What now?

Alex Nabaum

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Don't punish Wall Street
William N. Goetzmann ’78, ’86MPPM, ’90PhD

The financial crisis began with subprime borrowers failing to pay their mortgages, and it will not be solved until we get to the root of this problem. President Obama needs to listen to the numerous economists who have offered plans to insure, buy, or renegotiate subprime mortgages, and decide on a strategy.

But the president needs to avoid the temptation to overregulate and, in the process, kill capitalism. For the past three decades, financial innovation has been America's competitive advantage. But markets and institutions are fickle, and they can shift overseas if care is not taken to maintain an environment in which they can thrive. Punishing Wall Street as the villain in the current crisis will weaken America in the long run.

In its financial history, the United States has witnessed periods of dramatic change in the institutions of capitalism; one of these was the creation of giant mortgage agencies in the late twentieth century and a complex architecture of securitization in the early twenty-first century. This revolution in securitization seemingly provided unprecedented American access to credit for home ownership and social mobility, while at the same time sharing risks widely through the global economy.

The failure of securitization was an institutional failure. Despite the best of intentions, our institutions, bank regulators, risk management tools, and compensation structures lagged the extraordinary innovations in the marketplace. My concern is that the valuable features of securitization -- the widespread, democratic access to capital and the market-based technology for risk sharing -- will be rejected. These are enduring innovations when placed in the right framework.

In addition, President Obama needs to find a way to preserve American credit. A sterling reputation as a borrower gives us a low national cost of capital. In our haste to spend our way out of the current crisis, let us make sure we remain fiscally sound.

William N. Goetzmann ’78, ’86MPPM, ’90PhD, the Edwin J. Beinecke Professor of Finance and Management Studies, directs SOM's International Center for Finance.