Monday, March 09, 2009

Professor Jasper Kim on the Financial Crisis

Professor Jasper Kim
Ewha Womans University
Department of International Studies
(Image from Ewha GSIS)

Professor Jasper Kim, of Ewha's International Studies Department, published a column, "The global financial crisis 101," in last Thursday's Korea Herald that helped clarify for me our current financial crisis, so I'll provide a synopsis of his article.

Professor Kim presents a number of factors contributing to the perfect economic storm.

As the first factor, Kim identifies "the extremely low interest rates following the 9/11 attacks." The Federal Reserve cut rates to about 1 percent for some time, which resulted in very low interest rates on loans, including mortgages, and led to "cheap money."

As the second factor, the low mortgage rates were "coupled with relatively complex mortgage terms and conditions that were often hard to understand for the typical homebuyer." Significant for this point was that mortgages that required "only a 1 percent down payment . . . to buy a home" often had variable interest rates that would result in "lower interest payments . . . first, followed by larger principal payments later." These generous-sounding terms "induced many relatively unqualified borrowers to buy homes they in reality could not afford," and the loans were what have been called "subprime."

As the third factor, Professor Kim identifies "complex financial products that had a direct link to the U.S. mortgage market." On this complex factor, I need to quote the professor directly:

These products, known as mortgage-backed securities, or MBS -- one type of collateralized debt obligations, or CDOs -- were effectively represented by a high-yielding note or bond that entitled the MBS investor to principal and interest payments. These MBS products were also collateralized by money received from pooled mortgages (mortgage receivables). As part of the MBS structure, created by sophisticated financial institutions, investors who bought these MBS products effectively also bought "insurance" against payment default in the form of credit-default swaps, or CDS. So as long as mortgage borrowers continued to make their mortgage payments on time, no problem would exist.
I won't pretend to understand this very well, but I do understand enough to recognize that a lot of people had put their money into investments that depended upon mortgage borrowers continuing to make payments. Unfortunately, the US housing market was a bubble that burst as interest rates began to rise, requiring those who had taken out loans, especially subprime loans, to make higher payments that they could not make.

As the fourth factor, Professor Kim identifies "the fall of many of the major investment banks, such as Bear Stearns and Merrill Lynch," which had incurred enormous losses from the large number of bad mortgages on their books. The psychological breaking point was the fall of Lehman Brothers, which put global financial markets into a tailspin. Interestingly, the professor blames "the laissez-faire ideological stance that existed at this time," which prevented "a Lehman bailout of even a few hundred million dollars" that "would have . . . proved a much better policy move compared to a plethora of bailouts and stimulus packages that . . . looks to be in the trillions . . . of dollars."

Well, that's Professor Kim's analysis. Doubtless, the factors are both more numerous and more complex than these four, but the professor does call his article "The global financial crisis 101," thereby acknowledging an oversimplification of the issues. Moreover, as "a former banker with Lehman Brothers, Barclays Capital, and Credit Suisse," Professor Kim would appear to be a person who knows what he's talking about . . . though I must confess to a nagging doubt about precisely what bankers really do know, given their failure in this crisis.

Comments from those more knowledgeable than I are very welcome . . . and that category would include the majority of my readers.

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At 8:41 PM, Anonymous Toronto Realtor said...

Nicely written and explained. Of course there had been many other reasons of the financial crisis but I consider the loan boom as one of the main ones. In the Bush administration people were encouraged to buy houses and by all means they had to acquire a loan. Loans were given to anyone and any time. This is of course terrible for the economy since majority of these people were not able to pay it back. Loans were given even to illegal immigrants and people were buying houses with the down payment of 5000 dollars. But it was Mr. Bushes idea to promote the idea that everyone should be able to have a house, a place to live in of their own. Well of course this did not work as we can see nowadays.

Take care, Julie

At 9:23 PM, Blogger Horace Jeffery Hodges said...

Thanks, Julie, for visiting and leaving a comment. I also liked Professor Kim's clarity, even though I lack the expertise to understand the details. If you haven't done so yet, take a look at his original article.

Jeffery Hodges

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At 11:10 PM, Anonymous Anonymous said...

This program started under President Clinton's administration and continued under President Bush.
I believe it was 2006 that President Bush issued a warning about Fannie Mae and Freddie Mac. Senator John McCain introduced a bill to examine the lending practices, but the Democrats killed the bill, and said things were ok.
This is an example of how history is projected according to the viewpoint of the writer.
Somehow it became Bush's fault. And in a way it was, because he didn't follow up by taking it to the American public.

At 4:05 AM, Blogger Horace Jeffery Hodges said...

Uncle Cran, a lot of folks bear responsibility, but for me, the economic process is like the fog of war. I don't know what's really going on . . . but neither do a lot of the so-called 'experts'.

Jeffery Hodges

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At 12:04 PM, Blogger Hathor said...

I think it was the speculators that got over their heads, more so than the immigrants and poor people, but blaming those people is so gauche. That did not create the financial crisis, it was that funny paper that banks bought and sold, formerly known as MBS',CDO's, CDS' and other derivatives. People made money hand over fist on these sales and the banks and other financial institutions were stuck with the bad paper, most of it far removed from the original mortgages. Even if every mortgage had been paid, eventually the worthlessness of some paper would have caused failure. No one will say it but Bernard Madoff was not the only one running scams. This is my view of the financial crisis, which I think is as true as anyone else's. I came to this conclusion based on listening to what the economist, bankers and pundits have said, not on any knowledge of economics.i

At 12:15 PM, Blogger Horace Jeffery Hodges said...

Hathor, I've also begun to suspect that the bubble economy of the past ten years or so has been one enormous Ponzi scheme.

But what do I know about economics?

Jeffery Hodges

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At 5:59 PM, Blogger Troeltsch said...

Excuse the lateness of my remarks- I just came across the article.

I think Professor Kim does a good job at hitting the cursory points, but ultimately away from more substantive analysis including explaining why investment banks took (foolish) risks in the first place. Some of the missing variables include:

1) Global imbalances- this would simply be chronic current account deficits run by the US and chronic current account surpluses run by the Chinese. This structural feature, coupled with interest rates below the optimal level, led to the noticeable increase in liquidity.
2) Government intervention in the housing market that caused the sector to become too large

I am also somewhat suspect of Professor Kim's explanation of "complex financial products." Financial products may have amplified the underlying problems of the crisis, but they certainly weren't causal. That would go to the need of large investment banks to "leverage up" (assume debt) on those products in order to make money.

At 7:05 PM, Blogger Horace Jeffery Hodges said...

Troeltsch, thanks for the comment -- no time is too late for commenting here on my blog. You're likely correct about the structural weakness and the flawed attempt to make everyone in America a home owner.

And the fact that the structural weakness remains is frightening, coupled with the massive US debts.

Financial crashes are God's way of teaching me economics . . .

By the way, I see that you like Dostoevsky. I have a number of blog entries on the man.

Jeffery Hodges

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At 9:42 PM, Blogger Troeltsch said...

Professor Hodges,

Thanks for your comment and this excellent blog. I also enjoyed your entries on Dosteovsky. Have you read Rowan William's book on his work?

At 11:18 PM, Blogger Horace Jeffery Hodges said...

Rowan William? Or Williams? You mean the Archbishop of Canterbury? No, I've not read it, but I'll check into it.

Jeffery Hodges

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At 11:24 PM, Blogger Troeltsch said...

my apologies; the name is rowan williams. a review of the book can be found here:

At 3:23 AM, Blogger Horace Jeffery Hodges said...

Thanks. The link will make things easier.

Jeffery Hodges

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At 12:16 AM, Blogger Douglas said...

As an Koean American I was wondering why this is happening in the strongest and the richest country and what the real cause of this economic mess and I felt embarassed not noticing it at around 2006 and 2007. NOw I came acroos a recent WSJ article by Prof. Kim and your blog. His analysis gave me a clear pictures but I feel I need more analysis. If you know any recent books explaining it pleae let me know. Douglas

At 3:33 AM, Blogger Horace Jeffery Hodges said...

Douglas, I'm merely a novice in these things and therefore know too little to offer advice.

Perhaps you could contact Professor Kim himself. I don't happen to know his email, but you could probably get that by going to his departmental homepage at Ewha.

Good luck.

Jeffery Hodges

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