SPEAKER 1: This is a production of Cornell University.
SPEAKER 2: I'd like to welcome you to the first in this semester's seminar, International Planning. I'll start by welcoming [? Nima ?] back. Hi, [? Nima. ?] Great to see you. A couple of procedural announcements or administrative announcements-- if you're taking this for credit, please be sure to sign up. And Seth has sign up sheets in the back. You can you can get to those afterwards.
Second-- well, obviously this is both a lecture series and a one credit course. You can do it either way. We're happy to have people here who are not taking your course. It's typically every Friday at 3:00 in this room. There's a wonderful list of speakers that's on this paper. And it's also on other little hand outs and re-posted each week. Next week, however, the schedule has an additional event, which is on Thursday-- sorry, Wednesday evening, right?
Yeah. I don't have the time here. I think it's 7:30, but I'm not sure, downtown at the State Theater. If you haven't been to the historic State Theater, you should go just to see that. If you haven't heard Cory Booker talk-- the mayor of Newark-- you should go. It'll be a big event. There is a charge for admission, and if you want a free ticket for admission, see Seth in the back. Seth, you want to raise your hand?
So if you wanted a ticket for you self or your friend to go hear Cory Booker next Wednesday night, get that. That's a special session. I'm sorry, it's at 7:00 PM. OK. That's all. Any other administrative business? Great. Our guest today is our own colleague, Professor Iwan Azis, a distinguished economist and regional scientist who spends only half of each year on the Cornell campus, the other half are in Asia, in Japan, and Indonesia, and China, and elsewhere advising public agencies about global economic affairs.
He is widely published. I won't even begin to mention the list. He is also, at least in recent years, widely cited on topics having to do with the economic crisis. I feel extremely fortunate to get a perspective, not just from Iwan-- that's fortunate enough-- but from someone who looks at things regionally. A lot of economists don't. Of course, our economists do. So for me, it's a special pleasure to introduce my colleague and friend, Iwan Azis.
IWAN AZIS: Thanks, Bill. Friends, colleagues, I was-- Rob mentioned to me that I'm given 50 minutes time. And as you can see, what I was planning to do is to speak about five different topics. So it averages 10 minutes each. But of course, I'm not going to do that, because each topic has different degree of importance. So let me go through-- what I'm going to speak about today is really start by elaborating what went wrong that led us to where we are now.
And the second topic is really what is the impact of what went wrong that led to the global crisis and to what-- on the state economy. And the third one is I'm going to focus a little bit more, rather than talking with the state economy in general, about the fiscal side, because you will see in a few minutes that that is really the badly bruised part of the state economy. That is the fiscal side.
And the fourth one is what's in it for regional and urban planners, because I guess Rob asked me specifically for this particular session to talk about what's the relevance of all this crisis for the urban planners and so on. And the last point-- the last few minutes, maybe, we can discuss what-- in retrospect. So let's evaluate a little bit about the policies. I'm sure these days, it's very easy for you to get all this information almost every day in the media-- TV, radio, newspaper, magazine is always talking about this $700 billion US dollar TARP, and then another Obama $825 billion US dollar stimulus package and so forth.
So we'll spend the last couple of minutes on that topic. And hopefully, the last 40 minutes after that, we can have a discussion-- lively discussion. Having said that, however, please, if I'm saying something-- especially for some students who are-- if I mention some terminologies-- economic financial terms-- which sounds foreign to you, please interrupt me, OK? So don't wait until I finish with my 50 minutes talking, because otherwise if I keep continuing talking with that terms, it may not make sense for some of you, all right?
All right. Let's start what went wrong. If I want to buy a house, what do I do? I go to the bank, right? And I ask for mortgage. What does the bank do? The bank will evaluate my financial background-- whether I have a job, whether I have asset, whatever collateral. That's the standard procedures, right? But then, started with Bill Clinton, actually-- he started to make it easy for both the lenders and the borrowers to buy a house-- to own a house, actually. To fulfill the American dream, he said, OK?
But that kind of American dream apparently is valued by the next president. And not surprisingly, also supported by the congress. So basically, the mood in the country is really supporting how to make it easy for low income people to own a house, all right? So with that kind of environment, there's a group of financial players saw it as an opportunity to make money. And those groups are the mortgage firms, basically-- mortgage brokers, basically.
So instead of doing the standard one between bankers and the homeowners-- let me go [INAUDIBLE]. Instead of that, you have a broker-- mortgage broker now, all right? So this mortgage broker is basically the one who deal with the banks. So instead of you directly deal with the bank, it's the mortgage brokers who are doing that. Why? Well, if I'm poor and I'm going to bank, I'm asking for mortgage loan and they evaluate my financial background, of course I won't get, because I'm not eligible for that, right?
But the mortgage broker said, don't worry. I will be the one who deals directly with the bank, OK? Now, this mortgage broker apparently is not only serving the need of the so-called low income people, but they are proactively doing it. Now, who are these people? Because these people are not eligible to get the standard credits from the bank, so they are not prime. Because they are not prime, then they are subprime.
So that's the origin of the word subprime. They are not prime customers. They are the subprime customers. Now, so far, so good, right? What's wrong with that? Well-- and this is a little bit financial economics-- think about the balance sheet of that mortgage broker. What happened with the balance sheet?
Basically, all of sudden on the asset side-- on the left hand side of the balance sheet-- this is T account-- on the left hand side, the asset became bigger, because on the left hand side-- on the asset side-- all of sudden there is mortgage. The more they lend to this guy, the bigger is that asset.
Now, this reflects the attitudes of the firm or the financial players. What they want is they want to be bigger, bigger, and bigger, right? Now if on your left hand side-- on your asset side-- you have a huge amount of mortgage as your asset, what about the liabilities? Because finance-- economics 101-- tells you the liability has to be the same with the asset, right? So if you, let's say, adding $100 million on your asset side, what is the $100 million on the right hand side?
Well, suppose I'm the mortgage broker. What I do is I'll go to [? Pierre, ?] who is the investment bankers-- let's say, Lehman Brothers, OK? So I show to [? Pierre. ?] Look, [? Pierre, ?] I have this balance sheet. And I have huge mortgage in my asset. So why don't you buy my paper, my securities? Because what I do is I am issuing securities. Those who do not understand what securities, just imagine this is a piece of paper which says I owe you. That's it.
So it's like bonds, basically. It's like treasury, OK? So I go to [? Pierre, ?] which is the investment bank. So I tell them, why don't you buy my paper? Of course, [? Pierre ?] will ask, why should I buy? Well, remember, we are talking about house-- housing sector. The perceptions of all players, including the society. The only directions of the price of house is north.
Price of house never go south. That's a perception. So only from that standpoint there is no reason for [? Pierre ?] not buying my commercial paper. So he bought it, right? Now, the process by which I am able to sell commercial paper backed by my asset, which is the mortgage that I issued to this guys, that is called the Mortgage Backed Securities-- MDS.
Now, if you are interested with this financial crisis issues, especially these days, don't be surprised you will find a lot of abbreviations-- ABS, CDO, CDS, and so forth. But the most common, or most repeated mention, is really the MBS. This is it. Mortgage backed securities, OK? Now, keep in mind that brokers, basically, they got money. They borrow money from their banks, right? But now he can raise a lot of money from [? Pierre. ?] Now [? Pierre ?] is an expert sophisticated investor. His investment bank, Lehman Brothers.
So he look at it. Hey, this is a golden opportunity for me to do the same thing. So what does he do? The same thing. In his balance sheet, all of a sudden, there's a big asset, right? The moment he bought my commercial paper, the asset side of his balance sheet increase-- let's say $100 million. So with that $100 million, he goes to investors and tell exactly the same thing like what I did tell to him. Please buy my commercial paper.
And that commercial paper is also called the asset backed securities or mortgage backed securities. Why? Because that is commercial paper that is backed by your asset, which is nothing but mortgage, basically, right? All right. So when you do that, let's see what happens. So now [? Pierre ?] is interacting with the investors here. And again, the reason why this is happening is because there is a belief that the price of house will continue to go up.
And this is the MBS. Remember, I told you about the mortgage backed securities. Now those banks, when they started to see, hey, these brokers, they can get money from [? Pierre. ?] Why don't I do the same thing? I'm also selling my paper. So they are starting to sell to the investment bank as well as selling to the direct investor. Another MDS.
So you have the accumulations [INAUDIBLE] in the economy, OK? Now, at some point, an investors and [? Pierre ?] will started to worry. What happen if I'm not able to pay to [? Pierre? ?] And of course, the investors buying his paper have the same [INAUDIBLE]. What happens if [? Pierre ?] is unable to pay whatever I'm buying the paper from him, right? So if you are worrying-- investor with worry-- what they do is they buy insurance, right?
So they buy insurance. But before you buy insurance, you have to be rated first, whether this is a good rating or not. So the famous rating agencies like Moody, S&P, and so forth, they jump in into the system. And when they look at it, what is this asset about? What is this-- the properties that you're talking about? All these are mortgages. All these are houses. Oh, all right. The price of homes will always go up, so I give you AAA rating-- very high rating.
Now, when you have that kind of situation and that news spread out, right? And in the meantime, remember, the economy was booming under the Clinton administration and in the first few years of Bush administration. The economy was booming, stock market was booming. Everybody all of the sudden get a lot of money. But they don't know where to invest. They see this as an opportunity.
Boy, this is safe, because rated AAA by the famous rating agency. Why don't I buy it? Now, if it is private investors, that's it, because investor is-- people-- investor is basically the euphemism of speculators, right? They want to speculate, right? They try to get money. But all of sudden, because everybody thought this is safe, it's not private.
But even school started to buy that papers. Municipalities started to buy, because they thought this is safe. Pension fund in Norway-- as far as Norway. This is outside the US. Insurance companies started to buy. Why? Because this is safe-- rated highly by agencies. All right. Next, what happened?
This guy, the mortgage broker, started to play around repackaging their papers, selling more to the investment bank-- Lehman Brothers, [INAUDIBLE], Merrill Lynch, Goldman Sachs, Bank of America, and so forth, right? Delinquencies started. Now, let me say a few words about delinquency. I forgot to mention-- at the first part of the story, when the mortgage broker approached the so-called subprime borrowers, why the subprime borrowers was willing to take that offer?
Well, as the mortgage brokers, what I told them is that, don't worry, the first two years you don't have to pay. Even if you have to pay, it's just administrative fee-- very low, OK? This is what is called a teaser rate. But after two years, you have to be higher than the marketplace, all right? Now, put yourself in the shoes of people who have been dreaming to have a house.
That was quite a lucrative offer-- first two years, all of sudden they can own their own house, all right? With teaser rate. Now, what is interesting is-- take one example, a company named Countrywide. If you look at the brochure, the prospectus of Countrywide, that statement that after two years you have to pay higher rate than market rate and so on, it's put at the bottom-- very tiny.
I don't know if you ever receive your financial statement from your credit card. All the numbers are big, right? But then at the bottom there is a tiny almost like footnote, OK? So these people, they didn't pay attention on that. The only thing that they were thinking is, now I can get-- I can have my own house with teaser rate.
All right. So that happens. And because of the teaser rate, delinquency after two years started to go up, because all of a sudden, these people cannot pay, right? Now, these are worries now. All these investments started to worry, although it's not as high as now, because we are talking about, let's say, during the fall 2007. So delinquency rates started to go up during the fall 2007. But it's not that high yet, all right?
But to make sure that no one got bust because of this delinquency, insurance company jump in-- AIG, for example. What the insurance company do is basically approaching the investment banks and the investors. What they said is the following-- why don't I guarantee you. So in case these guys cannot pay, I will take care. But for that, you have to pay my policy. And it was so lucrative, because the amount was so huge, this insurance company was able to issue what is called a CDS-- Credit Default Swap. CDS, all right?
Now, before I proceed, let me give you a perspective-- something shocking here. What is the size of the US economy? GDP of the US economy is 14 trillion US dollar, OK? 14-- 1 4-- trillion US dollar. What is the size of CDS in 1998, or let's say 2000? Practically none. Nothing. There is no CDS.
By 2001, the amount of the CDS is close to $1 trillion. 900 billion US dollars, to be precise. That's 2001, OK? Keep in mind, today's GDP of the US is $14 trillion, OK? So what is the CDS now-- the size? GDP US is $14 trillion. Give me your best guess.
AUDIENCE: $62 trillion.
IWAN AZIS: He knows exactly. 62 trillion US dollar. This is five times more than the US economy size. That is the CDS issues by a group of insurance company, all right? Now of course, we know now the story that they got bust, right? And when they got bust, they asked help from the government. All right.
Now, delinquency continued to go up. Investment banks started to worry. Why? Because the so-called monitoring system was working. So it wasn't true that-- some people accuse the Federal Reserve that they didn't monitor well and so forth. They did monitor. But what did they monitor? What can they monitor? What can they monitor is only the official balance sheet, right?
So the investment bank apparently was smart. They set up a separate company off balance sheet, so not in their balance sheet. And that company can be as far as in Cayman Island. So what did this company do? Basically all this [? toxic ?] asset-- all this asset that was associated with the delinquency-- was put in their company, all right? Now of course, the company has to have their own balance sheet. So what does this company do? The company repeat what their headquarters did a year before, and that is try to sell to the investors.
Here they pool, and then they try to sell the investors. So how did they sell it? They issue commercial paper. And they said this is low risk commercial paper. Why low risk? Again, because this is rated by Moody's, S&P, Standard and Poor's, and so forth. So it's low risk.
Why the investor wants to buy that? Well, because every month the investor get the interest-- monthly interest payment. Who doesn't want to invest with such a security? I invest, let's say, a million dollars, and every month I got the interest. I trust you. So this is exactly the same with the Madoff Ponzi scheme, basically, right? All the investors got sort of [? agreed ?] as well as guaranteed monthly payment. So that was the beginning of the SPV interaction with the investors.
Now things get worse. So now we are entering, let's say, summer 2008. It's no longer just delinquency, but eviction. Some poor people have to be evicted from their houses because they couldn't pay. Delinquency continued to go up. Evictions goes up. That means these guys got bust. So the poor people got bust, right?
If they got bust, that means they cannot pay that guy, right? So the next step is that guy got bust, all right? So that guy got busted. Because that guy got busted, what happened with the investors? The investor got busted. Because the investors got busted, what happened with the investment bank? They got busted.
So friends, colleagues, welcome to the financial crisis of 2008. That was really the short story. I always call it one [? chart ?] of the financial crisis, all right? It's a long story, but this is maximum I can do to give it in 10 or 15 minutes, all right? Now of course, if you have questions, feel free to raise it.
All right. Now this is what happened with the housing price. Why? When this-- the previous one, when these guys was busted, all of sudden banks had lot of houses, right? Because that houses was foreclosure houses. Look, my business, my expertise is not in housing. It's not in property. I'm in banking sector. And all of a sudden, I have thousands and thousands of houses. What do I do with that?
Get rid of it. Sell it. But because I'm not expert and no one can buy-- no one can afford to buy-- I'm selling it with a lower price. That's the fire sale of the housing market in the US. That explains why the price of housing collapse, OK? Now remember-- if you recall a few minutes ago when I started talking, I started with a subprime mortgage, right?
Let me give a review. In an economy, there are at least three markets-- goods market-- that's production. There is financial market and there is labor market. Within the financial market, there are several types. One of them-- only one of them-- is called mortgage financial market. There is bonds, there is stock, there's many others. One of them is mortgage.
Within mortgage, there are several others. One tiny one, it's called the subprime. So you can imagine, we started with a very tiny segment of the market, which is called subprime. So the big question is how come that tiny market can bring down the world's largest economy, which is the US economy? That is really the $6 million questions, right?
From the story I was telling you, let's continue. Now, the price of housing is down. But just because of the collapse of the tiny financial market, which is called the mortgage market, the entire mortgage markets collapse. So the subprime delinquency increase, all right? But even all of the loans, which has nothing to do with subprime-- so this is including prime loans, like loans that [? Pierre ?] or Bill usually got from the banks, because they are people who have jobs with assets and so forth-- they also got busted.
So the [? contagions ?] was so severe. Who are these people who got the subprime? Sometimes they call it NINJA. Anybody knows NINJA, right? No Income, No Job, no Asset. So no problem if you don't have income, you have no asset, and so forth, because the mortgage guys, they offer you to own a house for the first time in your life with decent rate for the first two years.
That all started with that kind of actions. Of course, there's a lot of macroeconomic background, but I don't have time to explain low interest rate and things like that, OK? OK. This is just the chart showing you the CDS. Remember, I was telling you about earlier? That's $62 trillion now. Remember, the GDP of the US is only $14 trillion, and that is today. 2008 GDP of the United States is $14 trillion, and the CDS value is $62 trillion.
Now, if in the country there are two or three, let's say, factories close down because of mismanagement or whatever, the economy of the country was fine. But one bank collapse in one country, it created a systemic [? risk. ?] The entire economic collapse, OK? So now you know the key story from what I was telling you early that bring down the US economy is really the enforcement of the investment bank.
If only the mortgage firms, if only the mortgage brokers are doing all those things and they get busted at the end, the US economy will be OK. It will survive. But it's because the investment bank started to jump in. They started to join the party. When the party stopped, they got busted. And yet, bank is really the intermediator, right, for the credit. And credit is the lifeline of any economy.
So when the bank got busted, the entire economy got busted, OK? So why don't I stop here and just to show you the last charts for the first part. And that is what happened with the unemployment. You know very well. I don't have to spell it out. When the economy got busted, recession, lay off increase, unemployment rate increase, and so forth. So this chart's basically showing you what happened with the labor market.
So it started with a tiny, tiny segment of the financial market, but the rest of the market got hit-- labor market as well as the good market. All right. So next is the state economy. What happened with the state economy?
Well, it depends what indicators you're using to evaluate, right? Let's use four different-- yes, [? Pierre? ?]
AUDIENCE: What do you mean by state?
IWAN AZIS: State Is New York state. So I'm talking what the sub-national government, OK? So you can change it to regional economy here. But basically, a state economy. It depends on-- by the way, please interrupt me like what [? Pierre ?] did, OK, If you have some question to ask. It depends on unique indicators. Let's use four different indicators, OK?
Employment, foreclosure, growth, and personal income. Now based on those four indicators, this is a picture of what happened with the state economy as a result of that story that I was telling you about the global financial crisis and so forth. So let's see our state here. It got hit, but it's not the most severe. The worst is the dark red color there.
So in New York state was average. Now, average doesn't mean-- does it mean that New York state was OK? No. Everybody got hit. So this is only in the relative positions, just to make sure that you understand that New York state is also got hit very hard. Look at-- this is from the latest report, the [? Governor ?] [INAUDIBLE] Patterson. Is that his name? [? Governor ?] Patterson's report.
Manufacturers and firms-- widespread decline in business activity and employment levels, and a growing number plan to curtail capital spending ahead. Input costs and selling prices leveled off. Retailers-- weak sales and prices are flat to lower. Spending-- holiday season was lower. Tourism-- declined sharply. Real assets-- softened substantially. Loan-- demand weakened across all segments, substantial tightening in credit standards, and higher delinquency rates on all types of loans.
Not just mortgage and subprime loans-- all types of loans. That's the contagion, OK? So it's bad. This is New York state. So that chart can be misleading, but this chart's basically showing the relative position. So it's bad, but there are other states where it's far worse. That's all this chart is talking about, OK? All right. And this is particularly the three areas-- New York City, New Jersey, and New York state. And this is the trend after the crisis.
So it's straightforward. You can expect that they're all declining here. Now, this chart is interesting. It shows the number of states-- out of the 50 states, the number of states in which the CEI-- CEI is the standard index, which is called Coincident Economic Index for states, OK? How many states has the CEI declining?
You can see the number increase tremendously. So by-- this is, I think, October or November-- November 2008. There are 38 states in which the CEI decline, OK? All right. So that's the general pictures of what happened with the state economy. We know that the state economy was in trouble. Now, let's look at the finance part-- so only the budget part, OK?
Now, this chart shows you basically the state tax moves almost in tandem with what happened with the economy, OK? So if you look at this chart, it goes without saying what happened with the state tax, right? Because the economy is down and the state tax is also down. This is what happened with the state tax.
And you can see that the state tax fell more severely than the local taxes-- local government taxes, OK? County taxes and so forth. And then, if you look at different type of taxes, does anybody know what is the largest type of the taxes at the state level? Income taxes, property tax, or what? No. Sales tax is number three, basically.
Income tax is the highest, OK? The sales tax is not the highest. But look at the sales tax. It fell the most sharply because of this crisis. Now New York state-- this is chart showing per capita taxes in real terms, by the way-- not in nominal terms. So the red chart shows the average the US-- average 50 states, OK? And you can look at differences.
Of course, I can show you all the 50, but I don't have time. So I'm just showing you four states as an example. And there is our darling here, New York state, OK? If you compare what happened in New York state, and in Nevada, and in Florida, and Arizona, relatively doing well, right? Again, in the relative sense, we're talking what per capita taxes here in real terms. So our state is doing relatively better compared to the rest of the US from the tax point of view.
Having said that, however, this is what [? Governor ?] [? Peterson ?] last November when he presented his new plan for the budget and so forth. Look at that. We are going to have a deficit as high as $47 billion. And then, this morning I just calculated with the population. It's about $2,400 per capita. That's the size of the deficit for New York state until 2012. So despite the fact that I show you the relative positions of New York state is relatively good compared to the other states, they're suffering very hard, OK?
Now what is the effect of that? Well, of course there are many affects. You know very well. The potholes-- more potholes because you have less taxes. Fiscal deficits increase and you spend less, right, Including for infrastructure and so forth. But one of the most important spending at the state level is for the unemployment benefits. And for those who don't know, what is unemployment benefit? Basically, from your payroll taxes they deducted some percentage for the unemployment taxes, OK?
And then when there is an unemployment in the market and so forth, then you can get this benefit. That's basically it, OK? Now, these are studies showing that in many areas throughout the country, unemployment benefit trust fund-- because they put it in the trust fund-- has been declining, suffering. In Indiana, they went bankrupt already.
And New York state is [? still ?] [? inching ?] towards bankruptcy. Not yet, but it's coming. Now what does that mean? All right. Well, let me pass this, because I don't have time, because it's a bit complicated, but it's more financial issues. This is what happened with the number of unemployment insurance claims. As expected when the economy is in recession, the unemployment claims increase, right? And this is the distribution by states-- what happened with the month before unemployment trust funds are expected to deplete.
Ideally, you are on the right side. That is, about eight months to 12 months, or even better if you have more than 12 months. But look what our state. New York state is less than four months already. That's why I said, it's approaching bankruptcy. All right. Now, actually this chart is-- it's not important. It shows that New York state, actually, the size of the unemployment benefit is relatively small. Look at compared to Connecticut, Pennsylvania, New Jersey, and Massachusetts. New York state-- ours is the lowest, right? $405 per recipient, OK?
So even with that low level of unemployment benefit, the state is also in-- is already in trouble financially. All right. If you cannot raise taxes because of the economy going bad and so forth, what is the alternative? Well, it has been historically shown that if state needs more money, they issue bonds. This is what is called the municipal bonds, right? Or money, in short. So they issue bonds.
So the potential answer to this problem is, why don't states start to issue bonds? Well, the problem is, who is going to buy that, because the economy is in doldrums, right? Now, if you are investors and I'm state, and I need money, I'm issuing bonds and I'm begging you please buy it, what do you say? I'm willing to buy only if you offer me higher yield.
And this is exactly what happened. The yield-- the last 12 months, the yield of municipal bonds has increased tremendously. The yield in New York state now for bonds that with maturity 20 years is 6.5%. Everybody know what's the federal funds rate, right? It's very low. In fact, I predict it's going to grow close to zero, like in Japan in the early 1990s. But the municipal bond yield now is 6.5%.
Why? Because you are also in trouble, so your money is very valuable. The only way that you are willing to spend that money to buy my bonds is if I promise you higher [? interest-- ?] 6.5%. And other states, of course, have different rates. But the point here, it's higher.
Now, what is interesting is that if you are buying federal government bonds, which is called the US treasury-- this is 10 years maturity-- the rate is very low and it's declining. Why? Because treasury bond is the destinations of flight to safety. Everybody doesn't want to invest in a bank, because they are afraid that the bank will go bust and so forth. So the only safe place is US treasury.
So I have a chart showing you what happened with the US treasury yield. It's declining, compared to the money yield going up to the roof. So no one wants to buy the money bond. So the state is in trouble financially, OK? And this is the irony. When an economy is in crisis, be it federal level or state level, theoretically you have to pump prime. That's the Keynesian approach-- you have to spend more.
And the irony is you are now in big trouble financially, which means you cannot spend more. It's sad, right? So that's really the challenge of you guys, the planners-- how to design more or better resource allocations given the limited amount of resources and so forth. And also, what is interesting-- you cannot read this. In this country, it's very unusual. The balanced budget rule is strictly applied at the state level, but not at the federal level.
So that means there is another constraint at the state level. They cannot spend more than what they receive in terms of the revenue. It has to be balanced budget. So that's another problem.
All right. The last point is-- not the last one, one before the last is what's in it for the regional and urban planners. And here I need help of my colleagues, also here, who's more expert than I am in terms of the urban planning, regional planning, and so forth. Well, I just talked about the effect on the local finance, right? So the challenge is what do you do. I know in CRP, for example, they are students who are majoring in the financial part of planning. They are students who are majoring on the physical planning side more, historical preservation side, and so forth.
So those who are focusing on the financial part, think about this. This is your challenge. How do you do? How do you help the state level to cope with this huge challenge in [? them? ?] So more spending, but less revenues and so forth. Now, there are examples. For example, Minnesota and Wisconsin. The two governors from those areas already agreed that they will share facilities. Well, maybe that solution. So they are sharing everything from heavy equipment to software and road salt in hopes of easing both state's budget constraints and so forth, right?
But that's only an example. Now this is what's interesting. I know the issue of the urban sprawl have been dominating the field of urban planning and so forth. But the global financial crisis, plus-- by the way, plus. There's another shock, which I haven't talked about, because that's not the topic of today. The increase of oil price. Remember, now gasoline is already down, right? But people forget that it was fall 2004-- so the fall of 2000-- September 2004, price of oil started to go up, all the way until just few months ago, because it was only recently, right, the price of oil started to come down.
So that-- so the global financial crisis and oil crisis-- apparently, that leads to what some people call it the reverse of the urban sprawl. So the tendency now is moving toward city area, core area, OK? Now, naturally speaking, that present challenge for urban planners. What do you do, OK? Homes in neighborhoods close to downtown in Chicago and so forth having convenient access to transit have held their value. So the price of home in the core city area-- of course, they're declining.
Everybody-- every area suffer from declining housing prices. But it does not decline as much as houses in the suburban area. It shows that it's really the suburban area that's suffered. So the challenge is for planners-- because for several years planners always looking at the inner city issues and so forth, right? Maybe now they have to start to look at what happened in the suburban area-- support the production and preservation of affordable housing in the suburban area. Opportunity to end sprawl by reinventing the physical landscape and mixing land uses to enhance [? walk-ability ?] and public transit. Help local governments buy up foreclosed properties and put that land to productive use, and so on and so forth.
So basically, there is a new challenge because of the global financial crisis. Now this is what Obama said in June, 2008. All right. Maybe too small. Basically, there is a hope, because apparently Obama had an idea in terms of renewing the way of thinking about the urban sprawl, what-- rejuvenating the cities area and so forth. So it's not important. The point that I'm trying to say here is that there is a hope, because at least the new government-- the new administration-- is in line with the problem that I was talking about earlier, OK?
So they are aware of the problems here. What about the effect on housing and community? A glut of unsold houses-- we know that. I was just telling you why all of a sudden there's a lot of unsold houses and so forth. So what is the challenge? Well, maybe not how to better design homes and communities, but rather what are we going to do with all those homes and communities, because they are all becoming abundant properties and so forth. Turning them into something useful, but what? That's your challenge.
You have to think what kind of new landscape that you're thinking about. Efforts on home ownership-- rising foreclosure, could not sell their houses to make the down payments. Well, maybe some of planners should work trying to negotiate with the banking sectors how to save all those people from becoming homeless and so forth. I don't know. But this is more on the financial side.
But you have to think about ways to help people from becoming homeless. This is the homeless that I was talking about. Effect on migration-- now this is another interesting trend. Migration typically slows during recession, because new jobs are the primary reason people move across state lines. The long term trend has been for Americans to leave Northwest and-- Northeast. Sorry. Northeast and Midwest population centers for warmer job creating states in the South-- Sunbelt and West.
That movement has slowed and may reverse due to the crisis. So you may see different patterns of migration because of the global financial crisis. That presents another challenge, OK? Job creation and sectoral change-- prediction du jour for some urban planners who make it their business to track the larger sociological implications of the land use, because migration is not just posing economic issue, but also sociological issue. So those planners who are interested with the sociological part of the analysis, that will be very useful.
And then there's an effect on the local bank-- small banks. CFCU and those local banks. We are no longer talking about banks like [? Pierre-- ?] the investment bank, Lehman Brothers, big one. But we are talking with the smaller bank. Effects on elderly, because now the elderly, they cannot move to the nursing home because they cannot sell their houses. No one is going to buy their houses. And so that pose a new challenge, as well.
Effects on poverty-- well, even before the crisis the poverty in this country has already going up even before the crisis hit. But now, the crisis just exacerbated the problems. So what's the challenge? Dealing with struggling communities, local government planners may help to find the right place to inject public capital and do it in a way that leverages local participation. Things like that.
Let me just pass this, because this is a little bit too radical, because there's two views-- the classical view, [INAUDIBLE] Lewis view that urbanization is bad, because it leads to the urban poor, urban unemployment, and so forth. And that's why the policy direction is try to reduce urbanization. But then Robert Lucas, the Nobel Prize winner from Chicago, you will know. In fact, the urbanizations, the migrations of all these migrants is the center of the dynamism of the urban area. So instead of rejecting them, we have to facilitate the urbanization and so forth.
But that's more theoretical, OK? From the theoretical point of view. All right. So let me close with the retrospect. Policy evaluations-- what went wrong. OK. Now let me start by this-- OK. I still have time. Let me start with this. This is the testimony of the Chairman Greenspan. Basically, he acknowledges that the financial crisis had exposed a flaw in his view of how the world and markets function.
So Greenspan admitted that his idea was flawed. Robert Rubin, former Treasury Secretary in the Clinton administration, wrote in a letter before leaving Citigroup on January, 2009, "My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today."
And there is one, but I couldn't find the quote. But I remember I read between Greenspan and Warren Buffett. Greenspan basically believed at the time that all this derivative of this innovations in the financial sector is good for the economy, whereas Warren Buffett said, no, that's the financial weapons of mass destruction. And apparently, he was right. Now the economy was disrupted by the financial sector.
All right. So the rest of time, let me just close with this one chart to give you a bigger perspective. Why all this happened? Well, actually it started with a phenomena which unfortunately only a few economies paid attention on, and that is phenomena of global imbalances. It's a long story. Only if you are interested during that Q&A sessions I will explain. Otherwise, let me just mention this-- one of the characteristic of the global imbalances is low interest rate.
The US interest has been low for so many years, so it's easy money. So if it is easy money-- remember the first chart. These guys, the poor people, they can easily get credit. Even the mortgage firm can easily get credit, because interest rate was low. So in a way, that kind of easy money environment helped to propel the long story that I was telling you that led to the financial crisis, OK? That's the easy money.
The financial institution and the investors, they are greed. They are looking for profit, which is normal. But they want to be bigger. Remember, I was telling you if you have a balance sheet on your asset side, if your asset at the beginning is 100, you want to make it 300. If it is 300, you want to make it 600. And in doing so, what you do is you try to persuade all these guys to buy more house-- the subprime credit and so forth. Wants to be bigger than your neighbor, than your competitors.
That's the behavior part. But there is also something that is structural, and that is global imbalances, as I mentioned earlier, and market ideology. Everything will be taken care of by the market. So those three all led to the bubbles, be it in financial market, be it in the housing market, and in the goods market. There is also a bubble in the goods market, by the way.
And you know from the story I was telling you that it led to the delinquency and finally the bubble burst. Liquidity [INAUDIBLE], solvency, bankruptcy, financial crises, deep recession, flight to safety. So maybe in trying to put into a little bit different story is what are those there? Those are really the [? oilers-- ?] easy money, tax cut, deregulation, financial liberalization, fulfill the American dreams. Those are the [? oilers. ?]
What about the financial institution? No. This global imbalance, that is the engine. Global imbalance, low interest rate, market ideology, and so forth. What about the financial institutions? They are the conductors. So finally, the investors are the passengers. So we are all the passengers of all this crisis. Let me stop here, Bill. And if-- Q&A.
AUDIENCE: Would you like to recognize people for your own questions, and I'll hold line [INAUDIBLE]?
IWAN AZIS: Sure.
Just a couple of questions. First, I'd like to kind of start with a comment. Probably a little sarcastic, but we've been using a market ideology, and we've been told that we need to have market based solutions to our affordable housing problems. And well, now we've got them, and this is what it looks like. But secondly, I mean housing by its very nature, it has to be a function of income-- at least my understanding of it, in order for someone to be [INAUDIBLE] mortgage payments.
IWAN AZIS: Yeah.
AUDIENCE: So anything that we do at this point that prevents housing prices from falling to the point where someone working at a middle class job can afford housing, does that not only prolong the crisis longer?
IWAN AZIS: No. I'm not ready to say yes to that statement, because people can easily counter-argue with you. Look, what's wrong trying to help the poor to own property, to own house, right? There is nothing wrong with it. What is wrong is really the players there. So it's not so much whether it is right or wrong trying to make an environment whereby the low income people can own the house. It's not that question. The question is how do you do that, OK?
And because of all these three, unfortunately we came to this crisis. So I don't think it's because of that.
AUDIENCE: [INAUDIBLE] the ideal solution would be to have housing that's built at a price that low income people can afford. That's what this housing crash is doing right now.
IWAN AZIS: Yeah. But of course, you know I can easily say yes here standing in front of the class. But of course, it's not that easy. So-- but that-- I'm glad you raised that point. That's an example of a challenge for us-- for you planners, OK? What kind of mechanisms that you can design so that whatever you said can be fulfilled. Yes?
AUDIENCE: [INAUDIBLE] periodically has financial crises. I was trying to get a job in the early '80s. I remember the dotcom crisis [INAUDIBLE] the Asian financial crisis and a number of others. Which was this much similar to, or how is it different? How do you compare with some of those other very large crises.
IWAN AZIS: Excellent questions. The first answer is yes, the world occasionally will come into crisis. That's why this semester I'm teaching a course on the financial crisis. On the first day, I keep telling my students, if you come here wanting to take this course, you want to be able to predict crises, forget it. You come to the wrong class, because crisis is not predictable, but it is explainable. So if you want the explanations, then you can come to the class. But to predict, forget it.
So yes. In fact, it is very interesting, although I do not believe that there is particular theory for that. But it is interesting, the pattern is almost every 10 years, OK? '81, we have a crisis. '91, we have a crisis. 2001, we have a recession, remember? Now, other people said any years ending with seven. Remember the black Wednesday, 1987? Remember the Asian financial crisis, 1997? And now, 2007.
Now, OK, that happens to be the case, but I don't believe. I don't think there is any [? theory, ?] OK. So I think it's just inherent in the economics [INAUDIBLE] in the world of finance and so forth that crisis will happen. So that's the-- my answer to the first question. The second is, are they the same? Some elements are the same. For example, this is what I've been talking with some people here-- some people in this country that-- you guys should learn with the Asian financial crisis, because there are a lot-- a lot of aspects that are similar and that can be learned-- lessons that can be learned from the Asian financial crisis.
Let me just mention one, OK? I'm sure you hear and you follow this news about what to do with the TARP. It's 700 billion US dollar and so forth. And then a couple of days ago, we heard that now the-- Timothy Geithner, who gave testimony yesterday, who has become the next treasury and so forth, he said that we are going to set up a bad bank, meaning bank who will take care all the toxic and bad assets and so forth, right?
But he stopped there. There is no comma. What they should do, I think-- all right, you can take all the asset bad banks, but take equity ownership in that bank. It's unfair for [? Pierre's ?] bank, let's say Lehman or Merrill Lynch and so forth-- it's unfair for all the toxic bank of Merrill Lynch was taken over by the government through this bad bank, but the government didn't get any share there. It's unfair, right?
So why don't the government take all the bad banks, all the assets in the bad bank, but at the same time have some equity ownership. And then through this bad bank, let's say, two, three years they try to restructure [? Pierre's ?] bank. Once the [? Pierre ?] bank become healthy, sell it again to the private sectors. Now I know-- I shouldn't say I know, but I'm guessing the reason why they don't do that or they're afraid to do that, because they are so afraid with the n-word. They are so afraid with the word nationalization.
Because the moment the government has equal ownership, it's nationalization, right? But to me-- look, this is extraordinary event, so you have to do an extraordinary policies. All right. Next. Yes?
AUDIENCE: You mentioned earlier, Professor Azis, that the underlying assumption-- maybe the only assumption, maybe one of several assumptions-- for all the players in the one chart global crisis is the belief that housing prices will continue to rise. Didn't someone raise that issue based on the past global crisis? This [INAUDIBLE] continue forever.
IWAN AZIS: Well, of course, there are always one, two, three economists who already made gloomy prediction before the real recession came, OK? But the question is, of course, whether that gloomy prediction was really based on real fundamental of just making predictions, OK? Anybody. So the straightforward answer to your question-- yes, there were few economists who already believed that, no, price of housing cannot continue to go up, OK?
But look, what's-- you can gather all the Nobel Prize winner and say that way, but in the mind-- what is important is the marketplace, right? In the mind of all these households, all the financial players, no matter what the Nobel Prize said, they believe that the price of houses will continue to go up. You keep hearing the story, oh, I bought a house last year, let's say, for $200,000. Now that value of the house is $600,00. You cannot beat that kind of perception, right? Yeah?
AUDIENCE: I have two questions. But if you'll permit me, both begin with a comment. The first has to do with one of your very early slides where you showed increases in default rate or delinquency rate of subprime and prime mortgages. And the tone of your comments suggests that everything was triggered by subprime collapses. But in fact, the proportional increase was identical. subprimes went from 12% to 18%, and primes went from 2.5% to 4%-- something like that. It's almost-- I mean, the bottom line was exactly 50%, and the top one was maybe 50 something percent.
If you decompose the entire mortgage market, don't you find that subprimes is a very small portion of the total mortgage market?
IWAN AZIS: You want me to answer first or second question? I can answer now, or your--
IWAN AZIS: OK. Yes. The answer, of course, you can easily decompose that. Now, that chart can be misleading. What I was saying, and what I believe happened, is still it all started with the delinquency in the subprime, OK? But because of the delinquency in the subprime, immediately all other loans, including the prime-- in fact, they have subprime, they have prime, they have what they call Alt-A. Alt-A is between prime and subprime.
So in other words, you have a job, but you don't have really good record, and your income is not that high, and so forth. So you're still entitled to get the credit, OK? So all these other non-subprime credit, all of the sudden they got also busted because of the subprime. So it's all market perception. So it's not-- if you follow the timeline, for example, there was no case where the non subprime credit went bust first.
It's always subprime credit first, OK? But you were right in terms of the magnitude of the delinquency. Once everybody got the contagion, then the magnitude of this delinquency is big in the non-subprime. First of all, the size of the non-subprime is much bigger, because subprime is tiny, OK? But the chart is showing only the number of the delinquencies, so it's not the size of the credits.
AUDIENCE: That leads to the suggestion that if there had been no subprimes housing prices would have gone up forever.
IWAN AZIS: Yeah. Yeah.
AUDIENCE: I'm pushing.
IWAN AZIS: Yeah. No. I-- to some extent, it's true, but I will pick different statement. There had been the case that the investment bank, [? Pierre's ?] bank, did not jump in into the game, no recession. I'm strongly believe in that, OK? It's all started because the investment bank-- [INAUDIBLE], Merrill Lynch, Lehman Brothers, Goldman Sachs-- they all jump in into the party. That was really the source of the problem.
Because as I said, if it was only Countrywide, which is the mortgage brokers firms and so forth-- if only Countrywide collapsed, it's OK. US economy will not fall. But when all these banks collapse, the entire economy collapse.
IWAN AZIS: Sure.
AUDIENCE: What is it that is different this time that allowed the-- Pierre's bank to jump in that didn't used to happen? You haven't mentioned any of the rules. Well, you've mentioned them, but you haven't said [INAUDIBLE].
IWAN AZIS: Yeah. Thank you, Bill. That was very critical. He was referring to regulation, because this is all reflecting the lack of regulation, oversight, and so forth. It's really missing there, right? And I was so flabbergasted. I don't know if you remember, in 1998 there was another big crisis, not in the US but in Moscow-- in Russia. At that time, Russian government defaulted the bonds, and the entire-- the world bonds market collapsed in 1998, OK? Including in the US.
But it started in Moscow when the government started to default. And immediately two months after the default, as expected, one big hedge fund in the US. It's called LTCM-- Long-Term Capital Management-- collapse. Now, that was the beginning of potential indirect effects to entire markets in the US. Immediately Federal Reserve-- New York Federal Reserve-- bailed them out, OK?
Now what is interesting is that after that, I noticed when I read the comments from economists and so forth, they all cried out for more regulation, especially for the hedge fund. That was 1998. Nothing happened. Why? Because quickly after the bail out, the financial sector back on its feet. So they thought, it's nothing. And as I said, Alan Greenspan believed all these are healthy for the economy, except Warren Buffett said, no, this is the financial weapons of mass destruction. So it has to be regulated.
Now, I always like to use this analogy. If you go to some developing countries, in some intersection you still have police men or woman, right, control the traffic and so forth. So deregulation is similar to removing the policeman and woman. Let the traffic flow, OK? But I believe-- and you do that-- you remove the policeman and policewoman, but you put traffic lights, right? So that is the regulations needed.
You can imagine, if you remove this policemen and police woman, there is no traffic light, chaos. So that's what's happening here, right? Now, having said that, Bill, why the investment and why [? Pierre's ?] bank was not regulated? Actually, by definition-- and this is something to do with the law in 2008-- 2002, right? The US allow investment bank. Why investment bank? Because the word investment meaning that the bank is not only doing the intermediation-- that is, intermediating the customers money and the investors for credit and so forth-- but also they can do the investment.
So all these banks, they consider buying this-- the papers, the mortgage backed securities-- as an investment. So no law has been broken, basically, right? Now, the question here is that, of course there are rules-- only particular or, let's say, safe investment that you can do. That's supposed to be, right? So the Federal Reserve, maybe there should more careful in terms of looking at what kind of investment that investment banks are buying here.
But remember, the investment banks are smart. They put it off balance sheet. They put it in Cayman Island. And this is the reason, Bill, why since 2007 not only the Federal Reserve-- Bank of Japan, ECB, European Central Bank-- they put a lot-- injected billions of billions money in the market. It didn't work. Why? Because no one knows how much was money involved and who. How do you know? Because it's off balance sheet. You don't even know whether it's in Cayman Islands or in other tiny islands and so forth.
So they don't know. Until it's clear how much money is really lost in the system and who is doing it, it's hard to expect that the money injection will recover the economy. So that's my comment on regulations. I fully agree. I mean, this is the time when people-- I hope. I hope it's not going to be the repeat of 1998. Because as I said, in 1998 people talk about the need of regulation, but nothing happened. Yes?
AUDIENCE: I have that the reason the rating agencies rated these securities poorly, or they rated them very well but shouldn't have, was because they were using old data. And they were using data that wasn't based on these [? NINA ?] loans that were being given out. And so they weren't taking into account the increased rate of delinquency.
First off, is that true? And then secondly, I mean, that seems like something that if someone had been looking at it carefully they could have come up with. Are there other side stories to this, where you just say, wow, this could have been avoided had someone done this seemingly small detail?
IWAN AZIS: OK. First question, the answer is I don't know. The second answer is yes. So I don't know whether they used the old data or not, OK? But your second question of whether there's another side story of it, yes. Definitely yes. To me even if they used old data, I don't think that's a real problem. Even if it is true, but I don't know whether it's true.
I think the real problem is this-- who paid the rating agency? The issuers of these papers. Of course, the more papers being issued, the more the rating agency get income. I think that is more explanations why they do what they did. I don't-- think even if they made a mistake in terms of data, I don't think that was really the driving force of making such a huge, huge mistake in terms of rating those financial institutions. Yeah?
AUDIENCE: As I understand, the political history of regulation is that the limitation on how easy it is for government to regulate it has a lot to do with the availability of people with the training and the understanding of how the business works to actually do the regulation. And that what worries me about the situation now is that if we've been going for years and years thinking we don't have to do regulation that there won't be very many people who know how to do it.
And so it isn't just the incentive system that stopped the rating agencies from doing the right thing. It may also be that there aren't enough people who can do it. Obama wants to institute regulation now. He's going to have to very carefully worry about where he can regulate effectively and where the personnel are going to come from that can make it happen.
That might be an issue. But if we for years, and years, and years have been saying regulation is not important--
IWAN AZIS: I agree, [? Pierre. ?] I mean--
AUDIENCE: The market solves the problems. That means there's a whole area of stuff we don't have to think about, which means that for 20, 40 years we haven't been thinking about this stuff. A lot of the problems of anti-trust regulation, as I remember when I studied in the '60s, was that it was getting to be taken over by the lawyers. The economists weren't doing it anymore. So there wasn't the right kind of training to do anti-trust, which is one kind of regulation.
IWAN AZIS: Yeah. I agree with you. And I think that explains why if you don't have that capacity, that knowledge, that experience of dealing with this sophisticated financial mechanism and so forth-- so when you do not have that, and you have this kind of a big crisis, So what do you do? You tend to say, stop that kind of mechanisms, right? Instead of trying to find a better regulations to deal with this complex mechanism, try at least temporarily stop this complex mechanism. And that's what's happening now.
There's no more investment bank. So sorry, [? Pierre, ?] your bank is down. In the US, there's no more investment bank. All these banks turns back into the old style bank. It is called the retailer banks, which is doing the traditional things what the banks are supposed to do. That is, receiving the saving or your deposits and then lending, right?
But investment bank did more than that. That is, buying the papers. Now, no more. So even Goldman Sachs, Morgan Stanley now become retailer banks. It's like the regional bank. But I think it's temporary, because I wouldn't be surprised if, let's say, five years from now hopefully the economy is back on track. Then there will be a new idea about investment bank like kind of mechanisms. But then as you just said, the regulators have to catch up with-- have to understand the mechanism.
It's not just the lawyers, but also the economists, the financial expert, and so forth. They have to work together.
AUDIENCE: [INAUDIBLE]. But are there countries around the world that have a better job?
IWAN AZIS: No. In fact, this is a really sad story, but this is a bit side story. You know when Asian-- know very well Asian financial crisis in 1997. The IMF up with policies. And it turns out that the policies of this expert in Washington made things worse, OK? And then they hired the ex-- what's the name of this guy? The ex Federal Reserve. You know, the old guy. Paul Volcker. So they hired Paul Volcker to identify what's wrong with the banking sector in Asia that led to the crisis and so forth. And guess what-- what he found out?
If you look at all the regulation in Asian countries, they are good-- in some cases, even better than in the US. But the enforcement was weak, so that's the conclusion. Do you need an expert to say that? Sorry. OK. So, no. My feeling, they don't have the expert.
AUDIENCE: My impression is that the people who were leading the banks-- the insurance companies, the rating agencies-- say the 10,000 people at the top may indeed have lost 90% of their holdings, but they're still multi-billionaires. And I, frankly, don't think they give a hoot, including the Secretary of the Treasury until the day before yesterday, who himself-- if the reports in the newspapers are correct-- left his investment bank with $700 million-- a personal fortune.
Now if, in fact, there are 10,000 people, 50,000 people who made vast fortunes that way-- and the data on the distribution of income suggests something on that order-- then what sorts of regulations are likely to control the next batch of us who see an opportunity to make tens of millions of dollars? Used to be the investment banks were prohibited period. The-- what do you call it-- [INAUDIBLE] banking law that was actually changed. We don't tax overseas operations.
I mean, there's a whole series of regulations that aren't passed because a lot of people make a lot of money even passing through a crisis like this. A few of them jump out of the 40th story window, but not very many, right? Most of them just go out to the far reaches of Long Island and go to the beach. I--
IWAN AZIS: Honestly, I don't know exactly the answer to the questions. But I have a feeling, Bill-- I think it goes beyond just regulation. I think it's more on the paradigm here, OK? It's beyond regulation. Think about this-- this is what economists always call as the principal agent model. So if I have a company-- so I'm the owner of the company. I want to make sure people who mean it's my company doing well. The question is, what is the incentive of that people that manages to do well for my company?
If I just be a monthly salary, that's not enough incentive. Maybe then he or she will do just day to day activities as long as the company doesn't go bankrupt. And yet, we want to make the company grow bigger. So I'm the principle, he is the agent. So what I do is, all right, I tell you what. If you can make the share of our company in the stock market go up by 200%, then I give you option of ownership of that company. Now you're talking with incentive, right?
So that is an example that leads to-- I don't know-- millions of dollars of gift or stock options or what-- because as an owner, I want my company's share in the stock market triple or quadruple. And I need to inject an incentive to this managers. And one way to inject incentive is I let you own the company if the share goes up and so forth. So is that regulation? I think it's more-- it goes beyond regulation, I think. It's just the paradigm here.
And I'm not expert on that. Something much bigger than just regulation, I think. But I may be wrong, because I'm not expert in regulation. So maybe there are some regulations who can overcome this kind of problems. But that's a good point that you raise. Yes?
AUDIENCE: Most Asian countries have experienced the financial crisis in '97. So how did they act or respond to this financial crisis differently? I mean--
IWAN AZIS: You mean the Asian countries or--
AUDIENCE: Yeah. Asian countries.
IWAN AZIS: Oh. Well, which country, because you cannot say Asian country. Each country responded differently. For example, Thailand responded different from Malaysia. Thailand called 911. 911 means call the IMF-- called the 911. Malaysia refused to do that. So they said, no IMF. So we'll do ourselves and so forth. So you have to be specific which Asian countries you're talking about.
AUDIENCE: [INAUDIBLE] China.
IWAN AZIS: Oh, China was not in crisis in 1997.
AUDIENCE: [INAUDIBLE] it was not a major crisis, like it was not [INAUDIBLE] but they were also affected a bit [INAUDIBLE] scale--
IWAN AZIS: But his question is about 1997 Asian financial crisis, and China was not in crisis in 1997, right? Your question is about Asian financial crisis. OK.
IWAN AZIS: All right. So OK. What the Indonesian government did at that time, basically, follow what the IMF said, because Indonesia also called 911. And the IMF said, you have to do this, this, this, this. And as I said earlier, it turns out that the results was worse, OK? OK. I can mention three big things. One is raise the interest rate as high as possible, OK? And they did.
As a result, the economy collapse. The second, make your budget surplus at least balance. Don't make it deficit. As a result, no infrastructure, no roads, no school, no health center built. Collapsed, right? And the third, no bail out. You have to close the banks and so forth. Now, look at all these three-- completely the opposite of what this country is doing now. Interest rates as low as possible. Budget-- make as big as deficit. Now the deficit is $1 trillion. So 1 over 14. So it's about 8%, 9% of GDP, right?
Don't bail out. What are these countries doing? Bailing out all the institutions, right? So very different.
AUDIENCE: [? I've ?] [? got ?] [? the same ?] question. What's the downside if the United States simply decides to print enough money to simply make everything liquid enough?
IWAN AZIS: That's an excellent question.
AUDIENCE: How much would we have to pay later?
IWAN AZIS: OK, first of all, before I say what's the implications, let me mention what I believe-- they are doing it now. But they don't announce it, OK? Let me tell you why I believe this, OK? Remember that state deficit was just unbelievable. The federal government deficit is unbelievable-- $1 trillion. So let's look at what is the potential financing of those deficits, OK?
What they did is-- of course, they are still lucky that many other countries still buying the US treasury-- China is being the examples, OK? So that's one source. But lately, China started to diversify, because they started to also questions the safety of putting money in the US, right? So they diversify to euro, to yen, and other currency. All right. So it's not enough, just that.
So what other possibilities? Well OK. You try to make your fiscal plan more better allocation, OK? So more optimal allocation and so forth. But at the end of the day what they do is [? the ?] [? volume-- ?] this is what-- Ben Bernanke gave a talk in LSE-- London School of Economics-- a month or two months ago. He said that the administrations can issue bonds. Who are the buyers of the bonds? Because once the government issue bonds, they get the money, right? So they can finance the deficit.
But who are the buyers of the bonds? We, the Federal Reserve. What does it mean? Printing money. Of course, he didn't use the word we print money, of course. But the moment Federal Reserve buying the government bonds, that's printing money. Now what is the implications? Well, economics 101 tells you that inflation will go up, but I do not worry with inflation. If anything, now I think the US has to worry about deflation. And that is even more serious than inflation.
Why? Well, the proof is in the pudding. Look what happened with Japan. Japan fell into deflation in the mid 1990s. And they have been in recession even until today-- more than a decade. The recession lasted so long. So it's better if you suffer from inflation rather than the deflation. That's my [INAUDIBLE]. Yes?
AUDIENCE: I have a question on nationalization.
IWAN AZIS: National what?
AUDIENCE: Nationalization of those banks.
IWAN AZIS: Oh, OK. The N word.
AUDIENCE: I'm sorry.
IWAN AZIS: The N word.
AUDIENCE: Right. So why are they afraid of that? And also, they are afraid of, say, AIG and Fannie Mae, and Freddie Mac. I think those are actually [INAUDIBLE].
IWAN AZIS: Yeah. Well, why? I think Bill can answer better why the US doesn't want to be labeled as an economy with nationalization. I think it's more ideological, political, and so forth. That's all I can say. But the fact of the matter is in this country the word nationalization is something that you're supposed not to mention that, OK? Now you said with the bailing out of AIG, [INAUDIBLE], and so forth. Yeah, basically, it is part of the nationalization.
But if you do not have ownership, OK-- ownership of that institution-- then you can still say, no, we are not nationalizing those banks.
IWAN AZIS: That's a unique institution, actually. It's not government, it's not private, right? I believe that they are going to do something more drastic about Fannie, I think. So they're going to make it clear cut whether this or that. It cannot be this and that, because so far it's this and that, right? But that's different issue. But if you're talking about AIG and so forth, as long as there is no ownership of the government, you cannot call it nationalization.
AUDIENCE: What about [INAUDIBLE] trust funds.
IWAN AZIS: That's another idea, actually. Why don't they do that? Because that's exactly what the RTC do, right? Now of course, there is a difference between what happened in the S&L crisis and the current crisis, because in the S&L crisis things are relatively easy. Why? Because the RTC was dealing only with the failed companies.
IWAN AZIS: RTC is the Resolution Trust Company. This is the RT-- this is the institution set up by the government when they had the S&L crisis-- Saving and Loan crisis in the '80s, is it? In the '80s. Yeah. Late '80s, OK? So what they did is basically there's a group of banks collapsed. So they took all these banks into this company, which is called the RTC.
And what the RTC did is trying to clear up, trying to restructure those banks. Once it is healthy, sell it again to the private sector. That's why I like that idea. Of course, it's easy for me to say, why don't they do that, because it's different now. Because at that time, you know who failed and you know how much the money involved. Now let me ask you why the federal government bailed out Bear and Stearns, but they didn't bail out Lehman? That's a good question, right?
So now it's-- this guy has not collapsed, has not been in a collapse situation. But the government have to make the decision. The analysts have to make decisions to bail them out before they collapse or not. Whereas in the case of S&L, they are collapsed already. They were collapsed already. And that's why immediately they were taken over. So it's more complex now than then.
But the idea-- I am in favor of that. So if the government spend your money-- the taxpayers' money-- to bail these guys out, the government has to have some ownership. The government has to have control on those institutions, right? Just makes sense to me. Yes?
AUDIENCE: I'm just curious if you have any thoughts on the issue of consolidation in financial institutions. I think we've gone through a period where there's been quite a bit of consolidation and the emergence of outfits that are now, I think, considered somewhat--
IWAN AZIS: You mean [INAUDIBLE].
AUDIENCE: Yeah. [? Non-viable ?] and Citibank now divesting. But bank of America up until last month-- I mean, I think it's only been a month since they completed their acquisition of Merrill, still [INAUDIBLE] buying now, perhaps not doing that any longer. And we've seen a decline of more community based banking institutions, which actually I think up until recently were-- played a stronger role. And when we had the savings and loans, many of them-- at least in the earlier years-- were at least regionally based. Then they became more nationalized.
Just curious what you're thinking is as to whether there's-- I mean, in some fields there's this theory that as things get larger, the risk magnifies. And do we have a situation like that we ought to look at from a policy point of view as we go forward?
IWAN AZIS: OK. In theory consolidation is a good resolutions to problems like this, OK? In theory. But of course, we have to look case by case, OK? So if-- once we started to look case by case, things get very difficult. And I have to admit, I don't know. But I'm not feeling bad, because even this government doesn't know also. The example is-- look at-- in the case of Citibank that you mentioned, they're splitting out, right? That means they're becoming smaller, whereas bank of America, they buy Merrill Lynch, they become bigger.
And yet, both were bailed out. So what is the principle being used? I don't think they know, OK? Two different principles, but yet they bail them out and so forth.
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City and regional planning professor Iwan J. Azis has addressed and published on topics of financial economics, economic modeling, and the linkages between macro-financial policy and social issues. Azis is the director of Cornell University's graduate program in regional science. His lecture on Jan. 23, 2009 was co-sponsored by the Department of City and Regional Planning and the Mario Einaudi Center for International Studies.