ROBERT SIEGEL, host:
One of many concepts that I have trouble mastering in the multiple meltdowns on Wall Street is this, how much damage could all those subprime mortgages do to bring down this many lenders, brokers, bankers, and investment houses? I understand that those risky mortgages were sold after they were stuffed into securities like slices of rotten provolone in otherwise non-toxic subs, but how did those slices of bad cheese manage to throw off the whole food chain? For answers, we've called upon economist Kenneth Rogoff, who has been able to untangle other mysteries of this situation for us. Welcome back to the program.
Dr. KENNETH ROGOFF (Economics, Harvard University): Thank you.
SIEGEL: Let me start with this, would that it were only hypothetical. A lender makes 10 risky subprime mortgages totaling a million dollars, and they're sold off in collateral debt obligations. In the end, do those mortgages do more than a million dollars worth of damage?
Dr. ROGOFF: Well, no. And you're absolutely right that the amount of money that's been lost in the subprime pales next to the meltdown of the dot com. But there were a few factors that's made it have a much bigger effect. First, the debt was concentrated in a relatively small number of banks. It wasn't supposed to be. It was supposed to be spread out in Germany, in Kazakhstan, but it was. Second, these small number of banks holding all this debt were using very short-term loans to buy it.
Now, that's fine if you think you're a master of the universe, as many of these investment banks did, and everyone will always want to lend you money, but it's very fragile. So, when one bank ran into some problems, it started having to dump its debt on the market. That drove down the price for other banks of their holdings, and they had trouble rolling over their money. And the problem just began to cascade through the system.
SIEGEL: Now, the first point that you made is, well, it's counter to some of what seemed to be conventional wisdom last year. We kept on hearing about how your subprime mortgage would end up somehow in the coffers of some municipality in Norway that had bought bonds. It stressed how global and how far removed from the point of origin mortgages were. You were saying it's actually a fairly close-knit club here that was deeply engaged in the stuff.
Dr. ROGOFF: Yeah. I mean, it did hit Kazakhstan, and it did hit German banks, but a lot of it ended up being housed in the United States and our banks. But in this complicated way, banks created these special sub-banks, the so-called vehicles, to try to park the money in another place. But the problem is, they really had to pull them back onto their own balance sheet when things went wrong. So if you are a regulator, and you came in and looked at the bank's balance sheet and said, oh, it looks fine. I don't really see a problem. But then, all of a sudden, something goes wrong, and where did this bad debt come from? So that it was much more concentrated than anybody realized.
SIEGEL: Everyone seems to agree that what is needed right now is better, and in some cases, some people even say more regulation, not a common demand we've heard of our politics recently. But what kind of regulation do you think we would actually need to avoid this happening again or to set it right after it's happened?
Dr. ROGOFF: I mean, the best kind of regulation is regulation that makes the bankers, makes the investors think their own money is at risk, and the government is not going to back them up every time, and that they're going to lose their own capital. And so raising requirements of how much cash they have to have of their own in their business is really the single most helpful thing. There's no debate about that.
There is a question of how much that should be, and probably, also, we'd like to have their businesses be a little more transparent and easy to understand. Part of the problem with the subprime debt, this subprime mortgage debt, is nobody quite understood what these complicated obligations were.
SIEGEL: Economist Kenneth Rogoff, professor of economics at Harvard. Thank you very much for talking with us.
Dr. ROGOFF: Thank you.
SIEGEL: In these complicated economic times, every day brings new questions. And we'd like to hear yours about Lehman Brothers, AIG, and the meltdown on Wall Street. We'll collect them, and we'll try to offer some answers on air. You can write us by going to npr.org. Click on contact us at the top of the page, and in the subject line of your message, please write this phrase, economy question. Transcript provided by NPR, Copyright NPR.