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Report from AEA meeting, Part IV

In 2010 we will know who is the winner of the debate over V-shaped vs. U-or-W-shaped recovery; as for investors, we will know more about whether the market we are having now is a small bull in a long secular bear market (or the so-called New Normal) vs. the more optimistic prediction that this is the beginning of a brand new bull market, which I strongly doubt.

Here is my final report of the series (source: WSJ) on how economists at the AEA meeting think about the issue:

ATLANTA — Wall Street investors may be breathing a sigh of relief as the financial crisis fades, but academic economists gathered here for the annual meeting of the American Economic Association say we’re nowhere close to making sure it won’t happen again.

Over the past few days, economists here highlighted the many ways in which the lessons of the crisis have yet to sink in. Few think the U.S. and other governments have made needed repairs to the financial regulatory system. And some suggest governments’ response has increased the chances of a repeat, making the banking system more crisis-prone, putting new strains on institutions such as the Federal Reserve and stretching government finances closer to the breaking point.

[Unsolved Problems]

“Our response has made us more vulnerable to a bigger crisis,” said Tom Sargent, a New York University economist. “It’s distressing.”

Banks present the most immediate worry. By providing massive bailouts to commercial banks and securities firms, the logic goes, governments have given bank executives a sort of catastrophe insurance — and an incentive to take even greater risks than they did before the crisis. But it could take years for policy makers to impose the controls, such as tougher capital requirements, that would prevent the pain from spreading to taxpayers and the broader economy next time the banks get into trouble.

“If the banks really feel that they are insured, then we have a dangerous situation,” said Stanford University’s Robert Hall, the association’s president. “The incentives are to take a very risky position. They get to pocket it if they win and it’s the federal government’s problem if they lose.”

Policy makers find themselves in a tough position. They can’t impose controls immediately, for fear they would curb the lending crucial to a sustainable economic recovery. But as the banks regain strength, the political opportunity to create a new financial architecture could slip away.

“You have only a small window in which you can really change things,” said Markus Brunnermeier, of Princeton University. “It’s closing already.”

The crisis isn’t over for banks. The worst-case scenarios in last year’s stress tests, which restored the market’s confidence in U.S. banks, included only two years’ worth of losses. But banks are likely to face losses for many years to come as foreclosures mount and the commercial real-estate market sours.

“If the U.S. government could credibly say [to banks]: We’ll never bail you out again, it [the banking system] would collapse,” said Kenneth Rogoff, of Harvard University.

To quicken the banks’ return to health, Princeton’s Mr. Brunnermeier believes governments should place much harsher limits on cash dividend and bonus payouts, which deplete the capital banks need to absorb the losses and keep lending.

“I don’t think there’s enough forcefulness from the administration on this,” he said. “If Goldman Sachs is paying these huge bonuses, the other banks are forced to do so as well.”

Others fretted about the lack of a game plan for Fannie Mae and Freddie Mac, the money-losing mortgage giants — known as government-sponsored enterprises — that are now absorbing huge sums of taxpayer money as part of the U.S. government’s efforts to keep the mortgage market functioning. When long-term interest rates rise, as they inevitably will, said Anthony Sanders, of George Mason University, “We’re going to see tremendous losses taken on the bank balance sheets and [those of the GSEs].”

“The GSE structure must be ended because it creates inevitable failure based on the incentives,” said Dwight Jaffee, of the University of California at Berkeley. But he and his peers differed on the best solution. Mr. Jaffee called for the government to buy mortgages and package them into securities, as Fannie and Freddie do, but only temporarily; eventually, that task should be turned over to the private sector.

A pair of Federal Reserve economists, Diana Hancock and Wayne Passmore, emphasizing that they weren’t expressing the Fed’s official view, suggested the government should explicitly guarantee not only mortgages but other financial instruments against a catastrophe with a new insurance fund, financed by premiums similar to the one used to insure bank deposits.

Economists also expressed concern about the extent to which the unprecedented measures taken by the government and Fed could weaken them as a backstop in the future. The Fed’s massive interventions have exposed it to greater financial and political risk, both of which could lessen its ability to step in and calm markets. And the huge costs of financial and economic bailouts have put added burdens on the finances of advanced-economy governments around the world.

In the next few years, for example, the gross government debt of both the U.S. and the U.K. will exceed 90% of their annual economic output, an event that could both spook investors and seriously impair economic growth.

When advanced countries cross the 90% threshold, their annual growth tends to be about one percentage point lower, said Mr. Rogoff and Carmen Reinhart of the University of Maryland.

“This is very troubling for the U.S. and other advanced economies,” said Ms. Reinhart.

Report from AEA meeting, Part III

Truly enjoyed the Economics Humor session during this year’s AEA meeting. Here are some goodies:

AEA Economics Humor Session:

Sunday Jan 3 at 8 pm at the Atlanta Marriott Marquis:

  • Merle Hazard [www.merlehazard.com] (“Busted Dreams and Cheatin’ Hearts: The Credit Crisis, Nashville-Style”)

Report from AEA meeting, Part II

Are economists a stingy bunch? Justin Lahart wonders:

Academic economists gather in Atlanta this weekend for their annual meetings, always held the first weekend after New Year's Day. That's not only because it coincides with holidays at most universities. A post-holiday lull in business travel also puts hotel rates near the lowest point of the year.

Economists are often cheapskates.

The economists make cities bid against each other to hold their convention, and don't care so much about beaches, golf courses or other frills. It's like buying a car, explains the American Economic Association's secretary-treasurer, John Siegfried, an economist at Vanderbilt University.

"When my wife buys a car, she seems to care what color it is," he says. "I always tell her, don't care about the color." He initially wanted a gray 2007 Mercury Grand Marquis, but a black one cost about $100 less. He got black.

Some of the world's most famous economists were famously frugal. After a dinner thrown by the British economic giant John Maynard Keynes, writer Virginia Woolf complained that the guests had to pick "the bones of Maynard's grouse of which there were three to eleven people." Milton Friedman, the late Nobel laureate, routinely returned reporters' calls collect.

Children of economists recall how tightfisted their parents were. Lauren Weber, author of a recent book titled, "In Cheap We Trust," says her economist father kept the thermostat so low that her mother threatened at one point to take the family to a motel. "My father gave in because it would have been more expensive," she says.

"Where do I begin?" says Marisa Kasriel when asked about the lengths to which her father, Northern Trust Co. economist Paul Kasriel, will go to save a buck: private-label groceries, off-brand tennis shoes and his 1995 Subaru, with a piece of electrical tape covering the "check engine" light.

Mr. Kasriel says he buys off-brand shoes "so that my lovely children could have Nikes."

David Colander, an economist at Middlebury College in Vermont, says his wife — his first one, that is — was miffed when he went shopping for the cheapest diamond. Economist Robert Gordon, of Northwestern University, says he drives out of his way to go to a grocery store where prices are cheaper than at the nearby Whole Foods, even though it takes him an extra half hour to save no more than $5.

Mr. Gordon, however, is no ascetic. He, his wife and their two dogs live in a 11,000-square-foot, 21-room 1889 mansion on the largest residential lot in Evanston, Ill., outside Chicago.

"The house is full, every room is furnished, there are 72 oriental rugs and vast collections of oriental art, 1930s art deco Czech perfume bottles and other nice stuff," he says.

Some economists may be cheap, at least by the standards of other people, because of their training or a fascination with money and choices that drives them to the field.

In recent research, University of Washington economists Yoram Bauman and Elaina Rose found that economics majors were less likely to donate money to charity than students who majored in other fields. After majors in other fields took an introductory economics course, their propensity to give also fell.

"The economics students seem to be born guilty, and the other students seem to lose their innocence when they take an economics class," says Mr. Bauman, who has a stand-up comedy act he'll be doing at the economists' Atlanta conference Sunday night. Among his one-liners: "You might be an economist if you refuse to sell your children because they might be worth more later."

Economists long have studied "free riders," the sort of people who take more than their fair share of something when circumstances permit. Think of the person who orders the most expensive entr[eacute]e at a restaurant, knowing that the check will be shared equally among companions.

University of Wisconsin sociologists Gerald Marwell and Ruth Ames, in a 1981 paper, found that in experiments, economics students showed a much higher propensity to free ride than other students. In questioning after the experiment, the sociologists found that for many of the economics students, the concept of investing fairly "was somewhat alien."

Cornell University economist Robert Frank, working with a pair of psychologists, mailed questionnaires to college professors asking them to report the annual amount they gave to charity. Their 1993 paper reported that 9.1% of the economists gave no money at all — more than twice as many holdouts as in any other field.

The professors also ran an experiment in which participating Cornell undergraduate students could get a higher payoff if they agreed to have their partner get less. Economics majors were more likely to go for the higher payoff, they found.

Some dispute the notion that economists tend to be skinflints. "They aren't cheap," but they are concerned with a loss of economic efficiency, says Betsey Stevenson, an economist at the University of Pennsylvania's Wharton School. "That means that they often fail to do the nice little social gifts that seem wasteful to economists."

And the principles that can make economists seem cheap sometimes lead them to hire help, because they are taught to value their own time.

Ms. Stevenson and Justin Wolfers, also of the Wharton School, gave a friend $150 to hire movers instead of helping him themselves. Harvard University economist David Laibson pays to have a driver pick up his sister from the airport rather than driving himself.

Stanford University economist Robert Hall, incoming president of the American Economic Association, values his time so highly that his wife, economist Susan Woodward, occasionally puts her foot down. "Bob doesn't see why we can't just hire people to trim the Christmas tree," she says. "I tell him that's not what it's supposed to be about."

Given their understanding of the odds of gambling, economists seldom frequent casinos, which is one reason the meeting isn't held in Las Vegas. A decade ago, a hotel sales representative showed Mr. Siegfried a chart showing how little economists gambled compared to other people, he says.

The American Economic Association meetings, however, have been held in New Orleans, which has a few casinos.

One year, Yale University economist Robert Shiller, who'd never gambled in his life, found himself at a casino there. He says that was because Wharton economist Jeremy Siegel realized that by using coupons offered to conventioneers, they could take opposing bets at the craps table with a 35 out of 36 chance of winning $12.50 each. Over two nights, Mr. Shiller netted $87.50.

He hasn't gambled since.

Write to Justin Lahart at justin.lahart@wsj.com