In the market for answers

As the financial crisis starts to affect Queen’s, economists can only speculate about where we go from here

Economics department undergraduate chair Lorne Carmichael says some students have expressed interest in learning more about the current financial crisis.
Economics department undergraduate chair Lorne Carmichael says some students have expressed interest in learning more about the current financial crisis.
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To some, the worldwide financial crisis is a baffling assortment of diving graphs and daunting headlines. Others, though, see an intellectual upside to the downturn.

“For an economist, this is really like a geologist chasing an earthquake,” said Queen’s economics professor Lorne Carmichael. “We’re watching this with a great deal of interest—but I wouldn’t say glee.”

On Monday, a panel of four professors from the economics department—Carmichael, Thor Koeppl, James MacKinnon and Frank Milne—faced a full house in Dunning Auditorium to talk about the events that led up to the economic crisis and the question on the minds of many in the crowd: what now?

Carmichael, who’s also the undergraduate chair of economics, said a number of students have expressed interest in learning more about the financial crisis.

“The problem is that with the curriculum the way it is, if you’re teaching a course in, you know, microeconomics, it’s hard to fit something like this in,” he said. “We just thought it was a good idea to provide an exposition.”

He said the financial crisis is difficult to understand for a number of reasons.

“Maybe it’s because we have to readjust our expectations about how the people involved are behaving. We tend to think that bankers and Wall Street people are more or less on top of things and aren’t behaving like a bunch of drunken cowboys,” he said. “Yet the more we hear about it, the more we sort of understand … there was a lot of outright gambling and risk-taking going on, and that surprises us.”

There are people who think the recession—a period of reduced economic activity—will be quite short, Carmichael said, but most of that analysis is based on gut feeling.

“There isn’t a lot known about what was going on with these companies,” he said. “We just really don’t know yet in some sense how serious the problem is.”

Milne, Bank of Montreal Professor of Economics and Finance, used another analogy to describe how economists view the crisis.

“People must realize that an economist, they’re like an economic doctor,” he said.

“What we’re interested in is to really try and see if we can make the system work better.”

Milne—who spends two days in Ottawa each week as a special advisor to the Bank of Canada—said most people didn’t see the crash coming.

“It’s the old story—if you haven’t seen it, it can’t happen.”

He said the crisis is comparable to the financial situation in Japan in the early 1990s—but that’s only one of many examples.

Milne, who teaches one of the only risk management courses at the graduate level in Canada, said there was already a lot of regulation in the financial system, but improvements in regulatory training need to be made. The issue of training in banks is a large concern, he said.

“I think the training has been too narrow in some areas … and I think we really have to think hard about that,” he said. “Looking ahead to the future regulatory changes, what we’re going to do—we’re going to have to be very careful.”

Milne said there have been indications of financial trouble for a long time. In the summer of 2007, when he was one of a minority predicting a financial crisis, the CD Howe Institute in Toronto asked Milne to write a paper on the issue.

Milne said a number of countries blame the situation on the United States.

“This is a nice, self-serving statement,” he said, adding that it’s clear the rest of the world isn’t in agreement. “It’s easy to point to the U.S.”

He said the damage won’t last uniformly worldwide, but there really isn’t any way to tell where it will end first or when that will be. It might last two or three years, or it might become a very severe recession, he said, which could last longer.

Banks and financial institutions need to co-operate with each other so they can test for systemic issues, Milne said. He said a lot of the problems began as a result of “corruption, incompetence and things we didn’t see because they were complicated and subtle.”

MacKinnon, head of Queen’s Economic Department and the Sir Edward Peacock Professor of Econometrics, said there are ways to forecast where the economy’s going, but he’s skeptical of predictions.

“In a case like this where the economy is changing radically over a very short period of time, markets are unbelievably volatile,” he said. “For the short term, it’s very simple: everything gets worse.”

MacKinnon said the financial crisis has affected Queen’s pension plan, its donors, government funding and the University’s endowment.

The hit Queen’s endowment fund has taken will affect almost every part of the University, he said.

On March 30, the market value of Queen’s Pooled Endowment Fund was $632 million. By June 30, the fund was worth $613 million and at the end of September, it had fallen to $551 million, according to Gordon Lee of Queen’s Investment Services.

Yesterday in an e-mail to the Journal, Lee said the market value of the fund was $507 million on October 31.

MacKinnon said it’s not hard to account for the drop in endowment.

“The stock market is off more than 40 per cent. So you’ve got a big drop in the stock component, and then there’s also the losses in bonds. … Put the two together, you’re talking about a very big drop overall,” he said.

For instance, the S&P 500 index, a value-weighted index of the prices of 500 large cap common stocks actively traded in the U.S., is lower than the level it was at during the last recession in the fall of 2002, he said.

“All of the gains of the previous six years [were] erased in two and a half months.”

Yesterday, the S&P index slid a further 6.71 per cent.

MacKinnon said the pension plan has also taken an enormous hit.

“That is going to affect pensioners in the long run; it’s going to affect people retiring; it’s going to affect the University, because when there’s a deficit in the pension plan you have to provide additional funds,” he said.

In terms of donations, MacKinnon said the ability and willingness to give to the University is not as steady as it once was. He added that there’s a problem with the way Canadians approach charitable donations in general.

“That’s one of the reasons why the best American universities are so much better than anything in Canada, because they’re so much better-funded than anything in Canada. And a great deal of that comes from donations from alumni.”

The state of the Ontario government’s finances will affect its ability to provide financial support to universities, MacKinnon said, adding that the provincial government is already under-funding universities.

Matters got worse this week for Queen’s when, on Wednesday, Principal Tom Williams announced a 15 per cent budget cut, which will span the next three years and touch every faculty and administrative department on campus.

MacKinnon said he hasn’t received official numbers about cuts to the economics department, but regardless, he has no idea where to start cutting back.

“It’s basically impossible,” he said. “I have no idea how they expect to achieve that, given that so much of the money they spend goes to faculty salaries and you can’t just fire faculty members.”

Graduating students heading for the job market are also likely to be in for some trouble, MacKinnon said.

“I don’t think the job market has seen anything like the worst of it yet,” he said, adding that the automobile industry and the housing and construction industries are those being hit most severely.

Scott Carson, director of the MBA program at the School of Business, said the school will be looking for ways to support the University if the market continues to go down.

“We have the advantage of having programs—non-degree executive programs—that can generate revenue,” he said.

Carson said most of the MBA applicants he talks to are concerned about the economy.

“Business school applications tend to go up when the markets go down because people feel like the job prospects aren’t as good,” he said.

Carson said professors teaching courses on the marketplace, the role of government in business, regulation and the financial industry have been altering lesson plans as a result of the unstable economy. But he said it’s important to distinguish between keeping the discussion current and maintaining the overall structure of the academic program.

“Long-range strategic thinking, acting with integrity, depth of judgment—none of those principles are going to change as the result of a down market,” he said.

For instance, he said the sub-prime mortgage crisis hasn’t changed curricula.

“What do we need to learn that’s new about not lending money to people who you know can’t pay you back? Do we need to conduct a new research study? No. The things that are changing in management education are the day-to-day discussions, the context that things are being talked about.

“From a pure academic perspective, there’s never been a more exciting time to be in a business school because so much is happening in the marketplace that we teach about.”

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