Opening a March 31 panel discussion with the remark, "Don't take it personally — I really hope this is the last of these panels," moderator and organizer Ricardo Caballero, the Ford International Professor of Economics, Macroeconomics and International Finance and head of the economics department, sounded cautiously optimistic at times.
"Despite the many horror stories, we're not doomed. We're not even close to that," he said.
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An MIT panel discusses the current national economic news with the Institute community. Panel members: Ricardo Caballero, Bengt Holmstrom, Andrew Lo, James Poterba and William Wheaton
But Caballero was also careful not to minimize problems, saying, "Main Street and Wall Street are entangled in a very perverse downward feedback loop."
In the October panel, William Wheaton, professor of economics and urban studies and director of research for the Center for Real Estate, spoke pessimistically about a possible recovery of the housing market because of the large amount of housing inventory from foreclosures and overbuilding.
Recent data, however, point to a dramatic turnaround in some housing markets, he said. Investors and first-time homeowners "have stepped up to the plate" and started to buy property. "There is this big pool of capital willing and able to buy up distressed houses" often for investment purposes, he said.
Also upbeat was Andrew Lo, the Harris & Harris Group Professor of Finance and director of the MIT Laboratory for Financial Engineering at the Sloan School of Management. He argued that hedge funds — loosely regulated pools of capital that engage in broad array of activities — would play a large role in the economic recovery by taking over so-called toxic assets from banks' balance sheets.
"The hedge fund industry will lead the charge for creating additional investment opportunities and liquidity for more banks and more traditional institutions," he said.
Hedge funds have been unfairly maligned as "shadow banking systems" that helped cause the crisis, Lo said. He instead blames a "shadow hedge fund system" — the banks, money market funds and insurance companies that acted like hedge funds and invested in risky securities.
Bengt Holmstrom, the Paul A. Samuelson Professor of Economics, expressed frustration over the public outrage aimed at the financial services industry. He said the public is blaming "fools, idiots and crooks" in a system it perceives as fundamentally flawed. "If you start with that premise, I don't think you'll ever really get to the bottom" of the problem, he said.
Holmstrom particularly criticized calls for transparency, an issue that emerged when subprime mortgages were bundled together in investments that were given high ratings despite their risk. "Liquidity is fundamentally about not having things very transparent," he said. "If you start questioning, the music will stop, as they say."
So how to stabilize the fiscal system? Here panelists were less optimistic. Six months ago, the general consensus was the federal government's "deep pockets" could stimulate the economy without too much pain; that perception has dramatically changed, said James Poterba, the Mitsui Professor of Economics and president of the National Bureau of Economic Research. With the stimulus package, the federal deficit is now projected to run to $1.7 to $1.8 trillion for fiscal 2009, about 12 percent of GDP, a rate higher than any time since 1945. In 2010, the deficit will improve "a bit" to 8 percent of GDP and additional forecasts indicate more sustainable deficits of 2 or 3 percent of GDP until 2019.
But if the Obama administration proceeds with tax reforms and other program expenditures, the deficit could rise to 4 percent of GDP through 2019. Add in other proposed expenditures, like health-care reform, and projections run as high as 82 percent of GDP, Poterba said.
"At 82 percent of GDP, you start to get into a range where there are questions about the long-term fiscal health of a country," he said.
Efforts to find new sources of revenue are "not encouraging," Poterba said. The Obama administration plans to raise tax rates for about 1.4 million households that make more than $390,000 a year, who now account for about 40 percent of the federal income tax liability. However, many of these people have been hard-hit by the financial crisis and may see their taxable incomes drop. That would force the government to look for new revenues — possibly through introducing a national value-added tax.
The one silver lining is that with low interest rates on U.S. treasury notes, "the United States remains the port in the storm in many of the global financial markets," Poterba said.
A version of this article appeared in MIT Tech Talk on April 8, 2009 (download PDF).