Public Square: Tough times - the economy

Tom Silvestri, publisher of the Richmond Times-Dispatch: I want to welcome you to our 21st Public Square conversation on community issues of importance . . . . Our topic tonight is "Tough Times in the Economy." And this is an important conversation. In particular, what's happened here in the region in the last month or so has really brought this issue home . . . .So we thought we'd try to put some knowledge in the room and also hear what you have to say about this.

Alfred Broaddus Jr., former president of the Federal Reserve Bank of Richmond: I've been through a lot of business cycles. All of them have surprises. They're all different in many ways . . . and there are a lot of surprises in this one already. So I'm still guessing, like a lot of folks out there are.

Rudolph McCollum, attorney and former mayor of Richmond: I've been practicing law now for about 17 years. And I have been practicing bankruptcy law prior to that. Of course, during the time that I served as mayor, essentially I had to retire, because it just wasn't the time to do it. But the fascinating thing was when I got back into it, beginning of January 2005, there were some major changes that were taking place in bankruptcy law that were certainly going to be able to impact people's ability to respond to some of the economic challenges that they'd be facing.

Laura Lafayette, senior vice president, Richmond Association of Realtors: You know, after 9/11, there were a number of folks who gave a great deal of credit to the real estate industry for keeping our economy, our national economy, moving and going in the right direction. And I think that credit was well-deserved. Of course, now we find that the real estate market has fallen on tougher times. We've seen a slowdown. And so I think a lot of the questions that we have tonight revolve around, when does that industry recover? What does recovery look like, and where do we go from here?

Keith Muth, financial advisor and managing partner of Virginia Asset Management LLC: I have the good fortune of listening to a lot of the experts discuss the investment markets and what's going on there. And I interact with a lot of folks, individuals who have a lot of personal financial planning, and obviously, investment management concerns. So, hopefully I can add some perspective there.

Gaylon Layfield, president and CEO of Xenith Bank (in organization): I guess that in the midst of all this financial crisis that we've been experiencing, and the economic dislocation, the banks have kind of been very much at the center of it. So I think if we're going have a conversation, you probably needed a banker. And I qualify as a banker. I don't know that I know much. But it's also -- maybe you're just looking for somebody to blame. [LAUGHTER]

Silvestri: Now, we wouldn't do that. But I'd watch people behind you. No, just teasing . . . .The first question's a real simple one: How did we get here?

Broaddus: While we know a lot about at least some of the things that have brought us here, we don't know everything. And we're not going to know that really in detail for some time to come. As an example, I would cite the Great Depression. There was a lot of thinking and a lot of re-regulating and legislative action that followed the Depression in the mid-1930s. But the truth of the matter is that people who really studied it in depth didn't begin to come -- economists and historians and others -- didn't get close to a consensus for many, many years -- really, until the 1960s. So I think we need to keep that perspective. We may know some of the factors, but how important they are relatively, how they reinforce one another -- is going to take some time to make some judgments.

If you ask many people what the main factors have been, I think a lot of people would say greed and a greater willingness to take sometimes unreasonable risk were certainly factors -- and I think that's probably true. But that begs another question: What allowed these behaviors to change? Was there really a change in human nature? Did people all of a sudden become more greedy, become more willing to take risk to get a mortgage, or whatever the individual situation would be? I think the answer is no. . . .

One of the most persuasive things that I have seen recently was actually in

The Times-Dispatch, written by Robert Samuelson, who is a very good economist journalist. He said: Even now, as we're in the middle of this, if you want to begin to understand, you need to take a longer-term perspective. And the perspective he took really ran from the midto late 1960s until the present day . . . .The 1970s, many of you remember it vividly, was a period when the economy really was pretty dysfunctional. The stock market started going down in the late 1960s and didn't come back up to its prior peak until 1982. That was the age of inflation. There were all sorts of policy mistakes, and it was just a very bad time.

Paul Volcker -- who I'm sure everybody now knows is an advisor to President-elect Obama -- was chairman of the Federal Reserve in the late '70s and early '80s. And he essentially took charge of the situation. He was a very courageous guy, and a very good policymaker who, for all practical purposes, induced a recession. Those of you who remember that recession will remember unemployment went all the way up to 10 percent. It was an awful, almost two-year downturn, and a lot of people got hurt. But it did have the good result of breaking the inflation. And it created a situation where there was a lot less risk in the macro-economy.

It really was the foundation for a long period of stable and prosperous U.S. economic performance, beginning around 1982 and '83. Inflation began to come down. Interest rates were lower. There was more rapid growth in the economy overall. And there was a huge amount of job growth. The dollar was strong. Lots of good things. There were bumps, to be sure. We had a market break in 1987. We had an S&L crisis in the early 1990s with the recession, and then there were some other problems. By and large, a very healthy and prosperous period.

At least in the early period, you could say that there was a period of rational exuberance for people -- when they made decisions about investment and made decisions about borrowing or starting a business. But as this period progressed, it devolved into what Alan Greenspan eventually -- in 1996 -- famously called irrational exuberance. The good times laid the seeds for too much exuberance, too much risk-taking, and that's really what led us . . . to the kind of framework and frame of mind that we have now.

The first example of this, of course, was the tech boom and bust in the late 1990s. And then that was followed, in this decade, by the housing boom and now bust. . . .

Let me now just come down from 30,000 feet and very quickly -- most of this is going not be late-breaking news -- just list the main points that I think most people would point to as causes. Housing is obviously at the center of it . . . .

There were some very substantial changes in the structure of the mortgage market . . . .There was a time when bankers made a mortgage loan, made a decision about a mortgage loan, put it on the books of the bank, and expected it to stay on its books until it was paid back.

That created really good incentives: The loan officer knew that he had to make a good loan, or he might lose his job. The loan committee knew that they had to make good decisions about loans. That's all changed recently. Mortgage loans are now originated by -- they're still originated by banks, but many are originated by non-banks, or brokers of one form or another, who really don't have any skin in the game. They can sell it, and many of them are sold. They may be sold to Fannie Mae or Freddie Mac. But they could be sold to other financial institutions that package them through a process that we call "securitization" into bonds that have these mortgages backing them. There are many things about that practice which are beneficial. It tends to spread risk around to a lot of people and institutions that are willing to hold it. But it also creates many perverse incentives. The originators don't have skin in the game. So they don't have the incentive to make the really careful loan decisions that need to be made when you make loans like that. So the result has been that a lot of bad loans . . . .

I mentioned taking loans and making them securities. Well, you might even go further than that and mix several of those securities into another security, and maybe bring in some leveraged loans and other complex stuff and wind up with an incredibly complex security . . . .

Let me mention just one other thing -- a mea culpa here. And that's the Federal Reserve. This point has been made by many, and I need to acknowledge it. We went through a period, really beginning in late 2001 and extending well into 2004, where we followed a very easy monetary policy. By which I mean, we pushed the federal funds rate that we used to control monetary policy down to a very low level. I think we had good reason to do that. There was a fear of deflation . . . .Instead of prices rising, which is inflation, prices in general would be falling. That's what we had in the 1930s. And while we didn't have it in 2001 and 2002, there was a whiff of it. And we were concerned about it. There was a big problem with it in Japan. And so that's why we eased policy so aggressively.

The problem, Tom, is that we left it too easy too long. You know, hindsight is 20/20. And as I look back -- and I was at the table then, so you're looking at part of the problem here -- and I'll admit it easily. But looking back, we had the federal funds rate at 1 percent, and we left it there for a long period of time and did not begin to raise it back up until mid-2004. In retrospect, we should have. The economy was gaining steam in late 2003, and we should have acted sooner.

Muth: A low-interest rate environment really fueled financial firms. They were creating very risky assets, a lot of times with borrowed money. And there just was an appetite for that risk out there, in the whole housing-finance chain. From the lax lending that occurred, it became a cycle. Lending got easier. So folks were out there writing loans that may not have been written in prior years. Finance folks were borrowing money to create the products. They were very complex. The risk doesn't seem to have been understood. And as a result, the collapse in housing prices was the pin that popped the bubble . . . .

McCollum: I did a lot of real estate transactions. And honestly, when I looked at many of those transactions, I was completely shocked to see how some of those people actually obtained loans. When I looked at some of the numbers in terms of income and debt ratios, and some of their financial history, for them to have been able to obtain loans, to me, was shocking.

Layfield: There's just no question but that bankers lost sight of fundamental risk control and good underwriting standards. And it was an environment where it was very easy to make the loans and pass them off into sort of the stratosphere, where you didn't have to worry about them. And as a result of that, underwriting guidelines that were well-tested and served us well for so many years just were ignored by the banks. We began to make loans to people with no evidence of income. With no documentation.

Lafayette: A lot of people talk about the real estate market as being cyclical . . . .For the first half of this decade, we were really on a roll, nationally. In some markets we saw not just double-digit price appreciation. We would see price appreciation of sometimes 25 percent. And that's just not sustainable. What we also saw was a national policy drive toward home ownership. When you say the American dream, people know what the next two words are: home ownership. That sounds positive and it is positive, in many aspects. Because home ownership allows people to build assets, build wealth. It's not for everybody.

What we saw is -- particularly in some overheated markets -- if you wanted to purchase a house, and if you thought that's what you needed to do, then you went to some of these high-risk loans. Because you couldn't afford the home in any other circumstance . . . .A lot of people decided to take a bad risk. Certainly the lenders knew better. But consumers, in many aspects, knew better as well. In the first half of this decade, we had people financing not once, not twice, sometimes three times. And they lost perspective that your house is where you go in the evenings to relax. It's where you raise a family. It's not your bank. People were using it as a bank. . . .

In many markets, we didn't have a slowdown. We had kind of a crashing halt. And that's not happening in the Richmond metropolitan area . . . .But the good news is, if there is good news, that those regions where we saw precipitous declines, we're beginning to see slight turnarounds.

Silvestri: In hindsight, if we had to do it over again, . . . what would we have done differently?

McCollum: One thing that failed was some oversight and regulation of a lot of these changing products that were coming into the marketplace. And not having the opportunity to really sit down and reflect, and say, "What exactly are going to be the implications of all these things?"

Layfield: I think there's a real sense that we all, collectively, have to recognize . . . a sense of personal responsibility, and recognize that all the regulation in the world, and all the government intervention in the world, and bankers and everybody else -- at the end of the day, we all need to accept responsibility and say, "Can I afford this loan? And does this make economic sense for my family? Or am I stretching beyond what's rational and reasonable?"

McCollum: One of the problems that I see as a consumer bankruptcy attorney is: The first thing I do with a potential client when they come into my office and we begin the process of sitting there to determine where they are as a means to determine how they got to where they are, is to develop a budget for people. Tom, 90-plus percent of people do not do that. And to me, that's really something that we need to address as a nation when we talk about turning 18-year-olds out into society to be responsible for developing a household for the next 50-plus years.

I majored in economics. I had a very clear idea of how the system operates. That was my intention when I went to college -- to find out how this country's economic system operated. But the overwhelming number of students in high school don't get that background. And for those who even attend college, that's an elective.

Lafayette: People get caught up in kind of a collective euphoria. And I agree that there's this kind of irrational exuberance, that was not just the stock market. It was the housing market. I think we became victims of group think . . . .Government doesn't live within a budget. We don't set good examples for people about how to live within their means. As a society, we don't usually say no to ourselves.

Silvestri: Are these tough times going be here for a long time?

Layfield: I don't think it's going be over quickly. The severity of this downturn is such that it's going be some reasonably-protracted period of time. I don't think it's going be over in the next quarter, or six months. I think '09 is going to be, probably, a pretty slow, tough kind of year. And I expect it'll be well into 2010 before we see a lot of recovery. But we will recover.

Muth: There's going be a real impact on debt. Companies, consumers. The rules will change there, in that it'll be tougher to get credit. I think creditworthiness -- the definition of creditworthiness will change dramatically. And debt will probably be more costly.

Lafayette: The rest of this year, first quarter of next year, we don't see any particular growth. We're hoping that the spring market acts the way the spring market typically does, and that is that we see an uptick in housing activity in the spring. I think that everybody is prepared for a slow recovery . . . . We probably will see some more regulation. I hope that we don't see an overcorrection . . . .We don't want to tighten up to the point where people who are worthy risks cannot get the loans they need.

McCollum: We're talking about bailing out individual industries here. Why have we not heard anything about any basic policy about when government should bail out? . . . No criteria for what, when, and how a bailout should occur . . . .That, to me, is not the way that we should be approaching this issue.

Broaddus: We have a wonderful economy. Our economic system is solid. It's the wonder of the world. It has terrific internal healing powers, if you let it do it. Public policy, though, makes mistakes that can create problems. If you look back at the Depression, that again, was a failure of Federal Reserve monetary policy, compounded by a tariff, the Smoot-Hawley tariff that was put in place in the middle of it . . . .That would have been an ordinary recession if these policy decisions hadn't been made and caused it to really be a decade-long economic downturn . . . .Some of the bailing out that's been done in the financial sector, I think had to be done. The question now is whether it's going to be extended beyond the financial sector. And where does it stop? . . .

The Federal Reserve has done some extraordinarily different things from what it normally does. I know [Fed Chairman] Ben Bernanke well, served with him before I left the Fed. He's the world's leading expert on the Depression. He understands that, and he's a good person to have in that job. He's determined to avoid letting that happen again. These actions that have been taken have really been pretty dramatic, and I support them. Still, as an old central banker, they make me nervous.

Silvestri: For years we've heard that the Richmond region, because it's a state capital, because we've got this large institution called the state government, is recession-proof. It doesn't seem very recession-proof, what's happened here in the last three or four months. What's your perspective on what's happening locally?

Lafayette: I grew up in the Richmond metropolitan area. I've always thought -- up until the last, probably, month or two -- that we were fairly recession-proof. When I was growing up as a kid, we had DuPont and Reynolds Metals and Philip Morris. And now you have different industries, but you have service industries. You have the state capital. But what we've seen in the last few weeks with our major companies taking real body-blows in many respects, I think this whole issue of consumer confidence has come home to the Richmond metropolitan area in a way that's very, very different than anything we've seen in the past . . . . Those companies have been leaders in our community. They've poured thousands and thousands of dollars into our nonprofit communities, particularly some of the ones that I care most about, the housing nonprofits. So the consequences of what's gone on for those companies have some significant concerns for the Richmond metropolitan area.

McCollum: During the earlier part of the last year or two, particularly of course early this year, the major issues that I was seeing consumers facing were the result of the increase in gas prices. So transportation costs and food costs were what was bursting people's budgets. Because people only have so much discretionary income. Now, I'd say in this past quarter and moving forward into 2009, I think we're beginning to see more on the issue of unemployment. So you couple the increased cost of living with unemployment issues that we're going be facing even more -- we're not recession or depression-proof by any means . . . . I'm seeing now in my practice more people who are willing to walk away from their homes, because in effect, they're renting now. Because the values have reduced below the debt that they have on those properties . . . .In 17 years of bankruptcy practice, I've never seen that like I'm seeing it now. It's difficult times.

Silvestri: How will we know that the bad stuff is stopping, and we're going into recovery? What are the signs we should look for?

Lafayette: In the real estate market, the bottom-line number for us is going be absorption of inventory. When we see the homes that are for sale, when that number begins to shrink, then we're going see more of a return in balance to the market.

Layfield: From a banking perspective . . . we'll be looking for a return of stability to the credit markets .

Muth: The stabilization of the housing market is key. I think the banking system stabilizing a little bit. I think people feel a little better about it these days than they did a month or two ago.

McCollum: The concern primarily right now is lack of consumer confidence. If we can get a turn in terms of loosening up of the credit markets, that's when people, when businesses can be in a position to borrow more, to invest more.

Broaddus: Housing data are crucial. The inventory of unsold houses. Once that begins to look better, that'll be great. The indexes of home prices are another thing that obviously are important. And there are lots and lots of other things. But I'll tell you what I personally am going be looking for. I live out in the near West End, near the intersection of Malvern and Grove. There's a railroad there. Old Richmonders used to call it The Belt Line. It's the railroad that runs along the Powhite Parkway. It's the main trunk line from the Northeast to the Southeast and the Deep South. The volume of train traffic as I walk back and forth across that bridge is a good indicator for me. And I've tested this for about 20 years. There's not much traffic now . . . . When I see two trains stop because there's so much traffic they can't get into Acca Yard, I'll know that things are coming back in the city.

Silvestri: We'll turn the Public Square over to the audience.

Everette Felts: For years we've been losing jobs as a result of the purchase of foreign products overseas. And now it's coming around that this is really getting serious. To wit -- our garment industry is gone. Electronics industry is about gone. The tools and related industry is about gone. And now, we have our automobile industry, which is about to crash and to go into bankruptcy . . . .There's got to be some negotiations and adjustments to get production back in this country.

Broaddus: I hear you. And the loss of jobs overseas is, at one level, certainly part of the weakness of the U.S. economy now. But the issue you're broaching is one of the most sensitive in all of economic policy. And that's trade. And there's strong views on that, on both sides. Economists generally -- maybe this is dangerous -- but one of the few things we agree on is the benefits of trade. Now, that's not to say we don't see difficulties. There are unfair trading practices. Those need to be dealt with. There's often not a level playing field. That needs to be dealt with. But once those things are done, the lesson of history is that allowing free liberal trade over the long run is best for all countries, and especially the U.S. economy. We can compete with anybody.

What we need to be able to do, though, is to be sure that people have the skill levels so that if they lose a low-paying, low-skilled job to some country in the Far East, those people can move quickly and fluently into another, better-paying job.

Joe Andrews: I'd like to know what caused the banks to lower their lending standards and make them have such risky mortgage loan policies? Was it the lack of government regulation? Was it Fannie Mae, Freddie Mac?

Layfield: First of all -- and not in defense of the banks, because there's plenty of guilt and blame there -- there were a lot of people making mortgages other than just banks. Mortgage companies, mortgage brokers, and so forth. So it's a pretty diverse kind of an industry. Having said that, however, banks -- many of which are very large institutions -- publicly owned, publicly traded, very worried about quarterly earnings and reporting earnings reports. Very driven by the attempts to increase income on a regular basis, and they saw that as a vehicle where they thought they could pass the risk off to somebody else . . . .There's been a substantial amount of regulation in government policy, laws passed that pertain to the banks and other financial institutions about the kinds of loans that they have to make. And if you don't make them when the regulators come, you're going to be severely criticized about that. And there'll be penalties to pay.

Broaddus: There is a strong public policy commitment to encouraging home ownership in the U.S. And that's a good thing, socially . . . .But that has led to the passage of a number of things. There was the Community Reinvestment Act, a well-intentioned act that has had a lot of really good results. But it does create a tension between that objective and sound lending in some cases. And we need to recognize that. The other thing I would mention is Fannie Mae and Freddie Mac. They were seen by investors as institutions whose debt, even though there was no explicit guarantee, would in fact be guaranteed [by the federal government]. So they had very low cost-of-funds. And that whole thing got politicized, and you know where that went.

Ron Melancon: To put the bailout in perspective, we spent over $1 trillion. That's the equivalent of building 200 George Washington aircraft carriers. The consumer would feel more confident when somebody tells us how we're going pay this back. And I will feel better when Congress takes Rudy McCollum's class on how to budget!

Muth: Some of these bailouts could -- the government could actually end up recovering a lot of this value as assets increase down the road.

Layfield: Where does all this intervention on the part of the Treasury and the government, the Federal Reserve, take us ultimately? And what's the risk associated with it? . . . In the short run, I think it was necessary to a degree, and has helped. A concern here is that we pay it back by printing money and ultimately creating inflation.

Broaddus: Everybody in this room may wind up paying it back. Let's be realistic. That's really what we're talking about. We may get some of it back . . . .As citizens, we need to watch that process and try to demand that our representatives in Congress oversee it effectively and keep the cost down.

Mukul Paithane: I own a small business. And the part I liked most today was when you said "accountability." Somebody has to have skin in the game. Right? So, as a small business, you have skin in every decision that you make. . . . The real hole is, the decision-makers at the top of these institutions have really no skin in the game. So, what regulations could come about so that a CEO, or somebody higher up, doesn't enable decisions at this level that cause the economy to go bankrupt?

Layfield: In our free-enterprise system, we really do value that structure that allows corporations and entities, whether it's a small business or a large business, to be independent of too much intervention. And boards of directors are supposed to hold CEOs accountable. That's the system, and the way it ought to work. There have been abuses. There's just absolutely no question about that . . . .I think there is a role for some regulation and some rules to play by here.

Broaddus: If there's an iron law of regulation, it's the law of unintended consequences. When you put arbitrary regulations in place, however good the purposes, they can often produce results that turn out to be not very good.

My Lan Tran: I am with the City of Richmond . . . .I'm concerned all the time about the state of small business, entrepreneurship. Small, minority, multicultural. Those who are newcomers, immigrants. Imagine if the problem is so complex and native American-born have a hard time finding answers. Imagine all these people who are disadvantaged culturally and linguistically. And then the small minority businesses who really have very little access to resources, because they don't know where to go . . . . I'm here on a mission -- a research mission. As usual The Times-Dispatch is trying to find a solution. If I am to gather a few of my colleagues -- state, federal service, city providers -- and provide a technical assistance program for businesses, what aspect in financial literacy should I focus on?

McCollum: You know the old saying: When there's a cold in the majority community, there's pneumonia is the minority community . . . . I'm sure there's greater suffering that exists. But one of the things that we've talked about tonight is that the sun will shine someday. And what has to happen is that all of us need to be better prepared when the sun does come out, to be able to be stronger in our financial knowledge.

The area of personal finance is certainly one where it begins. Because it begins at home. Each household needs to understand. What is it going to take for them to survive, in terms of putting together a budget? And what resources they have available to them to meet those budgets. Then once they've got that accomplished, they can begin the process of looking at some potential alternatives for enhancing the resources in terms of investing opportunities and understanding the many tools and products that are available.

People can definitely then begin to look at moving beyond their households and looking into entrepreneurial opportunity. And then being able to operate a business successfully. Because I see a lot of that as well. A lot of people who are very talented in what they do. But once they move out into entrepreneurship, the business aspect of it is extremely complex, and they aren't prepared for it. And so clearly we've got some things that we need to institute institutionally, with our educational system. But also, I think, every person has the opportunity available to them to be able to read or take courses on personal finance, so they can begin to be better able to survive now, as well as prepare themselves for the future.

Silvestri: Panel, what are your closing thoughts on what you heard tonight?

Lafayette: I hope that we collectively, as a society, learned some lessons. Whenever I participate in conversations like this I always say, "I hope my children don't have to have this conversation."

Muth: How folks assess risk, take risks -- whether it's debt, planning their cash flow, is going to be critical for not only individuals, but small businesses. Hopefully this period will be remembered as a time that might well occur again.

Layfield: We ought to remain encouraged in both the resiliency of our economy and, particularly, the one that we all live in here every day.

Broaddus: Our system is just the economic wonder of the world. And it still is. It has problems, and it has cycles. And we're in a difficult period now. But we'll get through this. We're not going back to the 1930s. I can say that with confidence. We know a lot more. Public policy's an issue, and we've got to make the right decisions. But we know a lot more about the basics now than we did back then. So, hang in there.

McCollum: I think everybody who's here this evening certainly recognizes that there's always darkness before the dawn. And that we -- I agree -- are the greatest country in the world. And we've got great potential. We've also, though, got to make sure that our elected folks are accountable. And if anybody owns any stock, they've got to make sure their voices are heard at those shareholder meetings, so that the policies both in the public and the private sector can be those that are working to the greater good's interest, as opposed to what's good in the short run.