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Money Down

By Brad A. Greenberg '04, Illustrations by Lou Beach

Published Apr 1, 2009 8:02 AM

No one would accuse the people behind the UCLA Anderson Forecast of being Pollyannas. The lauded Bruin economic forecasters were way ahead of the curve on identifying the tech bubble that popped in 2001 and were cautious about the run-up in housing prices that followed. The quarterly forecast issued in December, which predicted the recession would burrow deeper in 2009, was similarly unsparing.

The nation's unemployment rate, already higher than it had been since 1992, would climb to 8.5 percent by early 2010, the forecast predicted; the U.S. housing market would continue to suffer; consumers would keep tightening their purse strings. The economy, the forecast concluded, was in for a long slump.

The situation in California is even worse, if that's possible. The prospect of a $42-billion budget deficit and a divided Legislature at war with the governor have pushed the Golden State, in the words of one assemblywoman, into "undeclared bankruptcy."


"There comes a point where if you are driving your car to a cliff, if you come close enough, it doesn't matter what you are going to do. Whether you step on the brakes or turn to the left or turn to the right, you're still going over the cliff," opines Daniel J.B. Mitchell, professor of management at UCLA Anderson School of Management and at the School of Public Affairs, employing a metaphor that's becoming ever more common. "If California hasn't already gotten to that point, it is very, very close."

In this sea of bad economic news, there is no shortage of opinions about what needs to be done to turn the U.S. economy around. There's also no indication of what will work.

"A well-designed plan needs to deal with the fact that in the long run we need to save more and prepare for the aging of our population, but in the short run we need to save less, because people focusing on their personal savings has made this worse," notes Edward E. Leamer, director of the quarterly Anderson forecast. "That is a delicate balance."

And that's an understatement. In search of solutions, UCLA Magazine canvassed Bruin faculty and alumni for economic insight. Their opinions vary widely. There's a lot of talk about cliffs, of course. Doubts about President Barack Obama's fix — and whether Franklin D. Roosevelt's really worked as well as we think it did during the Great Depression. Even a radical call to create a new central bank.

To Fed or Not to Fed

"Government intervention will never stop anything. It is just a big waste of money and transference of payment from taxpayers to financial institutions that made bad decisions and should go out of business," declares Richard Roll, the Japan Alumni Chair in Finance at Anderson.

A New York-based Bruin, Aswath Damodaran Ph.D. '84, professor of finance at New York University, demurs, saying that there is, in fact, a lot the federal government can do to improve the economy. But efforts so far have been frenetic.

"One of the problems I've had with the bailout package over the past few months," Damodaran says, referring to the $700-billion rescue for the financial markets that Congress set aside in September, "is that every morning you wake up and there is some new twist on it that you didn't know before. The market has enough uncertainty without that."

The bailout was originally supposed to unfetter banks by buying toxic securities. That plan was dropped and it became a source of capital for banks. Then the bailout, known as the Troubled Assets Relief Program (TARP), expanded its funds beyond banks and eventually to the automotive industry. The stock market responded accordingly in late September and October, on some days dropping 700 points in the morning before finishing up 300; more often, the market moved in the opposite direction.

"The market right now is like a child with a parent that has gone completely haywire. It doesn't know where to look," Damodaran says. "It needs at least one authority figure who can tell it what is coming down the pike. The government needs to say, 'This is what we are going to do,' and stick with it."

Was Roosevelt Wrong?

Washington turned its focus to a roughly $800-billion stimulus package put forward by the Obama administration — and stridently attacked by Republicans and even some centrist Democrats. The package, now passed, intends to pump cash into various fields that would improve the overall economy.

But how big is big enough? The $700-billion bailout seemed colossal, and the economy has little to show for it.

"My fear is that we will adopt a big, but not huge, stimulus now — and it will be very difficult to end it, let alone reverse it, in the future," adds Brad Sherman '74, a Democratic congressman representing the San Fernando Valley, worrying that "we will climb out of this deficit slowly and emerge with a much larger federal deficit than we have now."

Economists also are concerned that Obama's plan is filled with more buckshot than bullets.

"Government policies work well when the problem areas are very narrowly defined. We know that government policies work poorly when it is a shotgun approach," Lee E. Ohanian, UCLA professor of economics, says.

Ohanian co-authored a paper five years ago that argued Roosevelt's New Deal actually lengthened the Great Depression by seven years. While the creation of the Federal Deposit Insurance Corporation was a targeted attack on bank runs, Ohanian contends that the National Industrial Recovery Act, a broad effort that included increased pay for workers in key sectors, slowed any drop in unemployment by making workers too expensive.

"Right now we are doing some of the same things," Ohanian says. "President Obama's principal economic stimulus plan is to increase federal spending on a range of activities, anywhere from putting more computers in classrooms to putting in green insulation in federal buildings. While those programs may have merit, they don't directly address the central problems that the economy faces right now. And it's not clear whether the benefits of those programs exceed the cost of running up the national debt by a trillion dollars, which is what we are probably looking at."

"Priority No. 1 should be re-regulating the banking system and cleaning that up," he continues. "Once that is done, we will be back on the road to a healthy economy. But if we don't reform the banking system, we will likely languish in a recession for some time."

Alumni experts agree that fixing the financial system is essential. One of them, Mark Rubinstein Ph.D. '71, the Paul Stephens Professor of Applied Investment Analysis at UC Berkeley's Haas School of Business, says he's particularly concerned about hedge funds. During the go-go years, their top executives made tens of millions of dollars annually by making risky bets and leveraging their assets.

A Bank in Reserve

"Imagine I am running one of these investment companies. I'm doing real well; I'm getting paid a lot; people think I'm doing a great job; they raise my compensation. If I think of it rationally, I realize that I only need a few years here," Rubinstein says. "So I take these risks that when it bites, it bites them hard. I lose my job, but the shareholders lose everything."

Rubinstein doesn't want the government to dictate how much hedge fund CEOs can take home or on what basis they can be compensated, but he thinks the Securities and Exchange Commission should make it easier for stockholders to get representatives on a company's board of directors. A stockholder-designed representative might give shareholders a greater voice by deterring executives from overpaying themselves and taking excessive risks.

For a more revolutionary approach to reforming the financial system, look to Roger Farmer. A professor of economics and vice chair of graduate studies in Westwood, Farmer wants the federal government to create a new central bank, separate from the Federal Reserve Board, that would buy and sell stocks to prevent them from rising or falling erratically.

"These big swings you see in the value of the stock market are evidence of what [former Fed chairman Alan] Greenspan called 'irrational exuberance,' " he observes. "If we directly control the value of those swings by having the central bank buy stocks if they go too low and sell stocks if they go too high, it has the potential to remove excessive swings in confidence, which are unrelated to fundamentals.

"I believe strongly in free markets, and that might sound to be at odds with the statement I just made," Farmer adds. "I'm not advocating that the central government or the Fed or Congress or any institution should be picking winners and losers. I'm not advocating supporting individual companies. I'm advocating the support of a broad index that includes every traded share on the market."

Why? Well, like so many other economists, Farmer worries that without restrictions, the U.S. economy could drop into the abyss.

"The market is a little bit like a herd of buffalo grazing a cliff, chewing on grass or cud or whatever," he says. "Sometimes the whole herd of buffalo heads toward the cliff together and jumps off. I don't want to stop them from grazing; I want to put a fence to stop them from jumping over the cliff."

If Farmer's proposal doesn't become reality, and it's much more likely it won't, the Anderson Forecast's Leamer has a simple suggestion for getting cash back into the U.S. economy.

"The plan that I was floating" — in the Financial Times, National Journaland The New York Times — "was to have Uncle Sam send $100 gift certificates back in November to every man, woman and child in the United States. And you would have to spend that for it to be of any value to you, because by Jan. 1 it would be worth nothing," Leamer says. "It gets people to go out and buy stuff, and it's also a mood stimulator because you've got this uncle who cares about you."