Financial Restructuring to Sustain Recovery

Introduction: Financial Restructuring to Speed Recovery

 Introduction: Financial Restructuring to Speed Recovery 1 The financial crisis of 2007–08, which led to what is now known as the Great Recession, caused more widespread economic trauma than any other event in the postwar era. This experience has raised wide-ranging questions about how to reform the financial system to enhance its resilience and prevent the reoccurrence of such episodes. And, because the recovery has been disappointingly slow and uneven, attention has also turned to possible reforms to markets and the financial infrastructure that might speed recovery. This volume focuses on some of those potential reforms. The Nomura Institute of Capital Markets Research, the Brookings Institution, and the Wharton Financial Institutions Center organized the conference, held in late October 2012, on which this volume was based. This volume contains the revised presentations made at the conference. After this introductory chapter, the second chapter examines potential reforms to the U.S. market for housing finance, the collapse of which played a central role in the crisis and has impeded economic recovery. The third chapter focuses on reform to the U.S. bankruptcy process, which is essential for the efficient reallocation of capital and labor. The fourth chapter considers the market for U.S. initial public offerings, which facilitates the growth of new firms, which are often believed to be the main source of growth in employment and productivity, and has been very slow to revive. The volume concludes with an examination of Japan’s experience in attempting to reform the financial sector to resume growth. Japan’s real estate market collapsed in the early martin neil baily richard j. herring yuta seki 01 2524-4 ch1.indd 1 10/21/13 8:50 PM  martin neil baily, richard j. herring, and yuta seki 1990s and has struggled to recover for the past twenty years. Financial reform has been a central focus of policy and continues to be a challenge. Japan’s experience may well hold lessons for the current plight of the U.S. economy. As this conference series has demonstrated over the years, contrasts between the experiences of Japan and the United States can often be illuminating regarding both what to do and what not to do. In this introductory chapter we provide a summary of the book. A broad theme running throughout is that each of these aspects of the financial services industry can play a useful role in facilitating recovery and the resumption of growth, but the necessary reforms are sometimes subtle and often difficult to implement. Just as the financial sector was the source of many of the problems that caused the Great Recession, it may also have a crucial role to play in economic recovery. Mortgages In chapter 2, Franklin Allen of the Wharton School, University of Pennsylvania , James Barth of the Auburn University College of Business and the Milken Institute, and Glenn Yago of the Milken Institute discuss the restructuring of the U.S. housing finance system in a very broad context including both how the system has evolved from historical precedents in Europe and how the United States compares with other leading industrial countries. They begin by noting that the housing sector is an important part of the U.S. economy, with residential investment averaging about 5 percent of gross domestic product (GDP) and housing services averaging about 12–13 percent of GDP. It has always been subject to boom and bust cycles in new construction, but these cycles have not caused widespread problems since the Great Depression of the 1930s. This time, however, the boom and bust in the U.S. housing market contributed to a global financial crisis and the Great Recession. The bust was not widely anticipated in the United States, other countries also failed to see it coming, and so this failure to anticipate the bust cannot explain the unusually painful impact on the U.S. economy. What went wrong? Where was the problem, and how can we fix the system? Early on, the United States developed a system of housing finance that was similar to that in the United Kingdom. U.S. homeownership was greatly expanded with land grants so that by 1890 two-thirds of farm housing was owner occupied. The early introduction of savings-and-loan institutions (S&Ls) distinguished the development of housing finance in the United States, with the first S&L organized in 1831. The S&Ls were granted tax advantages (and later interest rate advantages relative to other financial institutions) so that the sector developed 01 2524...