Letter Re: UCLA’s Eye-Opening Colloquium on the Worldwide Financial and Economic Crisis

Yesterday [Friday. November 14, 2008] I attended the Marschak Colloquium on Mathematics in the Behavioral Sciences at UCLA {University of California, Los Angeles] . This thing is attended by lots of UCLA and USC [University of Southern California] economics professors, including many retired faculty members and other local luminaries. (Two seats to my right was author Alvin Toffler of “Future Shock” fame.) The main speakers presented for an hour, and then the whole group asked questions and discussed the topic. Here is the brief abstract that announced the talk: “The current worldwide financial and economic crisis is the greatest economic challenge we have faced since the Great Depression. The two speakers will treat the crisis in the light of historical experience, will identify some of its causes, and will consider possible policy initiatives at the national and international level to treat it.”

The topic was “The Current Worldwide Financial and Economic Crisis.” I expected it to be an interesting, balanced, reasoned and academic view of the current bumps in the road, with some modest suggestions for improving matters. Wow! It was all very reasoned, and there was even a little bit of mathematical modeling, but these people are very very concerned! The immense set of interlocking derivative bets made by the big banks is now acknowledged as a complete house of cards, and one that is currently collapsing! (The second speaker made suggestions about policy moves that could be taken “if officials somehow miraculously stop the process in mid-collapse.”)

The whole two hours was fascinating, but here are a few of the ideas and comments that I came away with:
• This is the first global crisis of the globalized world. Likely every country will be affected and all at about the same time. (Very different from [the economic crisis of] 1929-1937.)
• The causes were many: lax regulation, lax credit reviews by rating agencies, securitization of mortgages, insane(!) investment leverage, pressure for continuously increasing financial profits, herd behavior, deregulation, ….
Many financial institutions would be immediately bankrupt if the were forced to value assets at current market prices. (Instead, everyone has agreed to claim that “certain markets are frozen.” The regulators wink.)
• Deleveraging is essential to the survival of these institutions. But most deleveraging actions actually lower all institutions’ capital bases. So it’s a self-reinforcing positive feedback cycle. Serious deflation is a genuinely possible outcome. For the first time in our lives, money could become more valuable over time, rather than less.
• On the other hand, most Latin American currency crises began as fiscal crises. Government frantically created money to prevent deflation, and eventually they got hyperinflation. This, too, could happen here.
A former vice president of Citicorp was in the audience. He said that the explosion in derivative instruments ran far ahead of infrastructure (markets for trading them, etc.) and far ahead of legal frameworks. He said we haven’t even seen the beginning of the counterparty problem.
• An economist from USC in the audience said that we will soon have huge, massive unemployment in the U.S.
• What will happen next (even what could happen next) is unknown. A Swedish economist in attendance said: “Dispense with the illusion that you understand what is happening.”

It was a very interesting couple of hours. – M.D.I. (by way of SurvivalBlog readers Bill and Charley.)