“This will not be in an exam, but it will be in your life” said Dr. Michael Gombola, LeBow College’s department head of finance, to a packed auditorium occupied by more than 150 students and alumni during the Lunch, Learn and Lead series hosted by LeBow College of Business and alumni donors on October 15.
LeBow College Dean George Tsetsekos and Dr. Michael Gombola headed the discussion on the recent Wall Street developments accompanied by professors of finance Drs. Jacqueline Garner, Daniel Dorn and David Becher. Together they explained the cause and effect of the recent financial crisis, discussed the government’s solutions and also shared their views and opinions on what needs to change in order to prevent this from happening again. A podcast from the presentation can be viewed at www.lebow.drexel.edu/Newsroom/Podcasts/media.html.
Dr. Dorn, an assistant professor of finance who specializes in capital markets and behavioral finance, provided insights to financial trends. Dr. Dorn used the tech burst of 2000 as an example of what is currently happening in the economy. He presented indexes showing the previous bubble burst as well as the House-Price Index (HPI) which shows an upward trend up until a few months ago.
“After a burst, confidence in stocks drop which is what we are seeing now,” said Dr. Dorn, who believes the burst was caused by excess supply in the housing market.
Investors were “behaving as if housing prices could not decline,” this was causing consumer and government debt to increase said Dr. Gombola, a professor of finance. Dr. Gombola believed mortgages had always been a safe bet since drops in the HPI have always been “less than half of one percent.”
Past experience is not an accurate indicator of future performance,” Dr. Gombola assured the audience. “Banks are now being affected because of their leverage, the ratio of debt financed assets to equity.”
Since banks are allowed a higher ratio and “asset value declines produce larger declines in equity value” they are taking a bigger hit and it wiped out their equity he continued. This caused banks to stop lending money to each other, which reduced the amount of loans banks were issuing to consumers which is a source of the problem.
Dr. Jacqueline Garner, an associate professor of finance, offered background on the Securities and Exchange Commission involving securities regulations. She brought up a few events involving the SEC which she believed helped accelerate the crisis.
Dr. Garner started by mentioning the elimination of the uptick rule in July of 2007 which reduced the regulations on short selling. The second event was the ban set against short selling in September 2008; this was quickly removed one month later since the stocks which were supposed to be protected with this ban were actually affected by it.
“The failure came from lack of authority to regulate investment banks,” said Dr. Garner in her remarks. Her suggestions consisted of stricter regulations for investment banks in the future, more stringent limits on borrowing, as well as consistent regulation of all investments banks.
“Capital requirements have to increase and there needs to be coordination with regulators,” she concluded.
Dr. David Becher, an assistant professor of finance, followed up with a discussion about banking regulations.
“I’m going to explain things to you as if I were speaking to English major,” said Dr. Becher before giving us his opinions on what needed to change in order to prevent another crisis in the future. The recommendations he presented revolved around regulation since he believes there needs to be some degree of regulation in order to keep things running smoothly.
“Lack of a key institution” was stressed since there are currently different institutions which regulate specific fields instead of one institution overlooking everything.
“Elimination of riskiest practices followed, straw man loans need to be eliminated as well as loans which do not require income verification since these practices carry too much risk and are a source of the problem,” continued Dr. Becher. He also stated the “need of national standards” since there currently is no consistency in regulation.
Dr. Becher said there are some drawbacks to the current bailout plan.
“There will be a high concentration of assets; the four largest banks will be in control of $8 trillion since they are acquiring equity from other financial institutions. This is incredibly risky but needs to be done in order to improve the economy.”
He concluded by saying there will need to be a trade off since we have to let banks take risks if we want them to act like banks and help our economy, we need to find a way to oversee them but still let them do their jobs.