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James B. Stewart, Pulitzer Prize-winning journalist, said economic moral hazard must be a secondary concern as the U.S. government looks to shore up the financial system. He delivered the Kellogg Distinguished Lecture on Nov. 17.

James B. Stewart, Pulitzer Prize-winning journalist, said economic moral hazard must be a secondary concern as the U.S. government looks to shore up the financial system. He delivered the Kellogg Distinguished Lecture on Nov. 17.

Pulitzer Prize-winner addresses financial crisis during Kellogg Distinguished Lecture

James B. Stewart proposes strategies to curtail the recession, including ways to restore market confidence through innovative taxpayer investment.

By Rachel Farrell

11/18/2008 - When news of a subprime mortgage crisis first leaked in 2006, Wall Street Journal columnist James B. Stewart, like any good journalist, went out to investigate.

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Watch video of James Stewart's presentation. (Password protected for the Kellogg community)
After delivering the Kellogg Distinguished Lecture on Nov. 17, professor and journalist James B. Stewart continued the discussion about the U.S. economic crisis with Kellogg School students.
After delivering the Kellogg Distinguished Lecture on Nov. 17, professor and journalist James B. Stewart continued the discussion about the U.S. economic crisis with Kellogg School students.
Photo © Nathan Mandell
While researching the subject, Stewart met a low-income couple living in Boston who received approval from GE Capital for a $3,500-a-month mortgage, thanks to fabrications on their application by their mortgage broker. Not surprisingly, given their $35,000 annual income, this couple was unable to make any payments on their mortgage.

Stories like this are at the root of the nation’s financial crisis, Stewart told an audience of several hundred Kellogg School students, alumni and faculty in Owen L. Coon Auditorium at the Donald P. Jacobs Center on Nov. 17. A columnist for SmartMoney magazine and Wall Street Journal, Stewart is recipient of the Pulitzer Prize for his articles on the 1987 stock market crash. He is also professor of business and economic journalism at Columbia University and the author of Disney War: The Battle for the Magic Kingdom (Pocket Books, 2006), a New York Times bestseller and recipient of the Loeb Award for Best Business Book.

Drawing comparisons between the 1980s junk bond and real estate bubbles to recent years’ mortgage and credit bubbles, Stewart stated that “we are revisiting essentially the same patterns … Why is it that, when they are unfolding, we are falling back into the same patterns?” The problem with these speculative bubbles, he explained, is that they create consumer confidence and financial optimism that encourages behavior like GE Capital’s approval of subprime mortgages. Precipitating the current crisis, such mortgages were securitized — chopped up, re-packaged, sold to buyers seeking portfolio diversification and insured by companies such as AIG. When these mortgage-backed securities turned out to be mostly valueless, financial institutions collapsed and insurance companies were unable to uphold their contracts. “It sent a tremendous shock through the financial world,” Stewart said. “And what we have now is what I would call ‘full-blown panic.’ Asset values are collapsing across the financial universe.”

To remedy this crisis, Stewart proposed several courses of action. First, he said, the government must restore confidence in the financial system through providing bailouts to financial institutions. He noted existing opposition to bailout plans and acknowledged that many financial institutions have exhibited unethical behavior that makes them undeserving of government support. However, “we have to separate these issues,” Stewart said. “There will be a time for punishment, if it is warranted. But saving the American economy, not to mention the global economy, has to take priority at the moment. When there is complete failure of private individual ability and will to make the financial system function, then [providing a remedy] is the function of the government.”

He extended this obligation beyond the banking sector to the automotive industry, arguably an even more contentious arena, since some observers have blamed poor corporate management for the woes of General Motors, Ford, Chrysler and other U.S. automakers. Rewarding underperforming firms, some contend, creates perverse incentives and economic moral hazard. But while auto companies have failed to make fuel-efficient vehicles a priority, they are not responsible for the collapse in consumer confidence and the financial meltdown, Stewart said. In that regard, they deserve governmental support, he said, adding that a framework for addressing these kinds of situations must be established because other entities, such as the airlines and media companies, are likely to be in a similar position if the economic crisis lingers.

Stewart also proposed a more radical idea: Grant authority to the government to take taxpayer money, treat it as private equity capital, put it in a high-return investment, sell the investment in five to seven years and then return funds to the treasury. “Is this socialism?” Stewart asked. “Maybe. But I don’t think anyone would call it socialism if it were pursued with the proper motive.”

Those motives, coupled with traditional capitalistic rewards, are likely to see the nation through the current grim economic circumstances, Stewart said. Americans must retain “an incentive structure that encourages what’s made this economy and country great: innovation, hard work, imagination and creativity.” Stewart praised Google Inc. Chairman and CEO Eric Schmidt for leading a product that helps people, creates jobs and improves quality of life. “I wish we had more Googles,” he said.

Despite the fact that some Americans believe that a “Great Depression part two” is looming, Stewart said he remains optimistic about the nation’s financial future. “It took World War II to get us out of the Depression,” he said. “I don’t think we need another war to get us out of this recession. Let’s get out of this together.”

Stewart’s lecture, titled “Meltdown: The Credit Crisis and the Fall of Wall Street,” was sponsored by the Kellogg School Office of the Dean, which produces the Kellogg Distinguished Lecture Series. The initiative is designed to bring preeminent thought leaders from academia, journalism and business to address key issues and leadership challenges confronting managers today.