There is Nothing New Under The Sun

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Surviving the Panic
from the Wall Street Journal (wsj.com)
September 16, 2008


We're happy to report that the world didn't end yesterday, though sometimes it was hard to tell. A major Wall Street banking house filed for bankruptcy, the taxpayers didn't come to the rescue, and financial markets lurched but didn't crash. Amid the current panic, this is a salutary lesson that our fate is in our own hands and that a deeper downturn is far from inevitable.
[Surviving the Panic] Associated Press

The immediate priority is to calm markets and prevent a crash, and to do so it helps to recall how we got here. We are not living through some "crisis of capitalism," unless policy blunders make it so. Nor is this largely the fault of the Bush Administration, as Barack Obama claims, or of some lack of regulation, as John McCain asserts. These politically convenient riffs do nothing to reassure the public.

The current panic is the ugly aftermath of the credit mania that took flight in the middle years of this decade. As students of economic historian Charles Kindleberger know ("Panics, Manias, and Crashes"), financial manias throughout history have shared one trait: the excessive expansion of credit. This bubble was no different.

The Federal Reserve kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike. The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall Street and in mortgage-finance who created new financial instruments that in turn fueled the housing bubble. As long as it lasted, nearly everyone inhaled the euphoria of rising asset prices and soaring profits. Normal risk assessment gave way to the excesses that always attend manias.
[Surviving the Panic] AP

Enter the panic stage, or the great deleveraging that began some 13 months ago. Fear now trumps greed, while the short-seller and cash are kings. The core of our financial problem, as Treasury Secretary Hank Paulson said yesterday, is that these mortgage instruments are underpinned by real-estate assets whose value keeps declining. Until home prices stabilize, no one knows how large the losses will be. Thus no one is sure which financial companies are truly endangered, or how many.

Amid this turmoil and uncertainty, the challenge for policy makers is twofold: Protect the overall financial system from the fallout of individual bank failures, and protect the larger economy from recession caused by financial distress. They each require different policy levers.

On the finance side, there has already been much progress, albeit not enough. The banking system is reforming itself right before our eyes, without the advice of Congress or new regulation. The days of banks running with leverage at 30 or 40 to 1 are over. The companies that took those risks have either failed (Bear Stearns, Lehman) or been absorbed by others (Merrill Lynch, Countrywide). The SIVs, CDOs and other exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system.

On that score, Lehman's bankruptcy filing is another sign of progress. The Treasury and Fed have signaled they can say no. While Lehman's failure has spooked markets, the lesson that a storied investment house can fail without a federal rescue is its own crash course in risk management. The weekend decision by a group of major banks to establish a common fund to borrow against is also hopeful. The banks, which each anted up $7 billion to be part of this private lending fund, realize that acting in concert can serve their self-interest -- a lesson that J.P. Morgan would have applauded in the Panic of 1907.

And yet the financial system will remain fragile as long as asset values keep declining. More major bank failures are a certainty, including some very large ones. That means more Sunday soap operas like this month's, with all of the anxiety that inspires among the public. The longer these melodramas continue, the greater the risk of a recession.

Which leads us to suggest another Resolution Trust Corp. as one more tool to calm financial markets. The first RTC helped to buy, stabilize and liquidate troubled assets amid the savings and loan mess of the late 1980s. Then it blessedly went out of business. Former Fed Chairman Paul Volcker endorsed an RTC II yesterday in a speech in Naples, Florida, and we suspect the idea will gain more traction. He said he "reluctantly" embraced the idea for "dealing with the market breakdown, breaking the logjam of mortgages and other assets of uncertain value [and] restoring a sense of reasonable valuation and market confidence."

Yes, this would require a Congressional appropriation, and in that sense it would cost taxpayers. But by now it should be clear that some taxpayer money is going to be needed, if only to pay off insured depositors at failing banks. The Federal Deposit Insurance Corp. has already said it may need to borrow from its Treasury line of credit, and that's based on what could be optimistic estimates about home prices.

The taxpayer is also currently at risk through the Fed, which has become ever more creative with its use of the discount window. Its new lending facilities have been necessary amid this crisis, but they have also meant that the Fed is accepting ever-dodgier paper as collateral. Over the weekend it agreed to take non-investment grade paper. The danger is that all of this will put the Fed's own balance sheet at risk -- which would mean even bigger trouble. Better to put this bad mortgage paper on the Treasury side of the federal balance sheet.

Meanwhile, a new RTC would provide a buyer for securities for which there is no market, set a floor under the market, hold the securities until markets stabilize, and liquidate them in an orderly fashion, perhaps at a profit. Failed institutions and managers would not be bailed out. There's always a risk that the politicians will meddle, which is one reason for the Bush Administration to do this now so it can insist on enough political insulation.

As for the larger economy, the last 13 months are a guide to what not to do. The Fed recklessly cut interest rates, while Congress and the White House dropped "rebate" checks from helicopters. The rate cuts ignited another oil and commodity spike that walloped middle-class consumers, while the rebates did nothing to change incentives or lift investment.

We hope the Fed heeds this lesson and holds firm on rates today. Yesterday it injected $70 billion in liquidity to stabilize the fed fund rate at its peg of 2%, as it should in a crisis. But that money can be withdrawn over time as the crisis eases. Meanwhile, a more cautious monetary policy overall will help the dollar, which in turn will mean lower oil prices and more capital flows to the U.S.

What the economy really needs is a big pro-growth tax cut, the kind that will restore confidence and risk-taking. This is an opportunity for both candidates, but especially for Mr. McCain. Instead of focusing on an extension of the Bush tax cuts, the Arizonan should offer his own tax cut to revive capital markets and prevent a recession. Democrats will claim he's helping "the rich," but our guess is that every American who owns a 401(k) will figure he's one of those "rich."

One great lesson of past panics is that they needn't become crashes, if policy makers make the right decisions. Thirteen months into this crisis, the best choices are the same as they were last August: energetic emergency plumbing to protect the financial system, steady monetary policy to defend the dollar, and a tax cut to spur growth. It's also the kind of agenda -- and leadership -- that could win an election.

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Markets Crash, Media Hysterical, Democrats Thrilled
September 16, 2008 - by Rick Moran
pajamasmedia.com


“McCain Loses Fox News” blared the headline at the liberal website [1] Think Progress. And that appeared to be the least of the Republican nominee’s worries. From Wall Street to Main Street, Democrats could barely contain their glee over the sudden turn of events that culminated in the crisis in the markets on Monday.

When financial writers ran out of dire adjectives to describe the serious crisis in the markets, Democratic and liberal blogs helped them out by managing to find a few more. After all, business reporters are not generally given to hyperbole, and the adjective is something of a stranger to them. Thankfully, Obama-supporting websites had access to an online thesaurus or two which they were able to comb for exactly the right apocalyptic language that would freeze the blood while getting the point across that John McCain was at fault by reason of his association with George Bush and that it was time to make sure the windows on those Wall Street skyscrapers were suicide-proofed.

New York Times columnist, blogger, and resident hysteric [2] Paul Krugman referred to the day’s 500 point stock market drop as “Black Monday.” The problem with that is that 1) the name has [3] already been taken; and 2) it is hyperbole.

The real “Black Monday” occurred on October 19, 1987, when stocks lost more than 22% of their value. Today’s market “turmoil” (which is as hyperbolic as the [4] New York Times feels like getting) resulted in a loss of 4.4% in the value of the stock market. This is serious for those of us who have invested in mutual funds (I would suggest downing a good, stiff, Glenlivet or perhaps a strawberry martini before checking your portfolio today) but hardly the kind of thing that will result in an economic collapse.

Now before I am accused of trying to minimize the situation, allow me to plead guilty of my own accord. In fact, compared to the way that Democrats have gone overboard in describing what has happened, I am indeed trying to inject a little sanity into the debate. I can only go by what respected, nominally non-partisan analysts are saying. For the most part, there seems to be general agreement that the situation is serious but that the Federal Reserve is on top of the situation. There is some disagreement whether the federal government should be stepping in with both feet, but, as far as the immediate crisis, it is being handled.

The problem is uncertainty — a state of affairs financial markets hate. And that uncertainty is due to the least predictable element in the markets — the human mind. The next few days will tell the tale whether 50 million years of mammalian evolution has produced a rational being using his higher brain functions or a frightened, panicky marmoset scared of his own shadow who relies on the medulla oblongata for smarts.

But Krugman is doing everything he can to exacerbate the situation except telling his readers where to buy the cheapest apples to sell on a street corner. “Worse than it Looks” is the title of one of his more recent posts on the crisis. His[5] column this morning began, “Will the U.S. financial system collapse today, or maybe over the next few days? I don’t think so — but I’m nowhere near certain.” This is a given where Mr. Krugman is concerned because over the last six years, he has [6] predicted an economic downturn no less than nine times.

It isn’t only Krugman who has thrown gasoline onto this fire. He is only the most prominent of the bunch who have scoffed at John McCain’s contention that the economy is “fundamentally strong” albeit we are in serious difficulties at the moment. By the time this common sense statement made its way [7] around the blogosphere (old Wall Street hand Mayor Bloomberg [8] agreed and gave compelling reasons why), liberals had McCain saying there was nothing wrong with the economy, everything was fine.

I suppose a little hyperbole can’t be helped when the situation is unprecedented. But to read some commentary by partisans on the left, one would think the apocalypse is upon us and it’s just a matter of time before Mr. Potter takes over the Building and Loan while we’re all thrown out on the street with nary a farthing to our name.

[9] Alan Greenspan – who says he hasn’t seen anything like what has happened on Wall Street in his lifetime — now puts the chances for a recession at greater than 50-50. That’s hardly a ringing endorsement to start stuffing your mattress full of cash or sell your stocks and bury the money in the backyard. In fact, this bit of common sense from New York Times business writers Ron Lieber, the Your Money columnist, and Tara Siegel Bernard, a personal finance writer for the Times, is good advice in good times and bad:

Q. How will this affect the mutual funds in my 401(k)? I’m beginning to think I should move my money fast!

A. To put it mildly, it’s likely that your mutual funds aren’t having their best day: the Dow Jones industrial average closed down more than 500 points, or about 4.42%. But markets are mercurial beasts, and we don’t know what’s going to happen tomorrow, the day after — or six months from now.

That’s why it’s so important for investors to be diversified across different asset classes and investment types. It’s one of the most important ways investors can produce more consistent results, while helping cushioning against sharp declines. You want to make sure your money is divided across different slices of the stock and bond markets: that means domestic and international, large, mid-sized and small, as well as other alternative asset classes.

It also might be time to review your risk tolerance: if you’re tempted to move your money around on a difficult day, it might be time to rethink your stock allocation (in other words, you might want to lower it).

Also keep in mind that market declines work in your favor: they allow you to buy more stock or mutual funds shares cheaply.

Making hay of economic crisis is part of politics. The situation in 1980 may not have had the jarring impact of what has happened on Wall Street the last 72 hours, but it was, in many ways, much more frightening to ordinary people. High inflation, high unemployment, and high interest rates along with a stagnant economy were eating away at people’s confidence. Reagan and the Republicans were not above fanning the flames of fear and doubt. Nor will Obama and the Democrats hesitate in this case to use a little hyperbole in order to make things seem worse than they are. But you won’t find Obama predicting catastrophe and economic collapse.

Evidently, he is leaving that to his surrogates.

Article printed from Pajamas Media: http://pajamasmedia.com

URL to article: http://pajamasmedia.com/blog/markets-crash-media-gets-hysterical-democrats-celebrate/

URLs in this post:
[1] Think Progress: http://thinkprogress.org/2008/09/15/kelly-bounds-taxes/
[2] Paul Krugman: http://krugman.blogs.nytimes.com/2008/09/15/worse-than-it-looks/
[3] already been taken: http://en.wikipedia.org/wiki/Black_Monday_(1987)
[4] New York Times : http://www.nytimes.com/2008/09/16/business/worldbusiness/16markets.html?hp
[5] column this morning: http://www.nytimes.com/2008/09/15/opinion/15krugman.html?ex=1379217600&en=30a0512211a8dbaa&e
i=5124&partner=permalink&exprod=permalink

[6] predicted an economic downturn: http://mjperry.blogspot.com/2008/01/paul-krugmans-top-ten-recession.html
[7] around the blogosphere: http://thinkprogress.org/2008/09/15/mccain-fundamental-workers/
[8] agreed: http://www.politico.com/blogs/bensmith/0908/Bloomberg_agrees_with_McCain_Economy_fundamentallystrong
.html?showall

[9] Alan Greenspan : http://www.breitbart.com/article.php?id=080914181841.fsmkqu8s&show_article=1