The Housing Bubble Explodes: Fed Rushes for Fire Extinguisher
These are wild days on Wall Street. The broad S&P 500 index is already down 11 percent in January and almost 20 percent from its peak last fall. This decline corresponds to a loss of $4 trillion in wealth, more than $13,000 for every person in the country.
Of course the carnage has not been easily distributed. The financial sector has been especially hard hit. Citigroup’s stock price is down almost 60 percent from its year ago level, corresponding to a loss of $160 billion in stock value. Merrill Lynch is down by 48 percent, which translates into a loss of $40 billion in stock value. And Countrywide Financial, the wizard of the subprime mortgage world, is down by almost 90 percent, costing shareholder more than $25 billion.
The cause of the chaos is no mystery; the housing bubble is bursting
It was easy for any competent macroeconomist to recognize that the housing market was in the midst of an unsustainable bubble. By its peak in 2006, the run-up had generated more than $8 trillion in housing bubble wealth. It was inevitable that this bubble would burst and wreak the sort of havoc that we are now seeing.
The housing bubble was allowed to expand to such dangerous proportions because the Fed was not run by a competent macroeconomist. It was run by Alan Greenspan, who used to be the greatest central banker of all time. Greenspan did nothing to stem the growth of the bubble. In fact, he encouraged its growth by recommending that people take out adjustable rate mortgages. He also dismissed the views of the competent macroeconomists who tried to warn of the bubble, assuring the markets that everything was under control.
The Fed is right to cut rates and President Bush is right to cry for fiscal stimulus (even if he has the mix wrong). However, at this point, there is no way to avoid a great deal of pain. The bloodletting on Wall Street has just begun. (They still think that their losses are just in the subprime market – the boys and girls over there are real slow learners.) Tens of millions of homeowners will see much of their life’s savings disappear in this crash. The best we can hope to do is get the economy back on its feet as quickly as possible -- and then change the rules so that the bastards can’t do this to us again.
Dean Baker says:
Exactly, change the rules back to where they were before the Reagan gang and the rest of the Republican cretins 'changed the rules' put in place to protect the public after the crash of 29.
"We have to get Government out of the way and get rid of all these regulations that keep business from creating jobs and getting this economy moving again!"
heh heh heh.
January 22, 2008 8:23 AM | Reply | Permalink
Fuck all that. What has the stock market ever done for me? I don't own any stock and I don't see the possibility of buying any in the near future. Let's stop basing our economic analysis on this one measurement.
I say no stimulus package. Let the economy sort itself out.
January 22, 2008 8:51 AM | Reply | Permalink
It ain't the stock holders who will going hungry. You might want to re-think this Samson act.
January 22, 2008 9:27 AM | Reply | Permalink
The mom+pop shareholders get screwed either way. It's the insiders who do well whether the market is soaring or crashing.
For example, yes Merrill Lynch is down. But who profits from that and who loses? Large US investors like pensions will take a beating, but insiders get out ahead of the curve and move wealth overseas, into gold, and so on. Then they buy back in at fire sale prices. Large foreign interests also do very well as they're able to buy up our economy at crash prices.
The richest and most powerful only get more so with each market crash, and it continues to erode democracy every time the country goes up on the block.
January 22, 2008 11:21 AM | Reply | Permalink
Don't worry, the rich are getting hit by this crash, although probably not as much as they should.
January 23, 2008 2:46 AM | Reply | Permalink
Reece:
Too simple. I just came back from a trustees' meeting this morning involving a group of union-management trust funds that provide a combination of defined benefit and defined contribution retirement benefits and health insurance to union members, retirees and their families. They are a prudent group of trustees, half management and half union, and they never went crazy in the past (even in the 90s) with equity investments. But the stock market does matter to them and to the workers and their families who participate in the plans. I know it's easy and partially justified to look at stockholders as a bunch of those other guys with the fancy pants and stuff. But, unfortunately, it's just not reality. There was a lot more to talk about at the meeting this morning than yesterday's football results.
Bruce
January 22, 2008 9:32 AM | Reply | Permalink
of course it's too simple. of course people are going to get screwed. Yes, that sucks. But we can't keep going like this. We can't keep believing that it is our patriotic duty to buy stuff we don't need, or that what's good for our oligarchs is good for the rest of us. Perpetual growth with no recessions is impossible to achieve. Every once in a while, things have to get worse before they get better.
If we really want a stimulus package, it ought to be tied to more fundamental reforms in our economic policy so that stock prices aren't overinflated, housing bubbles don't happen, the dollar is strong, and people who don't rely on their capital investments for income can have a decent life.
Whatever. I'm not this radical really. I'm getting pissed off at our politics in general--the whole political system is simply unwilling to tell the people that they can't have everything that they desire. Our political leadership is simply unwilling and unable to make difficult decisions. The problem is that even if we can forestall making those decisions, a lot of people are still going to get fucked by our economy. We can pay some now or pay a lot more later.
January 22, 2008 10:08 AM | Reply | Permalink
"I'm getting pissed off at our politics in general--the whole political system is simply unwilling to tell the people that they can't have everything that they desire."
I think we are all frustrated Reece, and you are absolutely correct that politicians as a group are lacking the backbone that is sorely needed. But I think the problem right now is particularly exacerbated by the fact that, as far as any help that the federal government can and imo needs to be, it is just that much more difficult to embark on new initiatives due to what we have spent and continue to spend on the debacle in Iraq, coupled with the absolutely ridiculous tax slashing strategy of this Administration from its inception. And, now that we are in a recession, we will hear all of the pundits, with or without economic backgrounds, telling us that this is not the time to think about a tax increase. Sounds like self-fulfilling prophecy to me.
Bruce
January 22, 2008 11:14 AM | Reply | Permalink
I think of Winston Churchill. For all his personal faults he offered a particular strength of will and character to his nation when things appeared truly dismal. He offered words of courage and perseverance but tempered them with measured doses of harsh reality. He spoke of fighting and never giving up but with it spoke of toil, sweat and blood. There was a price to be paid by all (an important inclusiveness) to attain the goal. He provided the very important leadership that was needed for England to stand alone before America joined it in the war against Germany.
I think that this is the quality that all of our political leadership is sorely lacking. But in our culture/climate it is harder for a politician to speak of these things in plain terms in part because the reality of all of this is that it's always the same people who seem to do the bleeding and sweating with others seem to capitalize from it. This disparity is difficult to sell. Particularly when times are bad. There's a clear lack of inclusiveness when it comes to paying and sweating and bleeding.
We need to throw away bad ideas. We need to regulate our economy and institutions. We need to embrace the fact that greed will never lead to good but rather it's opposite. We need to have candid conversations about reality rather than complex and shifting definitions of theory. We need to stop experimenting with the marketplace and toss practices that are bunk where they belong, in the trash bin. Sometimes things are as complex as you make them. And very often things are made complex in order to hide the fact that they don't work as advertised.
January 22, 2008 11:46 AM | Reply | Permalink
"Economic depression cannot be cured by legislative action or executive pronouncement. Economic wounds must be healed by the action of the cells of the economic body - the producers and consumers themselves."
Herbert Hoover, December 1930.
January 22, 2008 10:06 AM | Reply | Permalink
Indeed, "hope" appears to be a key part of the strategy right now.
January 22, 2008 8:54 AM | Reply | Permalink
Call me crazy but isn't this like a child getting an upset stomach after they've snuck into the kitchen and eaten too many cookies? Awww, poor thing. Now let me whoop your ass so you don't feel that stomach ok?
This is greed fallout. Greed. They say "we're all connected" and "the economy effects us all". Really? How come I only get the bad parts of it? Dammit where's my 3 cars, 4 houses and a yatch? Why can't I be filthy rich and get bailed out when all my shennanigen's prove to be a burning bag of dog-doo?
Something stinks in all this... Stinks like burning paper and dog-doo...
January 22, 2008 9:11 AM | Reply | Permalink
It's times like these that make me glad I haven't prudently sunk tons of money away in a 401K and have instead squirreled cash in a lock box at the bank. Sure, it never grew, but it can't shrink either.
On the other hand, my children's college fund has pretty much lost any money it might have once made. Good thing the oldest is only in 1st grade.
Now if I could just get rid of this overpriced unsaleable doghouse I'm living in and go back to renting, it'll be just like 1991 all over again.
January 22, 2008 10:21 AM | Reply | Permalink
Inflation shrunk/will shrink the purchasing power of your money in the lock box
January 23, 2008 6:20 AM | Reply | Permalink
But it also shrinks the purchasing power of money outside the lock box. So I still end up ahead.
That's why our grandparents used to bury money in Mason jars.
January 23, 2008 2:14 PM | Reply | Permalink
Blaming all this stuff on the housing bubble is kind of backwards -- the stock market bubble preceded the housing bubble, making people think they were worth a lot more than they really were -- and therefore "deserving" of a better lifestyle.
And the coming recession isn't really about the housing bubble bursting either -- its real cause is the decline of the dollar in a consumer economy that is dependent upon cheap foreign imports -- and is simply not set up to take advantage of greater export opportunities.
The big problem is that we're looking at an economy that is both inflationary and in a recession -- the current inflation is caused not by higher wages, but higher import prices, which in turn creates less overall demand. Thus, the Fed's emergency rate cut is counterproductive, because it puts even more downward pressure on the dollar.
January 22, 2008 11:46 AM | Reply | Permalink
The dollar must fall. It was a big problem that we let it get so over-valued in the first place. That is why we have such a huge trade deficit. But you are right about the stock market bubble. Greenspan seized on the housing bubble as a way to let the economy recover from the crash of the stock bubble.
January 22, 2008 1:11 PM | Reply | Permalink
Never forget that happened under Bill Clinton who continued Reagan + HWBush's economic policies of deregulation, privatization and trickle down to basically give corporate interests whatever they wanted. Bill passed NAFTA, helped deregulate finance and energy markets. and plenty else to kill the middle class.
Nader was wrong when he said there wasn't any difference between the Republicans and Democrats. But he was right to the extent the establishment in both parties are tools, corporate owned and operated.
January 22, 2008 4:38 PM | Reply | Permalink
I feel about zero pity for these people, they did it to themselves, speculating and cornering markets and all that other good stuff, all for the economy you know, growth, and all that, and it's not just US companies that worked all this mortgage 'magic', there were foreign players, too, but so far it looks like the DOW's only lost 100 points since yesterday, although on the Bloomberg charte there was a brieve drop to 11,700, it's back up at 12,000 right now, they're saying some kind of thing about interest rates, but we'll see what Friday looks like.
I just wonder if my retirement savings is going to be worth anything in February.
January 22, 2008 11:55 AM | Reply | Permalink
There are two factors at work (I think) that made what is happening inevitable.
The first one is the combination of overspending on militarism and underspending on infrastructure and human capital development. The military is, in effect, the fourth branch of government. Couple this with the need to borrow to keep up with this level of spending and a crunch is inevitable. When there are no good options for prudent investment the money flows into speculation instead. This time it was housing, before this we had dot com firms, tulips and South Sea Islands.
This crash could have been minimized if the protections put in place after 1929 had not been systematically dismantled over the past 40 years. Even Clinton was responsible for the repeal of the Glass-Steagall act.
The second factor has to do with the reliance on stocks as an "investment". The entire culture of savings by putting your money in the bank has been replaced by buying equities. Stocks are not an investment, they are a gamble.
Stocks can only rise in price by three mechanisms: productivity increases, market growth through population growth and inflation. Under ideal conditions this has averaged out to about 7% a year which is more like 4% in real dollars.
But the investment industry promotes higher growth rate scenarios. In fact most people think that their stocks should be earning 10-15% per year. Those funds which fail to deliver get dumped. This forces managers to take bigger risks to satisfy the unrealistic demands of investors.
The prudent alternative is to put your money into a secure fund such as a bank or Treasury, but this isn't entirely satisfactory either. During periods of high inflation one will see the value of their capital decline. In general one is lucky to average 2% in real terms over the long term. Most people won't be satisfied with that.
The bottom line is that you can't generate money out of thin air. If you want to save for the future you have to set aside adequate funds. There is no other way. That many don't have excess funds available for this purpose is the gotcha that is going to cause misery for many in the future.
--- Policies not Politics
Daily Landscape
January 22, 2008 12:01 PM | Reply | Permalink
One more way stocks can rise in price: reductions of the workforce. How often we see a stock price rise after a company announces layoffs. Workers are considered a liability, an expense to be avoided if possible.
CEOs like Al "Chainsaw" Dunlap see the purpose of a corporation solely to provide profits for shareholders. Making a quality product or providing a service is secondary and treating employees with respect is tertiary. Protecting the environment is even further down the priority list.
January 22, 2008 12:25 PM | Reply | Permalink
Jeff: In economics speak layoffs are called productivity gains...
--- Policies not Politics
Daily Landscape
January 22, 2008 1:37 PM | Reply | Permalink
Re: One more way stocks can rise in price: reductions of the workforce. How often we see a stock price rise after a company announces layoffs.
That used to work, at least temporarily, but investors got wise to it. Hacking at the payroll either means that the company is in trouble and its stock should be avoided, or else it means the company will simply turn around and have to hire temps and consultants, sometimes costing more than regular workers. And the loss of experienced workers means a decline in the quality of the company's producst or services, spelling low term trouble. While companies can get away with measured reductions during downturns, slash-and-burn downsizing is no longer rewarded on Wall Street.
January 22, 2008 3:28 PM | Reply | Permalink
Actually, Dunlap didn't do very well for shareholders either. He just made lots of money for himself. He lied about profits and ripped off his shareholders too.
January 23, 2008 6:04 AM | Reply | Permalink
You nailed it there, bub. I don't know how many times I've seen "raise capital by cutting labor" mentioned in the last few days.
Yes, the milk cow provides a decent quantity of meat, and the seed corn can be ground to make bread, too.
January 22, 2008 1:42 PM | Reply | Permalink
There you have Mitt Romney's real economic program to revitalize the automobile industry in Michigan... Cut benefits (health) and jobs to improve productivity and the bottom line.
January 22, 2008 3:10 PM | Reply | Permalink
The war??? Anyone think sinking a trillion in the sand of Iraq might be a drain on the US economy?
January 22, 2008 12:01 PM | Reply | Permalink
Now, you're just not being serious. We should be able to have endless war and tax cuts, too. We should be able to grow our way out of any deficits.
And soon I will save money on airfare by hitching ducks to my couch.
January 22, 2008 1:44 PM | Reply | Permalink
The cause of the chaos is no mystery; the housing bubble is bursting Dean Baker
The housing bubble is not a cause of anything; it's very much a secondary effect. The real cause of the "chaos" in the financial system system which threatens to put a damper on eonomic growth is the imbalance in world trade.
For so long as developing countries choose to promote exports over local consumption, there will be a sea of capital (that is, money needing a home) sloshing back and forth in the world economy. This business cycle that money went into housing -- Spain, Australia, London, Shanghai, the United States, etc. -- and I might add, into commodities. Last business cycle, into IT; next, into something else.
If it hadn't been real estate (commercial's in a bubble, too), it would have been something else, and Dean would have been crying for someone else's head.
January 22, 2008 12:14 PM | Reply | Permalink
Let's see crowds with pitchforks storm the mansions and vacation homes of the people who got obscenely rich on this scheme.
Even if they get a haircut on Wall Street, they won't be living on the street as soon as the hopeful suckers who bought their mortgages.
January 22, 2008 12:33 PM | Reply | Permalink
Apparently, 2007 was a bad year for everybody--except the bank managers:
January 22, 2008 2:17 PM | Reply | Permalink
"-and then change the rules so that the bastards can’t do this to us again."
Yeah right, so they can do it another way next time. Dean Baker, reformism forever.
January 22, 2008 2:23 PM | Reply | Permalink
Regulation has to keep pace with the market innovations that gave us SIVs and subprime loans. You are damn right it's reformism forever, as it should be.
January 22, 2008 2:42 PM | Reply | Permalink
This problem with the stock market is the reason why Social Security should not be privatized, and should not be considered the wholly owned pension of the individual tax payer. If you happen to chase the returns and suffer these losses at the time that you need the money, will you be able to wait it out until the fund recoups its losses? Keep SS as a government program, safe and secure, as your safety net into retirement.
January 22, 2008 3:17 PM | Reply | Permalink
I had arguments with my union reps at work on chasing the stock market for the pension fund. (We lost ground in the late 80s drop.) My point was that the gains in market don't benefit any individual, who still gets his defined benefit, but losses can risk that benefit.
Instead, pension funds and other secure retirement systems should use only bonds or other fixed-payout instruments. They can budget whatever contributions are needed, build up the fund, and relax while the speculators hope to beat the market.
The biggest risk is of course a general drop, but as you point out, if everyone tries to liquidate at once, or even in a demographic concentration spread over some years, it has to depress the market.
January 22, 2008 3:47 PM | Reply | Permalink
Wheelbarrows are gonna' come in handy soon.
January 22, 2008 5:35 PM | Reply | Permalink
sully18
" The best we can hope to do is get the economy back on its feet as quickly as possible -- and then change the rules so that the bastards can’t do this to us again."
How about punishing the bastards who set this up.We all know who they are,and all we have to do to get them is to apply the Constitution and to stop cow-towing to their outrageous,criminal escapades.
IMPEACH,INDICT,IMPRISON.
January 22, 2008 11:56 PM | Reply | Permalink
What happens if they just close the stock market? Maybe they should.
January 23, 2008 12:13 AM | Reply | Permalink
Dean,
From the annals of famous understatements...
[Alan Greenspan, Age of Turbulence, page 378]
"Our hope [in April 2004] was to raise mortgage rates to levels that would defuse the boom in housing, which by then was producing an unwelcome froth."
Indeed, "unwelcome froth". He then goes into a lengthy explanation of why various global forces were holding down long-term interest rates.
No suggestion that, eg dreadfully skewed incentives in the mortgage industry, and other micro factors that ensured credit risk wasn't appropriately priced were a factor. No sirree, it was just an unwelcome froth, and nothing that a little monetary tightening oughtn't to be able to fix.
January 23, 2008 3:35 AM | Reply | Permalink
You can see why he used to be the greatest central banker ever.
January 23, 2008 3:38 AM | Reply | Permalink
Age of Turbulence is the wierdest book. You really want to read it because, for all his foibles, Greenspan's story is still an interesting one. And it is an engaging bus trip past the various economic pile-ups of the last 4 decades.
But goodness, the Randian market fundamentalism is hard to take for 500 pages. The repeated idea that market participants are basically compelled to make moral choices, that markets basically correct themselves. That markets are basically stable.
It's hard to pick out my favorite Greenspanism, but this one is near the top:
"Systemic breakdowns occur, of course, but they are surprisingly rare. Confidence in the global economy works the way it is supposed to work requires insight into the role of balancing forces. (Those forces regrettably seem more evident to economists than to the lawyers and politicians who do the regulating.)"
I didn't know whether to laugh or cry when I read this.
Ps. Dean, aren't you supposed to be in Davos? Or did Josh nix that idea?
January 23, 2008 4:44 AM | Reply | Permalink
I'm still waiting for my Davos invite. The best that I can do was an invitation to Dayton -- maybe next year.
January 23, 2008 7:00 AM | Reply | Permalink
Dean:
Can you provide some references to Greenspan pushing ARMs? They might be useful the next time I discuss this with my Freeper aquaintances.
-Dave Adams-
January 23, 2008 12:35 PM | Reply | Permalink
"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," Greenspan said. USAToday 2/24/2004
January 23, 2008 7:43 PM | Reply | Permalink
Ellen:
Oooh that's good! Thanks!
Anyone have more?
-Dave Adams-
January 24, 2008 4:46 PM | Reply | Permalink