Policy and Pizza in the Pit Series Looks at Origins of the Current Financial Crisis
Web Editor - Published: October 17, 2008

On Monday, October 14th at 12 pm, Professor Juliet Moringiello, Professor Katherine Jones, and Dean of Students Ann Fruth spoke to students, faculty, and staff about the origins of the current financial crisis. The first of several Policy and Pizza in the Pit events, the engaging discussion offered students insight into the problems facing the economy.

Professor Jones spoke first, describing some of the legislative history of banking regulation, focusing specifically on the Glass-Steagell Act of 1933, which mandated the separation of commercial banking from investment banking and created the Federal Deposit Insurance Corporation. The merger of Citicorp and Travelers Group on April 7, 1998 to create Citigroup challenged the provisions of the Glass-Steagell Act that forbade banks to merge with insurance underwriters. Under the then current regulations, Citigroup had two to five years to divest the prohibited assets, but the passage of the Gramm-Leach-Bliley Act on November 12, 1999 reversed Glass-Steagell and allowed financial services companies to offer commercial banking, investment banking, insurance underwriting and brokerage services.

As Professor Jones noted, “The moral hazard was saying that ‘we will let banks do things that are very risky’. If they make money on them, they get to keep the money. On the other hand, if they lose the money, FDIC is going to come in and pay everybody, and they’re not going to have to go under if the risk turns bad. This incentivizes people to take big risks that they wouldn’t take if they knew that there was a bigger downside to their losing. So, even some very conservative economists said that you should restrict what people are allowed to do with money that the government is going to insure.”

Professor Moringiello then spoke about how loans, including those people took to purchase homes and cars, turned into the securities that have dragged down the financial market. In addition to issuing loans that allowed people to spend beyond their means, financial institutions packaged the bad loans together as securities and then sold them off. As Professor Moringiello noted, “When the mortgages are carved up and sold to lots and lots of investors, the risk is removed from the originator.”

Dean Fruth then spoke about why these securities had become such a problem. Imprudent lending resulted in people being unable to pay their loans, which in turn resulted in foreclosures. Those foreclosures drove down the values of homes, making the securities less valuable, and tying up bank assets so that additional lending became more difficult because of the lack of liquidity in the market.

At the conclusion of their presentation, the three faculty members took questions from the student audience. One student asked about how the bank bailout package would help individuals. The three panelists essentially agreed that the package would do very little to help individuals, but Dean Fruth noted, “When banks stopped lending money, that caused the economy really to grind to a very slow pace,” adding later, “I think that the bleeding was so bad that this was triage.”

The next Policy and Pizza discussion will be on Thursday, October 23rd at 12 pm in the Pit. Professors Wesley Oliver, Harry Witte, and Amanda Smith will recap and critique the debates between Barack Obama and John McCain.

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