NEWS

US trying to stop the slide into depression

The first full day of trading will take place on Wall Street today after the US House of Representatives finally approved a $700 billion rescue plan for the financial sector, which has been rocked to the core by the recent credit crisis. The causes and implications of the collapse are likely to be the subject of much debate and analysis in the US and Europe for some time to come. Markos Kaminis spent a number of years working on Wall Street and now runs the Wall Street Greek blog (www.wallstreetgreek.blogspot.com/), which is syndicated to numerous web publishers that include UPI, Kiplinger Magazine, the Houston Chronicle, the Denver Post and private networks such as Factiva. He shared his views on the financial situation in the US with Kathimerini English Edition. The last fortnight has in many ways been unprecedented. What has the mood on Wall Street and among US traders and investors been? The mood has been dire. As you can imagine, the investment community has already undergone great agony; jobs have been lost and future prospects now seem limited. My contacts as far as India are concerned about their jobs, let alone in New York. It’s a cyclical business though, so Wall Street has been through hard times before. However, the feeling this time around, with the unraveling that the investment banking community has been through specifically, has folks on the figurative «Wall Street» quite concerned about the future. The question a lot of people are asking is «How did we get here?» Some people point as far back as [Chairman of the Federal Reserve] Alan Greenspan’s drastic cutting of interest rates post-9/11 which, if you recall, happened not long after the tech bubble had burst. Greenspan was viewed as a savior at the time. However, many are now looking back and blaming him for sparking this inferno. Those low interest rates played a big role in driving the housing bubble. But, intricate problems often have complicated causes, as does this problem. Low long-term interest rates and inflation were supported by globalization, which allowed for lower production costs, and technological advancement, which drove productivity gains. Low long-term rates (and mortgage rates) alongside a system that sought to promote home ownership, but lacked oversight and permitted negligence, allowed an extraordinary run of housing price value appreciation. Corruption found its way into the mortgage brokerage business. Liar loans, no-downpayment and interest-only loans, along with inadequate supervision, allowed people who were not qualified to own a home they could not afford, and inherit a mortgage that was beyond their means. So, we loaded the housing market with unstable payers. At the same time, financial engineers not long ago considered geniuses (now considered crooks) developed secondary markets and then moved forward the process of pooling assets into securities that were supposed to be of the highest caliber. They bought loans from banks, constructed these securities from pools of them, sold them, bought them, held them for investment and created huge markets for their trade. Third-party credit rating agencies Standard & Poor’s and Moody’s were charged with understanding these fixed-income investments, and rating their risk. They completely failed. Institutional investors purchased these assets en masse, based on these investment-grade credit ratings that turned out to be completely wrong. All these things, in combination, allowed the housing bubble to build and a snowfall of these risky assets to pile up. Finally, the economy started to show signs of weakness, and financial markets sniffed blood. Housing prices were inflated and they had nowhere to go but down. Suddenly buyers started to worry about price depreciation. Fear begot fear, and sellers stayed stubborn. As an avalanche began in housing, the investment geniuses started taking a closer look at the securities composed of mortgage debt, and the riskiest of those debts, «subprime loans.» The market for these securities froze because payments were suddenly suspect. Besides this, variable rates started to rise, which was a risk many of these borrowers did not understand well. Foreclosures began to skyrocket. The secondary market became illiquid, and banks had to account for that. Meanwhile, as banks’ asset ratios declined, their reserve requirements proved inadequate. Then, nasty rumors started by traders at some firms and profiteers who hoped to benefit on short bets, added insult to injury. In other words, all capital sources dried up for firms almost overnight. This is what happened to Bear Stearns. Credit fears spread to securities beyond mortgage, to municipal debts, commercial construction and consumer debts. The government found itself pumping liquidity into the system, cutting interest rates to encourage capital investment and even stepping in to take control of operations of defunct firms so as to prevent systemic collapse. But, as time passed, the federal governors were surprised to find that too many companies were «too big to fail,» and it recognized that it needed a broad-reaching solution to better address the problem. Thus the bailout plan, and here we are. The market is usually good at discounting and adapting to situations but this time it’s reacting to each event as if it was completely unknown, which seems unusual. Why is that? I partly disagree with your statement. It often seems like the market discounts perfectly, but this is more due to its sensitivity than to its prescience. The market bets on recovery and decline so frequently in response to information that it’s bound to eventually get it right. When we look back at stock charts, it seems to us that the market correctly forecast the beginning of economic recovery or decline. However, if we look closer, we see a series of jagged edges as the market guessed again, and again and again. However, I agree with you that this time it seems a bit more unstable than in the past. The reason is because we are standing at the edge of an abyss. The entire financial system is close to blockage, and more and more investors are becoming aware of that fact. So, we are seeing drastic daily changes. Are things likely to get worse or will we be looking back on this in a decade saying it was a moment of panic? Things could very easily get much worse, but that burden now rests on the peoples of America and the world. I believe the passage of a system rescue bill, and one based on the Paulson plan, is critical to scenario analysis. But, more crucial at this point is the sentiment of American savers and investors. If panic spreads, we could see a rapid wave of bank failures driven by the same run on the banks that were characteristic of the Great Depression. This is largely to blame for the failures of Washington Mutual and Wachovia. Similarly, if investors and savers panic and begin withdrawing capital from their pension funds in order to keep it safe, or if they shift it from risky assets into other asset classes, we could see stock market ruin. I’m not exaggerating, and I’m very concerned. Isn’t it unfair that people on Main Street have been asked to foot the bill for the mistakes made by financiers on Wall Street? This is the great misconception that caused the Emergency Economic Stabilization Act of 2008 to fail in the House of Representatives last week. Americans are angry, and they called their Congressmen en masse, demanding they vote down this bailout bill. Here’s the problem… This bill will not rescue Wall Street. Wall Street is already bankrupt and broken. We would not be penalizing Wall Street at this point. This bill will rescue the entire US banking system, and in so doing, hopefully stave off economic depression. Americans would be paying for their own salvation, not Wall Street’s. Whoever caused the problem is no longer important. Solving it is. Short-selling restrictions have been introduced in some countries and Congress had included a number of provisos in the rescue package. As someone involved in the markets, do you fear that because of the exceptional circumstances, the system is being weighed down with too much supervision? Yes, I am extremely concerned about this. I suspect regulation will become excessive. Reactionary behavior is characteristic of my society; I wish foresight were as common. I believe a sector likely to suffer because of regulation will be hedge funds and those responsible for this mess. I actually decided to start a publishing firm instead of a hedge fund because of this anticipation in 2006. Short selling restrictions in particular are likely only temporary, except for naked short selling, which will always be illegal. However, returning to the topic of regulation, I see witch hunts already taking place, as the FBI and SEC launch many investigations, some of which I already find suspect and more reactionary than are necessary.