Lewis Ranieri of Hyperion (left) and Milken Institute Chairman Michael Milken analyze the root causes of the credit crunch.
Myron Scholes, a Nobel laureate now with Platinum Grove Asset Management, began by discussing four areas for future financial innovation: 1) separating the risk-taking of financial institutions from their customers, both retail and institutional; 2) moving from the idea of tactical use of financial instruments to a system that evaluates risk and how it should be transferred to the marketplace; 3) modifying current accounting rules to reflect the complex structures of modern corporations; and 4) improving risk-evaluation efforts. As Scholes put it, "Each of our financial entities thinks that they are handling risk correctly, but does not know how others are dealing with risk and what is the aggregate risk in society."
"The root causes of this crisis are only peripherally related to innovation," maintained Lewis Ranieri of Hyperion Private Equity Funds, "and it is financial innovation that will help us get out of it."
Michael Milken introduced the topic of financial literacy and how it relates to our current financial crisis. He felt that the main issue has been the incorrect evaluation of risk and company valuations. Regarding the subprime mortgage crisis, he commented: "The money was lost the day the loan was made." Milken emphasized throughout the panel that the ultimate goal of financial innovation is to provide tools to address health care and social issues, and ultimately to relieve worldwide poverty.
Andrew Rosenfield of Guggenheim Partners asked the panel to address the current financial crisis and their relative outlook. While Ranieri was optimistic about the use of financial innovation to find our way forward, Scholes disagreed, expressing his concern that Federal Reserve measures are insufficient. He mentioned that the current financial turmoil can be mostly attributed to a combination of the de-leveraging of financial instruments and the credit crisis. He added that a change in the perception of risk in real estate investments is needed. "The public and the financial community will need to accept the move to a new state where housing prices will not always necessarily go up."
Milken followed with five key points on the current state of financial innovation and the economy:
1. Homeowners are ultimately concerned with their monthly mortgage payments more than their home's overall price. Therefore low interest rates will help the housing market.
2. Adjustments in the markets have already been made. To create protection against a crisis, American consumers have to become more liquid, not less.
3. The current depreciation of certain asset classes implies that financial institution have chance to buy assets at favorable prices.
4. There is excess liquidity in the world, especially in Asia.
5. The world is NOT leveraged, and history does not correlate rating and default very well, so it is expected more money will be lost on AAA securities.
Scholes insisted that "[there is] not a lot of liquidity because people are not selling their houses," and "institutions will not take much risk until they understand more about it." Milken added that in our current financial system, "70 to 80 percent of bank loans are not owned by the banks themselves." Ranieri reiterated that financial derivatives are a good thing because they allow risk to be spread around the world. However, they were abused in the current housing crisis. Consumers similarly got carried away: "We turned the house into an ATM."
Sandor of the Chicago Climate Exchange praised financial innovation, adding that "There are 1.3 billion people in China that want to imitate the financial systems in the United States."
Despite the current crisis, the panelists unanimously supported financial innovation as the key to global growth. Milken emphasized that we need to understand complex financial innovations and use them properly, as they will be the best tool for lifting populations out of poverty in the developing world.
Global Conference 2013
Former Prime Minister Tony Blair, philanthropist Bill Gates and Strive Masiyiwa of Econet Wireless discuss advancing prosperity in Africa.
