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The Sciences

Avarice and cluelessness

Cosmic VarianceBy Daniel HolzMarch 28, 2009 2:11 AM

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You may have noticed that there's some economic turmoil at the moment. The US is officially in a recession. And the rest of the world seems intent on following suit. At its heart, much of the problem appears to be related to the penchant of Americans for borrowing money so as to be able to buy things. In particular, getting mortgages to buy homes (the American dream). It became possible to get hundreds of thousands of dollars from a bank with no credit check, no proof of income or employment, and no money down. People ended up with mortgages they could barely afford, with the hope of refinancing or selling at a much higher price a few years down the road. The banks figured that in the worst case, they'd just repossess defaulted homes and sell them for more than the value of the mortgages. All this worked fine so long as property values continued to go up, and the banks continued to lend. But eventually it all had to come toppling down. And topple it did. There's plenty of blame to go around. Irresponsible consumers borrowed way beyond their means, and ended up in houses (or owning cars and huge flat-screen TVs) they couldn't afford.

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And irresponsible brokers and banks pushed mortgage products they knew were high risk, just to pocket quick commissions, knowing they would be able to sell the lousy mortgage contracts to larger financial institutions. And irresponsible financial institutions bought up mortgages from banks, figuring they could repackage them and sell them to investors around the world for a quick buck. And irresponsible traders created complicated financial products based on these toxic mortgages, somehow claiming to erase the underlying risk. And irresponsible ratings agencies (Moody's, Morningstar, S&P, Fitch) evaluated these complicated products, and officially declared them high-grade, when in fact they were essentially worthless. And an irresponsible government systematically deregulated and weakened oversight, allowing Wall Street to drive itself right off a cliff, taking Main Street with it. A lot of people made a lot of money along the way. It's hard to know if all of this happened because of rampant greed or astounding stupidity. Probably a healthy dose of both. Michael Lewis, of Liar's Poker fame, has written a nice piece that sums up some of these recent financial events. I also highly recommend listening to an hour-long program from This American Life, in conjunction with the news bureau of NPR, exploring some of the underpinnings of the current crisis (produced last May). The program will "explain it all to you"; and exemplifies the best of public radio. If you are too impatient to listen for an hour, you can also skim the transcript. We learn how a bartender with no training becomes a successful mortgage broker overnight. It's hard to know if this is tragedy or farce. There's a temptation within the ivory tower of academia to assume that this will have only a slight impact. After all, few of us are fortunate enough to have millions of dollars to lose in the market. And academics have a history of being quite conservative financially (with modest debt and modest spending habits), presumably forged in the poverty of graduate school. However, we all have retirement plans, and even though these are usually conservatively managed (e.g., TIAA-CREF funds, instead of invested in highly leveraged hedge funds), they have lost tremendous value over the past months (since there has been essentially no safe place to park one's money). Academics are impacted in more direct ways as well. After years of often spectacular gains, the endowments of many major research universities have suffered tremendous losses (such as in the case of Harvard and Chicago). Since these endowments can be responsible for a fair fraction of the operating budgets, this means that many universities have suddenly lost income. They are often restricted from dipping into their principal, so their only recourse is to reduce spending. State universities are also in terrible shape, since many state budgets have collapsed, and major funding cuts are inevitable (such as in the case of the University of California and Arizona State). Thus Universities are cutting costs across the board, including freezes on hiring and infrastructure development. The US federal government is arguably in the worst shape of all. We are already running large deficits, and now Congress is busy bailing out the financial industry, including Citigroup (one of the world's largest banks) and AIG (one of the world's largest insurance firms), and General Motors (the world's largest auto maker until last year, when it was passed by Toyota). Although the entire scientific enterprise in the US represents only a tiny fraction (~1%) of the current bailout, taxpayers (and their Congress) are probably not feeling particularly generous at the moment. This may have a severe long-term negative impact on the National Labs, as well as research funding across the board. My guess is that the profound nature of the current economic crisis has yet to make itself known. After all, it took a few years for the great depression to really kick in. It is sobering to think that, decades from now, this age may not be remembered for the tremendous hope and inspiration accompanying the election of the first African-American president. Instead, the defining event of our time could well be economic malaise. And this is something everyone, from Wall Street tycoons to scientists to Joe the plumber to farmers in rural China, will suffer for.

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