TOPICS > Economy

Paul Solman Walks Through Wall Street’s Wild Week

January 25, 2008 at 6:05 PM EST
Loading the player...
Wall Street and global financial markets took a dive this week, fueled largely by concerns over a slowing U.S. economy. Economics correspondent Paul Solman explains the wild week on Wall Street, and explores the larger causes behind the turmoil.
LISTEN SEE PODCASTS

TRANSCRIPT

JIM LEHRER: That wild trip down Wall Street and similar places this week. Jeffrey Brown begins with this report.

JEFFREY BROWN: When the closing bell rang this afternoon at the New York Stock Exchange, the Dow Jones Industrial Average had ended the day not that far from where it had begun the week.

But what a week it was, of markets in seeming panic at several points, policymakers and regulators trying to stem the fall, and a huge case of fraud thrown in for good measure.

It began Monday, when U.S. markets were closed for the King holiday weekend. Overseas, international markets plunged, some as much as 7 percent. Fears of their continuing vulnerability to the slowing U.S. economy were cited.

In turn, the Dow Jones Futures Index in the U.S. dropped more than 500 points, signaling trouble to come.

Tuesday morning, before trading opened, and in advance of its regular meeting, the Federal Reserve made a surprise and nearly unprecedented move: cutting the key federal funds rate by 0.75 percent, dropping the rate to 3.5 percent.

When U.S. markets opened an hour later, though, the Dow went into a nosedive, dropping 450 points in a few minutes.

ALEC YOUNG, Equity Analyst, Standard and Poor’s: It’s going to take more than rate cuts. Rate cuts are just positive steps to maybe stimulate the economy down the road.

JEFFREY BROWN: But as a tumultuous Tuesday wore on, the Dow managed to climb back into something of a symbolic victory, ending the day down, but only 128 points.

Wednesday turned out to be the wildest day of a manic week. Markets in Asia seemed to stabilize, but their European counterparts tanked, as the central bank on the continent said it would not mirror the Fed and cut interest rates.

In the first hour of trading in New York, the Dow followed suit, dropping 300 points. But two pieces of news during the day were said to have pushed it in another direction. Word leaked from Washington that a deal on a stimulus package between the Bush administration and House leaders was close.

And there were reports that New York state insurance regulators were taking steps to prop up two major bond insurers, MBIA and Ambac. The insurers have been hit with enormous losses on mortgage-related financial securities.

For its part, the Dow not only made up its losses, but kept going, closing nearly 300 points up, a 600-point swing from early trading.

On Thursday, there was more news for the markets to deal with, as word came from Europe of the largest financial fraud in history. Societe Generale, one of France’s most respected banks, revealed that a rogue trader had lost $7 billion in bad trades and risked tens of billions more.

Back in Washington…

REP. NANCY PELOSI (D-CA), Speaker of the House: Today, the leadership of the House of Representatives, on a bipartisan basis, is responding to the weakening economy and the urgent economic needs of the American people.

JEFFREY BROWN: … Speaker Nancy Pelosi, Republican Leader John Boehner, and Treasury Secretary Paulson announced a $150 billion stimulus plan that will give tax rebates to more than 100 million Americans, allow further business tax cuts, and help out troubled homeowners facing foreclosure.

A short time later, the president praised the deal and sought to soothe the nation’s nerves.

GEORGE W. BUSH, President of the United States: I know Americans are concerned about our economic future. Our economy is structurally sound, but it is dealing with short-term disruptions in the housing market and the impact of higher energy prices.

JEFFREY BROWN: The Dow closed up yesterday 106 points. But today, early gains were washed away, and the average fell 171 points, as investors seemed to rein in their optimism about avoiding a U.S. economic slowdown.

So what was going on this week? Our own economics correspondent, Paul Solman, joins me now.

Panic leads to selloffs

Paul Solman
Economics Correspondent
You have this self-fulfilling prophecy, the self-fulfilling downward spiral. Yes, that's the story of what happened over the weekend and the beginning of week, Monday.

JEFFREY BROWN: Well, Paul, if you look at the anatomy of the week, even before trading began there was a lot of nervousness out there.

PAUL SOLMAN, NewsHour Economics Correspondent: Yes, well, we've been in a period of high volatility, big swings, and in Europe, in Asia, lots of concern about the engine of world growth -- the United States, we buy so much of their stuff, after all -- going into recession, lots of talk about that at the end of the week, more talk about the subprime crisis.

Do we really know everything there is to know? Is there more, other shoes to drop? And the idea that the markets abroad have been doing so well after having tanked last summer, maybe there's a bubble there.

JEFFREY BROWN: It now looks like -- at least some people seem to be suggesting -- that when the markets open on Monday in Asia and Europe, this French bank's problems that we cited in the set-up, it may have been having an impact before we knew.

PAUL SOLMAN: Right, because the idea is that the rogue trader had been taking illegal -- for the bank -- positions, huge positions in European stocks. The bank didn't know about it, discovered it over the weekend, and now needed to unwind those positions, because international markets are going down -- were going down -- and selling into those markets very difficult thing to do, they were trying to...

JEFFREY BROWN: Unwind the positions means...

PAUL SOLMAN: Unwind, sell.

JEFFREY BROWN: Selling a lot of...

PAUL SOLMAN: And this is tens of billions of euros worth, this guy had accumulated positions which the bank didn't know about. So you've got to get rid of all that. So you're selling into a down market...

JEFFREY BROWN: It's already worried... So the traders on Wall Street on Monday -- I mean, the traders overseas on Monday morning, because Wall Street was closed -- they don't know about the rogue trader yet.

PAUL SOLMAN: Well, no.

JEFFREY BROWN: The world doesn't know that until later in the week, but they see something is going on.

PAUL SOLMAN: Well, they see the market is going down, going down fast. They're getting scared. And they're going, "I better get out the door before the other guy. I got to get out of my position."

And so you have this self-fulfilling prophecy, the self-fulfilling downward spiral. Yes, that's the story of what happened over the weekend and the beginning of week, Monday.

Government works out stimulus

Paul Solman
Economics Correspondent
An economic stimulus package, obviously, more spending, more money in people's hands. That means that the recession that people are afraid of might not happen, less likely to happen.

JEFFREY BROWN: Another event during the week, a couple of them, government and regulators, the Fed steps in early Tuesday morning. We have this stimulus package talked about and then agreed to during the week. What do people say about how that affects what happened, what effect it would have on Wall Street?

PAUL SOLMAN: Well, the simplest level, it's good for the economy long term -- lower interest rates stimulate the economy, there's more money in the economy. An economic stimulus package, obviously, more spending, more money in people's hands.

That means that the recession that people are afraid of might not happen, less likely to happen. If a recession happens, companies make less money, right? I mean, that's what happens.

If a recession doesn't happen, the companies make more money. They make profits. If you buy the share in a company, you are, in the most fundamental sense, buying a share in that company's future profits. Therefore, stimulus, Fed cut, looks like the economy will be better. The stocks that represent that economy...

JEFFREY BROWN: A chance for a turn-up?

PAUL SOLMAN: Better, yes. Well, now we're more optimistic. And on optimism, you buy into the future. That's the same basic story there.

JEFFREY BROWN: OK, now the least-talked about event -- and it occurred on that strange day on Wednesday, in the middle of the day -- we referred to it in our set-up -- is a New York regulator doing something involving these bond insurers, trying to prop them up.

First, tell us about these bond insurers. What do they do? And how did they get into trouble?

PAUL SOLMAN: Well, bond insurers only insure bonds. They're called monoline insurers, one line of insurance.

JEFFREY BROWN: That's their entire business?

PAUL SOLMAN: Yes, because if they're also insuring Katrina, let's say, Katrina happens, then it jeopardizes the bond market. So this is monoline, just one line of insurance.

Unfortunately, the bonds that they've been insuring, a lot of them are in real trouble. These are these pools of mortgages, right, mortgages pooled together. The money from the mortgages goes into the pool.

People who buy shares of the pool get that money. Ah, the mortgage holders stop paying, the pool holders stop paying. Those bonds out there, the collateralized or mortgage-backed securities, they're called, those things, what are they worth?

The money is not coming in, and they're getting downgraded. Well, but a lot of them were insured by these monoline bond insurance companies. That's great, until...

JEFFREY BROWN: And now those companies are in trouble.

PAUL SOLMAN: Right.

JEFFREY BROWN: So the regulator is going to Wall Street firms to try to raise some capital to back them up.

PAUL SOLMAN: Yes, to allay the fear. There were several suggestions that the economic stimulus package should be protecting the bond insurers, shore them up. And so this was something in the wind.

Now, it looks like something is being done about it and being done in a hurry -- this was on Wednesday -- and that, the story goes -- had a tonic, salutary effect.

Psychology played a big role

Paul Solman
Economic Correspondent
When I see these things plunge, I'm not doing anything with my asset allocation. And yet by not doing anything, I'm sustaining, you know, losses on a day like this and I feel the fear.

JEFFREY BROWN: OK, so things ended up Wednesday, things ended up Thursday. We fast-forward to today, the end of the week. By the end of the day, things are down. And I read to you this quote from a Wall Street Journal at the end of the day.

PAUL SOLMAN: This is online, I take it.

JEFFREY BROWN: Online. "Analysts said that concerns about the effects of the mortgage crisis have crept back into the market throughout the day. Now, that's where we were at the beginning of the week. Now, what does that mean? What are analysts worried about?

PAUL SOLMAN: That's just a way of saying people are scared, right?

JEFFREY BROWN: And that brings us to the fun part of this, which is psychology.

PAUL SOLMAN: Yes.

JEFFREY BROWN: How much do -- I mean, this was a week where you hear these words "frenzy" and "panic." How much does psychology, do the traders tell you that it plays -- how much of a role does it play in a week like this?

PAUL SOLMAN: Well, I talked to a couple this morning -- not that I really, I don't think, needed to -- but I talked to a couple. One said 90 percent, that the market's 90 percent psychology, 10 percent luck. Another one said 90 percent psychology.

Both economists I talked to today -- people I really revere; I didn't know the traders -- basically went with 100 percent.

JEFFREY BROWN: So between 90 percent and 100 percent?

PAUL SOLMAN: Yes, yes.

JEFFREY BROWN: That's a lot.

PAUL SOLMAN: Yes, but I think it's right. I mean, again, we're talking what happens day to day or over the course of this week, which is the conceit of this conversation we're having...

JEFFREY BROWN: Right, but it links to the more interesting question about the things that we've just been talking about, the Fed or a regulator in New York, the things that people point to.

PAUL SOLMAN: Yes, well, I mean, it's not -- they may or may not set off this psychology, but the psychology is clearly, you know, the fight or flight response, I mean, right? You get scared. I remember you when we've talked about this, you know, being...

JEFFREY BROWN: Don't get too personal here, but go ahead.

PAUL SOLMAN: ... but worried about the stock market when it goes down, because you have a pension fund. You're not anywhere near as close to retirement age as I am.

But I can certainly vouch for the fact that I, when I see these things plunge, I'm not doing anything with my asset allocation. And yet by not doing anything, I'm sustaining, you know, losses on a day like this and I feel the fear.

And it's a commonplace, it's the most obvious judgment or description of a market, that it has this momentum quality to it. When it starts to go down, people get scared. When it's up, they're exuberant.

Remember Alan Greenspan, 1996, "irrational exuberance." What else could that mean?

Ultimately, impossible to predict

Paul Solman
Economic Correspondent
It's unknowable what goes on when you have hundreds of thousands, perhaps millions, of players in a market having the flight-or-fight response every moment, particularly in times of great volatility.

JEFFREY BROWN: Well, so on a given day, on a given week like this, is it silly to think about rational behavior leading to what we saw this week?

PAUL SOLMAN: Thoughtful people think that we come up -- we, human beings -- come up with after-the-fact explanations for how the world works. There's plenty of psychological research to show that this is so.

And so, as one guy said to me -- I want to get the quote right here -- it's, "You chase for the real news, but the real news doesn't exist."

Let me ask you a question: JFK, John F. Kennedy assassination, market go up or down that day?

JEFFREY BROWN: Well, I would guess down, but now you're going to tell me it went up.

PAUL SOLMAN: Yes. Of course if it had down, people would have said, "Well, it went down because of the assassination of President Kennedy." It didn't; it went up.

It's unknowable what goes on when you have hundreds of thousands, perhaps millions, of players in a market having the flight-or-fight response every moment, particularly in times of great volatility.

In 1987, the stock market one day went down 23 percent. That would be 2,600 points on the Dow now. I asked both traders -- they were both traders at the time -- so now, after all these years, what happened? No idea.

JEFFREY BROWN: Still no idea.

PAUL SOLMAN: Still no idea.

JEFFREY BROWN: All right, Paul, have a good weekend. And we'll see what happens next week. Paul Solman, thanks a lot.

PAUL SOLMAN: Sure, Jeff.