Assistant Professor of Finance, MIT Sloan School of Management, Emil Verner
From The Hill
After a severe financial crisis, it’s common to see a surge in political polarization and in the popularity of populist parties, especially on the far right.
We’ve seen this decade after decade, and it’s clearly the case now around the world. Just look at the Law and Justice Party in Poland, Podemos in Spain and Jobbik in Hungary. The U.S. has certainly seen its share of political polarization, too.
This shift matters, as the emergence of far-right parties increases policy uncertainty and can threaten economic growth and democratic institutions. Those parties often bundle together radical economic platforms with xenophobic policies and racist rhetoric.
As a result, it’s important to understand whether (and how much) financial crises lead to increased support for extremist parties and why there is a connection.
In a recent study, my colleague and I analyzed these questions in the context of Hungary after the 2008 financial crisis. That country experienced a particularly severe household debt crisis starting in 2008 and a sharp increase in support for the far right.
Ever since I was a graduate student in economics, I’ve been struggling with the uncomfortable observation that economic theories often don’t seem to work in practice. That goes for that most influential economic theory, the Efficient Markets Hypothesis, which holds that investors are rational decision makers and market prices fully reflect all available information, that is, the “wisdom of crowds.”
Certainly, the principles of Efficient Markets are an excellent approximation to reality during normal business environments. It is one of the most useful, powerful, and beautiful pieces of economic reasoning that economists have ever proposed. It has saved generations of portfolio managers from bad investment decisions, democratizing finance along the way through passive investment vehicles like index funds.
Then came the Financial Crisis of 2008; the “wisdom of crowds” was replaced by the “madness of mobs.” Investors reacted emotionally and instinctively in response to extreme business environments — good or bad — leading either to irrational exuberance or panic selling.
“Are new regulations creating new problems for the housing market?”
“Has the federal government now become the subprime market?”
“Could the financial crisis happen again any time soon?”
These were just a few of the questions tackled by Deborah Lucas, the Distinguished Professor of Finance at MIT’s Sloan School of Management and the Director of the MIT Golub Center for Finance and Policy, during the #MITSloanExperts Twitter chat on October 30.
Joined by host Amy Resnick, editor of Pensions & Investments, she asked Lucas questions about the future of financial regulation and housing market finance reform, as well as ideas for fostering stronger ties between the regulatory and the academic communities.
Did you miss the chat? That’s OK, but we’ve encapsulated everything in the Storify below.
Deborah Lucas, the Distinguished Professor of Finance at MIT’s Sloan School of Management, and the Director of the MIT Golub Center for Finance and Policy, will discuss the 10-year anniversary of the financial crisis during an #MITSloanExperts Twitter chat on October 30 at 12 p.m. EDT.
As the 10-year anniversary of the great financial crisis approaches, Lucas will focus on answering what have we learned and whether we have made enough progress to prevent a repeat of something similar. Lucas’ recent research has focused on measuring and accounting for the costs and risks of government financial obligations. Her academic publications cover a wide range of topics including the effect of idiosyncratic risk on asset prices and portfolio choice, dynamic models of corporate finance, financial institutions, monetary economics, and valuation of government guarantees. An expert on federal credit programs, she has testified before Congress on budgeting for Fannie Mae and Freddie Mac, student loans, and on strategically important financial institutions.
The host of the chat will be Amy Resnick, editor of Pensions & Investments. Resnick will ask Lucas questions about the future of financial regulation and housing market finance reform, as well as ideas for fostering stronger ties between the regulatory and the academic communities.
To join the chat, be on Twitter on October 30 at 12 p.m. ET and follow the hashtag #MITSloanExperts. Questions can be submitted in advance or in real-time, using #MITSloanExperts.
Wall Street’s gambles and risky borrowing directly led to the financial crisis, causing the collapse and near-collapse of megabanks and greatly harming millions of Americans. But thanks to government bailouts, those megabanks recovered quickly and top executives lost little.
In response, Congress passed the Dodd-Frank regulatory law to ensure thatno failing bank ever receive such special treatment again. But legislation that favors very large banks
Professor Bruce Grohsgal
and undermines those reforms is in the works again. The bill is called the Financial Institution Bankruptcy Act, or FIBA. The measure already has been passed by the House, and the Senate may take it up soon.
In theory, the bill attempts to solve a major issue in the Bankruptcy Code that prevents failing megabanks from restructuring through traditional Chapter 11 bankruptcy protection. In effect, though, FIBA offers banks an escape route, creating a subchapter in the Bankruptcy Code through which the Wall Street players who enter into these risky transactions will get paid in full while ordinary investors are on the hook for billions of losses. Not only is that deeply unfair, but it will encourage Wall Street to gamble on the very same risky financial instruments that caused the recent crisis.
Under Chapter 11, a failing company can get a reorganization plan approved to keep its business operating while paying its creditors over time. It then can emerge from bankruptcy as a viable business. During Chapter 11 bankruptcy protection, creditors are prohibited from suing the debtor to collect on their debt, a key provision that ensures all creditors are treated fairly and enables the business to reorganize. This is known as an “automatic stay.”