Over the past several weeks, Americans all over the country have seen global markets plummet. The crisis on Wall Street and how it has translated to Main Street has been splashed across newspapers nationwide. Three weeks ago, a $700 billion bailout of investment and banking firms was unthinkable; now, according to students and faculty at Boston College, the passing of such a measure was vital and unavoidable.
In a speech before Congress prior to the vote on the emergency bailout legislature, Rep. Barney Frank Democrat of the 4th District of Massachusetts and chairman of the House Financial Services Committee said, "We regret being here because we all deeply regret the economic conditions which have made this decision day necessary. No one is happy that we have seen the failures that we have seen in our economic system."
While any number of fingers can be pointed at various reasons for the failure of the investment market in the United States, it is agreed upon that something had to be done.
"The changes are long overdue: more stringent mortgage-origination process, with greater documentation of borrower income, more oversight of 'liar loans' and predatory lending, less ability to leverage up your bets," said Alan Marcus, a professor in the finance department of the Carroll School of Management (CSOM) and who holds a doctorate in economics. "The bill will also make it easier for homeowners to renegotiate their loans."
Marcus described the crisis as having two main components: insolvency and liquidity. Of the two, he cites insolvency as having an expensive but more straightforward solution, which would involve flooding money into the system to help pay off any debts owed.
"The harder part is the fact that no one knows what these assets are really worth and what the exposure of their potential trading partners are to this risk," Marcus said. "So no one feels comfortable making loans to anyone else."
The cause of the continuing declines on Wall Street can be attributed to a credit freeze, in which lenders are either unable or unwilling to lend money to businesses, which is where the crisis spills onto Main Street, Marcus said. Without small business owners and the average American being able to take out a loan, the recession becomes more and more severe.
"There won't be instant results," Marcus said. "The issues are too subtle, and too intertwined with the whole structure of our financial system, and this will take a long time to rethink and reorganize."
The original draft of the bill received enough opposition from the American public that it was voted down by a margin of 228-205 in the House; however Marcus believes that the measures that ultimately passed and were signed into law by President Bush represent an investment for taxpayers, rather than a loan of titanic proportions.
"If all goes well, the cost to the public will be far less than the stated $700 billion. In principle, at least, the government can buy the mortgages back for something approximating their fair market value. So while the government will have to borrow $700 billion to finance the purchase of these mortgage-backed securities, it will end up with assets that hopefully roughly match its new liabilities," Marcus said. "Why should students care? How many families are helping finance their tuition bills with home equity lines? Or stock market investments? Need I say more?"
James Primes, CSOM '09, said that discussions over the future of Wall Street began with the collapse of Bear Stearns, although no one predicted a decline of such epic proportions.
"U.S. financial markets have a history of being stable, with people going on faith that the market will eventually come around," Primes said. "The problem is, with deregulation companies have more freedom and are making riskier decisions - eventually you have to know that the other shoe is going to drop."
Along the same lines, Philip Strahan, a professor in the finance department of CSOM who holds a doctorate in economics, said he believes the problem to be rooted in the growing amount of risky investments that occurred following the lowering of interest rates post-Sept. 11.
"The problem is that when returns on safe investments get very low, investors start looking for other ways to earn a decent return," Strahan said. "The only other way to achieve a higher return is to add risk, and that is exactly what happened. Wall Street fell in love with the idea that diversification could solve all manners of risk management problems. It can't. At some point you need someone to do the heavy lifting of evaluating credit."
Much of the problem is also a psychological one, Primes said; however, he stressed the importance of taking all sides into consideration.
"Markets are obviously going to react to what happens to the mortgage crisis and the bailout plan," Primes said. In one example of conflicting interests, he noted how General Electric (GE), which controls the lending corporation GE Finance, also owns the television giant NBC.
In terms of the bailout, Primes noted that it continues to be a major point of contention among Americans.
"It comes down to how much you trust the companies," Primes said. "It's about asking yourself, 'How much faith do I have that it's going to be repaid?' On one hand, we're asking, 'Why should we bail them out of the mess they got themselves into?' But another way of looking at it is that a deal needed to get done."
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