The stock markets went through yet another awful week last week through some combination of lack of confidence on the part of buyers and dismal earning figures on the part of publicly-held companies. International leaders are calling for concerted action:
HONG KONG: Heads of state from across Asia and Europe called for a coordinated response to the global financial crisis in a two-day conference in Beijing, an event that underlined China’s growing role as a diplomatic counterweight to the United States.
But the leaders fell short of offering specific solutions to the current economic troubles, which have shown no signs of slowing. On Sunday, the central bank of South Korea, where stock markets and the currency have been plunging, said that it would hold an unscheduled monetary policy meeting Monday morning, Reuters reported.
The bank, which gave no other details about the meeting, is under pressure to cut interest rates for the second time this month. Top government financial officials met Sunday with President Lee Myung Bak and agreed on “the need to stabilize market interest rates and to provide sufficient liquidity to avoid corporate bankruptcy,” Reuters quoted a senior presidential economic policy aide, Bahk Byoung Won, as saying.
In the difficult balance between preserving financial innovation and ensuring adequate regulation to prevent crises, the presidents, prime ministers and other leaders assembled in Beijing tilted toward more regulation in their meetings Friday and Saturday. A joint statement issued at the conference did not suggest how to accomplish this, but it said “necessary and timely measures should be taken.”
The statement did not exclude innovation, but contained a two-sentence section that indicated the preference of the attendees: “Leaders were of the view that to resolve the financial crisis it is imperative to handle properly the relationship between financial innovation and regulation and to maintain sound macroeconomic policy. They recognized the need to improve the supervision and regulation of all financial actors, in particular their accountability.”
What is that old definition of a committee? A group of people, none of whom can do anything individually, who meet to agree that nothing can be done?
Why haven’t the fixes been working?
Are We There Yet?
Although the factors underlying the crisis have been percolating along for decades and the decline in housing prices has been proceeding merrily along for a year now, the measures to shore up the financial system have only been in place for a couple of weeks. However impatient investors, lenders, and borrowers may be, believing that the actual problems can be solved overnight is irrational.
In all truth we’re far from agreement on what the problem actual is. Last week the Minneapolis Federal Reserve Bank produced data calling into question some of the key claims of the financial crisis alarmists, particularly that bank lending to nonfinancial corporations and individual borrowers has declined sharply (it hasn’t) and that interbank lending is essentially nonexistent (it isn’t).
The only thing we may really have to fear is fear itself.
Derivatives Derive Their Value
Derivatives are called that because they derive their values from some underlying assets. Attempts to shore up the value of a derivative without shoring up the value of the assets from which they ultimately derive their value are likely to be in vain however cleverly we may try to finagle.
A good part of the problem in the financial sector is being caused by a beastie called the credit default swap which is a derivative. The problem children are those who ultimately derive their values from house prices. When housing prices continue to fall the credit default swaps derived from them simply can’t be shored up by themselves.
The original Bernanke-Paulson plan largely was a plan to shore up the derivatives while doing little about the underlying assets. There’s been increasing pressure to shore up the assets themselves which in the short term is probably all to the good.
Fallacy of Composition
As I’ve been saying here for some time, treating the problem of plummeting housing prices as a national one is incorrect and any approach that rests on that assumption is bound to fail. Falling housing prices are a highly localized phenomenon—much of the problem is in just one state, California. California has something like 10% of all the housing stock in the country. That, combined with the insane rate and heights to which housing prices have risen there skew the entire country’s numbers.
I don’t remember the exact figure but something like half of all of the borrowers who are under water (negative equity) are in just twenty counties and ten of those are in California.
The underlying underlying problem is branch banking but that’s a subject I’ll need to return to another time.
Insistence on the Morality Play
We’ve got to stop insisting on treating this crisis as a moral issue. Don’t even think about punishing the guilty and rewarding the virtuous. Stop the bleeding first. To do that we’re going to have to accept that we’re going to need to let some people who’ve made dumb investments profit by them and punish those who’ve made prudent decisions in the short term. An astonishing percentage of those under water are speculators. If we try to distinguish between speculators and regular homeowners we aren’t going to solve the problem. Let’s keep our eyes on the prize.
In the longer term we need to let housing prices fall, particularly where they’ve grown beyond all reasonable bounds, e.g. California. But the fall needs to be managed. That’s going to require commitment from government at all levels and strong stomach and nerves. I’m not sure we’re up to it.
BTW, what’s the role of slowing immigration in the decline of housing prices in California?