Dollars and Sense

Joseph Tracy, executive vice president and senior advisor to the president of the Federal Reserve Bank of New York, stands at the front of a classroom in early December, fielding questions from a room packed with students. He’s just given a presentation on Fannie Mae and Freddie Mac, the two mortgage-buying agencies that incurred significant losses in the 2008 financial crisis. To keep them from going bankrupt, the federal government took them under its wing. A student asks Tracy whether Fannie and Freddie learned their lesson about buying risky loans. 

He pauses for a moment. A faint smile appears as he begins to describe how his dog loved chasing the family van down the driveway—until he got too close one day, and the van clipped him. The dog had to wear a cone around his neck, and seemed to lose interest in his dangerous hobby. But it didn’t last. “Three months later, he’s chasing the van down the driveway again,” Tracy recalls. The students laugh. But the anecdote has touched upon a disturbing reality. 

Tracy is the last of four experts who have visited Chicago Harris in recent months as part of the inaugural speaker series from the Center for Economic Policy (CEP), founded this academic year at Harris. While the speakers have come from various backgrounds—the Federal Reserve, a business school, an economics department—their presentations all revolve around a key question, one that speaks to the need for an institution like the CEP: in scenarios like the 2008 crash, how can policies and institutions make the consequences of financial risk-taking less disastrous? 

To answer that question, future policymakers must be equipped to delve into the notoriously impenetrable world of finance, explains CEP Executive Director Thomas Coleman. “There’s a real value here for master’s students,” says Coleman. "Whether they’re going to work at the World Bank or IMF, or in state or federal government, they need an understanding of how financial institutions and public policy interact.” The core goal of the CEP is to introduce students to the regulatory and legal frameworks in which financial institutions operate, through guest speakers as well as coursework. In its first year, the CEP has introduced a new curriculum through which students can obtain a certificate in economic policy. 

The certificate curriculum consists of three required courses, which together provide a strong foundation in finance, investments and real estate markets. The courses have already proven integral for students like Cristina Martinez Cuellar, who will join Citibank after receiving her MPP/MBA in the spring, and hopes to work for the central bank in her home country of Colombia. "I'm very passionate about financial inclusion,” Martinez Cuellar says. She credits the CEP for allowing her to delve deeper into the areas where finance and social issues intersect. 

In the spring, Coleman will teach the first CEP elective, "Risk Management and the History of Financial Crises.” The course will look back at how financial institutions have handled and mishandled risk to precipitate economic crashes over the last century, something he hopes will broaden students' perspectives beyond the most recent recession. "We think of the crisis of 2008 as unusual, but it’s not unique at all,” says Coleman. "But because these kinds of events happen very rarely nowadays—every 20 or 30 years—it’s easy to forget about. We need to know that history." 

Why these damaging crashes continue to occur even as the regulatory environment evolves has been a topic of debate in the finance community. One of the most prominent voices to arise on the subject is that of Anat Admati, the George G.C. Parker Professor of Finance and Economics at Stanford University's Graduate School of Business, and author of the book The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It, who also participated in the CEP's inaugural speaker series. 

In her lecture, Admati addressed another Harris classroom filled to capacity, describing a disconnect between those who take risks and those who pay the price when those risks become costly. As she explained in a breathless, rapid-fire presentation, regulations allow banks to fund their investment with dangerously little equity, and to rely largely on debt funding from depositors and other creditors. 

That makes for high profit margins, but it also means the banks quickly run out of cash in a downturn. The resulting contraction of credit ripples through the economy as the government scrambles to bail the banks out. “There are people on the balance sheet who must lose,” Admati told students, “and the most natural candidates are the ones who also get the upsides.” 

Admati chocks the status quo up to “a toxic mix of confusion and politics”—the complexity of the financial sector prevents strong oversight, while the finance lobby maintains the clout necessary to prevent meaningful change. "It’s easy to remain blind,” she says. 

In a way, the same can be said for bankers themselves. Jessica Tong worked at the Federal Reserve Bank of Chicago before enrolling at Harris. "At the Fed, working behind a desk and carrying out operational tasks, you sometimes can lose sight of the purpose and global impact those actions have on the economy,” she says. "The events the Center offered helped me to reignite my passion, and to not lose focus on my own career and policy footprint." 

Through the CEP, Coleman seeks to open the eyes of future policy leaders and scholars to the realities of modern finance, from the regulatory and political issues that Admati and Tracy described, to big questions now being explored by the world’s top macroeconomists. To that end, the CEP is partnering with the University of Chicago's Becker Friedman Institute to host "Next Steps for the Fiscal Theory of the Price Level” in April, a unique meeting where economists will come together to discuss unresolved questions about how monetary policies like interest rates interact with fiscal policies like taxation. Monetary and fiscal policy have long been segregated, explains Coleman. “But macroeconomists are coming to the conclusion that they’re not really separate,” he says. The CEP is also hosting a “Development and Central Bank Week” in late January, which will feature networking and informational events with guests from influential financial institutions like the World Bank, the Federal Reserve and the International Monetary Fund. 

While they serve different purposes and address distinct audiences, Coleman sees the conference, the events, the curriculum and the guest lectures working together to paint a more nuanced and complex picture of the fiscal world. “The University of Chicago has a tradition of bringing together the theoretical and the empirical,” he says. "I think Harris, from a policy perspective, has a real opportunity to bring them together here." 

—Jake J. Smith