Ask an Economist: Breaking Down the Financial Crisis

It has been a jarring September for Wall Street. It is just the middle of the month and some largest financial institutions have met an unflattering demise. Bernard Anderson, Professor at the Wharton School of Business in Philadelphia and a member of the Black Enterprise board of economists weighs in on the crisis, the economy, and which candidate is best prepared to rescue Wall Street.

BlackEnterprise.com: In March, securities institution Bear Stearns was purchased by J.P. Morgan Chase. Just last week the government took over loan giants Fannie Mae and Freddie Mac, and yesterday the federal government agreed to loan AIG $85 billion. Today Lehman Brothers was acquired by Barclays and on Monday Merrill Lynch was acquired by Bank of America. There’s a lot of flux in the financial services industry, what’s causing these financial institutions to flounder?

Bernard Anderson: There was a common problem with each of the financial institutions, and that was rooted in their heavy investment in financial instruments called collateralized debt obligations. A CDO is a debt instrument that companies invest in with the expectation that instrument will generate quarterly revenue. In this case they were mortgage backed securities. Now when you write off the value of those securities in order to balance in your portfolio, you have to raise more capital. Banks raise capital by selling shares, but in this case no one wants to buy the shares. The share price of the companies plummet, which means they face a capital shortage. They are running out of money to meet their financial obligations and that drives them near bankruptcy.

Fannie Mae and Freddie Mac were taken over by the government, how will this affect the way these companies will run now?

You will have government appointed officials running the companies. Those officials will technically be political appointees, but will have extensive experience in the private sector. They will be able to reorganize Fannie Mae and Freddie Mac and bring them back online as successful mortgage companies. Fannie Mae and Freddie Mac will be subject to far greater regulatory scrutiny. The federal government, probably through the Federal Reserve Board, will have new authority to regulate. Also, the treasury will have new authority to regulate and will be more attentive to regulating Fannie Mae and Freddie