TOPICS > Economy

From Lending Rules to Job Woes, Economic Tumult Persists

March 13, 2008 at 6:10 PM EST
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Treasury Secretary Henry Paulson called for tougher rules for mortgages lenders Thursday, while investment fund Carlyle Capitol faced collapse after defaulting on $16 billion in debt as a string of new reports this week signaled continued weakness in the U.S. economy. Economic experts offer insight.
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RAY SUAREZ: There were new and disturbing signs this week signaling more economic pain ahead. The dollar is at record lows, oil prices at record highs, and a report out today found retail sales were down more than expected last month.

On Wall Street, more troubles. The investment fund Carlyle Capital Corporation neared collapse today after defaulting on $16 billion of debt.

Official Washington has tried to help restore order. Earlier this week, the Federal Reserve offered to pump as much as $200 billion into the financial system to help banks and brokerages.

And Secretary Paulson’s pledge today to toughen lending rules was aimed at preventing a future crisis.

To help us understand what’s happening, we turn to Mark Zandi, chief economist for Moody’s Economy.com, and Alan Blinder, professor of economics at Princeton University. He was vice chair of the Federal Reserve from 1994 to 1996.

And, Professor Blinder, listening to that litany of a low dollar, high oil, low consumer confidence, are all these things related to each other? Are they connected?

ALAN BLINDER, Former Economic Adviser to President Clinton: I think they are. All of these are various aspects or most of them are various aspects of a weak and weakening economy. Whether we’ll have a technical recession or not remains to be seen. We might.

But even if we don’t, we’re skittering along at very miniscule growth rates. And a lot of this, frankly, traces back to the housing problem, which is causing the financial travails. It is also weakening the economy.

RAY SUAREZ: Mark Zandi, do you agree that the housing problem is sort of the first domino to tumble?

MARK ZANDI, Chief Economist, Moody’s Economy.com: Yes, most fundamentally, that’s absolutely right. The housing market is a mess. Since it peaked over two years ago, housing starts are down 60 percent. Home sales are down 35 percent. And, most importantly, house prices are down 10 percent nationwide.

That’s leading to mortgage defaults and foreclosures, which is undermining the value of mortgage securities, and just creating turmoil throughout the entire financial system. So at the root is what’s going on in the housing market.

Federal response

Mark Zandi
Moody's Economy.com
I mean, the housing market, the mortgage market, outside of what Fannie Mae, Freddie Mac and FHA do, is completely dead.

RAY SUAREZ: So what did the Federal Reserve do -- mechanically, what did they do in response?

MARK ZANDI: Well, two days ago, they said, "We're going to take treasury securities and we're going to trade those for mortgage securities, high-quality mortgage securities," securities that are backed by Fannie Mae and Freddie Mac, implicitly backed by the federal government, and so-called AAA-rated mortgage securities, very low probability default on these securities.

And the idea is to try to shore up these markets. I mean, the housing market, the mortgage market, outside of what Fannie Mae, Freddie Mac and FHA do, is completely dead. They were fearful that the market that Fannie and Freddie and the FHA operate in was starting to come under pressure. And this was an attempt to shore it up, to help it out.

RAY SUAREZ: Professor Blinder, you're very familiar with the Fed. Is this, compared with other responses in other downturns, aggressive action by the Federal Reserve Bank?

ALAN BLINDER: Yes, I think it's very aggressive. This is a very unusual step for the Fed to take, I think an intelligent step. It's not going to solve the problem, but it will ameliorate it around the edges. It is not the sort of thing the Fed likes to do, by any means.

And also, Mark didn't mention, but of course, as you know, the Fed's been cutting interest rates aggressively and is probably going to do that again in another week.

RAY SUAREZ: Let's talk a little bit about Carlyle Corporation. Now, here, at a time when people are trying to pump liquidity in, stabilize things, calm the waters, a company that borrowed $21 billion from some of the biggest banks in the world seems to be on the verge of evaporating. How did that happen?

MARK ZANDI: Well, this goes to Dr. Blinder's point that what the Federal Reserve is doing is going to help, but it's not going to solve the problem.

Carlyle Group set up a fund. It took investors' money. The fund was to invest in mortgage-related securities, high-rated securities. But they borrowed money to do that so they could make a high return.

Of course, the value of those mortgage securities have fallen with the erosion in the housing market and the erosion of mortgage quality. Lenders say, "You don't have enough there of your own investment. You've got to put more money in."

The Carlyle Group says, "We're not going to do that." So the banks pulled the plug and now own the securities that the Carlyle Group used to own.

Securities rating system

Alan Blinder
Princeton University
[T]hat word, AAA, has gotten thrown around so horribly, with such abandon that it's lost all meaning. I don't think investors trust it anymore.

RAY SUAREZ: Now they own the securities. Well, Professor Blinder, if I understand this correctly, much of the securities that are being taken back by these lenders and investors are AAA-rated securities. Does that mean that we have to take another look at what AAA means or it's not as solid as it sounds?

ALAN BLINDER: Absolutely. I mean, that word, AAA, has gotten thrown around so horribly, with such abandon that it's lost all meaning. I don't think investors trust it anymore.

It's had different meanings for different sorts of securities. So a AAA municipal bond is not the same as a AAA mortgage-backed security. A lot of people didn't understand that; a lot of people believed these AAA ratings when they shouldn't have.

And that's one of the many things that -- you know, we were supposed to have mechanisms that stopped something like this from happening. That's one of the many mechanisms that failed and got us into this problem.

RAY SUAREZ: Well, Mark Zandi, the president's working group tried to take another look in its most recent report at these mechanisms, the built-in protections. And in part, Treasury Secretary Paulson said, "We've determined that market participants' behavior must change."

So is he blaming what's happening now on the people who make the market operate the way it does?

MARK ZANDI: Yes, I think he is. And there's plenty of blame to go around: the guys who originated the mortgages; the Wall Street firms that securitized and sold them off; rating agencies involved in rating the securities; and, most importantly, regulators, the regulators themselves really didn't see this coming and didn't forestall it, and they probably should have.

And I think today's efforts or announcement by the treasury secretary is to say, you know, the regulatory framework, the regulatory structure didn't keep up with the pace of financial innovation. We've got to change that; we've got to make the regulatory system come up to date.

And hopefully -- it's not going to help today's problems. It means nothing for what's happening today. But hopefully we forestall something like this happening in the future.

Helping the housing market

Alan Blinder
Princeton University
As you know, we've been seeing Secretary Paulson kind of migrate. I mean, he does come out of a Wall Street background. He understands these markets. He was participating in them for many, many years.

RAY SUAREZ: Well, Treasury Secretary Paulson came to the job, Professor, from the investment banking world. And weren't the Paulsons of the world pushing in the other direction for the last 20 years, toward less deregulation, less oversight -- excuse me, less regulation, less oversight, more freedom on the part of banks to lend as they see fit?

ALAN BLINDER: There's no doubt about it. They absolutely have. And they got a lot of that freedom, and they ran with it.

As you know, we've been seeing Secretary Paulson kind of migrate. I mean, he does come out of a Wall Street background. He understands these markets. He was participating in them for many, many years.

And at first, he was very reluctant to move away from laissez-faire and into the direction of regulation. I mean, with this step -- and of course, it's not him alone. It's the whole group of agencies. But with this step, there's another substantial movement in the direction of tightening up the regulatory regime, which, as you say, had been loosened substantially.

RAY SUAREZ: So what now? Today, out of the House and Senate came plans from Chairman Barney Frank and Chairman Chris Dodd of the respective Banking Committees talking about shoring up hundreds of billions of dollars worth of shaky-looking home loans.

Is it medicine that's going to work? Is it something that can even pass? The president's not too happy about it.

ALAN BLINDER: So are you asking me, Ray?

RAY SUAREZ: Yes, please.

ALAN BLINDER: Passing is another question. I hope and think maybe the president will get happier and happier about it as time goes by and this problem festers and gets worse. I mean, attitudes in the administration are visibly changing.

I think something like this is necessary. I myself advocated a plan analogous to these, though not exactly the same, in the New York Times a couple of weeks ago.

These two versions coming out of Congressman Frank and Senator Dodd are quite similar to each other and similar in spirit to what we did during the Great Depression, which is the last time we had such a wave of foreclosures to cope with.

I hope that they will pass. I hope they will get more and more political support. I think, if and as they do, the markets are likely to start improving, because these would be very big steps to resolving not fully, but partially resolving the mortgage mess that we're in now.

Consumer confidence

Mark Zandi
Moody's Economy.com
Oil prices are rising, we're at record highs, and gasoline prices are sure to follow. We may be looking at $4 for a gallon of gasoline come Memorial Day, if things don't change soon.

RAY SUAREZ: Are these the kinds of things, these concerns, that feed into what we saw in consumer confidence and retail sales this week and last?

MARK ZANDI: Absolutely. I mean, there's nothing going right for consumers, for households. Obviously, the problems in the job market, we're losing jobs. We've lost jobs for three months. The stock market is down, about 15 percent from its peak.

Oil prices are rising, we're at record highs, and gasoline prices are sure to follow. We may be looking at $4 for a gallon of gasoline come Memorial Day, if things don't change soon.

And, of course, the housing market. House prices are down. For most of us, our home is our most important asset, and it's now down at least 10 percent, in some parts of the country 20 percent, 25 percent from the peak. So when you add it all up, it's a very difficult picture for consumers.

They have lost confidence. Confidence is as low as it's been since the early '90s and the recession of the 1990-'91 period. And they're pulling back: Retail sales fell today. And that's a very clear sign that the economy, if not in recession, we're just right there.

RAY SUAREZ: Is that a lagging indicator, though? Will things have to be better for a while before consumers actually say, "I don't have to grip my wallet quite so tightly any longer"?

MARK ZANDI: You know, not at turning points in the economy. Generally confidence just reflects economic conditions, unemployment rates, gasoline prices, what's going on.

But at turning points, when we go from a weak economy to recession, the causality shifts and it's confidence that drives the economy down. It's this loss of faith in the economy. It's when the businesses pull back on their hiring and they start laying off and it's when consumers start pulling back on their spending.

So it's that loss of confidence that is the difference between a weak economy and recession. We've lost the confidence, and it feels like recession to me.

RAY SUAREZ: Mark Zandi, Alan Blinder, gentlemen, thank you both.

ALAN BLINDER: Pleasure.