Don’t blame the economic crisis that Americans are suffering through on excessive selfishness or greed. It stems from a massive failure of public and private leadership—a double-barreled debacle that has created a distrust of experts, a slumping economy and a broken financial system that will take new standards, new regulations and new ways of thinking to fix.

These were among the key findings of a conference of 16 top economists—including two Nobel Prize winners and a regional Federal Reserve bank president—who met Jan. 31 at the University of Richmond’s Jepson School of Leadership Studies to discuss “Leadership in Times of Crisis: Economic Science and the Constitution.” In so doing, the panelists also spotted some glimmers of hope.

The economists, who tackled these issues against the backdrop of Washington’s $700 billion banking bailout and the more than $800 billion proposed stimulus plan, held a wide range of views. Among those attending the daylong event hosted by the Jepson School were Nobel laureates James M. Buchanan and Vernon L. Smith, and Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond.

The participants met first in private sessions and then discussed the results with some 150 students, faculty members, visitors and news reporters.

Panel members gave mixed reviews to the costly stimulus package, noting that it lacked coherence but included a well-timed effort to rebuild the crumbling U.S. infrastructure. One member suggested a new use for the bailout.

Nobel-winner Smith traced the cause of the crisis to “the largest housing bubble in U.S. history.” From 1997 to 2006, “buyers, sellers, real estate agents, mortgage packagers, mortgage insurers and rating agencies all believed that prices were going up,” said Smith, a professor at Chapman University in Orange, Calif., who specializes in experimental economics. But when the bubble collapsed, everyone stopped lending.

Nobelist Buchanan blamed what he called “a fundamental constitutional failure” for allowing financial conditions to get completely out of hand. Buchanan, advisory general director of the Center for Study of Public choice at George Mason University in Fairfax, Va., called for replacing today’s “jerry-built” policies with a “monetary constitution” that would set firm rules for policy makers and market players. “The real question,” he said, “is must we really reach catastrophe levels before we solve problems?”

The participants were particularly hard on their own profession, noting that economists have been largely missing in action. Economists first failed to foresee the crisis and then offered clashing policy prescriptions. The problem is that economists are taught to write academic papers rather than to grapple with real-world problems, said David Colander, a professor at Middlebury College in Vermont. Many economists are like “show dogs” that have learned to strut their stuff, he said, rather than like hunting dogs that are trained to jump fences and chase game.

Panelist David Warsh said economists could provide a valuable service by holding more public sessions like the Jepson School forum. “It’s easy to imagine economists of all stripes being involved in more discourse with the public,” said Warsh, a former reporter for The Boston Globe whose blog,, covers economic news and trends.

Jepson School Dean Sandra J. Peart, who co-organized the conference with David M. Levy, a professor of economics at George Mason University, said the event could help end what the 19th century humorist Josh Billings called “knowing what just ain’t so.” She said such stoutly held beliefs at the time of the crisis included:

 • Mortgage-backed securities weren’t risky.
 • Housing markets were local and not connected.
 • Rating agencies knew how to evaluate bonds correctly.

The conference agreed that the U.S. has reached “an inflection point in economic history” in the words of Perry G. Mehrling, a professor at Barnard College at Columbia University in New York City. Regulations designed for an era of local banks and housing markets were powerless to keep toxic mortgages from infecting the entire financial system by being bundled into bonds and sold around the world.

“We’ve moved from a banking credit system to a capital-markets credit system,” said Mehrling, referring to the financial revolution that turned once-staid mortgages into high-flying securities that subsequently crashed. “The credit crisis is testing us as we’ve never been tested before and we're learning where the weak points are.”

But the process is proving painful. Lacker noted that policy makers “face significant challenges in the next 12 months in redesigning a supervisory regime” to replace old rules that have proven “insufficient to restrain additional risk.”

The panelists took a close look at the taxpayer-funded $700 billion TARP (Troubled Assets Relief Program) that was rushed through Congress last year to rescue the banking system and jump-start lending. But the fund has mainly been used to buy preferred stock from banks to buttress their capital, without doing much for lending. Michael Bordo, a professor at Rutgers University in New Brunswick, N.J., called for restoring the original idea of using the fund to take bad assets off the banks' books, as Germany has considered doing. Trying to revitalize banks without such a move “will only create zombie banks as happened in Japan in the 1990s,” said Bordo.

The economists praised moves by the Federal Reserve to shore up troubled institutions through loans and other programs, but warned of long-term consequences. William A. Niskanen, chairman emeritus of the Cato Institute in Washington, said the Fed has doubled the money supply since August in the fastest build-up ever. “By 2010 this will lead to high inflation or tight interest rates,” said Niskanen, unless the Fed pares back the increase.

Lacker expressed concern that the bailouts might tempt lenders to assume that Washington will always rescue those deemed too big to fail. Such assumptions may have contributed to the crisis in the first place, he said. “The way institutions reacted was influenced by expectations about whether they would receive support,” he pointed out. Since then, “Congress and the Fed have taken significant actions, but how much they have affected credit markets is unclear.”

Meanwhile, economic woes are likely to persist once the financial crisis passes. Sidney G. Winter, a professor emeritus at The Wharton School at the University of Pennsylvania, said the plunge in home values will hold down consumer spending. When a stable financial system returns, the economy will still be operating below its potential, he said, and this makes “the long-term outlook still a very serious thing.”

Winter saw an “enormously strong” conflict between the need to rev up spending and the need to attack long-term economic problems. Yet this could be a good time to start fixing the Social Security system, which is expected to take in less in taxes than it  pays out by 2017. “It’s politically possible to get a bipartisan package,” said Winter, by combining “a technically sound proposal, negotiation, leadership and political will.”

Niskanen was critical of the more than $800 billion stimulus plan. “It has no particular coherence as a stimulus,” he said, and could make the U.S. “vulnerable to less foreign lending” by worsening the federal deficit. He added that while the Obama administration has good economists, they must be willing “to speak truth to power” and “be prepared to quit” if they disagree with policy decisions.

Panelist Dean G. Croushore saw some good things in the stimulus plan. “It’s good timing for the government to rebuild infrastructure,” said Croushore, a University of Richmond economist, and it’s also “good to borrow when interest rates are low. If you’re going to do something like this, now’s the time to do it.”

Responding to a question about how the public can evaluate the stimulus and bailout programs, Colander said the costs should be clearly spelled out. “Am I hearing the cost?” he asked. “If I’m not, I’d worry.”

This includes the cost of the bailouts to the banks themselves. Mehrling cited a dictum of the 19th century writer Walter Bagehot, who urged the Bank of England to “lend freely but at a penalty rate” during crises. Mehrling said the Fed should “insure freely but at a high premium” to protect the banks and instill caution at the same time.

Looking ahead, Nobel-laureate Smith called it “entirely possible that a lot of good will come out of” the current crisis. “Right now, everybody is worried that people won’t spend their money,” he said, because stunned individuals have pulled back from their consumption binge. But this could set the stage for new policies to discourage future runaway spending and promote savings instead.

Posted: Jan. 31, 2009