Stock Markets and Credit 'Crunch': Free-Market Experts Speak Out
It has been a topsy-turvy few weeks for the stock markets, as fear of tightening credit markets fueled by prime and subprime mortgage woes have frightened the news media. The business media have been alternately hysterical and calm about the current economy.
Free-market economists have mixed views on how good or bad things really are. But there’s one thing most agree on – government action is not the solution.
The Business & Media Institute talked with several economists and financial advisors to get their perspectives on hot questions about the state of the markets.
How did this happen?
“There clearly, and I blame the Fed for a lot of this, was a frothy housing market and it was due to extremely low interest rates. When the Fed drove interest rates to 1 percent, all of a sudden you could get a teaser at 2 percent, then lending standards got lax and people were getting mortgages – subprime mortgages – with no documentation of income, with no money down. A lot of people want to blame corporate America for all of this – banks, lenders or whatever – but the fact of the matter is, it was the Fed that drove interest rates down and real people signed real mortgages, thinking they were getting a deal that was too good to be true.”
“As these subprime delinquencies increase and go into default, the lenders are all canceling these products, raising their credit standards, raising their rates – that knocks out credit on the margin. That knocks out house buyers on the margin. So at the same time as you have a huge overhang of increased supply in housing, you also have the decreasing demand … What do you think is going to happen to the price? It’s going to drop and as house prices drop ...”
“The problem is how we created such enormous leverage throughout the credit structure of the financial industry. When you have one bit of it begin to collapse … that has a reverberating effect of the over-leveraged credit structure. The concern in my mind is not mortgages at all, it is the larger credit structure of heavily leveraged businesses and the sources of that leverage – there is a significant international risk portfolio that needs to be attended to.”
What has been the business media’s impact?
“Here’s where there has been some irresponsible reporting and that is most of what hasn’t been said is the Federal Reserve has averaged $9 billion a day – they had up to Wednesday of last week – in addition of liquidity. So in other words, they’re coming in every single day and on average adding $9 billion a day. That’s not $24 billion, that’s not $38 billion, but still they’re in every day. And they also, frequently in the past year have bought mortgage securities. This is not new either. … To believe this is somehow brand new is just not true – they’ve always done that.”
“I think what you have is a combination of panic because of the sort of over-coverage of this – I mean this is constant. This is like the “shark attack” story of the summer. The financial press just keeps relentlessly going after it and that scares people.”
“I know there is a lot of media coverage, but this always happens whenever there’s a significant problem and everyone focuses on it.”
“It’s markets overreacting and for a long time, the media has been playing up the poor credit in some of the mortgage markets – the subprime market in particular, but the fundamentals of the stocks in sell-off – if you look at those fundamentals, they haven’t changed very much – not as much as the market’s been moving in the last week or so. I think in some sense, it is almost as if the media is unhappy that the economy has been doing so well and it’s been looking for something to indicate that it’s doing poorly …”
How bad is the housing sector really?
“There have been some bankruptcies and foreclosures and they’re ratcheting up. They’re higher than they were, but they’re still pretty low. There still haven’t been that many bankruptcies. The fear is there will be a lot more. No one knows for sure if there will or won’t be.”
“I think we have a genuine bust underway. There is a simultaneous bust in house building. We got the private mortgage insurance companies taking some good hits. There are some real serious busts in this sector of housing finance and housing, which in my judgment is going to go on for some time.”
“The subprime mortgage sector is infinitesimally small compared to the U.S. economy. There is just absolutely no way that can be responsible for the type of gyrations we’re seeing in the stock market. From the fourth quarter of last year to the first quarter of this year, we went from a 0.54 [percent] foreclosure rate on U.S. homes to a 0.58 [percent] foreclosure rate. So, we’re talking like a difference in the tens of thousands, if even that. So it’s tiny.”
“What’s going on is that some people who hold the paper on these things [houses] are going to get burned, but for everybody that loses on the transaction, somebody’s gaining. If I am the lender and I got the mortgage for $200,000 and you buy it for $100,000, then you’ve now obtained this house and got a great deal, right?”
Why is this a drag on the stock markets?
“The financial problem is based on too much leverage in the system. It is not based on the underlying fact the economy is falling apart and nobody can repay their debts anymore. It is way overstated.”
“This was a triggering event for a correction on what needed to take place anyway on what got to be an over-optimistic, unreasonably priced small spread situation. My guess is that will sort of stabilize, not without some damage to people.”
“The volatility [in the markets] is now reflecting political risks more than economic risks.”
“[The Fed] did the exact right thing … There’s a real lack of liquidity in the system and cutting rates isn’t going to change that. The best the Fed can do is help us get through this situation with the fewest stresses on the financial system that we can have. There’s plenty of liquidity in the marketplace – there’s more than enough liquidity in the marketplace.”
“The only thing they [the Fed] ought to be doing right now is maintaining this excellent policy of the past decade of maintaining fairly neutral money. And they do have a banking role to play – that is when their borrowers are in trouble, they can salt the portfolios of member banks with additional funds. They do that by buying Treasury bills and that’s the proper banking role. I don’t think they want to go around reducing the interest rate because that would increase aggregate demand and would have an upward pressure on interest rates at a time when you want to have liquidity and not illiquidity. And they certainly don’t want to produce inflation, which would have the same effect of producing an upward flow and it would increase the risk premium on prime rates and that would also increase illiquidity.”
“If you interject liquidity into the system, prices rise at some point. What happened when the market started to melt down a few years ago, the market cut rates down to 1 percent … If you know the Fed is going to bail you out, then you’re going to take actions that are more risky than you otherwise would have. People anticipate what the Fed is going to do and that anticipation may affect their behavior …”
Will things get worse or better?
“We still got some ways to go. If you look back to six months ago, people were saying this looks like it is bottoming, but it was not bottoming and clearly is not bottoming.”
“I think people are confusing a couple of things – one is the price of houses and the other is the health of the industry that builds and sells houses. Builders can still build and sell houses if the price of houses are going up, if the price of houses are still the same or if the price of houses are going down. The only way we have a problem with the housing industry is if we don’t have a growing population and we do have a growing population. People live in houses.”
“I’m worried, but I’m not at the point of enormous concern. You’ll see how well a very fine-tuned international financial system works now. It is supposed to work its way through the crises well and it has in the past. We had one about two years ago that hardly anybody noticed and we’ll see how things go forward. I’m very concerned about its implications – its potential, but the actual source of it – the subprimes are no longer on my radar screen that much.”
“Homebuilders are probably not going to be booming again for awhile, but I think the overall effect on the credit markets and the effect on the economy as a whole will have been worked out in another six months.”
Why Shouldn’t the Government React to ‘Fix’ the Problem?
“Now I think we’re kind of into the phase where the markets are worried about sort of a political backlash. … They [mortgage brokers] are terrified to sign off on any mortgages because they’re afraid the regulators are going to come in and they’re going to execute the innocent along with the guilty, so there’s this sense we have this sort of regulatory backlash coming. We’re at the point where the risk from subprime mortgages is infinitesimally small. The largest risk is the political risk of an overreaction from regulators, trial lawyers and Congress. … Just think about it – if it is a giant mortgage banker versus a family being put out of their home – no matter what the fact pattern may be after that, who wants to take those odds?”
“Remember, Congress never touches anything they don’t hurt. They never intend to do that, but it turns out they can’t act fast enough in our modern economy to do any good as a reactive force. So, for example, should they go back and regulate subprimes – well subprimes are shut down and they have already fixed themselves. That’s exactly the right response – no more subprime loans. If they were to go in and say, ‘let’s regulate the hedge fund industry,’ that would be bad because that means one of the things that has reduced risks would be regulated, even though there is some indication hedge fund investments may be at the root of at some of the asset level. I would urge Congress to look after long-term policy change. … They need to do just long-term things and stay away from the short-term because markets are working very rapidly, sometimes in a bloody fashion, but nevertheless effective.”
“I think busts and their losses for investors, lenders and borrowers almost inevitably generate political reaction – which is usually an overreaction. There is actually one political move which I am really promoting, which is the one-page mortgage disclosure form. I think it is a very good idea from anybody’s point of view because on the one hand if you get borrowers to really understand much better what they’re getting into, that’s a consumer protection idea, but that also a market function idea and for markets to really work well, the parties entering into contracts have to understand what they’re getting into.”