Lapse over Lehman

According to Siegel, federal officials -- particularly outgoing
Treasury Secretary Henry Paulson ­-- mishandled initial efforts to
intervene in the crisis. For example, Paulson was concerned about the
political backlash that might be unleashed by bailing out Lehman
Brothers. He allowed the firm to collapse last September but
underestimated the impact of Lehman's demise on financial markets.
Despite a $700 billion bailout, banks are still unwilling to extend
credit, Siegel said.

Siegel told his student audience that in many important measures, the
economy is not nearly as battered as it was during the early 1980s,
when unemployment, inflation, and interest rates were all considerably
higher than they are today. Stocks -- as evaluated by their
price-to-earnings ratios -- are undervalued to the point where they
could draw enough investors to spark a recovery before the end of 2009.
"I'm actually an optimist," said Siegel. "I think by the second half of
this year, things might turn around faster than people are now
predicting."

While angry investors and taxpayers are anxiously looking to assign
blame for the current state of the economy, it's important to know not
only which factors led to the meltdown, but which ones did not. He said
that government programs encouraging home-buying by low- and
middle-income families and short-selling of financial stocks -- which
was halted for a time last fall -- have little to do with the crisis on
Wall Street.

Instead, Siegel pointed to two interlocking issues: One is a massive
failure, not only by traders, but by CEOs of financial firms, their
risk management specialists and the major rating agencies to recognize
that an unprecedented housing-price bubble began building after 2000.
Their faulty reasoning was that the inability of homeowners to pay
their mortgages -- and the consequent foreclosures -- would not pose a
threat to their mortgage-backed securities. They believed that as long
as home prices kept rising, the underlying value of the real estate
would provide a hedge against the risk of such defaults. They failed to
realize that this reasoning was based on the assumption that home
prices would go in just one direction -- up. In fact, these assets
became enormously risky once the housing bubble burst and home prices
began their inevitable decline.

Siegel also argued that ultimately, the buck stops with corporate CEOs
who didn't ask hard enough questions about the risks posed by
mortgage-backed assets. He said he and others have wondered why firms
like Lehman Brothers, Bear Stearns and Morgan Stanley -- which survived
the much more severe Great Depression of the 1930s -- collapsed during
2008. One reason, he suggested, might be that, back then, these firms
were organized as partnerships. In such an organizational structure,
the partners would have to risk their own capital. When the
partnerships were reorganized as widely held public companies, however,
they no longer had such constraints. "Back when it was a partnership,
you had your life invested in that company," said Siegel, noting that
banks also began making higher-return but higher-risk investments in
recent years as public ownership increased.