January 27, 2010

Crisis and the Curriculum

Last May, Dean Glenn Hubbard asked a group of faculty members to form the Crisis and the Curriculum Committee to look at how the School should address the financial crisis.

Topics: Leadership

Last May, Dean Glenn Hubbard asked a group of faculty members to form the Crisis and the Curriculum Committee to look at how the School should address the financial crisis. Their conclusion — that the crisis has heightened the importance of contextual thinking — validates one of the aims of a Columbia Business School education: to prepare leaders who can connect the dots.

Meeting over the summer of 2009, the committee worked to identify the themes that defined the causes and consequences of the crisis — which also had permanence for business education. They identified four: agency and governance; leverage and risk; bubbles and behavioral biases; and regulation and the role of government in business.

Four Themes That Contributed to the Crisis

Agency, incentives, compensation and governance: Unsuitable mortgages, opaque securitization, compromised credit ratings and large bonuses tied to short-term gains have all featured prominently in the unfolding of the crisis, and reflect problems of agency, incentives and governance. The pipeline leading from the origination of subprime mortgages through the banking system to the capital markets has been fraught with conflicts of interest and separations between actors and consequences. The incentives created by the compensation system in financial services and by proposals for changing that system have been at the center of some of the most heated debates surrounding the crisis.

Measuring leverage and risk: Prior to its demise, Lehman Brothers, like all the leading investment banks, was a phenomenally leveraged business, and its leverage produced both exceptional profits and vulnerability to risk. Capital requirements for banks, despite their evolution towards greater sophistication, failed to adequately gauge risk and capture new forms of leverage. Beyond the financial system, excessive leverage has contributed to and magnified the crisis through high levels of debt at the household and national levels.

Bubbles, overconfidence and behavioral biases: The sharp declines in the stock and real estate markets at the center of the crisis have renewed a longstanding debate over the extent to which markets can be understood as the result of rational decision making, and the role of behavioral biases like overconfidence in shaping financial outcomes. The real estate bubble leading up to the crisis, like previous bubbles, has raised questions about the extent to which markets are efficient and driven by fundamental value. An understanding of consumer behavior in the face of financial decision making is likely to play a more prominent role in future financial regulation — for example, in redesigning disclosure requirements for mortgage lending.

Regulation and the changing role of government in business: The financial crisis cannot be understood without an examination of government actions before, during and after the crisis. A monetary policy that kept interest rates low, a regulatory regime with a high degree of confidence in market discipline, and even programs to encourage home ownership were significant in the lead up to the crisis. The Treasury and Federal Reserve have taken unprecedented and even controversial measures to try to stave off a worsening crisis — measures that are likely to have lasting effects on the economy and on reshaping the regulatory landscape. Political acumen has had newfound importance in separating surviving and failing financial institutions. Fannie Mae, Freddie Mac and even General Motors have been put in government receivership. All of these developments suggest a new prominence for the role of government in the world of business.

Crisis and the Curriculum Committee Members

David Beim
Professor of Professional Practice in Finance and Economics

Joel Brockner
Phillip Hettleman Professor of Business

Paul Glasserman
Jack R. Anderson Professor of Business

Trevor Harris
Arthur J. Samberg Professor of Professional Practice

Wei Jiang
Associate Professor of Finance and Economics

Eric Johnson
Norman Eig Professor of Business

Bruce Kogut
Sanford C. Bernstein & Co. Professor of Leadership and Ethics

Chris Mayer
Senior Vice Dean and Paul Milstein Professor of Real Estate

Stephen Zeldes
Benjamin Rosen Professor of Finance and Economics

Amir Ziv
Vice Dean and Professor of Accounting

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