Conference Highlights Financial Crisis Research
Since the current crisis engulfed the global financial system, finance and economics scholars have been working to understand its origins and to develop the most effective policy and regulatory responses to correct it and prevent future crises. On July 11 and 12, the Yale SOM International Center for Finance and the Review of Financial Studies gathered a select group of these researchers to discuss their latest findings at the Financial Crisis Conference.
"We wanted to highlight the research that has been done on the crisis, research that speaks to many of the aspects of the crisis. The goal was to start the process of understanding what happened," said conference co-organizer Gary Gorton, the Frederick Frank Class of 1954 Professor of Management and Finance.
Gorton organized the conference with colleague Andrew Metrick, Theodore Nierenberg Professor of Corporate Governance and Professor of Finance, and Faculty Director of the Millstein Center for Corporate Governance and Performance. Like many SOM faculty, Gorton and Metrick have been actively involved in work related to the crisis: Metrick is currently on leave from SOM serving as a senior economist to the Council of Economic Advisors, and Gorton’s recent research includes an analysis of the role of the shadow banking system that was recommended by Federal Reserve chairman Ben Bernanke.
The two-day event drew participants from institutions such as the Federal Reserve Board and several member Federal Reserve Banks, the European Central Bank, the International Monetary Fund, and The Vanguard Group, as well as from leading business schools. The twenty papers presented examined a broad range of crisis-related issues including how the small percentage of securities backed by subprime mortgages could infect the entire banking system; the causes of the recent collapse of the Auction Rate Securities market and the Asset-Backed Commercial Paper market; how government bailouts affect the risk-taking behavior of banks; and whether securitization was associated with selling the riskier loans off-balance sheet.
"The papers on the program were overwhelmingly empirical," said Gorton. "Using data, the authors show that many of the claims about the crisis are not true — for example, there was no decline in underwriting standards of subprime mortgages; mortgages that were securitized were not worse than other mortgages. There were runs on asset-backed commercial paper and auction rate securities."
The research to date underscores the work that still needs to be done in both the research and policy arenas, says Gorton. "While there is a long way to go in terms of really understanding the crisis, I think the research shows that most of what the media and Congress have focused on are not the core issues. For example, the so-called 'shadow banking system' is genuine banking and serves an important function. We still need to convince policy-makers of this."
In his conference keynote, Robert Shiller, the Arthur M. Okun Professor of Economics, spoke about how he sees opportunity for innovation in the crisis. "…[W]e shouldn’t be too dismayed by these crises because in many ways they are an opportunity. They stir things up, they shock us out of our complacency, and we can end up with a better world after the crisis. But the point is that we have to take the initiative. We have to use the opportunity, and we have to, — and this is what I want to emphasize — think. This is a great time, I think, to be a financial engineer….Sometimes that word is used pejoratively, but a financial engineer is someone who thinks like an engineer — practical mind, interested in technology, wants to see things happen, in this case in financial technology."
Shiller’s talk focused on the long-term solutions that will have lasting benefits to society — improvements to information infrastructure, and creating broader markets and better financial retail products for consumers — which he believes are an important part of the recovery that are not receiving enough attention. "They way I view this financial crisis is as an opportunity that will play itself out over the next five to 10 years. That’s how it worked in the Great Depression. Things were happening that were new and important in 1938 when Fannie Mae was created, or 1940 with the Investment Company Act, that still seem to be repercussions. We should be continuing to think about long-run solutions."
One long-term result of the crisis that Gorton sees, and that is apparent in the research presented at the conference, is a change in scholarship and its relevance. "Econ and finance academics need to seriously rethink what they are doing. The crisis completely embarrassed them (though it seems that they are not all aware of this); much of the research of the last 25 to 30 years or so is just plain irrelevant. It is much like what some say about modern art: a conversation with itself that has no meaning otherwise. The crisis has prodded many academics into new lines of research, but the profession as a whole will take years to turn around."