Paul Solman: With the world shifting under our feet as I write (2 pm), today’s question came from the editor of The Business Desk, who asked for a response to the events of the second: Dow down 500+ (and I haven’t looked in the past 45 seconds), bailout busted. For now.
As I wrote here two weeks ago (IS it the end of the world as we know it?), the key issue is “credibility.”
The English economist John Maynard Keynes, writing during the Great Depression, said that all business undertakings stem from “spontaneous optimism” which, if extinguished, can blow out an economy more quickly than it can stoke it.
What we’re experiencing today might be called spontaneous pessimism. It’s a phenomenon that, like its happy-face counterpart, feeds on itself. Unfortunately, it’s no more “irrational” than self-propelling exuberance. All you have to believe is that the other guy will be exuberant, and then it makes sense to invest, to buy stock. You’ll spur her, she’ll spur you: the economy spirals up. But, the same thing happens in reverse.
The fear of the moment is, of course, the Keynesian DOWNWARD spiral. And if my writing about it scares you, maybe I’m only making things worse.
I remember a live NewsHour discussion segment years ago, when the Dow was at 5500. In the green room before we went on, one of the panelists – a candid economist – suggested that the Dow was cruisin’ for a bruisin’. (At 5500!) But when I put the question to him live, he issued no such warning. When I twitted him afterwards, he said smilingly that he just hadn’t wanted to contribute in any way to a panic.
Many years before that, in the early ’80s, I interviewed Paul Volcker, then head of the Fed, about the banking crisis of HIS era, involving insolvent loans to countries like Brazil and Mexico: the so-called Third World Debt Crisis. After our interview, he said something similar. But during the interview, I remember asking him: “What happens if Mexico, say, defaults on its debts?” His on-camera answer, if I remember right: “That question is not posed.”
There are similarities between that debt crisis, the S&L crisis of the late ’80s, the so-called “Asian” crisis of the 1990s and what we’re experiencing now. But frankly, the rest seem to pale in comparison just at the moment. (Hold on while I check the Dow – down 528.)
What might be so special this time around? It’s the size of the problem, the extent to which it has spread worldwide, and the fact that so many of the debts are owed by institutions that actually won’t EVER be able to pay.
Mexico borrows money and some day, somehow, there’s enough of value there – hard-working Mexicans to tax, oil under the ground, whatever – that you can get back something, restore confidence, start the spiral upward once again.
S&Ls owned real property that wasn’t worth anything like what they’d loaned against it – remember those see-through buildings in Texas, uninhabited once the price of oil plummeted? But the property values came back over time. Some investors actually made a killing, buying cheap from the government’s RTC, which had taken over the S&L properties.
Yes, today too there are real properties beneath those mountains of iffy mortgages, which serve as collateral for mortgage-backed securities, which in turn serve as collateral for CDOs (collateralized debt obligations), which themselves are collateral for “CDO squareds” – all of which are “insured” by credit default swaps (CDS’).
That’s one reason to argue that the mortgagees — the homeowners — should be bailed out instead of the investors who loaned them money, and borrowed against those loans, ad infinitum. Then the collateral for the Himalayas of debt would be good again.
Sure, a lot of undeserving house-flipping investors might get bailed out in the process, though maybe there’s a way to restrict a bail-out to owner-occupied dwellings. But I guess the main reason Congress hasn’t gone this route is that it would take too long, and the crisis is NOW. (Dow down 574 and falling; panic comes easy.)
So Congress proposes a bailout of the borrowers because they – the banks, investment banks, money market funds, insurance companies, et al. – are the institutions through which the world’s capital runs. If they go dark, the capital goes dry. And then, the fear is, not only won’t the local McDonald’s get its loan to buy the new coffee maker, but your credit card might not be honored when you try to buy a cup of the old Joe.
Congress will go back to the drawing board. Will the Democrats demand a truly populist bill that promises to bail out homeowners and slash the pay of executives, propose a “transactions” tax on all securities trades that would provide money for current and future bailouts while discouraging speculation? Will the Republicans press their own initiatives, or simply see if the markets fail?
I don’t know any economists who were happy with the bailout that failed today. The bad news is that I haven’t heard of any plausible alternatives that are a good bet to pass. The worst news is that this all corroborates a motto I first adopted when I became a journalist in 1970: There is no big time. That is, even the experts don’t know what to do. In the meantime, it is up to us mere mortals to muddle through the current crisis as best we can. (Dow down 748 at 4:11pm)