Tag Archives: Deborah Lucas

Tackling the challenges of governments as financial institutions

From the MIT Sloan Newsroom:

Governments not only regulate the private financial marketplace, they also own and operate some of the world’s largest financial institutions. Government agencies make trillions of dollars of loans, insure large and complex risks, and design new financial products. Yet their leaders often lack the analytical support and rigorous financial training of their peers in the private sector, and transparency is often lacking.

 

The MIT Center for Finance and Policy officially launched this month to address those gaps, along with other challenges facing financial policy makers.

“This is a big unmet need,” said Professor Deborah Lucas, director of the center. “To have an academic center devoted to the broad swath of government financial policies that have such an enormous effect on the allocation of capital and risk in the world economy.”

“What we want to do is to promote research that policymakers, practitioners, and informed citizens can turn to as an objective source of information when they’re thinking about these policy issues. That information often isn’t available now,” she said.

Research endeavors so far include, among others: the production of a world atlas of government financial institutions, an effort helmed by Lucas to catalog, compare, and evaluate governments’ financial involvement worldwide; a project led by Professor Andrew Lo to develop a dashboard that measures systemic financial risk; a study of the effects of algorithmic and high frequency trading, led by Professor Andrei Kirilenko; and a study of policies on retirement finance led by MIT Sloan professor and Nobel laureate Robert Merton.

Lo, Kirilenko, and Merton are all co-directors of the center.

Along with the research work, Lucas said there is also an educational mission for the center. In many cases, the center’s leaders say, financial problems could have been avoided, mitigated, or at least predicted had public sector workers had an education on par with that received by many private sector finance professionals.

“The idea is to provide the people who are working on finance within a government context with the same skillset as their peers in private industry,” Lucas said. “One reason you see a lack of finance education is because it’s tended to be a rather expensive education. And people going into the public sector may not even realize that finance is what they will need to know.”

At MIT Sloan, work at the center has already led to the creation of Kirilenko’s new course—Core Values, Regulation, and Compliance—as well as a student club on financial markets and policy.

The center began sponsoring events in October 2013, but officially launched Sept. 12-13 with the inaugural MIT Center for Finance and Policy Conference in Cambridge, Mass. More than 120 people attended the invite-only event, which featured discussions on the cost of government credit support, the costs of single-family mortgage insurance, and contagion in financial markets. Peter Fisher, senior director at BlackRock Investment Institute and a former undersecretary at the U.S. Department of the Treasury, gave a keynote talk.

The conference also included a panel discussion on improving government financial institutions, which addressed the need for government agencies to improve how they manage credit portfolios and monitor program risk levels over time. Panel members also discussed ways to raise red flags when there are problems in government credit programs.

The outlook was not entirely dire. “The move toward embracing risk management concepts across the federal government has been impressive in recent years,” said Doug Criscitello, a managing director at Chicago-based audit, tax, and advisory firm Grant Thornton and the former CFO of the U.S. Department of Housing and Urban Development. “We’ve seen the rise of independent risk management offices … that are housed outside the credit extension department.”

Lucas said she believes MIT’s depth in finance, economics, policy, and systems thinking make it the ideal place to study governments as the world’s largest and most complex financial institutions.

“I think an important reason that more academics haven’t taken on these issues—despite their importance—is that they are extremely complex,” she said. “Making progress takes a big investment in understanding institutions and laws and motivations. The problems are inherently interdisciplinary. And MIT is this great institution in terms of having the horsepower and energy to go after it and say ‘We can hit this question from a lot of different dimensions.’”

Bridging the knowledge gap on governments as financial institutions

Ask most finance experts about the “world’s largest financial institutions,” and you’ll hear names like Citigroup, ICBC (China’s largest bank) and HSBC. However, governments top the list of large financial institutions, with investment and insurance operations that dwarf those of any private enterprise. For instance, last year the U.S. federal government made almost all student loans and backed over 97% of newly originated mortgages. Add to that Uncle Sam’s lending activities for agriculture, small business, energy and trade, plus its provision of insurance for private pensions and deposits, and you’ll discover it’s an $18-trillion financial institution. By comparison, JP Morgan Chase, the largest U.S. bank, had assets totaling about $2.4 trillion.

While government practices differ across countries, the basic story is much the same everywhere. As the world’s largest and most interconnected financial institutions — and through their activities as rule-makers and regulators — governments have an enormous influence on the allocation of capital and risk in society. And as financial actors they are confronted with the same critical issues as their private-sector peers: How should a government assess its cost of capital? How should its financial activities be accounted for? What are the systemic and macroeconomic effects? Are the institutions well-managed? Are its financial products well-designed?

Surprisingly, little research has focused on governments as financial institutions in their own right, and on finding solutions to the challenges they face. While private-sector financial theory and practice have benefited from decades of transformational innovations, public-sector financial thinking and education have not kept pace.

To help to bridge this knowledge gap, MIT is launching the Center for Finance and Policy (CFP) under the aegis of MIT Sloan’s Finance Group. A primary goal of the CFP is to be a catalyst for innovative, cross-disciplinary, and non-partisan research and educational initiatives. Its activities will address the unique challenges facing governments in their role as financial institutions, and also as regulators of private financial institutions. The aim is to provide much-needed support for policymakers and practitioners that will ultimately lead to improved decision-making, greater transparency, and better financial policies.

A quick look at recent headlines shows just how much is at stake and some of the significant decisions that need to be made. There’s the announcement by the BRICs about the formation of the New Development Bank, which will serve as a channel for large government-backed investments in those countries. In the U.S. there’s been heated debate over whether the Export-Import Bank should be reauthorized and whether the federal student loan programs are adequately serving students. There’s also the question of if, how and when the U.S. mortgage market will be reprivatized.

Research supported by the CFP is organized around three main tracks: the evaluation and management of government financial institutions, the regulation of financial markets and institutions, and the measurement and control of systemic risk. A critical focus of the CFP is the dissemination of knowledge to turn theory and data analysis into practice. That will be accomplished through policy briefs, conferences, the website, a visiting scholars program, and other initiatives.

We’re also focusing on education. The aim is to provide greater access to the tools of modern financial analysis to current and future regulators, policymakers and other stakeholders in the public sector. People working in the public sector have traditionally faced barriers to obtaining high-level financial education due to the cost and lack of a developed curriculum. We’re planning to use MIT edX to develop and offer material that will reach a broad audience free of charge. We also plan to offer special executive education programs and short courses at Sloan. To support those efforts, the CFP is investing in curriculum development in the application of financial concepts to public policy contexts.

The CFP will be officially announced in conjunction with our inaugural conference, which will take place Sept. 12-13. The conference will highlight new research related to its three main research areas. It features six paper sessions, three panel discussions, and a keynote address. Over 100 participants are expected to attend including policymakers, practitioners, and academics. The event will be available afterwards online.

I believe that the CFP’s research and educational initiatives will significantly move the needle on how policymakers think about their role as financial decision-makers and regulators, and ultimately have transformative effects on the quality and conduct of financial policy.

Deborah Lucas is the Sloan Distinguished Professor of Finance at MIT Sloan and Director of the MIT Center for Finance and Policy

In Shanghai, charting the future of global finance

Third MIT Sloan finance forum examines interconnected finance systems and China’s role in the world economy

Professor Robert Merton

More than 200 finance professionals and MIT Sloan alumni gathered in Shanghai this month for a day of discussion on the future of modern finance, the third in a series of forums that bring MIT Sloan faculty around the world for frank discussions about finance and policy.

“[MIT Sloan] has the responsibility to lead and develop what the world needs for finance,” dean David Schmittlein told the audience at the July 19 event. “It’s important for us to develop the concepts and methods that will allow us to develop the complex, sophisticated financial systems that the world needs, with a resilience that the world also needs.”

“The world needs more smart people who understand complex financial systems,” he said. “Not less.” MIT Sloan this year launched the MIT Sloan Center for Finance and Policy.

Sound modern financial systems are built using expert knowledge to interpret vast amounts of data. To contribute to the discussion, MIT Sloan professors Deborah Lucas, Robert Merton, Jun Pan, and Stephen Ross shared their latest research on financial models and systems that address some of the challenges in modern finance.

And MIT Sloan alumni covered a range of topics in two panels. On one, two of China’s top financial professionals discussed the role of finance in emerging markets, while another group discussed ways to lead the financial organizations of the future.

Finance is becoming increasingly important for emerging markets

Shanghai, China’s financial capital and aspiring world financial center, was an apt location to discuss the role of finance in the growth of emerging markets. Leaders in emerging markets are seeking to better manage growth, gathering more knowledge and talent from the financial field than ever before.

“The era when very few Chinese financial professionals were up to date with the latest academic research findings is over,” said Haizhou Huang, managing director and head of the sales and trading department of China International Capital Corporation. There is an “ever-increasing number of Chinese financiers being educated at leading institutions like MIT Sloan,” he said.

Emerging markets are also challenging the post-2008 financial crisis system. Huang pointed out the benefit of China’s lack of heritage in finance, suggesting it gives China “an opportunity to create finance for the future, with a completely new financial system.”

Interconnectedness in finance can be a strength

Increased interconnectivity of global financial markets, a phenomenon of the modern financial system that was widely commented on during the crisis, was a key theme throughout the forum.

Professor Robert Merton, a Nobel laureate, introduced a new approach for analyzing and managing macro financial risks by leveraging the many connections between financial bodies that makes the world of finance so complex.

Merton’s goal is to “figure out ways to convey information with vast connections and numbers in a fashion that’s useful in trying to understand what’s going on.” He believes his approach will help guide finance professionals toward asking prescient questions when examining global markets.

Rather than view the complicated interconnectedness of financial systems as problematic, Merton was optimistic.

“The mere observation of growing connectedness is not in itself a suggestion of contagion or systemic risks. It may even be a reflection of the improvements in the global system,” he said.

MIT Sloan has also held finance forums in New York City and London.