Forum on Liquidity Shock and Financial Stability:

Interview of Professor Avanidhar Subrahmanyam

Watch the interview of Professor Subra

Professor Avanidhar Subrahmanyam, the Goldyne and Irwin Hearsh Chair in Money and Banking at the University of California, Los Angeles, was interviewed by the Institute of Global Finance’s Director, Professor Fariborz Moshirian. He is also one of the Senior Fellows of the Institute, and a member of the IGF’s International Advisory Board. He provided his insights regarding the causes of the Global Financial Crisis (“GFC”) and resulting contagion to other economies, as well as whether we have the right policies in place to prevent another crisis. Professor Subrahmanyam also shared his perspective on US monetary policy, and about liquidity.

Professor Subrahmanyam considered some major causes of the GFC were overconfidence and greed. It’s clear now that the real estate boom in the US was driven by irrational expectations that returns on real estate would be perpetually positive. It was also driven by people trying to get rich quick through real estate because traditional ways of getting rich were not working as a result of the US manufacturing sector drying up. A precipitating factor to all this was the easy credit granted to households, as well as the high ratings given to mortgage-backed securities based on the belief that real estate would perpetually go up.

One major way in which the financial crisis then spread to other economies was through a decrease in consumption in the US leading to the decline of manufacturing sectors in other economies. As a result, this has led to a jobs crisis in other countries. Moreover, manufacturing has shifted to Pacific Rim countries as a result of the lower cost of labour there, and so whole generations of youths are unable to find work because there simply is none.

Professor Subrahmanyam highlighted that one key policy to minimise the chance of another crisis was for policymakers in other countries to move towards more independent decision-making and rely less on US beliefs on financial markets. He highlighted the biggest mistake was to trust a few influential gurus in the US.

In terms of monetary policy, Professor Subrahmanyam prefaced his discussion by saying his views are radical. He argued that the quantitative easing program in the US will not yield the outcome desired in the long-run because it is not addressing the problem. The assumption behind quantitative easing is that there is a starvation of capital amongst US businesses, and by lowering interest rates, it will stimulate borrowing by businesses and hence stimulate growth. But the problem in the US is not starvation of capital. It’s people not having enough money to spend, so the quantitative easing policy is not addressing the problem. The policy does not benefit the middle class.  Instead, the problem is a fiscal one – how to stimulate spending by the middle class.

Finally, Professor Subrahmanyam highlighted that the right way to create liquidity is to ensure there are policies in place so banks do not take undue risks. The lesson from the GFC is that more effective internal and external controls must be implemented. Unless there are these controls, we’ll have more liquidity crunches in the future.