WHERE IS THE CRISIS HEADING?

http://www.washprofile.org/en/node/8155
Sebastien Gay, Professor of Economics at University of Chicago.

Question: What is your comment on the recent economic crisis?
Gay: It is devastating. People are scared about losing their jobs, their homes, their retirement, and their college savings funds. It is a very stressful time. I think we are seeing an example of unregulated traders manipulating the market system where people bought and sold bad credits without looking to see what it really was.

Question: An ordinary person might think or question – could that be an eventual or ultimate end of capitalism?
Gay: It is a very good question. I don’t think this is the end of capitalism per se. What we see here is how people manipulated the capitalistic system in such a way that it would be bound to fail. Although it has had terrible consequences for consumers we are seeing a weeding out of those companies that made these bad decisions (barring the bailout). The bailout was a decision to get capitalism back on its feet, or at least an attempt to do it.

Question: So it is rather a mismanagement of the system but not the system itself.
Gay: That is exactly right. Nowhere in capitalism are you supposed to loan money without having the necessary back-up of liquid assets. The mistake the financial institutions made was promising that the back-up existed and they sold the debt to other financial institutions. Eventually the hard truth caught up with them that they were making money out of money and that there was nothing underneath.

Question: What to expect with jobs? Which are going to disappear first and which will stay?
Gay: This is a difficult question to answer right now. We are still in the middle of the crisis. I think it will be very difficult to say which jobs are eliminated and which ones are safe, because nothing is really safe. In an economic downturn, what the companies need to do is to cut costs and sadly that often includes labor.
What I imagine, is when the economy will come back up, employment will rise again. I think layoffs will be more permanent in the banking industry due to the consolidation we are witnessing though mergers and acquisitions. But thankfully these workers will find jobs eventually in other sectors of the economy.

Question: When do you think the situation might get back to some sort of stability? Saying that we are now in the middle of crisis, when can we expect to notice changes?
Gay: Like any economic cycle, we can imagine that the period of recession will last for three to five years. I do not think that this recession is new. It started when the prices of houses went down and the first mortgages fell. So, what I imagine is that we are in the middle of this crisis or more likely (hopefully) towards the end. But we continue to see a lot of turbulence in the stock market. Therefore we are not out of the woods yet.
But in order to get out of the crisis, people need to have their confidence in the market and capitalism restored, and then companies will start again to understand that they can work on a sound foundation. But we just have to hope that the companies are coming clean right now. I do not think the American people will be as generous a second time around.

Question: Regarding the actions and measurements by the government – bailout plan – how do you see that?
Gay: I am not a big supporter of this bailout. I think this was a reactionary policy. It should not have come as a surprise that the stock market would go down when people were given mortgages that they could not be expected to pay back. The government should have intervened earlier, but did not because it did not regulate this new market of sub-prime mortgages. It is inexcusable to have the equivalent of a black market on Wall Street. Where was Congress? Where is the SEC? Where was corporate responsibility?
And now as a result of negligence and greed, the economy is in a coma. People don’t trust the system and there is no wonder why the market is down. Besides, so far, with this bailout, people still don’t trust the market.

Question: To what extent, in your opinion, should the general population be responsible for taking the risk and accepting the mortgages it ultimately cannot pay back?
Gay: In the United States a person cannot drive until she is 18; she cannot drink until she is 21, but she can get a credit card at 18 years old without having to take any class on managing her credit card debt. People in the U.S. can use credit cards and take out loans without knowing the effects of revolving credits. And banks prey on these people and try to sell them more credit cards, telling them it is okay. Banks try to lure people into these bad deals so that they can make money out of the fees that they will then collect. In my opinion, the financial institutions have abused the system.
People don’t realize that in the American culture, you are entitled to a card and a credit card, but you are also entitled to debt. And this needs to change. We need to learn how to live within our means and to learn to be fearful of excessive debt. But it will take time.

Question: Will the capitalistic system have to be modified then as well? Since it is related to the entitlements to a house, a car, and therefore to debt.
Gay: The capitalistic system will not have to change, but what needs to change is how we prepare future generations for managing credit and debt: in high school and in college there should be mandatory classes that teach people how to manage their credit and their debt. Then, at the end of the class, each person should have to pass a test, just like one has to pass a driving test. If one fails, they should not be authorized to get a credit card.

Question: Which countries suffered the most and which the least? Due to globalization, many countries are participating in global economy and trade market.
Gay: Obviously the United States was hurt a lot but because of globalization. But everyone is affected, and it is very difficult to see the full consequences right now. So far we see banks failing, unemployment rising, but we do not know when and how it is going to end. With globalization, everything that happens in the U.S. affects the world. As an example we saw the European Central Bank follow the same policy on interest rates as the Federal Reserve to try to fix the global market.
In the long run, I am sure we are going to get out of this crisis. Recessions are a natural phase in economic cycles. We have overcome past recessions and we will succeed again. The only thing left to know is for how long are we going to remain in this depression-like period. I wish I would know. I would also expect to see some return to protectionism because of the recession as governments would want to ensure local solutions to their constituents and decrease the risk of further recession.

Question: What changes would you predict on the stock market?
Gay: Right now is a period of huge uncertainty, which is the reason why we have such a turbulent market. It goes up 300 points one day, then the next day it goes down 600 points, so we have to look at it long-term, and in the long run, what you can imagine is that the stock market will go back up, and we will certainly go over the 20,000 point-mark within the next decade. Until we manage to get this crisis under control and get people to trust the economy again, we are going to see a turbulent market. It is the responsibility of the next president to restore consumer confidence.

Question: You mentioned the next president, and since this is the Election Day, which candidate, in your opinion, has a better economic plan which will expedite the healing of economy?
Gay: Both candidates have compelling economic strategies but it will ultimately be a great challenge for the next president to fix this mess. I think there are two important components that should be included in the next president’s economic policy: (1) Commitment to a dynamic creative process. There is no reason to lock into one strict plan in advance; and (2) sensitivity to taxes. I would advocate for a freeze on taxes for both consumers and firms to keep jobs in the United States and to encourage people to spend money. If you increase taxes on companies, they might go in countries where taxes are lower – for example, Ireland, where the corporate taxes are 12.5 %.

Question: If someone has 1,000 US dollars, what would be your advice – to spend, to save, or to invest?
Gay: If you have $1,000 it is most important to have as little debt as possible: pay your credit card debt, commit not to go into credit card debt during the holiday season, and be on top of your mortgage. If your debt is under control, then save the money in order to cover a few months’ expenses, just in case you lose your job. And only then, if you still have some money left sign up for a class on personal financial management. A market this turbulent is only for long-term investors.

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