I’m not very good with financial matters. I feel I understand some aspects of economic history fairly well, but where economics crosses into the management of my own resources, I start to feel very uncertain.
Largely I don’t worry too much about money because the basics of my own situation seem fairly good. Decent job with a lot of security built in, modest house in an area that I think will retain values, and so on. I worry politically about some of the larger social terrain of American life, about whether we’re really a society of opportunity any longer, about the Nouveau Gilded Age that we seem to be drifting into. Mostly I don’t try to read the tea leaves of the economic future with the intent to try and stay ahead on investments or anything like that. I leave that to other people who may want to try and maximize their investments, beat the market, what have you.
However, ever since the story about subprime mortgages broke, I’ve been reading more and more avidly about the underpinnings of this particular financial story. Last night, I had a hard time sleeping. The primal, reptilian part of my brain, the kind that generates premonition and dread when it thinks it heard a dangerous animal in the woods or sees a fight coming, was churning away. Being middle-aged opens the gates to that kind of dread in small ways all the time, I’ve found. It’s easy to fall into being the “worried well”.
This feels different to me, though. I can see a lot of plausible scenarios in which the entire economic and social world that I am part of could be seriously damaged through a cascading series of financial events. And that’s without the really unnerving scenarios like a global call on the dollar.
Anybody else starting to feel nervous? Besides the people who’ve been desperately trying to sound the alarm for some time, that is?
Yes, I’m also worried. Credit-crunch downturns tend to be much harsher than others, even in post-WW2 history. We would call 1981-82 an old-fashioned depression if we hadn’t retired Depression’s uniform number after 1940.
I am not worried about my own personal situation, but one friend of mine who lived in Houston worked in the mortgage industry and she has been warning me for more than a year about what was happening. Then this spring, it happened really quickly for her, because her mortgage company went out of business and she is out of a job.
Another friend who had a family home in Yakima decided he wanted to move to Denver. He took some of his pile and bought a house in Denver because the prices were going up. He tried to sell the house in Yakima and couldn’t move it. So he is now trying to sell the house in Denver and is getting nowhere. He is worried.
Finally, the other shoe that remains to drop is how many hedge funds will be wiped out by this. We don’t know and they really don’t have to tell anybody but their investors. It is a big question mark. It is more than millions, probably billions, but it could be a trillion or two. We just don’t know.
But probably the Fed will do all it can to bail everybody out and spread the damage across the population including people who practiced sound fiscal policy. I say thank heaven for those sensible people for without them, the idiots would all be homeless.
This credit crunch — aka predictable meltdown of high-risk practices — is going to affect even us “stable homeowner” types. The housing lending boom fueled a housing construction boom which is busting right now, but not before flooding a collapsing housing market with lots of nice new houses.
Not a problem if your salary is stable and you don’t have to move, but anyone who does need to relocate will be selling at a loss (though they’ll be buying at fire-sale prices, I suppose: I’m not sure it really evens out, most of the time).
Just out of curiosity, does the title refer to Macbeth or Bradbury’s novel?
As a parent with two grown children, I worry about this a great deal. Not on my own account: like Tim, I feel reasonably secure, by American standards, though as retirement looms that feeling ebbs. But we have no idea what economic problems and dangers await our son and daughter, or of what they’ll mean for their chances of developing careers, buying places to live, educating any children they may have. The credit crunch won’t make any of this easier in the short run, that seems certain.
No, I’m not nervous at all.
Economists have known for a long, long time that the real estate market is not an efficient market — this means that it’s prone to bubbles and bursts. So prices swing up way past the real value of a property during a bubble, and fall below when it pops. And just as Econ 101 predicts, when the price of a property falls below the outstanding loan value, the default rates spike, because default becomes an action with positive returns. What’s going on at the individual level is utterly unremarkable.
Now, remember that 1) banks make home loans mostly to homeowners all living in the same region, and 2) prices in a given region are correlated, since they’re part of the same local market. So a burst bubble is very expensive for a bank, since defaults are highly correlated for them.
To break this correlation, since the 1970s banks have been engaging in mortgage securitization. What this means is that they trade their loans for shares of a portfolio of loans. As an example, imagine a bank in Boston, which has a portfolio of 100 loans to Massachusetts homeowners. So, to reduce their risk they trade their portfolio of 100 loans in MA for a portfolio of 2 loans from each state. Since Alaska’s market is hopefully not correlated with MA, they have lower overall risk. Think of a mortgage-backed security as like a mutual fund of loans.
Much more recently — say, the past decade — hedge funds have been trading derivatives based on these securities. Derivatives are a great way of leveraging your capital, and that means that when the market is going up you make a hell of money, and when it’s going down you lose in equal proportion. What has happened is that the market has gone down, and the hedge funds have lost gigantic amounts of money.
Naturally, they’re screaming their heads off about this, and since they’re the richest companies on Wall Street the press has been paying a lot of attention. But me? I honestly couldn’t care less whether Bear Stearns makes 10 billion dollars or not.
But then again, they’re the richest companies on Wall Street, so they’ll probably get bailed out. Annoying, but that’s life.
I’m nervous for the country; personally, my financial security still depends most strongly on getting a tenure-track job. As for the country, though: I think, perhaps, that “overwhelming bad news” might translate into what Japan just emerged from–twenty years of no economic growth, teetering on the edge of a deflationary crisis–not a Great Depression, or even necessarily a 1981-82 depression. Bad enough, in its own way, but very different in character.
My situation is probably fragile, but I don’t know how high the risk is.
What worries me about the whole economy is that the people who were getting fortunes to make clever and/or sensible investments weren’t especially much paying attention to simple logic about whether those investments were any good. What else are they missing?