Credit crunching, rate rising, and recession fearing: pessimistic phrases that sum up the current U.S. economy. As the housing industry struggles to stay afloat, the Fed continues to cut interest rates and balloon the economic bubble. While the government brainstorms new methods of recession prevention and plans a hopeful economic rebound, Americans wonder: when will normalcy be restored? Could this situation have been avoided?

Though there is no way to predict economic pitfalls and therefore eliminate them, preparation can prevent added panic and anxiety. Mays Business School at Texas A&M University plays a role in this preparation. With courses focused on the changes and history of financial markets, Mays faculty makes it their goal to prepare students, so that when future economic crises arise, the next generation of business leaders is ready for the challenge.

Pop goes the bubble
How did we get here?

As students evaluate the current economy and hope to glean some insight, Clinical Associate Professor of finance Amanda Adkisson offers this brief analysis of recent events:

  • Economic bubbles form when the price of any market asset rises rapidly.
  • In the case of today’s bubble, easy credit through mortgage lenders skyrocketed the price of houses, as more people could afford to buy them.
  • People experience what Alan Greenspan refers to as “irrational exuberance,” which can cause asset prices to disconnect from normal valuation principles.
  • The bubble pops when something brings investors back to their senses. In this instance the credit crunch and sub-prime debt crisis have put the current bubble in popping mode.
  • Investors now recognize the risk of losing their purchasing power, creating unusual market volatility in areas other than the mortgage market, leading to a general market decline.

According to Mays Clinical Associate Professor Amanda Adkisson, a bubble forms when asset prices rise rapidly, causing them to disconnect from normal valuation principles. But this isn’t anything new—in 2000, investors experienced the burst of the tech stock bubble, one of many similar economic situations in American history. The current situation is unique and more challenging, however, because it involves homes. In most households, the home is the single most valuable asset, one which should give families a sense of economic security.

In Adkisson’s opinion, the credit problem and housing meltdown can be related to the price of gasoline, the rate of inflation, and the political turmoil in the Middle East—all situations of great uncertainty that have created economic pain for consumers. As the government raised interest rates to head off inflation due to rising oil prices and the War on Terror, the housing market cooled. Suddenly, the credit markets realized that homeowners faced a perfect storm of declining home values with escalating mortgage payments, and rising gas and food prices—effectively strangling their purchasing power.

“Uncertainty makes people worry more about what might happen in the future. Because people are risk averse, they are more sensitive to negative outcomes,” said Adkisson. She adds that increasing American negativity regarding the national economy could lead to even more volatility, threatening the broader financial system.

Class, what have we learned?

While it is crucial to realize that there is no surefire way to prevent economic bubbles, they can be avoided. Adkisson cites a study conducted by financial expert Ross M. Miller as evidence to this claim, explaining that learning from past mistakes in times of economic crisis is the best way for investors to better prepare for future financial obstacles. Adkisson says this research explains why investors become less adventurous as they age.

Warren Buffett
Warren Buffet’s “Mr. Market” philosophy is a main topic of discussion in Britt Harris’ Titans course.

“If you experience a bubble directly, you learn from it. The problem is, you don’t learn to avoid a bubble by watching someone else experience it,” said Adkisson.

Experience plays a crucial part in avoiding poor economic conditions, but it must also be complemented with knowledge of history. One way Mays faculty focuses students’ attention on financial lessons from the past is through the Titans course, brainchild of Thomas Britton “Britt” Harris, chief investment officer for the Teacher Retirement System of Texas. The course aims to focus on short-term technical competence while providing an understanding of past economic conditions.

“The idea for the course was spawned partially by the observation of how many supposedly smart and experienced people (CEOs, etc.) totally missed the last bubble, and in fact contributed significantly to it. How could that be, as these were the smartest, most experienced, best-resourced and most successful men and women in the world?” Harris explained.

The Titans discuss Warren Buffet’s “Mr. Market” philosophy and behavioral finance, review every economic bubble in the past 200 years, and study hedge fund evolution to teach the necessity of choosing wisdom over technical knowledge. Harris gives students a “real” market experience by requiring them to compete against classmates while managing their own “paper” portfolios, reporting weekly on the state of their virtual investments. Through this, the students keep track of the current economic situation and become aware of the best ways to maintain successful investments regardless of the financial environment.

The final evaluation: don’t panic!

This focus is not restricted to only the Titans class; the Department of Finance also engages aspects of economic preparation and awareness throughout its various classes, presenting classic financial theories that relate to the rapid adjust of prices in volatile markets.

Executive Professor of Finance Cydney Donnell cites the “fad” that often produces today’s economic situation: the fear of losing everything causes investors to perpetuate existing bubbles by taking advantage of the easy credit and failing to closely analyze capital movement. Because of this, she warns students to not accept conventional wisdom and to always ask questions. “Much of the Wall Street mechanism is built on selling investment ideas to investors; many have merit and some don’t. You have to investigate on your own, you can’t just accept the popular theory,” said Donnell.

As for today’s investors, Donnell says it’s important to keep a few things in mind and proceed with caution as assets become more attractive when market prices fall. “The best plan is to stick with the asset allocation and make investments over time, adding a little every year. Then, make sure to rebalance if things get out of whack,” she said. She also counsels students that it can better to make only a few investments and forget about them rather than be overanxious and constantly tweak one’s portfolio, a trait common to young stock market players.

Above all, it’s important to remember that the U.S. economy goes through cycles, suggest Adkisson and Donnell. So have no fear: with proper knowledge and the help of Mays faculty, students can look forward to a brighter financial future.