October 3rd, 2008
John Paglia, PhD
The recently approved bailout is yet another attempt to prop up the markets with an election around that corner that will only delay and worsen the inevitable pain ahead…
There is definitely a lack of trust and confidence in the markets, but it is due to the blatant lies and unethical representations. How many times have we heard an NAR (National Association of Realtors) economist call the bottom in housing? How many times have we heard the reporters on CNBC call a bottom in the equity markets? How many times have we heard phrases like “subprime is contained,” “we’re comfortable with our capital position,” “we have adequate liquidity,” and “the economy is fundamentally sound?”
The benefits of this package are being oversold to Main Street. And many don’t realize that a large part of this funding will be channeled to foreign banks through our domestic institutions. Furthermore, distribution of funds will not be exclusively through reverse auction; therefore preferential distribution—both in funds provided and responsibilities assigned to select agents—is a negative consequence. It is a disaster in the making and we will be left with a really bad hangover in a few months once we realize what happened.
During the early phases of this crisis, capital providers were buying these representations and investing billions of dollars of fresh capital in troubled financial institutions only to find out that portfolio values were not as represented. After sustaining large losses and with the inability to adequately assess risk due to lack of transparency and misrepresentation, capital providers, for the most part, have decided to sit on the sidelines with trillions in capital.
What we really needed was a market solution. I would rather have seen these institutions be forced to mark their portfolios (and their level 3 assets and off-balance sheet assets) to fair value and then raise private capital to fund any solvency gaps. Only when this happens can we truly assess the risks and raise the appropriate capital. Adding capital to these financial institutions may shore up solvency, but we’re still in a recession and lending always tightens when that is the case.
Unfortunately, we are headed for a nasty recession and the bailout will not stem the tides. In my opinion, it’s about time. Economic recessions are the natural cleansing process of an economic cycle and come as a result of excesses that have been built in periods prior. The longer we delay, the worse it will be.
John K. Paglia, PhD, MBA, is an Associate Professor of Finance of the Graziadio School of Business and Management of Pepperdine University.
Related in the GBR
Doing Business in a Volatile World: Graziadio School faculty reflect on ways in which business perspectives have changed since September 11
Using Asset Allocation Strategies to Recover from a Bear Hug by John K. Paglia, PhD, FRM, CFM and Ivan C. Roten, PhD
Has the Dow Really Escaped the Bear? by John K. Paglia, PhD,
September 30th, 2008
Joetta Forsyth, PhD
The United States is facing the greatest financial crisis since the Great Depression. Financial institutions are failing, as is confidence in the financial system.
U.S. Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have testified that Congress must act immediately to bail out troubled financial institutions, or we could face a financial collapse. There is much furor over the proposed $700 billion bailout, which didn’t get the required number of votes today to pass the House. Why, taxpayers ask, should people who were responsible and didn’t buy a house that they couldn’t afford, pay to bail out people who did, along with Wall Street fat cats? Exacerbating the problem is the fact the some of the people who are viewed as contributing to the crisis are now asking Americans to trust them to solve the crisis, using what could be an enormous amount of taxpayer dollars.
I share the same fury. And there is plenty of blame to go around. However, I would like to focus on the immediate problem. We are being told that something has to be done immediately, or we might have a financial collapse.
The key questions are:
April 7th, 2008
This is a guest post by Peggy Crawford, PhD, Professor of Finance, and Terry Young, PhD, Professor of Economics
The housing saga continues. The hope of “owning a piece of the American dream” is becoming a nightmare for some home buyers. While optimists argue that the “worst” is over as they cling to any sign of positive news, such as the slight upturn in sales of existing homes in February, others call for the government to come to our rescue and save homeowners by declaring a moratorium on foreclosures or “encouraging” financial institutions to renegotiate loan terms. Meanwhile, the Federal Reserve continues to cut interest rates (sometimes dramatically) hoping to ease the pain for some as interest rates reset on their mortgages and to spur activity in the sagging economy.
Have housing prices stopped plummeting? The experts disagree, but Business Week states that home prices could decline by another 25 percent over the next 2 or 3 years, returning the values to their 2000 levels in inflation-adjusted terms.
What can we expect? Like any market, the housing market is based on economic fundamentals of demand and supply. In general, housing prices are inversely related to interest rates. Now, both interest rates and housing prices are falling at the same time.
So, why aren’t sales increasing? Things have changed.
First, lenders are scrutinizing borrowers more carefully. No/low down payments are disappearing and no documented income is a thing of the past—at least for the time being. And second, potential buyers hear the news and are waiting for prices to fall further. On the other hand, some potential sellers are still in denial that the value of their property is decreasing not increasing.
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