CFP Advisory Board Member Eric Billings meets with Smith Finance Fellows

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Feb 192012

February 8, 2012

Over 55 undergraduate Finance Fellows gathered at the Robert H. Smith School of Business to hear CFP Advisory Board Member Eric Billings talk about his experiences as an entrepreneur and finance professional.   Billings is the Chairman and CEO of Arlington Asset Investment Corporation, a publicly-traded investment firm specializing in the residential mortgage-backed securities market.

Billings encouraged the students to be optimistic about their job prospects in the financial sector.   He told the group that regulation was not in place to control securitization and the non-depository financial system during the 2007-2009 financial crises.  However, he expressed positive signs for an economic recovery, particularly through new, sound regulation such as the Basel International Standards.

Billings co-found FBR/Arlington Asset during another dismal economic period in 1989.  A combination of knowledge, logic and emotion enabled him to be a successful entrepreneur despite the many challenges he faced.   “Emotionalism can trump logic every day,” said Billings, encouraging the students not to be afraid to act on emotion when building a business.   He gave a few pieces of advice to the ambitious undergrads: know what you don’t know; learn how to survive change; and have the ability to understand a company’s capital structure.

After his prepared remarks, Billings and the Finance Fellows engaged in conversations about the US government debt, systemically important institutions, the European sovereign debt crisis and executive pay structures.

About the Undergraduate Finance Fellows Programs

There are six Finance Fellows programs at the Smith School: Emerging CFOs Fellows; Financial Services Fellows; Lemma Senbet Fund; Quantitative Finance Fellows; Accelerated Finance Fellows; and Private Equity and Venture Capital Clinic Fellows.  Students enrolled in these programs are interested in various aspects of the financial industry including corporate finance, investment banking, quantitative tools, financial series, and private equity.  In addition to their academic coursework, Finance Fellows also participate in various related co-curricular activities.

For more information on the Finance Fellows Programs, visit their website.

About the Center for Financial Policy (CFP)

The Center for Financial Policy leverages the Smith School’s world renowned faculty to lead research in a collaborative exchange of ideas and solutions on critical policy issues between business, government, and academia, while working to enhance and broaden the exposure of the next generation of business and government leaders to leading academics and practitioners in financial policy.  For more on the center, please visit the CFP website.


Growing Inequality in Income and Wealth Caused the 2007-09 Financial and Economic Crisis

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Feb 172012

by Bill Longbrake
Center for Financial Policy

This is an excerpt of the February 2012 Longbrake Letter.  To read the letter in its entirety, click here.

Occupy Wall Street has helped focus attention on growing income and wealth inequality – “we are the 99%”.

Two papers, one a theoretical economic analysis prepared by two International Monetary Fund economists, Michael Kumhof and Romain Ranciere[1], and the other a white paper authored by Anant Thaker of the Boston Consulting Group and Elizabeth Williamson of the Frontenac Company[2], assert that the 2007-09 financial and economic crises was a direct outcome of income and wealth inequality that built up over 40 years.

Data. Kumhof and Ranciere provide time series data for the share of income received by the top 5%.

These data indicate the following for share of income earned by the top 5%:

  • 1920 – 24%
  • 1929 – 34%
  • 1983 – 22%
  • 2007 – 34%

During the same two periods (1920 to 1932 and 1983 to 2007) Kumhof and Ranciere found that the ratio of household debt to GDP nearly doubled in the earlier period and more than doubled in the latter period and reached a higher level in 2007 than in 1932.

Thaker and Williamson report share of income data for the top 1%, which was originally compiled by Piketty and Saez, but updated by Thaker and Williamson:[3]

  • 1920 – 16%
  • 1929 – 24%
  • 1968 – 8%
  • 2007 – 24%

Piketty and Saez use two different data series to track the debt to GDP ratio. The earlier series is individual and non-corporate private debt to GDP and the recent series is the more common ratio of household debt to GDP:

  • 1920 – 60% (individual and non-corporate private debt to GDP)
  • 1932 – 95% (individual and non-corporate private debt to GDP)
  • 1968 – 60% (individual and non-corporate private debt to GDP)
  • 1968 – 40% (household debt to GDP)
  • 2007 – 95% (household debt to GDP)

The pattern in both measures in the years preceding crisis is clear and eerily similar.

Mechanism through Which Growing Income Inequality Leads to Financial Crisis. The triggering event is a shift in relative income bargaining power in favor of the top 5% relative to the bottom 95%. This initial shift in bargaining power sets in motion a series of events that takes decades to develop.

First, as the share of income of the bottom 95% shrinks that group attempts to maintain consumption through borrowing. Second, as the top 5% gains income, and thus wealth, that group needs to find ways to invest its accumulating wealth. Accordingly, it provides the funds that the bottom 95% borrows.

Borrowing is enabled by financial innovation, such as subprime mortgages and home equity loans in recent times. All of this activity facilitates tremendous growth in the financial sector of the economy.

As the financial sector grows relative to the rest of the economy its political power grows as well. This leads to adoption of policies that promote and protect the interests of the financial elite, which in turn tends to reinforce the building inequality. One can place deregulation, reduced capital requirements and other “free market” elements into this basket.

Financial crisis eventually erupts because there is an ultimate limit to how much debt households can support. Increases in debt and decreases in savings reduce a household’s ability to manage through a life crisis – illness, loss of job, divorce and so forth.

Sum this increase in financial vulnerability across millions of households and in the aggregate the economy’s ability to withstand a shock, such as a sudden and sharp increase in oil prices, steadily erodes. Also, as we now know, runaway speculation in housing propelled a bubble in prices which was aided and abetted by abundant and cheap debt, steadily diminishing credit underwriting standards, and a laissez-faire attitude on the part of government regulators perhaps swayed by the belief in “The Market” as an efficient regulator or perhaps inhibited by the political power of the financial elite.

And, as I have opined frequently, the greater are the excesses during the bubble period, the harder will be the crash when it eventually unfolds. The same is true for income inequality. As income inequality escalates, the macro economy becomes increasingly fragile. The crash, when it finally arrives, is horrific and the convalescence period is painful and extended.


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[1] Michael Kumhof and Romain Ranciere. “Inequality, Leverage and Crises.” International Monetary Fund Working Paper, November 2010.

[2] Anant A. Thaker and Elizabeth C. Williamson. “Unequal and Unstable: The Relationship Between Inequality and Financial Crises.” New America Foundation. January 2012.

[3] T. Piketty and E. Saez. ‘Income Inequality in the United States, 1913-1998.”Quarterly Journal of Economics, 118(1), 2003, pp. 1-23, with updated data to 2008: U.S. Census Bureau; U.S. Federal Reserve Flow of Funds; National Bureau of Economic Research.




State of the Housing Market: Removing Barriers to Economic Recovery

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Feb 092012

By Phillip Swagel, CFP Academic Fellow and International Economics Professor at the University of Maryland School of Public Policy

This is an excerpt from Professor Swagel’s February 9, 2012 testimony before the Senate Committee on Banking, Housing and Urban Affairs.  To read his full testimony, click here.

The continued weak state of the housing market and the toll of millions of foreclosures already, millions more families still at risk of losing their home, and trillions of dollars of lost wealth all reflect the lingering impact of the collapse of the housing bubble and ensuing financial crisis.  A range of policies have been undertaken over the past several years aimed at the housing market—a recent summary from the Department of Housing and Urban Development lists 10 separate policy actions.[1] These can be grouped into two broad categories.  What might be seen as “backward-looking” policies seek to avoid foreclosures on past home purchases through actions such as incentives for mortgage modifications and refinancing.  By avoiding foreclosures, these policies both assist individual families and help reduce the supply of homes for sale (and in the overhang of the so-called “shadow inventory”) and thus reduce downward pressures on home prices that in turn affect household wealth and the broad economy.  In contrast, “forward-looking” policies seek to boost demand for home purchases, such as with the first time homebuyer tax credit and the Federal Reserve’s purchases of mortgage-backed securities (MBS).

The common feature of these housing policies is their limited effectiveness.   To be sure, these policies have done something:  MBS purchases resulted in lower interest rates for families buying a home or refinancing a mortgage; some 930,000 homeowners have benefited from permanent mortgage modifications through the HAMP program; and so on.  But relative to the scale of the weakness in home prices and housing market demand, and especially compared to the tragically huge number of foreclosures, the set of housing market policies to date appears to have underperformed compared to expectation set at each policy unveiling. Moreover, these programs have involved considerable costs for taxpayers, with the benefits accruing mainly to a relatively small group of recipients. And on top of the millions of foreclosures not prevented by the policies of the past several years, there is likely another huge wave of foreclosures set to take place in the next year or two, with many of these representing foreclosures that were delayed but not ultimately prevented by policies to date.

This experience is important to keep in mind as the Congress contemplates a range of new and expanded housing policy proposals from the administration, along with a white paper from the Federal Reserve that covers similar ground.  Broadly speaking, the proposed actions look to provide homeowners with reduced monthly payments through government-assisted refinances; to lower principal mortgage balances; and to speed the pace at which vacant homes become rentals.  The goal, as with all policies throughout the crisis, is to have fewer foreclosures and stronger consumer spending. These policies are well-intentioned.

Unfortunately, there is every reason to believe that the new policy proposals for streamlined refinancing and principal reduction are likely to have the same modest impact—and at an even worse tradeoff in terms of cost to taxpayers for each foreclosure avoided than for the policies to date.  Simply put, we have learned that mortgage modification programs are difficult to implement and execute because of the intrinsically one-at-a-time nature of the transactions involved.  And the expansions of some programs, such as considerably increased payments from the government to motivate reductions in mortgage principal, face less promising conditions now for being effective than was the case when many  of these policies were launched in early 2009.  Three years of a weak job market have forced many of the borrowers who might have been helped by reduced payments or a lower mortgage balance into foreclosure.

There are other approaches that can be taken to help heal the housing market and speed the recovery of home prices and construction while reducing the pain for American families. This testimony first provides a critical analysis of recent policy proposals and then discusses alternative steps that the Congress might consider.  The goal of these policies is for the housing sector to once again contribute positively to the U.S. economy and to American society—to have a housing system that works for families looking to buy homes, for investors with funds to lend, and for taxpayers who deserve a stable financial system and protection from another expensive bailout.

To read more, click here.

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[1] See the appendix of the January 2012 HUD-Treasury Housing Scorecard: