TOPICS > Economy

Dow Jones Industrial Average Suffers

July 26, 2007 at 6:10 PM EDT

JIM LEHRER: Ray Suarez has our stock market story.

RAY SUAREZ: The Dow Jones’ fall came on a day with record volume and lots of volatility. At one point this afternoon, stocks were down nearly 450 points. For the second session in three days, housing worries were a big drag on the stock market. New home sales were worse than expected today, while two key homebuilders reported disappointing results.

On Tuesday, the chief executive of one of the nation’s largest mortgage lenders, Countrywide Financial, said the housing market may not recover until 2009.

To explain what’s happening, we turn to Thomas Lawler, a housing economist who runs his own consulting firm outside Washington, D.C.; and Diane Swonk, who watches the markets as chief economist for Mesirow Financial in Chicago.

Diane Swonk, let’s start with you. Take us inside what happens during a sell-off. By late morning, huge numbers of shares were changing hands, and great big chunks were being taken out of the levels of the indices. So what was happening?

DIANE SWONK, Chief Economist, Mesirow Financial: Well, what we really saw was a lot of things happening simultaneously. What we saw was not only were people unsure of what credit people would be paying for — price they’d be paying for their credit, so they didn’t know how to value a lot of stocks out there, particularly financials.

People weren’t sure, all of a sudden they would have to pay a lot more for their credit or many of the big banks would be stuck with all this debt on their balance sheets that they thought they’d be able to sell into the market, and they’ve not be able to place in recent days. All of those fears culminated at the same time that we got the bad economic news on the housing market, which although was kind of expected, I think got blown up by this prism of subprime and mortgage defaults that we’ve seen out there.

And the result was, in that kind of uncertainty, it’s just safer to get out and run away and hide then try to buy.

Housing market suffering

RAY SUAREZ: Well, when you say people were unsure about the price of credit, does that mean they're buying securities with borrowed money?

DIANE SWONK: No, they're not buying securities with borrowed money. The issue is, at what rate will many of these corporations be able to borrow money at down the road? That's a carrying cost for these corporations.

And I think the important issue is, even though we've seen some big failures in the credit market -- not being able to fund Chrysler debt, for instance, that was a big blow to the market this week -- even though we've seen that, the banks are still going to take on that debt. And some of you are saying, "Well, should they? Are they ever going to get it paid back?" Well, actually, yes, they're going to get paid back a lot of the debt that they are issuing.

And, in fact, the market is -- we've got such a liquid economy, we've got so much liquidity out there from abroad, as well, that I think we're going to be just fine through all this, but you can understand the sort of reality check that's happening. For so long, credit was free out there.

RAY SUAREZ: Thomas Lawler, the S&P shed reportedly $300 billion worth of value in today's trading session. Now, how does one segment of the economy -- granted, a big one, housing -- do that, even pulling down the shares of companies that, at first glance, seem to have nothing to do with housing?

THOMAS LAWLER, Economist: Well, I think what a lot of people are focusing on is, up until recently, people thought -- mistakenly, in my view -- that the trouble in the housing and the mortgage industry was limited to this little subprime mortgage market or loans to people with spotty credit, when, in fact, it's actually been a very weak housing market. And the trouble showed up the most in this riskier segment.

So now what's going on is a lot of people are saying, "Gee, it really appears to be affecting the broader housing market," in a period where home prices were already moving lower in a lot of areas. And people are now thinking, "Gosh, might home prices fall even more?" And if home prices fall a lot, might the consumer actually start being affected because they see the value of their own homes fall and either can't take equity out or their just overall net worth has declined?

Record supply of unsold homes

RAY SUAREZ: Well, why do people rush to sell? Why don't they then hold on even more tightly to this big asset, often the only big asset that they've got in their family portfolio, their home?

THOMAS LAWLER: Well, it's not that everybody is rushing to sell their home. It's that if, in fact, the demand for housing moves down because there's yet another tightening in mortgage credits, so it's harder for people to get credit, and therefore demand falls at a time we have record supply of unsold homes, including the highest number of vacant homes for sale ever seen in the country, and people might be thinking, "Gee, we were already seeing prices go down before the demand fell. Now demand is going down. How much more will prices fall?"

We're sort of in uncharted territory, because right now it looks like national home prices could fall by more than any other period we've ever seen measured.

RAY SUAREZ: I ask because some of the big lenders are reporting that people can't sell their homes in order to cover their liabilities before they start missing payments and end up in foreclosure instead of at a closing.

THOMAS LAWLER: That's correct. That's correct. And that's something that people are worried -- you know, at a time we already have inventories incredibly high, so supply is way high, demand is falling because people are more worried about extending credit to the riskier segment, and foreclosures are increasing, delinquencies are increasing. What might that do to the value of my home?

And I think in the stock market, people are going, "I don't know. We've never seen it on this magnitude. There's an incredible uncertainty. What do I do?" And they're thinking, "I'm just going to hold back, flight to quality, put things in short-term safe assets until I get a better picture."

Economy stronger in certain places

RAY SUAREZ: Diane Swonk, do the concerns about the housing market and the downstream affect of a big sell-off like today's have specific regional effects, hit some places harder than others?

DIANE SWONK: Well, certainly, it's a bigger impact for Wall Street than it is for Main Street, but I think, in a larger context, the housing market has been some very regionalized issues, as well. The markets like Cleveland and Detroit have been very weak economic markets, in addition to being a weak housing market, and so those markets were feeling pain even when the housing market was booming.

And there's where we've seen the largest number of foreclosures and, you know, literally hundreds of homes being auctioned off at once all in the same neighborhood. I mean, there's just no way but to feel a very big, deep depreciation in those markets.

With that said, a lot of those homes initially have been fairly inexpensive homes. They weren't the pillars of the economy. And even though it's really tragic to see many of these people who were promised a home, placed in a home, and they really could never pay for the mortgage, now it's taken away from them because they weren't the pillars of strength in the economy, which has really been the very high-income households, you're seeing consumption slow, but not collapse.

I mean, the fact that we have a job market that's still pretty strong out there in general helps the overall economy, even though it's not helping places like Detroit, which are now going into these UAW contract negotiations which will be very brutal this year.

RAY SUAREZ: Well, if these kinds of loans, the kinds of loans made to families that may be at another time wouldn't have even been able to get a mortgage, once they're with personal tragedy squeezed out of the system, how does it bottom out? How does it start to come back?

DIANE SWONK: Well, I agree totally that it does take a long time to come back. The housing market tends to be very asymmetric, anyways. When we've see regional booms and busts, we see prices go up very rapidly. They come down much more slowly. They come down, but slowly, because people do hold onto their house, and they move in and out of it.

So it really does take quite awhile to clear this out. I do agree it's going to take through 2009 to really see prices begin to even see some firming. With that said, very regionalized, places like Naples, Florida, are not only overbuilt, you can't get insurance now because insurers won't provide insurance for hurricane insurance, so you have to self-insure to buy a home. So some parts of the country clearly being hit much harder than others.

On the other side of it, Las Vegas, which saw a huge run-up in home values, is now seeing a collapse, but a lot of people are still moving there. So their excess supply of housing, although it's great, at least has a chance of being absorbed.

A mortgage without verification

RAY SUAREZ: Is the experience, Thomas Lawler, of buying a house going to be different after this market shakeout and after companies like Wells Fargo get out of the subprime business all together?

THOMAS LAWLER: I think for a lot of people it absolutely is. In 2004-2005, and even a lot in 2006, you could go in and be able to put virtually nothing down and have your mortgage underwritten where all you had to do was state your income. You didn't even have to verify it, and you could buy a house with nothing down, nobody verified your income, even if you had spotty credit.

And now people are finding that in a weak housing market where home prices are falling that those mortgages perform horribly and people stop making them. And so if you want, it is going to be a lot harder to buy a home with putting nothing down. It is going to be a lot harder to get a mortgage if you don't verify what your income is and what your assets are.

And as a result, there are a lot of people who might have been able to buy a home a year ago who are not going to be able to put a home until they put away some savings for a down payment and are willing to verify their income. And that's a good thing.

RAY SUAREZ: Thomas Lawler and Diane Swonk, thank you both very much.