Jon Stewart asks a version of the same basic questions to every economist he interviews on “The Daily Show”: “What happened to all our money, why are we bailing out these companies and how poor are our grandchildren going to be?” Stewart’s guests never seem to give a straight answer.
Vernon Smith, Nobel Laureate and UAA’s first Rasmuson Chair of Economics in the College of Business and Public Policy, tried to clarify a few of them for a micro economics class in his annual visit to the university July 20.
Smith began experimental economics work in the 1950s to scientifically prove classic economic theories by observing human behavior in studies and helped found UAA’s own Experimental Economics Lab.
Smith’s explanation for the housing market collapse centered around the recurrence of bubbles in asset markets:
“While consumer product markets operate rather strictly to the laws of supply and demand, asset markets depend not only on the value of the goods or services tendered, but the perceived value.”
This mentality, when applied to the housing market, led to an asset bubble similar to that of the dot-com bubble of the late 90s. Sparked by the elimination of capital gains taxes on homes up to $500,000 in 1997, housing prices grew steadily until August 2007, when the bubble burst.
Before the burst, the housing market accounted for $19 trillion – about one third of America’s wealth. But it was increases in credit, not consumer income, that funded the most recent bubble.
“Every lending firm from AIG to Goldman Sachs had it in their minds that this increase in prices was going to go on forever,” Smith said. “Even the bankers didn’t see [the crash] coming, even though they should have.”
It wasn’t until 2005 that Alan Greenspan, then Chairman of the Federal Reserve, warned of high-risk lending practices. If the man once considered the preeminent economic mind of our this century took nearly a decade to realize something wasn’t right, how could securities and lending executives see it coming?
“You see bubbles and bursts throughout history with asset markets and the burst is inevitable. You can’t prevent bubbles, but you can prevent collateral damage from the bursts,” Smith said. “We don’t know what causes bubbles or why people expect to always make more by reselling the same assets.”
Smith found the bubble phenomenon a natural occurrence in small scale experimental economic labs. But certain pockets of the country experienced less fallout from the 2007 burst. Texas, for example, had preexisting laws prohibiting loose lending practices by commercial lenders.
“The cheaper the loan, the worse the bubble and the greater impact on banks in the crash,” Smith said.
With the current recession nearing the two year mark, anxiety over the collapsed housing market and its overall damage to the American financial system has spread to students, even though they’re not traditionally the most fiscally-minded of demographics.
“I’ve never seen such concern from students,” Professor of Economics Larry Ross said. “Students are very anxious, but they’re engaging and having Vernon here is incredible,” Ross said.
Junior Nicholas Anderson, a business major, shared the passion in the room.
“We care about what’s going on, because we’re all waiting to see if our elected leaders can fix this or not,” he said. “We may be in the throes of the final stages of being a first-world nation if this isn’t fixed.”
Not quite as convinced of the impending revolution, Smith was optimistic that the U.S. economy will bounce back in due time, adding, “Hey, we survived the Great Depression, right?”
Smith did offer a possible solution to the housing crisis, saying the simplest form of regulation would have prevented this – by mandating public listings.
“That way the market would demand collateral for all loans. Risk would be severely reduced,” Smith said, also proposing a modified version of Milton Friedman’s idea of a negative income tax to help those below the poverty line build capital.
Friedman’s proposal was highly controversial when proposed in 1962 but didn’t seem so far-flung to the economics class.
“Why not cut a check to the poor to bring them above the poverty line?” Anderson said.
“It’s not going to discourage them from working and no one likes to be poor.”