Yale's Swensen: U.S. Should Have Learned Lesson in '87, '98

Yale endowment manager David Swensen, who has been one of the most successful institutional investors in the world for the past two decades, tells Charlie Rose that the underlying problems involved in the current financial crisis are similar to those from the 1987 and 1998 crises — and that the country now needs to learn the lessons it failed to learn from those previous incidents.

Swensen said that ’87 and ’98 both involved extensive use of problematic derivatives and massive off-balance sheet exposures. “Now we’ve got exactly the same forces contributing to the crisis that we’re currently experiencing,” he said. “Unfortunately the crisis in ’87 and the crisis in ’98, both of those were resolved too quickly and there wasn’t a regulatory response.” (A special thanks to The Big Picture for highlighting this interview.)

Swensen in particular cited the demise of Long-Term Capital in 1998 as an example of the government failing to learn lessons that would’ve prevented the current crisis. “People focus on the idea that [Long-Term Capital] had $5 billion of equity and $150 billion on the balance sheet, but it was actually supporting $1.2 trillion of positions” because of its massive off-balance sheet exposure, he said.

Swensen said the government needs to make it its business to understand the magnitude of the derivative and off-balance sheet exposure in the market. “That was a lesson that was clear in 1998,” he said. “But even today we don’t know where these derivatives are and what the magnitude of these derivatives are.”

As for the current crisis, Swensen said the government needs to focus more efforts on helping those in the mortgage markets — and adds that markets involving other types of debt, like credit cards, auto loans, and corporate debt, also need to be addressed. And he says talk of economic recovery is premature. “I think that we can’t even talk about when the economy will mend itself until the financial system is fixed,” he said. “Right now, the financial system is broken. Period. Unless we get credit flowing freely again, you can’t begin to talk about economic recovery.”

Still, Swensen says that the country has survived the financial crisis. “One of the things that I always remind myself no matter how dark things look, no matter how dire they are: This is an incredibly resilient system,” he said.