Professor Jim Johannes, left, senior associate dean of the University of Wisconsin-Madison School of Business and director of the Puelicher Center for Banking Education, shared his insights on banking and the economy at the March 4 CEOnly Network meeting in Madison. Pictured with him are Kathy Kienitz from the Graduate School of Banking at UW-Madison and Terry Burrington of Financial Marketing Corporation.

Navigating Uncharted Waters

History can provide clues to getting out
of economic crisis, banking professor says

The Federal Reserve, Congress, the banking system and the American people all share the responsibility for the nation’s current economic crisis – as well as the burden of getting us out of it, said Jim Johannes at a CEOnly Network meeting in Madison on March 4.

“I am usually an optimist when it comes to the economy, but not anymore,” said Johannes, senior associate dean of the University of Madison School of Business and the director of the Puelicher Center for Business Education. He also teaches finance, investment and banking to undergraduates as the university’s U.S. Bank professor of banking.

“There are a lot of people looking for paddles, trying to figure out what we’re going to do,” he quipped, showing a slide of an aptly named creek.

In his one-hour talk that combined historical perspective and present-day analysis, Johannes pointed out several indicators of an increasingly dismal economy: a national unemployment rate of 8 percent; excess manufacturing inventory; diminished corporate profits; and declining consumer spending.

Equally troubling is the fact that the nation’s mortgage problems are far from over, he said. “Right now, the Fed is putting a lot of liquidity into the system. At some point, unless something dramatic happens, that’s going to lead to higher inflation. And then interest rates have to go up,” Johannes said. “My fear is that today’s adjustable-rate mortgages will reprice at a higher rate just at the time the economy is about to recover and that people won’t be able to make those payments.”

Other nations that have had significant housing and real estate issues experienced a significant drop in gross domestic product as a result, Johannes said. In Argentina, the GDP declined 55 percent; in Spain, 17 percent; and in Japan, 10 percent. “The cost of working out bad housing investments is severe, and we haven’t even seen the tip of the iceberg,” he said.

But it’s important to remember that financial crises are nothing new, the banking professor said.

Just as the United States did a century ago during the financial panic of 1907, the government should focus on saving the banks first, he emphasized. In an effort led by banker J.P. Morgan during that time, the nation’s largest and strongest banks formed a consortium with the U.S. Treasury Department to rescue the smaller banks and keep the financial system going. That effort led to the creation of the Federal Reserve in 1913.

“We’ve learned that trust is very fragile,” Johannes said. “What we’re going to do to save the economy is to try to restore trust in the banking system” through efforts such as the Troubled Assets Relief Program and the government’s plan to buy back toxic assets.

“I don’t really think we should be bailing out homeowners,” he continued. “It creates huge moral hazard problems. We need to realign people’s expectations – if I can’t afford a house, I need to trade down to one that I can.”

Citing the “Greenspan put” – which refers to the former Federal Reserve chairman’s monetary policy of injecting too much liquidity into the economy – as a factor that helped create the current financial crisis, Johannes said the Fed has attempted to redeem itself since then.

“I’m usually not a big Fed defender, but I think the Fed is doing all it can right now. First, they’re keeping the financial markets afloat. Second, they’re keeping us from a major bout of deflation. That would be a knockout punch – this economy would collapse,” he said.

President Obama’s stimulus package, however, is an example of “Viagranomics,” Johannes said. “It’s temporary – you’re not going to get a permanent boost of this program,” he said.

Every American is going to get a one-time benefit of around $2,500 – not enough to make a significant difference in the economy over time, Johannes pointed out. Despite claims that the stimulus package will restore infrastructure, only about 14 percent of the program will be spent for that purpose. “How far do you think $150 million of infrastructure spending in Wisconsin is going to go?” he asked.

Another assertion was that the stimulus plan will create 70,000 new jobs in Wisconsin. In analyzing the numbers for all 50 states, Johannes said he found that the Congressional Budget Office simply multiplied the current labor force in each state by the same 2 percent to come up with the projected increase in jobs in each state. It would seem improbable that non-identical states would have identical outcomes. That observation convinced Johannes that the implications of the stimulus plan werenot been carefully thought through but rather were hurried through the approval stages.

“This is what I call the ‘Dope-ler Effect.’ It’s the tendency for stupid ideas to get smarter the faster they come at you!” Johannes said.

Ending on a more positive note, the nation will restore its strength in several key areas over the long term, he said. We’ll have plenty of liquidity in the economy; a solid technology base and strong educational system. Debt will be restructured more realistically, and both businesses and individuals will be more disciplined. “These are the ingredients for a steady recovery,” Johannes said.

Please join us for the next CEOnly Network meeting, June 23-24 at the Jefferson Street Inn in Wausau, with featured speaker Andy Sigl of Wipfli LLP.