Economic Crisis, In-depth With Dr. Dalgin


Economics professor, Dr. M. Halim Dalgin sits down with BU Now on Oct. 9 to explain the details of the Economic Crisis.

Q: Is the sole cause for the crisis we’re in the sub-prime housing mortgage agreements? Were there other players, and if so, who were they?


A: We are having a financial crisis as a result of the bursting of the real estate bubble. Why was there a bubble in the rst place has a lot to do with the imbalances the world economy had for so many years. By this I mean that in the world economy, production and consumption was not equally or about equally shared by all the countries. The United was the consumer and the East Asian countries, especially China was the producer. To give you an example, the U.S. consumes 70% of its income, whereas China only 40%.

This naturally led to led to a “savings glut” in the world outside the U.S., as the chairman of the Federal Reserve, Ben Bernanke called it. (He was not the chairman then.) Those countries in turn lent all their savings to the U.S. Moreover, the Federal was following an easy monetary policy leading to lower interest rates. (remember they loved Alan Greenspan for this and revered him like a patron saint of nancial markets.) Consequently, when there is a lot of money sloshing around, it has to and a cause for itself and this usually goes to the real estate.

Before we say who burst the bubble we should also ask who inated the bubble. For some years, starting with the Clinton administration and continuing with the Bush policies, house ownership has been encouraged and subsidized. On top that, Fannie and Freddie, Government Sponsored Mortgage Companies, have been required to lend to low-income to middle-income families with no down payment. Clearly this is very risky. But it was not really Fannie or Freddie who went to excesses. It was Wall Street who came up with the idea of sub-prime lending. (This really means lending to riskier groups.) Perhaps nothing novel about it, but the real novelty they were bringing was the way they hid the risk involved by slicing and dicing securities. They were claiming that , by doing so, were diversifying and spreading the risk, but basically they were very cleverly hiding it.

For various reasons this was very pro-table and Fannie and Freddie felt the urge to jump on the bandwagon so they also started lending recklessly. Clearly in this saga we see the culprit as the subprime mortage market and bad debts incurred in this market. But this is not enough to justify the magnitude of the crisis we are going through now. Because this is a crisis enveloping the whole world whether developed or developing. The reason for this worldwide contagion is the sophistication and integration of nancial markets across the world. The rest of the world is now holding about half of its income in the U.S. assets and the U.S. is also holding about the same amount in the rest of the world assets. Only 10 years ago the corresponding amounts were around 15%. But still the reason why defaulted subprime mortgages are causing not so proportinate amount of influence is through the balance sheets of companies balanced on a knife edge. Therefore, a smallest disturbance to the asset values are throwing them off and contagion through the world highly efficiently integrated markets taking care of the rest. Sometimes e_ciency works in the opposite direction.




Who do you feel is more so responsible – The housing mortgage companies, or the citizens who signed the agreements they couldn’t afford to pay?


A: I am not sure how much it helps to pinpoint who did it. Simply, there were incentives to do so and people respond to incentives. Yes, lack of oversight, deregulation, greed by the wall street bankers all contributed to the cause. The fundamental reason is the imbalances in the world economy and this is a harder problem to solve.




Q: In your opinion, could this crisis have been foreseeable, or preventable?


A: It is easy to say yes with hindsight 20/20. If you look at the Case-Shiller housing index, an index that tracks real estate prices, it is at up to mid-1990s and then it starts gyrating. But people are very inventive coming up with wonderful reasons to justify “it is different now,” in other words to claim that the fundamentals are different now. And then they had wonderful reasons to justify higher real estate prices in terms of zoning laws, government regulations, etc. Yes indeed there were a few dissenting voices but they were summarily discarded as doom-sayers. The funny thing is this is not the first financial crisis, nor is it the last one. Only at the end of the 1990s, people were talking about new economies, changes in fundamentals again, and then there was the stock market crash again.




Q: How do you feel about the new bailout plan?

A: The new bailout plan was not welcome among the economists nor among the public. First of all it was not really clear what the treasury would do with this money and whom it would save, as well as there was a lack of oversight. The real problem is asset valuation: we are not sure how toxic assets are toxic on banks’ balance sheets. Buying up those toxic assets will not solve the problem or repair the damage on the balance sheets. A better way is to do what Britain is doing now: injecting capital into companies and assuming stakes.



Q: How will the crisis affect businesses, particularly in Bloomsburg?

The problem with the crisis, that it will impact the local economy, is so called “contractionary dynamics” as a result of credit crunch. Firms which need credit to invest and expand but cannot find credit, cut back on production, lay off workers, who in turn cut back on their consumption. Moreover, falling house prices creates weaker household balance sheets reducing their expenditures and reducing aggregate demand. Hence, this will slow down the economic activity along the lines of the local economy.



Q: What does this crisis mean for students who are:

* Looking to get loans and looking to payback loans soon?


A: As the credit dries up in the nation students should feel this effect in the short run, but this should not be a big problem. Paying the loans back will of course depend on their ability to get a job and generate income. As I say below this is really not a great time to be in the job market.


* And graduating soon and about to look for jobs?


A: Students graduating at the end of this teaching year will probably feel the pinch of the slowing down economy. I believe it will be a bad time to look for a job. So far the crisis did not hit the real economy yet although we are starting to hear news about dropping sales and rising unemployment.




Q: What are your recommendations for students and business owners who are trying to survive the crisis?


A: These are really hard and once-in-a-lifetime events, mostly beyond the individual’s control. I guess we should all get ready for a hard ride.