Martin Feldstein on the Housing/Credit/Economic Mess

Wednesday, September 12, 2007 | 10:39 AM

Regular readers know that I am not a fan of the WSJ Op Ed page. In addition to their playing fast and loose with facts, I find their rhetorical tactics intellectually dishonest. I also suspect that excessive usage of the drug exctasy has left most of their editorial staff crispy remnants of their former selves, subject to frequent delusional flashbacks, delirium tremens and incontinence.

But I must put those intellectual reservations aside and direct you to
Martin Feldstein's utterly dead on piece in today's Journal. In a straight-forward, no nonsense manner, Feldstein perfectly sums up how we got to where we are today:

"Three separate but related forces are now threatening economic activity: a credit market crisis, a decline in house prices and home building, and a reduction in consumer spending. These developments compound the general weakening of the economy earlier in the year, marked by slowing employment growth and declining real spendable incomes.

The current credit market crisis was started by widespread defaults on subprime mortgages. Borrowers with poor credit histories and uncertain incomes had bought homes with adjustable-rate mortgages characterized by high loan-to-value ratios and very low initial "teaser" interest rates. The mortgage brokers who originated those risky loans sold them quickly to sophisticated buyers who bundled them into large pools and then sold participation in those pools to other investors, typically in the form of tranches with different estimated degrees of risk. Many of the buyers then used these to enhance yields in structured bonds or even money market funds.

Many subprime borrowers eventually had difficulty making their monthly payments, especially when teaser rates rose to market levels. The resulting defaults exceeded what investors in the mortgage pools had expected.

Credit risk in financial markets had been underpriced for years, with low credit spreads on risky bonds and inexpensive credit insurance derivatives provided by investors seeking to raise their portfolio returns. With such underpricing of risk, hedge funds and private equity firms substantially increased their leverage.

The subprime mortgage defaults have triggered a widespread flight from risky assets, with a substantial widening of all credit spreads, and a general freezing of credit markets. Official credit ratings came under suspicion. Investors and lenders became concerned that they did not know how to value complex risky assets.

In some recent weeks credit became unavailable. Loans to support private equity deals could not be syndicated, forcing the banks to hold those loans on their own books. Banks are also being forced to honor credit guarantees to previously off-balance-sheet conduits and other back-up credit lines, further reducing the banks' capital available to support credit of all types." 

Feldstein notes what many TBP readers will recognize as big themes: The significance of housing to the prior "boom," the ongoing risk of inflation, the dangers a slowing economy presents, and of course, moral hazard.

We have seen and heard a lot of anti-free market, who-was-Schumpeter-anyway?, begging for a Fed bailout. Unlike that group of socialist whiners, Feldstein makes the most eloquent and persuasive case I have yet to come across . . .



Liquidity Now!
WSJ, September 12, 2007; Page A19

Wednesday, September 12, 2007 | 10:39 AM | Permalink | Comments (56) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Note my own usage of distasteful rhetorical trickery.

That was ironic parody on my part!

Posted by: Barry Ritholtz | Sep 12, 2007 10:54:13 AM

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