View From MIT: A Depression Still Avoidable

A chat with the dean of MIT's Sloan School of Management


I spoke recently with David Schmittlein, dean of MIT's Sloan School of Management. Here are some of his thoughts about the recession's impact on corporate America, entrepreneurs, and the ambitions of business school students:

What will it take for Treasury Secretary Timothy Geithner's bank bailout plan to work?

It's an opportunity to get some of those toxic assets off their books, but I'm not sure it matters how much of that stuff they get off their books. The banks increasingly know what these assets are. Over the last six months, they've put a whole lot of effort into understanding that. Now there's a pretty good inventory of what those bad assets are. That's not the same thing as valuing them, and the private firms in this partnership will mainly be the ones that value those assets. I really wonder how many firms will want to get into a public-private experiment if Congress is setting a midmanagement pay scale. You have to ask, do you trust the government to keep its hands off your business?

[See how bailouts can butcher capitalism.]

How will we tell if it's working?

I want to see buyers willing to jump in. I'm not as concerned about sellers. The overall economy matters, too. If this program works, then the global economy will improve. If the global economy improves, then those assets will become more valuable. It becomes circular. Won't some of the big investors buying these assets be the same banks or other institutions that got bailout money in the first place?

Possibly. Everything we're talking about is a mechanism for sharing the losses. Everybody's going to share in this. The question is how big are the overall losses. And everybody loses more if the economy takes longer to recover. There will still be huge losses even if the economy recovers quickly. There's not enough money in all the financial firms to bear all the losses. We're spreading the cost among 300 million Americans. How bad do you think the whole situation will get?

We still have a great opportunity not to have a depression. It's quite likely that success will lead to a moderately robust economy and some inflation, in a few years. [See a tally of $2 trillion in bailouts-so far.]

What's your biggest concern?

The biggest downside scenario is protectionism. That could create political instability and more bad economic news. Is this just a cyclical thing in corporate America? Or is it a crisis? A lot of firms are doing OK, basically hunkering down until the economy improves.

I think it's a crisis. Some companies aren't that affected. Procter & Gamble might be down a little bit, but they'll be OK. In technology, there are still opportunities to grow. But in some ways, it feels like we're speeding up history. Global banking was moving away from New York—and away from London, too—and now that's been sped up dramatically. Where's it moving to?

Abu Dhabi. Moscow. Beijing. The seventh-biggest bank in the world is now Brazilian. Banco Itaú. That's because there are no mortgages in Brazil. If you buy a house, you buy in cash. [See more companies that could fail.]

What about entrepreneurs? It's a tough time to start a business. Are venture capitalists still funding new businesses?

There are two fundamental jobs in capitalism: Take capital and use it to innovate. And take risk and assign it to people willing to bear it. In other words, get capital and risk to the right places. If you're a VC, you have to ask, are you willing to make a bet where the odds of success are 1 in 3? Right now, the answer is no. But it's never more than 1 in 3. We tend to think there are thousands of brilliant ideas going to venture capitalists. There aren't. What are some indicators that will tell us the economy is starting to improve?

One indicator of a recovery will be reliable access to mortgages, which means you can get mortgage money with decent credit and 20 percent down. Including jumbo mortgages. Also, obviously, when unemployment bottoms out. When that doesn't look like it's getting worse anymore, that will be a good sign. A lot of savvy investors look for a slowdown in losses rather than an actual bottom. Can the Detroit auto companies recover?

It's hard to construct a midterm scenario of success for the U.S. auto companies. I don't understand why they don't declare bankruptcy now. Their customers are going to go away eventually. They've got to get out of that fundamental situation. [See why booting CEO Rick Wagoner wont solve GM's woes.]

I'm guessing applications to Sloan are up. With the job market so bad, the opportunity cost of going to graduate school is lower now.

Our applications are up 33 percent over the last two years. One upside is that our students are actually starting to think, "What will make me feel fulfilled?" You mean instead of graduating and going straight to Wall Street to make $50 million?

Right. It used to be, if you didn't earn that kind of money, you were the doofus of the class. Or if you weren't on a plane six days a week, you were a loser. Now our students are thinking about other things. I met one graduate recently who went to work for American Airlines. He said, "I may or may not be here forever, but I like the challenge." They're still not all that interested in manufacturing companies, though, to the extent that you just become a small part of this giant bureaucracy. They want to find ways to make a real difference.