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Too Late To the Downturn

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By David Ignatius
Sunday, January 20, 2008

So where were all the politicians who are now saying "Hurry up! Fix it!" about the looming recession, back when the economic mess was brewing? You know the answer. Most of them were focusing on other issues. And now that the slowdown has begun, it may be too late to blunt some of its effects.

That's one of the dirty little secrets about economic policy: The response to a crisis is often too late. Policymakers are slow to recognize that a problem is brewing and then slow to take action. As a result, the lag in policy often has a pro-cyclical effect -- a stimulus package that juices the economy after the recovery has begun, or a cut in interest rates that encourages more lending well past the time it would do the most good.

What's infuriating is that the problems in the housing market were clear to everyday folks long before they registered with the geniuses at the Federal Reserve and the Treasury Department. In fact, that's why we are heading into a recession -- because consumers and business managers realized last fall that there was something seriously out of whack in the housing sector, and they began trimming their spending and investment. The result is the pattern we are now seeing, of declining retail sales and rising unemployment.

Here's what neophyte Fed Chairman Ben Bernanke said in May, when warning signs about a mortgage squeeze were already flashing red: "The effect of the troubles in the subprime sector on the broader housing market will likely be limited." Sorry, but that was not the correct answer.

Wall Street traders saw a housing crunch coming, and the smart ones were aggressive enough to profit from it. Last week, the Wall Street Journal profiled a hedge fund manager named John Paulson who has made between $3 billion and $4 billion over the past year betting that the shaky structure of subprime mortgage loans would topple.

"This is crazy," Paulson is said to have told his colleagues, as he looked at the imbalances in the U.S. economy back in 2005. "Where is the bubble we can short?"

Goldman Sachs, too, recognized that there was trouble ahead in the housing market. In late 2006, Goldman's chief financial officer, David Viniar, decided that the bank should reduce its holdings of mortgages and mortgage-backed securities and buy insurance against further losses.

And what was Goldman's former chief executive, Henry Paulson -- now in Washington as secretary of the Treasury -- doing about the looming crisis when his former partners were reducing their exposure? Sad to say, the answer is very little.

Even journalists saw this one coming. In December 2005, Kirstin Downey, who covered housing at the time for The Post, wrote an article headlined: "Mortgage Stress Seen for '06; Delinquencies on Subprime Loans Seen Likely to Spike, Report Says." She continued to write warnings about the subprime mess through 2006. It's eerie reading them now, like watching a replay of a car wreck.

Steven Pearlstein, a Post financial columnist, wrote some of the sharpest warnings about what was ahead. In a prescient March 2007 column about the gimmicky loans that fueled the subprime disaster, he wrote: "What we have here is a failure of common sense."

Now congressional Democrats and the Bush White House are jostling over the size and shape of an emergency stimulus package to reduce the damage of the coming recession -- with presidential candidates shouting out their advice from the wings. It reminds me of Hurricane Katrina, with frantic action after the disaster has begun but little precaution beforehand.

Economists, who have a theory for everything, have come up with an explanation for this chronic tendency to delay until it's too late and then scream for action. " Procrastination and Impatience" is the title of a paper published in December by the National Bureau of Economic Research. After conducting elaborate experiments, the three authors concluded: "Our results lend support to the hypothesis that subjects who have a preference for immediacy are indeed more likely to procrastinate."

So there you have it: Our political process is a self-frustrating machine. Our politicians want immediate action, but only after they have delayed to the point that it will be ineffective. Our Fed chairman wants to shower the economy with money, but only after bankers have gotten too nervous to lend it. With this one, nobody can say that people didn't see the crunch coming. The policymakers just didn't do anything effective about it, back when it would have made a difference.

The writer is co-host ofPostGlobal, an online discussion of international issues. His e-mail address isdavidignatius@washpost.com.


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