Here is the real reason, according to Siegel: Financial firms bought, held and
insured large quantities of risky, mortgage-related assets on borrowed money.
The irony is that these financial giants had little need to hold these
securities; they were already making enormous profits simply from creating,
bundling and selling them. “During dot-com IPOs of the early 1990s, the firms
that underwrote the stock offerings did not hold on to those stocks,” Siegel
says. “They flipped them. But in the case of mortgage-backed securities, the
financial firms decided these were good assets to hold. That was their fatal
flaw.”
Speaking in Philadelphia on January 20, Siegel, author of Stocks for the Long
Run and The Future for Investors, provided a detailed analysis of the factors
that fueled the worldwide financial meltdown. His talk was the inaugural lecture
of a 15-session course on the financial crisis that Wharton is offering MBA and
undergraduate students. Siegel’s mission was to detail the factors that sparked
the crisis that has caused the U.S. stock market to lose more than a third of
its value in a year, while sending unemployment to its highest level since the
1980s. Siegel’s lecture was on the same day that millions of Americans expressed
optimism over the inauguration of President Barack Obama, even as the Dow
plunged another 300 points.
Explaining his theory further, Siegel pointed out that many troubled banks and
insurers continued to prosper in almost every other aspect of their businesses
right up to the 2008 meltdown. The exception was the billions of dollars in
mortgage-backed securities that they bought and held on to or insured even after
U.S. home prices went into a free-fall more than two years ago. American
International Group (AIG), the insurer that received an $85 billion federal
rescue package last September, is a prime example. Some 95% of its business
units were profitable when the company collapsed. “AIG has 125,000 employees,”
Siegel noted. “Basically, 80 of them tanked the firm. It was the New Products
Division, which had an office in London and a small branch office in
Connecticut. They came up with the idea of insuring mortgage-backed assets, and
nobody at the top decided it wasn’t a good idea. So they bet the house — and
the company went under.”
Lapse over Lehman
According to Siegel, federal officials — particularly outgoing Treasury
Secretary Henry Paulson ­– mishandled initial efforts to intervene in the
crisis. For example, Paulson was concerned about the political backlash that
might be unleashed by bailing out Lehman Brothers. He allowed the firm to
collapse last September but underestimated the impact of Lehman’s demise on
financial markets. Despite a $700 billion bailout, banks are still unwilling to
extend credit, Siegel said.
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[More results for: stock market] Siegel told his student audience that in many
important measures, the economy is not nearly as battered as it was during the
early 1980s, when unemployment, inflation, and interest rates were all
considerably higher than they are today. Stocks — as evaluated by their
price-to-earnings ratios — are undervalued to the point where they could draw
enough investors to spark a recovery before the end of 2009. “I’m actually an
optimist,” said Siegel. “I think by the second half of this year, things might
turn around faster than people are now predicting.”
While angry investors and taxpayers are anxiously looking to assign blame for
the current state of the economy, it’s important to know not only which factors
led to the meltdown, but which ones did not. He said that government programs
encouraging home-buying by low- and middle-income families and short-selling of
financial stocks — which was halted for a time last fall — have little to do
with the crisis on Wall Street.
Instead, Siegel pointed to two interlocking issues: One is a massive failure,
not only by traders, but by CEOs of financial firms, their risk management
specialists and the major rating agencies to recognize that an unprecedented
housing-price bubble began building after 2000. Their faulty reasoning was that
the inability of homeowners to pay their mortgages — and the consequent
foreclosures — would not pose a threat to their mortgage-backed securities.
They believed that as long as home prices kept rising, the underlying value of
the real estate would provide a hedge against the risk of such defaults. They
failed to realize that this reasoning was based on the assumption that home
prices would go in just one direction — up. In fact, these assets became
enormously risky once the housing bubble burst and home prices began their
inevitable decline.
Siegel also argued that ultimately, the buck stops with corporate CEOs who
didn’t ask hard enough questions about the risks posed by mortgage-backed
assets. He said he and others have wondered why firms like Lehman Brothers, Bear
Stearns and Morgan Stanley — which survived the much more severe Great
Depression of the 1930s — collapsed during 2008. One reason, he suggested,
might be that, back then, these firms were organized as partnerships. In such an
organizational structure, the partners would have to risk their own capital.
When the partnerships were reorganized as widely held public companies, however,
they no longer had such constraints. “Back when it was a partnership, you had
your life invested in that company,” said Siegel, noting that banks also began
making higher-return but higher-risk investments in recent years as public
ownership increased.
Greenspan’s Role

One other key player that Siegel criticized for not heading off the collapse of
the mortgage-backed securities is former Federal Reserve chairman Alan
Greenspan, who oversaw the government’s central bank until 2006. Greenspan was
so influential while he oversaw the Fed that he could have easily blown the
whistle on the over-accumulation of mortgage-backed assets by the U.S.-based
financial giants. He, however, failed to discover that firms were taking such
large, risky individual stakes without protecting themselves against a housing
market collapse. “[Greenspan was] the greatest central banker in history — he
had access to every piece of data,” Siegel said. “He could have looked at the
balance sheets of Morgan Stanley or Citigroup and said, ‘Oh my God — they
didn’t neutralize their risk.’”

Another reason why federal officials and economists failed to detect the
perilous economic risks of the 2000s, Siegel said, is the so-called “Great
Moderation.” This term refers to the fact that since the 1980s, the volatility
of the business cycle has declined, thanks to more aggressive fiscal policy and
the rise of a service-based economy, among other factors. Siegel noted that a
similar flattening of the economic cycles had occurred during the 1920s after
the 1913 establishment of the Federal Reserve Bank, a factor that caused stock
investors to ignore risks, which eventually led to the stock market crash of
1929 and the Great Depression.
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Supply?”People asked, ‘Are we ever going to have a big recession again?’” Siegel
said of today’s policy makers. “Everybody thought we were in a new stage and
risk premiums didn’t need to be so high.” But those risks hit home last year.
While it would have been difficult for federal regulators to save Lehman
Brothers — which had invested billions of dollars in assets related to subprime
mortgages — even if they had acted six months sooner, the fall of the
158-year-old financial house had a disastrous impact on the wider financial
market. Lehman Brothers was connected to 950,000 or so transactions. As a
result, bankers became gun-shy about making any type of loan, even to companies
with a flawless credit history.
Trouble with TARP

For that reason, Siegel said, the initial phase of the Bush administration’s
Troubled Asset Relief Program (TARP) was seriously flawed. Paulson’s Treasury
Department decided to buy equity stakes in troubled banks, assuming they would
make more loans with more capital on hand. The amount of capital, though, has
little to do with the reluctance of banks to make loans, even as the rate on
federal funds is slashed to near zero. John Maynard Keynes, the British
economist, called this situation a “liquidity trap,” Siegel noted. “The big
failure of TARP was that it misunderstood why banks weren’t lending. Officials
thought it was because they didn’t have enough capital. In reality, they were
worried about the solvency of all the borrowing that was out there.” Siegel
suggested that the government rescue plan could be improved with guarantees that
recipients demonstrate they are using the federal dollars to extend credit.
According to Siegel, monetary policy has failed to stimulate the U.S. economy.
The U.S. faces a situation similar to what happened in Japan during the 1990s
when interest rates of zero could not revive the country’s moribund financial
markets. The only viable solution now open to American policy makers is
Keynesian fiscal policy, a stimulus program that lowers taxes or increases
government spending or both. Indeed, this is exactly the type of program –
costing at least $825 billion — that the Obama administration and Senate
Democrats are considering. Siegel said that policymakers should not worry about
the impact on deficits; it is large, he added, but not dangerously so.
Towards the end of his 90-minute talk, Siegel offered some tongue-in-cheek
advice to would-be entrepreneurs. “Start a new bank,” he said. “You won’t have
the problems of existing banks, and the federal loans interest rate is near
zero. Demand for loans is high, and you will face no competition from the
private market. You could become very profitable.”
Additional Reading
Jeremy Siegel’s Advice to Banks: Lend that Money Now
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Richard Marston and Jeremy Siegel: Will the Bank Plan Revive Global Markets?
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Save settings Thread active 6 days agoCollapse thread Expand thread +4Vote
upVote down Walter_P_Blass • 1p
I am loth to question Prof. Siegel, but my stockbroker in NY told me well before
the collapse of Lehman Bros ( whom he once worked for) but after the Bear
Stearns debacle that BOTh firms had a reputation on Wall Street for taking
untoward risks, as compared to other companies. Listening to Tim Geithner
testifying today, I heard that no other company was willing to take over Lehman
without a huge injection of Fed money, say as compared to the Merrill Lynch, or
Wachovia takeovers. Are those statements are true, should all banks, or all
investment banks be tarred with the same brush, or are Lehman and Bear Stearns
indeed “more guilty” than others in taking risks? I realize there are
limitations ( including libel) that might prevent Prof. Siegel from
rank-ordering the risk-takers. Still, I am struck by Joseph Ackerman’s statement
that Deutsche Bank was invited to participate in the Madoff investments and
“just said no”, obviously because someone in that bank said “it’s too good to be
true!” Report Post reply » 1 week ago
+2Vote upVote down Janice_ • 24p
Well, you could be really smart and sell those toxic derivatives in one part of
your company while shorting them in the other.. that would be Goldman Sachs. As
for Madoff, the only true victims where those invested in fund of funds who had
no idea that all their money was invested in Madoff.. There is such a cautionary
tale here for the average investor . Trust no one. Report Post reply » 6 days
ago
This comment has 1 hidden reply. Show it! +2Vote upVote down Janice_ • 24p
With all due respect.. Hindsight is 20 20. You had a front row seat to all of
this.. Where were the lectures to instruct and direct in real time? I don’t
know.. how smart to you have to be to give a lecture on the folly of these
markets from the safety of academia?
I am profoundly disappointed in everyone that conducts business, instructs and
comments on the financial fiasco that we are all living through.
I have said many times that it takes a certain mentality to gamble the house
with other peoples money. May I remind you that many sat in your classrooms.
I remain, though barely solvent
Janice Report Post reply » 1 week ago
This comment has 0 hidden replies. Show them! Thread active 1 week agoCollapse
thread Expand thread +1Vote upVote down Brian P.
Perhaps I’ve missed something. Is Prof. Siegel essentially teaching his students
is that it’s alright for financial institutions to participate in the creation
and marketing of dodgy investments vehicles (like the good old Dot Com days) as
long as they’re not left holding the rubbish bag?

If one of the world’s foremost universities turns out graduates with this
perspective then I suspect it’s a matter of when, not if, the next financial
upheaval wrecks havoc on the world’s economy. Out of curiosity, do Wharton MBA
students also hear from U. of Pennsylvania professors of ethics or civics on
what they feel was the most significant cause of this financial crisis? Report
Post reply » 1 week ago
0Vote upVote down Meryl Steinberg
Brian.. I’m not an economist, but that was what I took away from Professor
Siegel’s lecture as well. Shame on him to send such a message. Report Post reply
» 1 week ago
This comment has 1 hidden reply. Show it! 0Vote upVote down Le Minh Tuan
Prof. Siegl said the real reason of the financial crisis is that financial firms
hold large quality of risky securities. My question if these financial firms do
not hold, what would they do? They would sell them in the stock market? We can
image what would be when a very large amount of risky securities would sell out
in the market.
My idea is why they have invented and developed these risky securities? did they
know how risky they are.
Greed is most probably the reason of the current crisis. Report Post reply » 1
week ago
This comment has 0 hidden replies. Show them! Thread active 6 days agoCollapse
thread Expand thread 0Vote upVote down M Hodak
I think Brian and Meryl missed the point of that part of Dr. Siegel’s comments.
The fact that the banks held those securities themselves when they didn’t have
to clearly indicates that they didn’t understand the risks of what they were
selling to others. Greed is not meaningful in this context. The key decision
makers at the bank simply didn’t know what they were getting into. Anyone who
says they should have known is simply a Monday morning quarterback. I’m sure
Dick Fuld did not intend to personally lose $500 million dollars from bad bets.
He just screwed up. Report Post reply » 1 week ago
0Vote upVote down Donald Jenner
Well, yes — but these guys are supposed to know what goes on in their
businesses, that’s why the get the big bucks. This is not, as Siegel has it, a
question of being good or bad; he rightly stays on the descriptive side of the
ethical issue (which it is), and says that the people who should have been
paying attention, taking care of business, weren’t. That is bad business
practice, and that is the only ethical judgment that obtains. So, screwing up is
an appropriate moral condemnation, as well as a condemnation of the way business
was transacted. [And as for the folks upset by Siegel’s seeming approval of the
actual business of packaging mortgages &c.: This is Wharton School of >what<?
Add to this, the man is making perfectly appropriate economic assumptions, that
people are rational an make rational judgmennts. Report Post reply » 1 week ago
+1Vote upVote down Mukul_Pandya • 16p
I agree with M. Hodak. While it might appear that Prof. Siegel is advocating
flipping the toxic assets (as the financial institutions did with worthless
dot-com stock), he is actually just describing the difference between the way
these institutions behaved during the dot-com bubble and the housing bubble. In
one case, they flipped the assets, in the second, they held them because they
did not realize their toxicity. Had they realized it, they would not have been
in trouble — but those who bought them obviously would have been.

The trouble was their faulty logic, as he explains later in his lecture. Those
who held and insured the mortgage-backed assets believed that these securities
were safe. This is because the ability or inability of borrowers to pay the
mortgage did not matter as long as the value of the underlying real estate kept
rising. That was true enough for several years during the housing bubble. But
when that bubble burst, those who were left holding the assets had to pay the
price. That is the fallout we see today. In short, Prof. Siegel is explaining
what happened — and not justifying the behavior of those who acted as they did.
Report Post reply » 1 week ago
+2Vote upVote down Janice_ • 24p
I disagree strongly with the notion that these institutions did not know the the
toxic nature of many of these assets. Why then create this bundle of mortgage
backed securities ? It was to hide not spread the real risk with complicit
insurers who also picked up fat fees. If simpletons like me saw this coming, how
is it possible that these great minds on Wall Street did not. This reminds me of
Willy Coyote( Road Runner reference) filing a building with dynamite and
standing right outside with the the detonator . The entire consumer economy was
based on the housing bubble and easy credit. With the collapse of the housing
market, the house of cards folded. If economics is not predictive, then perhaps
we should just hire fortune tellers. Report Post reply » 1 week ago
+2Vote upVote down Mukul_Pandya • 16p
Thanks for your comments, Janice. You’ve probably heard the joke about
economists — when they don’t know facts, they base their actions on
assumptions. (-: I love your analogy to Wile E. Coyote and the building filled
with dynamite. It is, of course, true that some people on Wall Street knew of
the risks and flowed along with the tide because they were making good money
doing so. But I doubt if this was a widespread conspiracy perpetrated by people
in the know simply to pick up fees. I have always been impressed by people’s
capacity for self-delusion, especially when these delusions serve their
interests. Report Post reply » 1 week ago
+2Vote upVote down miroslodki • 13p
moreover to Janice’s point, how can anyone buy any asset and not expect a
downside risk – what weed do they smoke. I have to suspect that greed and the
ability to offload opaque risk ( we haven’t dragged the credit agencies into
this as yet) was the means to a big payout. Maybe they were holding onto those
MBC’s because they thought that part was safe- or if we invoke occam’s razor
—-dumb Report Post reply » 6 days ago
This comment has 5 hidden replies. Show them! Thread active 5 days agoCollapse
thread Expand thread +1Vote upVote down CTW
It is quite clear from the history of mankind and the history of financial
crises that the interests of a nation are not the interests of the private
sector. Left completely unregulated, markets inevitably fail (yes Milton
Friedman, turn in your grave). And they fail because of man’s pride, lust and
greed. It’s the same for the government. A bloated bureaucracy without the
checks and balances to keep it accountable would inevitably become corrupt (e.g.
Communist regimes). I agree with Siegel for apportioning the blame on both the
banks and the Fed, but I think he needs to go one step further – that the
incentive structures of the financial institutions need to be completely
revamped to make sure that the bankers who are really responsible for creating
this mess take a hit to their pockets ultimately. And the private sector should
not only care about bottomlines but their impact on the community. Many
companies simply pay lip service to corporate social responsibility. This is a
narrow-minded view with long-term consequences. Report Post reply » 1 week ago
0Vote upVote down vkuc
Nicely stated!! Report Post reply » 5 days ago
This comment has 1 hidden reply. Show it! 0Vote upVote down Amitabh
Three points:
1) Economists are incapable of predicting future. All economics knowledge is
post-facto. Read The Black Swan for proof.
2) Greed is inherent in any economic system. Such crisis will occur again. The
reasons might be different but will happen. Some other economist will offer an
explanation then.
3) Present crisis is due to loss of risk appetite by banks. All solutions must
address this aspect. Otherwise it is doomed to fail.

One out-of-the-box solution:
1) Do nothing. Yes, that is right. Do nothing about the present crisis. Such
crisis are cathartic in nature. They take away the weak and the incapable. The
ones that will survive will come out stronger than before and the economy will
bloom once more. And what about the common (wo)man who suffers. Divert the huge
cash and credit injections to them. This will actually simulate the economy.
Report Post reply » 1 week ago
This comment has 0 hidden replies. Show them! 0Vote upVote down jrham
Dr. Siegel’s stated cause of the crisis, "The excessive greed of Wall Street" is
a symptom not the cause. The root-cause was the government programs supported by
activist such as ACORN who pressured lending institutions to lend to subprime
mortgage borrowers with continual support by Congress. Report Post reply » 1
week ago
This comment has 0 hidden replies. Show them! +1Vote upVote down cvanslyk • 1p
Maybe the fact that the govt through Fannie and Freddie quasi guaranteed the
loans had something to do with it. Google the Community Reinvestment Act. Geez.
Talk about a white elephant. Report Post reply » 1 week ago
This comment has 0 hidden replies. Show them! Thread active 3 days agoCollapse
thread Expand thread 0Vote upVote down ewashler
While all of the above is relavent and is to blame in part for the mess we are
in, nothing is said about the root causes of payment failure by the millions of
persons who borrowed the money in the beginning. While many of the borrowers
obviously over extended on their borrowing and pay back capabilities in normal
times, who expected the cost of oil would increase to $5.00 at the pump, heating
oil to triple, etc. ,etc.. Over the past few year,the oil exporting countries,
the oil companies and others in the energy sector reported exorbitant profits.
Common people paid that price, that profit . They had to get to work in their
overpriced vehicles built by over paid labor. While paying that price, many of
simply could not keep pace with their mortgage payment requirements, car
payments, other costs of living . The economists, the bankers, the other
"experts" in the financial world need to see the real world, the world people
live in who are paying the bills. There is a lot of blame to pass out, but let’s
not ignore the folks who reaped the really enormous profits over the past few
years. They weren’t all in the housing and banking sectors of the economy.
Report Post reply » 1 week ago
+1Vote upVote down Janice_ • 24p
If I am not mistaken, wasn’t the run up in oil a result of Wall Street creating
a commodities bubble?The world responded with a slowdown in production and the
consumer pulled back on consumption driving demand way down . So much of the
pain we are enduring could have been prevented . I mean you had Goldman Sachs
predicting oil would go up to $150 a barrel.
I have said that it was impossible for the average consumer to understand the
depth of this crisis.
The fact that the Fulds and the Thaines of this world stole billions of dollars
in compensation that was based on funny numbers is just reprehensible.. It’s
fraud and should be treated as such. Where are the indictments? Report Post
reply » 3 days ago
This comment has 2 hidden replies. Show them! +1Vote upVote down walkelrouk •
1p
Those who held and insured the mortgage-backed assets believed that these
securities were safe. This is because the ability or inability of borrowers to
pay the mortgage did not matter as long as the value of the underlying real
estate kept rising. That was true enough for several years during the housing
bubble. But when that bubble burst, those who were left holding the assets had
to pay the price. That is the fallout we see today. Report Post reply » 1 week
ago
This comment has 0 hidden replies. Show them! 0Vote upVote down Jim
At the very foundation of the debacle was govenmental interference in the
housing system as our politicians (Federal, State and Local) promoted the myth
that home ownership represents the "American Dream." To ensure that those who
clearly weren’t able to fulfill the responsibilities inherent in home ownership
(ability to save for a 20% downpayment, the self-sufficiency to cover monthly
mortgage, taxes and insurance burdens, sufficient income to pay for upkeep
etc.), these "leaders" exerted pressure and provide dollars to make home owners
out of apartment dwellers. Now look at what we have; apartment dwellers unable
to pay for their houses!!! So what do they do now?They hand us the bill -
surprise, surprise! There is a way out of this mess. For my suggestion, please
see the next comment (system limitation). Report Post reply » 6 days ago
This comment has 0 hidden replies. Show them! Thread active 5 days agoCollapse
thread Expand thread 0Vote upVote down Jim
Here is my suggested remedy.

Simply, reward those citizens who have managed their personal lives with the
responsibility and discipline so as not to infringe on their fellow citizens. To
do that, I recommend a 25% tax credit to all households with a credit rating
above 725. This tax credit is given in the form of a credit card issued (free of
charge to the American taxpayer) by those banks receiving TARP monies. The card
would be non-transferrable, could not be redeemed for cash and would have a 90
day life (spend it or lose it). The net result is an immediate infusion of
capital into the economy by our most credit-worthy and responsible citizens. To
foster responsible financial management, this tax credit would become the law of
the land. Report Post reply » 6 days ago
+2Vote upVote down Susan
I agree with Jim. My husband and I worked hard to buy a house we could afford
and paid off our mortgage early. We are fortunate enough to now own it free and
clear. I could never understand banks giving mortgages to people who could not
afford the house. After all, the mortgage payment is just the tip of the iceberg
in home ownership. Couple that with the ridiculous amounts of credit card limits
and home equity loans extended to people and it was inevitable the entire house
of cards would come tumbling down. I believe the bankruptcy laws should also be
revised. The banks should lose by not being allowed to collect any further
interest or penalties, but those who incurred the debt should have to pay it
off, regardless of how long that takes. No one should be able to run up tens of
thousands of dollars in credit card debt for things like vacations, dining out,
expensive clothes, everything and anything for their kids, etc., etc., and just
be able to walk away from it because they cannot pay. Current bankruptcy laws
continue to foster and enable irresponsibility. Report Post reply » 6 days ago
+1Vote upVote down grayfox • 12p
The first principle of long-term lending is that the primary source of repayment
is cash flow, not collateral. ____The first principle of leveraging investments
is or should be to match maturities. Yes the real estate market began deflating
in 2006 when the Fed raised rates in an effort to "slow" down the overheated
market. But the economic meltdown began in 2007 when the gurus on Wall Street
found the short term financing market frozen. Their investments began rotting on
the vine because of the deteriorating underlying collateral at a time when the
mark to market accounting change in 2006 was beginning to impact their capital
positions. In short, their investments became toxic.They held these assets
because the market went away.____Our present situation will happen again and
again without firm regulation and enforcement of the regulation. Criminal
consequences should follow intentional violation of regulations or intentional
failure to enforce regulations. Competition and ill conceived social benefit
drove all involved parties to compromise any hesitancy they might have had.
Report Post reply » 5 days ago
This comment has 2 hidden replies. Show them! 0Vote upVote down Joe
Why hasn’t Mr. Siegel or anyone else brought up SOX in this whole mess? Did we
not learn from Enron and MCI? How can a couple that earns 50k a year live in
480k house? It doesn’t take an Alan Greenspan to figure out there is a problem
with this. Also what about all the folks that are walking away scott free from
their debt? I’m sick of hear people feel sorry for them losing their home, what
made them think could afford or should a house that price (which is what drove
the market to crazy levels in the first place). Report Post reply » 6 days ago
This comment has 0 hidden replies. Show them! 0Vote upVote down paul
I could have overpaid for a Florida condo in 2007, but recognized that the cost
would overwhelm the average income. The many who misjudged the market, perhaps
with government bailout as their back-up plan, cannot be held blameless. Report
Post reply » 6 days ago
This comment has 0 hidden replies. Show them! Thread active 6 days agoCollapse
thread Expand thread 0Vote upVote down Penny K
A certain ability to disassociate from conscience and long term, larger thinking
seems to be basic to make up of those who go into business, with notable
exceptions, some of whom go on to become great philanthropists. Report Post
reply » 6 days ago
+1Vote upVote down Janice_ • 24p
I am beginning to think that a good deal of philanthropy is predicated on a
guilty conscience. Oh, and tax write offs. Report Post reply » 6 days ago
This comment has 1 hidden reply. Show it! 0Vote upVote down Frank Lopez
Lesson #2. Don’t get high on your own supply. Report Post reply » 6 days ago
This comment has 0 hidden replies. Show them! +3Vote upVote down Sean Olender
Professor Siegel overlooks a few inconvenient facts. First, the US economy has
come to rely on increasing debt inputs to produce the same GDP growth over the
past 25 years. The debt loads of consumers are mathematically impossible. This
is less a banking crisis than an economy wide debt crisis that results when it
is no longer possible for a critical mass of consumers and businesses to make
debt maintenance payments because their debt to income ratio has grown too
large.

If you look back at mortgage equity withdrawal and the real estate boom, it WAS
the economy from 2002 to 2007. Actually, if you remove the unprecedented boom in
homeowners borrowing against their homes and taking the cash to buy cars,
jewelry, vacations, home remodels, and all manner of things — if you subtract
just mortgage equity withdrawal from GDP (leaving the rest of the housing boom
insanity in there), you get negative GDP for 2001 and 2002 and below 1% growth
in 2003-2005. You would have certainly had a full two year recession if not for
mortgage equity withdrawal and almost certainly had a five year recession if not
for the housing boom (40% of all jobs created from 2001 to 2006 were in real
estate and related industries).

There is a broader problem in the US economy and that is a fantastic disparity
of wealth has developed unprecedented since the 1920s. The only way to push GDP
is to loan money to most people because they can’t afford to shop enough to
support corporate profitability at existing prices because wages have fallen
while corporate profitability has risen. There comes a time when it is
mathematically impossible for a person to borrow more money for consumption on
even the favorable estimations of his future income.

The future moving forward from here is that "consumers" appear to have realized
that they cannot perpetually borrow more to support a standard of living that
assumes a future windfall (like a lottery winning or a 100% return over four
years on an expensive home). We’re thus not merely facing the inability of
consumers to borrow more because their incomes can’t support it, we’re facing
the day of reckoning when consumers must, like indentured servants, begin to pay
down some of their heavy debts. That is a process that could drag on for years.
Report Post reply » 6 days ago
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thread Expand thread +3Vote upVote down Sean Olender
Americans have little to look forward to except paying down their debts. At
least this is a more dignified and rational goal than selling years of future
servitude in exchange for marked up retail junk today. The undeniable truth of
our current predicament is that a decade of consumption was pulled forward and
compressed using borrowed money. GDP reflects a level of consumption obviously
unattainable at current consumer income levels. That consumption was a trade off
as all debt financed consumption is: consume more than income supports using
debt today and you must consume less than income supports in the future using
the surplus income to pay back debt.

The discussion to date is focusing on the reduction in consumer borrowing and
government efforts are focused on trying to restore unsustainable consumer
borrowing. Those efforts will obviously and necessarily fail. But that’s only
half of the pain. The other half is further reduced consumption and thus GDP
because surplus income is needed to pay down debts.

Let’s take the example of an idiot. Suppose a man makes $100,000 a year after
taxes and he borrows $20,000 a year to supplement his income because he just has
to have those new consumer gadgets made in offshore slave labor camps and marked
up 1,000%. So he’s spending $120,000 a year and grows accustomed to it. After
five years he owes $100,000 (assuming he’s been paying the interest during the
five years). At 5% interest, he must pay $5,000 a year even if he doesn’t borrow
one additional dollar. If he stops borrowing, how much money can he spend?
Professor Siegel would probably say, $100,000. The very most he can spend
without additional borrowing is $95,000 a year because he owes the $5,000 a year
in interest. But a funny thing happens when people stop expanding their debt.
Many often start to understand math better and they realize that the debt
hanging over them drains away their income for a lifetime unless they pay it
down. So if this man wants to pay down this debt over ten years, he needs to
spend about $10,000 a year paying down principal, plus $5,000 a year in interest
(although the interest will fall as he pays down principal). So he’s going to
pay roughly $12,500 or so in debt payments over ten years to retire this debt.
That means that it’s not $100,000 or $95,000 that he can live on for ten years,
but $87,500 a year.

The burden of debt repayment on consumption levels is not something economists
talk about because it is unthinkable that a properly socialized American would
ever consider the bondage of debt servitude (median households paying on average
14% or 15% of annual income in interest payments to evil banks aren’t believed
to have the intellectual capacity to even understand their bondage). The
assumption is that Americans will never ever pay down their debts. If you add
this possibility of some majority of Americans returning to a rational dignity
and not trading a promise of future labor for stupid trinkets today, if you add
the possibility of Americans deciding to pay down their debts some in addition
to not expanding their indebtedness, you come up with a much larger decline in
consumption, GDP and corporate profitability.

Now I have no problem with corporate profitability generally. But here corporate
profitability has reached unbelievable heights through global labor arbitrage
and the hard selling of debt at every transaction (hey, if you open a store
credit card with a $10,000 limit and 18% interest rate, you can save 10% on that
dish soap you’re buying!"). Corporate profitability rests now on Americans
paying $100 for a sweater or jacket made in Honduras or Bangladesh at a real
production cost of $3 or $5 – a product made by workers paid $8 a day. Add to it
that the American finances this sweater or jacket at 18% interest on a credit
card and the interest alone exceeds the production cost in just three or four
months. That is a level of corporate profitability that, I believe, we aren’t
going to see return until the next roaring 20s. An historical survey suggests
that will be sometime around the year 2060. Report Post reply » 6 days ago
+1Vote upVote down Janice_ • 24p
Sean,
That was the most informative and cogent analysis I have ever read. Why aren’t
you standing in a lecture hall or sitting on the Banking and Finance Committee
in Congress.
I don’t know if you are old enough to remember Tennessee Ernie Ford, but he sang
a very famous song called" I Owe My Soul to the Company Store. Google it.. That
is what Americans have become. Report Post reply » 5 days ago
-2Vote upVote down Michael
Sean Olender, I agree with Janice. You should’ve been the lecturer — not
Siegel. I knew Jeremy back in 8th grade, and mostly disagreed with him then.
Roughly two years ago I caught up with him and e-mailed him that my take was
that the most prudent thing to do would be to get out of the markets. He
e-mailed me back that it didn’t matter since he was in the markets for the long
run. Good luck with that. (He went on to predict an 8% to 10% market increase
for 2008.) I think the only thing that Sean missed–unless I missed it–is the
approximately $558 trillion (yes, trillion) out there world-wide in
derivatives–and nobody knows what the hell they’re really worth. I went to what
is now NYU’s Stern School of Business, so perhaps I was taught from the wrong
lesson book, possibly causing me to run successful businesses and not losing any
money — even in today’s economy. Does Wharton still have a better reputation?
Report Post reply » 5 days ago
+1Vote upVote down Janice_ • 24p
Can I give you what is left of my decimated portfolio for you to invest? Report
Post reply » 5 days ago
0Vote upVote down vkuce
Well stated. However, the economic lesson including the uderstanding and control
over one’s finances is something that was taught by my family members to me by
the age of 8. Does one really need an MBA to understand this? Report Post reply
» 5 days ago
+1Vote upVote down Janice_ • 24p
Sean,
Can you explain the part that short selling had in the collapse? Report Post
reply » 5 days ago
0Vote upVote down Mike Groleau
I’m so glad to see someone talking about the ROOT cause of the problem – growing
debt. All the discussion has been on the collapse of the housing market, NOT
what was behind that – the unsustainable debt loads that Americans have been
taking on. The data suggesting a looming problem has been around for years,
namely the decline of personal savings rates from 10% in 1980 to 0% in the last
several years (it actually went negative recently). That’s insane! The only
surprise was the rate at which the chickens came home to roost.

It seems that savings (government or personal) is like a cushion. When the
downturn hits, savings provides a buffer that prevents spending from collapsing.
In the absence of savings, mortgages cannot be repaid, spending drops
precipitously – all the things that are at the root of the current debacle.

Am I missing something here? Why is there so few otalking about the role of debt
and savings in stabilizing the economy? Why are so few focusing on the symptoms
and not the root causes? Report Post reply » 4 days ago
0Vote upVote down Mike Groleau
So now that the bottom has fallen out, savings rates have increased as people
finally realize they are extremely vulnerable financially. In theory, that would
sound like a good thing – people are finally coming to their financial senses.
However, the timing is awful. Instead of saving while times are good, people are
reducing spending in a downturn, and the "paradox of thrift" kicks in, further
fueling the downturn as spending decreases.

So, what’s the solution? Try to convince millions of people to modify their
spending and savings habits? It will never happen! That’s where we need state
and federal governments to step in. Governments need to go on a "savings spree"
when the economy booms. Then, when the economy falters, we have a cushion.

My fear with the current stimulus package is that we will spend our their into
further debt, then fail to repay that it when better times return.

Maybe I’m totally off base here. "Dammit Jim, I’m a doctor, not an economist".
Yes, I’m not an economist…. but I did stay at a Holiday Inn Express last
night! Report Post reply » 4 days ago
This comment has 7 hidden replies. Show them! Thread active 4 days agoCollapse
thread Expand thread -1Vote upVote down E.A.
I thought professor Siegel did a good job of breaking down the cause and effect
of the current crisis. The root of the problem as I see it is the American
lifestyle: 7 credit cards, houses as ATM’s, McMansions, leased Hummer in
driveway, 50" plasma tv in every room, cell phones, must have gadgets, all
purchased without working very hard and without any emergency fund savings. Oh I
forgot to mention, college students with credit card debt and over 100K in
student loans who will default or declare bankrupcy shortly after graduation.
Report Post reply » 5 days ago
+1Vote upVote down Janice_ • 24p
I agree that we have become a cashless society. I think that is what is at the
heart of the problem. It is reasonable to assume that we should all be above
succumbing to the societal pressures that lure us in to live better .That
translates to cheap car leasing, easy credit and ridiculous mortgage products
that put us in homes we can’t really afford. It is my very humble opinion, that
most believed that their savings were replaced with the unsupportable belief
that home prices would continue to rise. Report Post reply » 4 days ago
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thread Expand thread -3Vote upVote down B.G.
Oh…here we go again….another 20/20 hindsighted backseat car driving
financial drivel spieling professor…where were these views when the industry
was taking on these instruments of "fatal flaw"? Report Post reply » 5 days ago
-1Vote upVote down Janice_ • 24p
Amen. We spend thousands to educate our children. We need to start paying
attention to what they are being taught. What has Wharton done to promote a
measured and ethical approach to finance? I am so weary of these academics
sitting in their ivory tower dispensing their wisdom. My contention is where
were they when it would have made a difference. Where were these teachers when
it came to instilling in their students a respect for the hard work that
provided the dollars they would be entrusted to invest?
My respect goes to the laborer, the small business owner who is out there in the
trenches doing the kind of work that these finance types have absolutely no
respect for. Herein lies the problem. Wall street looks at Main Street from
30,000 feet. Just like the bombardier. Report Post reply » 5 days ago
+3Vote upVote down miroslodki • 13p
when did anyone put a gun to any consumer’s head and say buy this and over
extend yourself. Harsh as it is, there is no pity for those who can’t manage
their financial affairs or for the speculators who lost on the roll of the dice.
If these real estate flippers won the game, they’ld be crooning about how smart
they were to invest, articles would be written about the wisdom of investing in
rental property or vacation property etc….

the system is broken, multiple parts of it failed at the same time.
greenspan blames it on a failing in the pricing of risk
the flat earth and shrinking middle class led people to pursue a dream that was
no longer attainable
people bought and were allowed to take on more risk than they were able to
handle
mortgage brokers made money on sales but didnt own the risk
credit agencies lied and turned toxic into investment grade instruments
investors/investment managers bought stuff without knowing the risk because they
relied on due diligince of others and/or were chasing the return and
deliberately oblivious to the risk
investors then leveraged with derivatives they didnt understand
derivatives that were supposed to be insurance ( being unregulated) created an
off track betting parlor disguised as a financial market
the derivative modelers (quants/physicist) simply created mathematical models-
not realizing the real consequences to their assumptions – let alone the hubris
that risk can be eliminated by calculation – forgetting their basic Newtonian
physics – for every action,,,there is an equal and opposite reaction
financial leaders failed to provide stewardship since they wanted their
quartelry bonus
political leaders…. dont get me started
stockholders allowed management/directors/boards to run without enough control
management doesnt own enough of the risk/equity in the corporation to ensure
measured management that balances short and long term profit
government oversight bodies werent monitoring because of the lassiez faire
attitude

there is a fundamental paradigm misalignment between risk, reward. long term and
short term event horizons
(mckinsey call this a structural break)
unless this is addressed in the reboot – this will happen again because greed
knows no boundaries

I think the most telling guidance comes from the very end of Obama’s inaugural
when he quoted Washington and the passing of the torch to the next generation.
That quite simply is the key for the future. IMHO

"America. In the face of our common dangers, in this winter of our hardship, let
us remember these timeless words. With hope and virtue, let us brave once more
the icy currents, and endure what storms may come. Let it be said by our
children’s children that when we were tested, we refused to let this journey
end, that we did not turn back, nor did we falter; and with eyes fixed on the
horizon and God’s grace upon us, we carried forth that great gift of freedom and
delivered it safely to future generations"

PS – remember its human nature to dissect a train wreck after the fact and claim
to be smarter than the victims
the bigger question is how the moral questions are debated. pursuit of profit
and efficiency is a noble objective – but we must come to recognize and
appreciate multiple perspectives. Might is not right, nor is privatizing profits
while socializing costs.

PPS LUCY. You got some ‘splainin’ to do Report Post reply » 5 days ago
+2Vote upVote down Janice_ • 24p
I respect and appreciate the substance of your comments. I will only add that
the average wage earner bought into the "myth" of acquiring wealth with
property.. They lacked the sophistication to understand the risks that were
inherent in such absolute subterfuge.If you can measure the catastrophic
consequences of the Greenspan doctrine, you can understand how the average
citizen was unable to comprehend the level of risk they were buying into. I
mean, if the poobahs on Wall Street were spinning these products as reasonable
risk, how was the average consumer to understand that the housing market would
not sustain a refinance when the time came.

Can you see that those with knowledge had the responsibility to sound the alarm
and put a stop to this? I knew. I am a Broker and did no transactions where
clients took mortgages that would be at risk. never, not once. There are those
of us out there that steered the innocents out of trouble.

There is ample blame to go around, but none as deserving as the Wall Street fat
cats who worried only about preserving their own wealth. Look what Thaine just
did.. I just can’t wrap my head around a million dollar renovation on an office
when he is asking tax payers to bail them out.. What is wrong with these men?

Where were the Boards of Directors.. Well honestly they were hired by the CEO’s
.. It is so demoralizing isn’t it?

Let’s hope this government, made up entirely of people who enabled this whole work, so that the mortgage payments may be made and
foreclosures stemmed. The value produced by employment of people in the area is
generally what keeps the real estate value levels. Areas of low value added
economic activity generally have low real estate values, vacation areas exclued
of course.

For the banks to recover, it should not be done by bailout of the toxic assets,
(nor by more consolidations and mergers and acquisitions) rather, assisting
(providing capital) the local banks making accountable loans and mortgages on
the local level.

W.r.t. your statement on needing laws, consider that every attorney will state
when asked about "right and wrong, and ethics and morality" that "it is not
justice, it is the law". The question remains about ethics and morality for all,
not just the select exempted few. Report Post reply » 5 days ago
+1Vote upVote down Janice_ • 24p
Vkuc,

Can we legislate ethics and morality? I have learned a great deal reading these
comments. There is much that is really beyond my knowledge base.

I was so disheartened listening to the Senate confirmation hearings on our soon
to be Secretary of the Treasury, Geithner. I know he’s smart, but he is not
ethical. Listening to him try to spin this tax evasion was depressing.

We don’t need the smartest guy in the room , we need the one with common sense
and a moral compass.