2014 (www.jlgresearch.com) © 2014. All Rights Reserved Worldwide. Abridged version August 25, 2014. Page 2 Foreword and Contents This manuscript attempts to capture the perspectives of emerging managers and public policy makers as evinced in the perspectives of graduate students and others who were enrolled in my newly developed course on the global financial crisis—first offered in the 2010 Harvard Summer Economics Program--at a time when students were engaged in the midst and aftermath of the most severe U.S. and worldwide recession since the Great Depression of the early 1930s. The many perspectives gathered on the causes, consequences, remedies, and perhaps more importantly, a glimpse at student thoughts, concerns, and worries at the time--have been collected from the final paper that I assigned in the global crisis course over three cohorts of students including, (1) the Harvard Summer Economics Program of 2010 (Cohort 1), (2) A “Special Topics” course at the University of Massachusetts Boston during Spring semester 2012 (Cohort 2), and (3) the same course offered in the Harvard Summer Economics Program during the summer of 2012. While we have all heard the many opinions and perspectives on the global economic and financial crisis from academia, government, industry among others, we have yet to hear from emerging managers and public policy makers, as captured in this manuscript by the perceptions, beliefs, and positions of graduate students and others of similar standing who will likely hold the reins to managing the global economy and political and societal developments in the years to come. With this in mind, this manuscript attempts to fill the missing void of opinions and perspectives of the next generation of managers and public policy makers—as their opinions and views will likely influence the lives of all for years to come. Perspectives on the Global Financial Crisis from Emerging Managers and Public Policy Makers, James L. Grant, Edited Manuscript, February 25, 2014 (www.jlgresearch.com) © 2014. All Rights Reserved Worldwide. Abridged version August 25, 2014. Page 3 This document is an abridged version of the broader manuscript on the Global Financial Crisis dated February 25, 2014. The full-text version of the edited manuscript consists of 38 chapters: the interested reader is referred to: http://www.jlgresearch.com or http://www.umb.edu/financial_services_forum A non-exhaustive (and non-ordered) listing of the “Causes” of the Global Financial Crisis that were cited in contributed papers to the manuscript and/or class discussions includes: Giant housing bubble (Case-Schiller Index: 2000-2006) Fed’s easy money policies (low interest rate policy) Deregulation-lapse in governmental/quasi-governmental oversight Irresponsible lending/borrowing (local banks/individuals) Community Reinvestment Act-misguided social engineering Wall Street securitization-misguided financial engineering (RMBS, CDOs, CDS) Wall Street Greed and Excess Housing market as Wall Street’s next great trading opportunity (following bursting of the tech-driven, NASDAQ bubble) Credit Rating Agencies-misguided rating standards/oversight “Irrational exuberance”-all assets & markets Prices can only go up mentality Unreasonable expectations-real estate, economy, jobs Consumerism-“Keeping up with Jones mentality”; “Mc-Mansion mentality” Contagion conditions everywhere (locally and globally) Leverage and more leverage (too much debt) A “paradox of deleveraging” The “Recourse rule” Incentive misalignment--rational market participants but with misaligned incentives Non-rational elements in the decision-making process A “Tragedy of Commons” Black swan event Reflexivity Perspectives on the Global Financial Crisis from Emerging Managers and Public Policy Makers, James L. Grant, Edited Manuscript, February 25, 2014 (www.jlgresearch.com) © 2014. All Rights Reserved Worldwide. Abridged version August 25, 2014. Page 4 Minsky moment Failure of corporate governance systems Interconnectedness-“Too Big to Fail mentality” Systemic risk (housing prices as macro factor) Misguided application of Modern Portfolio Theory [highly correlated housing markets equals low (not high) diversification benefits] “The securitization lie” (again, misguided financial engineering) Complexity of instruments (derivatives) ‘This time is different’ syndrome Moral hazard--“Passing the risk buck” Degradation of ethics Breach of fiduciary duty Behavioral factors-leading to adverse selection, risk-seeking, excessive optimism, overconfidence, among others Investor need for alternative investments following Dot-Com bust (VC, private equity, real estate) Persistent US trade deficits, weak dollar, and international capital flows Excessive local vs. international competition among financial institutions China (and other developing countries) as financier of pre-Crash boom and lender of last resort A collapse of credit and global trade Errors of attribution (misguided view of rising housing prices related to economic fundamentals) Social contagion & information cascades Neglecting the parallels from past crises-a naive “this time is different mentality” Perception that housing price changes are easily forecasted A “corrupted system” Likewise, a non-exhaustive (& non-ordered) listing of “Who is to blame” for the Global Financial Crisis cited in the contributed papers to the manuscript and/or class discussions include: Borrowers--individuals Lenders--local banks & mortgage companies Government Sponsored Enterprises--“Fannie & Freddie” Perspectives on the Global Financial Crisis from Emerging Managers and Public Policy Makers, James L. Grant, Edited Manuscript, February 25, 2014 (www.jlgresearch.com) © 2014. All Rights Reserved Worldwide. Abridged version August 25, 2014. Page 5 Federal government—misguided social engineering The Fed--all too accommodative, then restrictive monetary policy Wall Street--investment bankers; big insurance; institutional investors Credit rating agencies (CRAs) Shadow banking system (investment banks, hedge funds, SIVs, SPVs & offshore funds) The “Quants” The remainder of this abridged version of the GFC manuscript includes acknowledgements, about the editor, disclaimer, table of contents (38 chapter titles), editor perspective, economic foundations by Professor Richard T. Selden, and sample chapter contributions from the two Harvard cohorts (Summer 2010 and 2012) and the University of Massachusetts Boston cohort (Spring 2012). The sample papers included herewith on the Global Financial Crisis are meant to be illustrative of the quality of papers that I received from the three Cohorts, and are not meant to be a reflection of the “best” papers. James L. Grant PhD August 25, 2014 Perspectives on the Global Financial Crisis from Emerging Managers and Public Policy Makers, James L. Grant, Edited Manuscript, February 25, 2014 (www.jlgresearch.com) © 2014. All Rights Reserved Worldwide. Abridged version August 25, 2014. Page 6 Acknowledgements I would like to acknowledge Dr. Richard T. Selden, Carter Glass Professor of Economics Emeritus at the University of Virginia, a distinguished guest lecturer in the global financial crisis course that I offered in the Harvard Summer Economics Program. “Dick” taught two classes on macroeconomic theory and polices-in the context of the “Classical” (pre-Keynesian) and Keynesian persuasions-with application of how competing economic theories would relate to the causes, consequences, and prescriptive remedies of economic and financial crises in general and with specific application to the recent global financial crisis. Dr. Selden’s lectures on macroeconomic policy were highly regarded and appreciated by the students enrolled in the course. Included in this manuscript is Dr. Selden’s paper, “A Classical Perspective on Macro Policy,” which I invite all to read for a more comprehensive and balanced understanding of how competing economic theories--both Classical and Keynesian—apply to financial and economic crisis. I would also like to acknowledge the Harvard Summer Economics Program and the University of Massachusetts Boston for giving me the opportunity to develop and offer a timely course on the global financial crisis. I wish to thank Eric Pinsoneault and other graduate -research assistants at the University of Massachusetts Boston who helped me launch