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Vol. LXIII, No. 2
Wednesday, January 14, 2009
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Nobel Prize Winner Maskin Talks to Chamber About Financial Crisis

Dilshanie Perera

At the monthly membership luncheon hosted last Thursday by the Princeton Regional Chamber of Commerce, Eric Maskin, a professor at the Institute for Advanced Study and 2007 Nobel Prizewinner in economics, explained why financial crises occur. Newly-appointed Chamber President and CEO Peter Crowley also addressed the gathering.

Characterizing the current economic downturn as only one in a long series of crises, Mr. Maskin said that “each one is sufficiently different from its predecessors,” calling the mortgage loan market the “imminent cause” of today’s fiscal meltdown.

“Credit is the lifeblood of the rest of the economy,” Mr. Maskin remarked, cautioning that if credit markets slow down or stop, “then enterprises in all markets will have trouble.” Additionally, he said that credit markets are not necessarily self-correcting, meaning that when banks start to fail, “we can end up in a situation where no banks are doing significant lending, and we get stuck in a credit crunch.”

An outside force, usually government, is necessary to lead the way out of such a credit freeze, said Mr. Maskin, who used a comparison between the potato market and that of credit to explain the subprime mortgage crisis, and how it grew from something relatively confined to a phenomenon affecting the entire economy.

Introducing the concept of an externality, or “the effect that your actions have on others that you might not take into account,” Mr. Maskin sketched out the beginning of the economic plunge, observing that as creditors started to default on loans when housing prices began to fall, banks could no longer refinance the loans. These banks also had other borrowers, who had to scale back or stop their activities, and thus had a harder time repaying other loans from other banks, which is a trend that put pressure on the entire financial system.

As for the primary justification for a bailout, Mr. Maskin said that “when some banks go under, a government infusion is an important thing to keep them in business … for the sake of other banks.”

“Ironically, the solution to financial crisis actually makes crises more likely,” he claimed, stating that the difficulty with a bailout policy is that it is certainly not free, the cost is difficult to recover, and it perhaps also emboldens banks to be willing to accept greater risks in the future if the potential for a government bailout exists.

Thus, “the bailout policy needs to be coupled with regulation,” Mr. Maskin observed, though he sees a “magnification of the problem at every level of the economy” with employers losing credit lines and cutting costs by laying off workers, who are demanding less and thus affecting other employers, hence the rationale for a stimulus package.

During the question and answer portion of the lecture, Mr. Maskin acknowledged that he hadn’t discussed secondary markets or the reselling of subprime loans. In response to a question about where the funds for the bailout are coming from, Mr. Maskin admitted ruefully that “the money is going to come from our children” as well as “creditor nations like China.” But because various assets are “laying idle” right now, there is the possibility for increasing output in a way to actually stimulate the economy, he noted.

In his own remarks at the beginning of the event, Mr. Crowley introduced himself to over 150 Chamber members present, envisioning 2009 as the year of various collaborative opportunities. In reference to financial crises, he said, “we don’t know when the recovery will happen, but it will.”

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