CBJ: Darden dean Bruner weighs in on the recession

Having lived through economic peaks and valleys and co-written a book about the financial panic of 1907, Robert Bruner isn’t surprised by events playing out today.

What does surprise the dean of the University of Virginia’s Darden Graduate School of Business Administration? The depth and duration of modern problems.

“Depending on when you define the start of this panic - and it is a panic - this is beginning to rival the length of the most severe part of the Great Depression,” Bruner said during a recent visit with The Daily Progress editorial board.

Bruner said the scope, speed and complexity of the economic crisis confound efforts to get things back on track and have combined to create a self-reinforcing spiral that author Jim Collins calls the “doom loop.”

“The most fascinating question of the moment is what are we doing to interrupt the reinforcement, because if you do that you lay the foundation for a recovery,” said Bruner, who joined the Darden faculty in 1982.

In an edited transcript of the conversation with Progress editors, Bruner addresses the severity of the problem, the government’s attempted solutions and more:

Q. So much of what has been done so far feels like guesswork. Is it?

A. [Fed Chairman Ben] Bernanke and [former Treasury Secretary Henry] Paulson have taken what seems to a lot of us a graduated approach to the crisis. Trial and error. Try something. See what the impact is. If it doesn’t work very well, try something else. This is an ad hoc approach, probably appropriate for a crisis of smaller scale, complexity and speed. Today, now, with 18 months or 2 years into the crisis, we say if we could wind the clock back we’d just organize this comprehensive fix, this incredible one-two punch that’d interrupt the self-reinforcing loop, and put us back on the road to recovery.

Now, you see today several proposals under consideration within the Obama administration … proposals ranging from nationalization of banks at the most extreme end to a Resolution Trust Corporation-type rescue, which is what we did with the savings and loans in the late 1980s. That means the government basically buys up all the toxic assets of the banks. We’ve been trying to avoid that because we were hoping the financial system would shoulder those assets, bear the risk and suffer the losses. Now it looks like maybe the taxpayers need to suffer the losses or at least suffer more of the loss, has been the supposition so far.

Q. How do you reconcile the fact that the information is hard to pin down, but we need the information to develop a solution?

A. It’s obviously a lot harder than anybody thought. Part of the issue is we just don’t know what these toxic assets are worth. In the absence of trading, theoretically, they’re worth zero. And yet there are some private investors - George Soros and others who are forming private pools of capital - to buy these toxic securities in the belief that, held to maturity, the rates of return on these will be in the high 20s to mid-30 percent range, which is very high. It’s economics 101.

You know, John Maynard Keynes said in the long run we’re all dead, and it’s nice to think in the very long run. We have a crisis on our doorstep today and the issue is how do we quell the crisis, normalize business conditions, restore the economy, bring it back to a stage of recovery. That’s why in all probability we will see a much more coordinated set of proposals emerge in the [Obama] administration. We already know about this very large economic stimulus act. We hear about proposals for more aggressive restructuring of the mortgage market and of the loan portfolios that are out there now being traded. We hear proposals to restructure banks, the ownership of banks.

“Part of the issue is we just don’t know what these toxic assets are worth. In The absence of trading, theoretically, they’re worth zero.“ -Robert F. Bruner

Q. In simple terms, what are the two or three things that need to start happening to get the economy in the right direction?

A. We will know the turnaround is around the corner or here when banks start lending actively to big and small businesses and individuals. For that to happen, bankers need to be less afraid. We always want them to be cautious but we want them to overcome the immense fear prevailing today about the risk of counterparties, meaning the possibility that anybody they would lend to would default.

The bankers will tell us the reason they’re not lending is they are concerned about the credit risk of the prospective borrowers, small businesspeople, big companies.

To build certainty among bankers we should begin by restoring the balance sheets of the bankers with sufficient transparencies so that if they look at one another they see institutions that are healthy and in all probability going to survive the next five years just fine. What Paulson has been doing with the TARP money is buying preferred stock in banks, which is a means of helping to recapitalize the banks, giving them a firmer base.

And the theory was that by giving the banks more capital they would go on to relend it to other banks. The lending among banks is the hidden market here and is the acid test of the level of uncertainty prevailing in the economy. If the banks will begin leaving excess deposits with each other we will see a flowering of lending. Presently they’re not doing it. They’re leaving their excess deposits with the Fed because they know the Fed is always going to let them have the money when they need to get to it. But if the deposits are put on the books of another bank that is shaky and unreliable, they can get burned. They don’t want to go down that path.

Q. What opportunity does a new administration have at this point in the economic recovery effort?

A. The most important aspect of the new opportunity is Barack Obama’s bully pulpit, his opportunity to define a tone of resolve and optimism in the face of a crisis, much like FDR did in 1933. But that won’t be sufficient. As FDR realized, it would take much more to jumpstart the economy out of the Great Depression. We’re going to look for more. We’ll need more to restart this economy. Now, mind you, FDR was facing unemployment of about 25 percent in 1933. We’re at a little north of 7 percent. Economists think we’re going to rise to 10 percent at the worst. Remember the phrase “doom loop.” It could get a lot worse if we don’t get traction on this very soon.

The chief political question to people in the business sector and in the academic sector would be, will government use its ownership interest in banks and industrial companies to dictate how they should operate.

Q. Is a “bottom up” approach that focuses on sending money to consumers or using it for public works projects too diffuse or slow?

A. Those are two plausible ideas and something we should consider, but the downside of each is how the money gets used. We gave taxpayers a rebate of $150 billion last [year] and the evidence is that a fair amount of it was used to pay down debt. Well, that’s rational. That’s what you and I ought to be doing with excess funds today, given the gravity of the crisis. But that in and of itself does nothing to help Circuit City stay afloat or does nothing to help keep the mills or factories operating. It simply helps to balance the books in the financial system. If the financial system, upon receiving those rebate loans, were to go out and relend them, that’d be great, but that didn’t happen. So the question is, what will the taxpayers do with that money? That’s a very big question.

Today, as the news gets worse, the risk grows that the taxpayers will horde the cash, stuff it under the mattress, under the hearth stone, into a safety deposit box, which is the kind of behavior we see in the depths of every single panic. The other idea - public works - that was part of FDR’s program. It certainly had a role in helping to stimulate the economy. There are two concerns. One is we don’t know how large the public works program will have to be to really stimulate the economy.

The public works spending during the Great Depression didn’t really move the needle very far. The government spent a lot of money yet the depression dragged on. And it was only the public spending associated with the second World War that really kick-started the economy back to a higher level of activity.

The second concern with public work spending is, spending on what? Much like our concern on giving the taxpayers a big rebate. The concern would be to which localities, which public officials, which pet projects will the infrastructure spending go? Ideally, we’d like to see the spending go to areas of greatest need, greatest economic impact. But the history of government spending during the Bush administration with the earmarks and the “bridge to nowhere” and other projects suggests that the decision making in Congress is vulnerable to the appeals of special interests and the regional concerns, in ways that may not suit the needs of getting us out of this crisis.

Q. To what extent could the government moves result in runaway inflation later on?

A. The actual disbursement of all of this money in a short space of time would create inflationary pressure on the economy. We have so far committed in excess of $8 trillion in support of the fight against the crisis. Of that about $3.9 trillion has been spent, actually dispersed. There are estimates that this crisis will ultimately require $15 trillion to truly quell. And that’s a lot of money to pump out into the economy. So if we get out of the crisis and inflation rears its ugly head, the only ways to fight it would be through monetary and fiscal policy. Monetary policy to take cash out of the system through various means. It would inevitably raise interest rates, which would put pressure on less creditworthy borrowers, again. And through fiscal policy through higher taxes, simply to repay the public debt.

The relevant question for the man or woman on the street is when will the economy return to a level of activity prevailing before this crisis began. I suspect this is going to be a longer, more gradual hill to climb than a shorter, steeper hill. For the simple reasons that the damage to the financial and industrial system is pretty great and it will take some while to rebuild that. We’ve wiped out all of the top five largest investment banks. Major retailers are closing. The Detroit auto manufacturers are a basket case. I can look to many other industries in great distress. So it will take some time to repair that.

I look at the massive amount of debt overhanging the U.S. economy. All the debt in the economy - that includes households, businesses and government - hovered at about one times gross domestic product from 1952 to about 1982. And then it took off in the early ’80s to reach 3.5 times in 2007. So we’ve seen a very dramatic buildup. The only comparable time of buildup was around the second World War when we had a national emergency and it was the will of the people to borrow to fight the war. What has happened in the last 25 years to create this extraordinary buildup of debt? More importantly, what needs to happen in the foreseeable future to deal with that buildup of debt?

Well, you need to repay the debt. And unfortunately, many of the creditors live outside of the United States and it’s not a straightforward matter of simply recycling money within our economy. But we’ve lived beyond our means. And in that sense we all own this crisis. It’s easy to demonize some CEOs, some executives, some government officials, credit rating agencies, Fannie Mae, Freddie Mac, on down the line. Bernard Madoff. We have rogue’s gallery of perpetrators we could point to. But at the end of the day we all own this. We need to live within our means and that’ll take some material adjustment in how we live our lives.

Q. What do you think of the notion that we need to “simple down?”

A. I like that phrase a lot. It’s quite consistent with the feelings of the students we see at the University of Virginia who are frankly the future of the country - they and their peers and their age group nationwide. They get it. They tell us in a variety of ways the virtue of living more simply, exploiting new technology in artful ways that can help us achieve that. Some of their deepest values are around environmental sustainability. Look at the garbage we produce, they will ask quite bluntly, and what can we do to mitigate that? Do we really need to behave in the ways we always have, endlessly into the future?

But “simpling down” is a great phrase. Unfortunately, and this is a paradox of the crisis, if we all start to do that immediately we create an even worse outcome than what we hope we’ll obtain in five or 10 years. … We need to stimulate consumption in order to sustain the economic infrastructure of the country long enough to restore employment and innovation and investment. So it’s a paradox we need to manage. Bush, Bernanke and Paulson have approached the management in an ad hoc, stepwise fashion, understanding that they’re conservatives and didn’t want government to intrude quite deeply. They wanted to move in very gradually and carefully. I suspect that the new administration embracing a much more activist and interventionist philosophy of government will be much more comprehensive and aggressive.

We hope it will succeed but we also hope that they recede from that intervention and that, as Margaret Thatcher called it, the dead hand of government needs to lift sooner or later, because it can have an oppressive impact on research, development, innovation, new business and industries.

Q. What should be the message to the public?

A. I believe the public is more resilient than we give them credit for and I believe we need to tell them the facts, is essentially how I come out. But the facts are so often open to a variety of interpretations. I think our responsibility is to reflect the uncertainty of the path forward. Things could get a lot worse. Things might turn around, six to nine months. We don’t know. How should individuals, business owners and the like behave in the interim?

I’ll tell you personally I haven’t sold a share of stock in the last year because every crisis has been followed by a recovery. And it’s very, very difficult for us to time the market and say, this is the bottom and this is what I’m going to start buying. In fact, individual investors are notoriously late in calling the peaks and bottoms of market cycles. I’m not a registered investment advisor so I won’t give detailed stock recommendations. But I’m of a mind to suggest that we will come back. We just don’t know how much more pain is to be endured. And in the meantime we need to act responsibly as individuals and businesses.

I’d say that in the longer run we all need to grow in our economic sophistication. Back to that extraordinary run up in debt, I think at the heart of that is a problem of economic illiteracy. The belief that you can get something for nothing in society, that you can just buy a condo with no money down. That you could submit a loan application that was false in material respects and there would be no summation, no settling up, the market wouldn’t eventually catch up with you. The belief that you could stay one step ahead, that the game of musical chairs would never catch you out.

There is no free lunch in society. You get what you earn, and therefore you should invest in your human capital in ways to elevate your contribution to society and your ability to earn.