Chicago Booth Faculty -- Lecture -- Financial Crisis

On Friday {Jan-15} i had the opportunity to attend a lecture by Raghuram Rajan. Raghuram Rajan is the Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business.

Dr. Rajan is also currently an economic advisor to the Prime Minister of India. Prior to resuming teaching in 2007, Dr. Rajan was the Economic Counselor and Director of Research (in plain English, the Chief Economist) at the International Monetary Fund (from 2003).

There were some 32 Booth alums also present. Raghu spoke on "The Financial Crisis and Beyond : Challenges for India and the Global Economy."

Unlike other people Raghu was not blaming Sub-prime alone for the Financial Tsunami that de-railed the global economy in 2008. Raghu shared other factors such as "US Educational System", "Export oriented economies such as Germany, Japan, China", "Compensation system of big banks", "Competition among CEOs" etc.

According to Raghu the rising gap between income levels of High school pass outs and that of people with higher degrees forced the US govt. to frame certain policies that led to this Financial crisis. There was an oversupply of people who were high school pass outs and this oversupply led to a net reduction in their remuneration. While, people with degrees such as M.S and M.B.A saw their salaries rise by approx 25%. Moreover, there is a continued under-supply of people with higher degrees in US and this is creating a greater than ever rift between the earnings of two income groups.

The problem started way back in 1991 when un-employment rate rose above 10% in US and George Bush Sr. lost the election. The congress forced Fed to cut the rates so that economy could be revived. Congress believed that reducing the fed rates would have a positive effect on the economy and the businesses. As the surplus liquidity would increase the spending power of lower income groups.

In effect the reduced interest rates forced people and businesses to take risk and invest the money in instruments that were traditionally considered risky. Also Mortgage backed securities were developed by leading US i-banks such as Merril, Bear Stern, Lehman etc. In nutshell, the reduction in interest rates provided liquidity to people who in turn invested this money in products such as CDS, MBS etc {Collaterialised debt securities, Mortgage Backed securities}.

To add to the woes the compensation system allowed the traders to take bigger and bigger risks. For, there were big rewards if a trader made money but no penalties if a trader incurred loss. Raghu proposed that the compensation system needs to be altered to bring the sanity back to the market.

Raghu was particularly critical of Bear stern, Lehman and Citi group for placing big bets in 1990s. The bets placed in 1990s paid off but laid the foundation for future problems. By 2007 things got out of control and BS, Lehman and Citi were the biggest losers. Also, Raghu pointed to the competition between CEOs of big i-banks. He was critical of John Thain because Raghu believed that John conciously or unconciously competed with CEO of Goldman Sachs over the compensation. John matched his and his traders compensation with that of traders at Goldman but failed to produce the profits equal to Goldman.

Finally, Raghu drew the attention of audience towards the export oriented economies such as Japan, Germany and China. These economies were highly dependent on US for their own well being. When US sneezed these economies caught cold. This over dependence of three big exporters led to the collapse of global economy. The consumption in US suffered and led to problems for Japan, Germany and China.

Raghu was also critical of China throwing jabs at US. He believes that US engagement in wars was preventing US from acting sternly against China. If US simply imposes an import tarrif on Chinese goods, the Chinese economy would be in trouble.

Post the lecture there was a brief QnA session followed by the networking reception.