Washington Post business columnist Steven Pearlstein was online Wednesday, March 12, at 11 a.m. ET to discuss the housing market, credit markets, and recession.

About Pearlstein: Steven Pearlstein writes about business and the economy for The Washington Post. His journalism career includes editing roles at The Post and Inc. magazine. He was founding publisher and editor of The Boston Observer, a monthly journal of liberal opinion. He got his start in journalism reporting for two New Hampshire newspapers -- the Concord Monitor and the Foster's Daily Democrat. Pearlstein has also worked as a television news reporter and a congressional staffer.

Read Pearlstein's latest columns.

____________________

Vienna, Va.: How does the Federal government account for the credit risk that it assumes when it swaps Treasury instruments for mortgage-backed securities? The prices for the latter are falling for a reason. AAA ratings are meaningless, as reported by Bloomberg yesterday.

Steven Pearlstein: The Fed does not have to mark to market since, for one reason, it has no quarterly reporting requirement. Also, it does these swaps for 28 days at a time (although perhaps we'll discover they can be renewed). So you are right in that the purpose of this is to make it possible for the broker dealers to exchange something that they would have to mark down, in the current environment, for something they wouldn't. But the real purpose here is to find a way so the broker dealer doesn't have to sell the mortgage-backed security, dump it on the market, and thereby drive the price even lower and grigger even more margin calls and more forced selling.

_______________________

Cincinnati, Ohio: Steve -- as usual, I enjoyed your column today. My question: In general (historically), are you bearish or bullish? I ask because, although forecasts are all over the map lately, yours seems a bit on the bearish side. If I'm making an accurate observation, what is it that you see differently than other forecasters?

Steven Pearlstein: The difference is that I'm going totally by my gut. I have no computer. I have no technical analysis. I have no inside market information. I just have history and feel. And there is no indication I see that the financial sector is even halfway through with repricing assets and taking losses that will run to $1 trillion. It is definitely going to take another 6 months or so, and during that time, there is no way that financial markets can avoid being in a down-drift. After that, there will be a period of bouncing along the bottom and then financial assets will probably take off fairly briskly, as they usually do after such a washout. And that will come precisely when the real economy has hit bottom. When that will occur, its hard to say, but its unlikely to be before next spring, in my opinion.

Is that bearish or bullish? I'll let you decide.

_______________________

Rocky Mount, N.C.: Good morning. The Fed has been doing these maneuvers like accepting more risky collateral and lowering interest rates although I myself can't benefit from them, and one step goes farther than the last to try and make things all better. What's left for them to do beyond this point? I can realistically see them taking interest rates down to 1 percent again and they're already accepting the garbage collateral from the big Wall Street firms, such as Bear Stearns as you state in your article. I'm skeptical on whether said moves will work, but what else do you think they will try?

Steven Pearlstein: As I suggested in my tongue in cheek lead today, they will simply make their balance sheet available in more creative ways, whether it is lending against more stuff, or swapping it or, in the most extreme case, actually buying paper -- either Fannie, Freddie and other agency paper, or even non-government-related paper. We are about to discover, in fact, how powerful the Fed can be as a printer of money and buyer of last resort. And this is different than their other power, the power to set the Federal Funds rate, which is rather crimped right now because the channels through which it works are rather clogged because of this credit and liquidity crunch.

_______________________

Ashburn, Va.: When do you think we will hit bottom on the real estate market?

What factors will be positive signals that we are on the right tract to recovery?

Steven Pearlstein: The first thing that needs to happen in real estate is that the rate on 30 and 15 year fixed mortgages has to come down to the point that lots of people can, and do, refinance. That's the first goal, and once it is achieved, it will begin to put the floor under prices of existing homes. then it will be one of those situations where it will take some time for sellers to accept the fact that their homes aren't worth what they used to be and agree to sell at the lower prices. That capitulation will represent the bottom.

On new homes, its a market by market situation but I think it will be a while in many markets before demand returns. That is more a reflection of the economic cycle and we're just entering into the downturn now.

_______________________

Takoma Park, Md.: Hi Steve:

Enjoyed your analysis - spooky as it is. But isn't there another dynamic at work here, with the Fed pushing on a string when it continues to lower rates and no one's ready to borrow any more? With the dollar falling in value as a result, and commodity prices - especially oil - rising, inflation rears its ugly head which in turn causes businesses to raise prices and layoff workers. As a result, businesses don't want to borrow at the new higher rates, and so we have a downward spiral. Care to comment?

Steven Pearlstein: Yes, there is the usual pushing on a string problem that happens in every recession. But in addition, the Fed believes that the credit market turmoil creates even additional problems for monetary policy in that its hard for lowering the cost of borrowing to have a positive effect when the financial system is in the midst of a lassive deleveraging. Its like swimming up stream with a heavy, heavy current running against you.

_______________________

Vienna, Va.: Is it fair to postulate that the war in Iraq has played a major role in the demise of the dollar, and the current mess we have in our economy?

Steven Pearlstein: No, that's probably not a big factor.

_______________________

Vienna, Va.: Steven;

I'll take your word for it that we all needed the bailout as I watch my own portfolio tank - even though the need for it was created by Wall St. going to the casinos the past several years. Here's my question: I worked in a hospital, where, when we harmed a patient, we went through a formal process of "root cause analysis" to ensure it never happened again. What, in your opinion, is the root cause, and I mean the VERY root, of the current situation? I hear the same old thing about the Fed keeping interest rates low for too long, but the Fed didn't invent SIV's and CDO's. Is this bubble economy doomed to keep repeating itself in different sectors forever and ever, or how can it be prevented?

Steven Pearlstein: The fundamental problem is that we allowed a huge, unregulated alternative credit-creation machine to develop outside the regulated banking system. Broadly speaking, its called the credit market and it involves hedge funds and derivatives markets and swaps markets and asset-based securities market, etc. etc. And this got very big, trillions of dollars, all of it essentially unregulated but, more significantly, all of it with no capital cushion. In fact, it was the ability to have very high leverage with no equity or capital cushion that gave this market its advantage over the banking system in terms of being the lower-cost and more "efficient" intermediary. But it was this lack of capital that also has now caused the fix we are in, because there was no financial shock-absorber when things started to go bad. And THAT is the basic problem.

At an even more abstract level, of course, the problem was that the US economy was running on too much cheap, borrowed money and we were living beyond our means.

_______________________

Silver Spring, Md.: Thanks for taking my question. It's my understanding that financial institutions are using "bad debts" as collateral for the infusion of cash from the Fed. Am I missing something, or is this as bizarre as it sounds? How can "bad debt" be redeemed should the financial institutions be unable to meet their own obligations?

Steven Pearlstein: You are right and wrong. Right in the sense that they are being able to trade securities that are now selling at distressed prices for securities that are not. But they aren't necessary securities backed by bad debts -- in fact, in the case of Fannie, Freddie and Ginni Mae securities, they are mortgage-based securities with either an explicit or implicit government guarantee. So there is, effectively, no credit risk (i.e. risk of non-repayment to investors). Or put another way, the market is at the moement irrationally pricing these securities because there are suddenly lots of sellers and very few buyers. Sellers are selling because they are subject to margin calls, not because they think the long-term prospects of getting repaid are bad. And the buyers are on strike because nnobody likes to try to catch a falling knife -- that is, nobody wants to buy when prices are falling, figuring that if they just wait, the price will be lower an hour or a day or a week from now. So everyone is acting rationally, it is just that when everyone acts rationally in these instances, you get a very irrational outcome, which is to drive down the prices of these mortgage-backed securities even lower than the likely default rates would suggest.

_______________________

The Mall Was Busy: My husband and I relocated to a small town for his job a couple of years ago. This past weekend we drove almost two hours to go to one of the two nicest, most "upscale" malls in the southeast. The mall is in Atlanta and we go up there several times a year to get fashionable clothing and shoes. It was PACKED. My husband joked that you'd never guess that our country is in a recession. Seriously, are they all using credit cards? I did not make a purchase in one store as there were about twenty people in line.

Steven Pearlstein: Let's remember what a recession is: it is the lack of economic growth. That means the growth rate could be zero, or slightly negative. Which means that everyone is buying what they bought last year, but no more. Well, last year, they bought quite a lot, so if the economy is in recession, it may mean that most people will still have jobs, most of those people who have jobs will have incomes that are equal or nearly equal to what they earned last year, and they will spend as much or nearly as much as they spent last year. That's still a lot of spending. In fact, I'm not sure you would, with a naked eye, be able to tell the difference between last year's sales volume and 95 percent of last year's sales volume. And yet if sales of all retail stores fall by 5 percent, that would be a recession.

_______________________

Baltimore, Md.: Steven: In today's column, you wrote that: "Then yesterday, the Fed announced that it would swap $200 billion worth of Treasury bills for $200 billion worth of mortgage-backed securities held by the major investment banks that are members of its 'prime broker' network on Wall Street." In reality, isn't this just trading good money (the T-bills) for potentially worthless IOUs, as no one really knows the value of these mortgage-backed securities? And by printing this money,is the Fed revving up the inflation engine, which is running pretty hot already due to the ever-increasing cost of fuel? Thanks.

Steven Pearlstein: Well, as I just explained, that IOUs are not worthless in an economic sense, that is, when valued against the income stream they are currently producing and they are likely to produce in the future. The market is deeply discounting them now, too deeply, but that is because of what is a temporary liquidity shortgage, or the reluctance of anyone to buy at the moment. And that is precisely the moment when you need a central bank to be the buyer of last resort, which was the original reason for creating central banks in the first place.

_______________________

Washington, D.C.: Steve, you mentioned in your article: "For it is only when bank lending and credit markets have returned to more normal operations, say Fed officials, that the beneficial impact of their interest rate cuts can be transmitted to the economy." Assuming this is true, does this mean rates on consumer loans will go down significantly from here? I am contemplating taking out a large (over $1 million) mortgage on a commercial property to do renovations, but i keep having this feeling that rates should be much lower given all the recent fed cuts. Thanks

Steven Pearlstein: I can't speak to the timing. This action by the Fed might bring the credit markets back into a normal state so that lower Fed Fund rates translates into lower rates up and down the yield curve. Or it may take more time. It is just not possible to know. It may be that 30 year fixed mortgage rates never go below 6 percent again if one result of all this pump priming is that inflation expectations rise. So it is a delicate line the Fed has to walk here, and there are risks in both directions.

All of which is to say I can't offer you any useful advice for your particular situation.

_______________________

Potomac, Md.: Will the Fed's policies drive us to 7-10% inflation in six months?

Steven Pearlstein: Let's just say it won't dampen inflation. As I've said many times before, we are in for a period of staglation over the next two years, of that I'm pretty certain. How much stag, how much 'flation, I can't say. There are some tradeoffs to be made there. My colleague Bob Samuelson says that unless the inflation last for many years, it's not really stagflation. Maybe he's right. So I'll call it two years of negative growth or growth below potential, accompanied by headline inflation rates of 3 percent or more. How's that for precision?

_______________________

St. Petersburg, Fla.: With a severe housing correction, a credit crunch, and heightened pressures on household budgets due to record oil prices, what hope is there for the economy? That is, what could prevent this from becoming a severe downturn and what will help the economy recover?

Steven Pearlstein: There will be a downturn, although how severe I'm not sure. For all the troubles out there, businesses are still in good shape financially and that should allow them to weather a slowdown in sales without having to take the kind of extreme measures that begin to feed on themselves and cause a vicious downward cycle in terms of the overall economy. So it could well be a shallow recession if that reality continues to hold. On the other hand, it could get worse if the financial crisis really begins to threaten the flow of credit even to businesses that deserve it, or if household wealth (value of homes, stocks, etc) gets so low that consumers really pull back on their spending and start saving a lot more or paying off their credit card debts. Again, we're not there yet but you can't rule it out as a possibility.

_______________________

Anonymous: Good morning Steve. What do you think of the current standing of the Feds who keep pumping money into the economy--increasing the monetary base--in a situation where the internal deficit is already so high? And where is the imported inflation (because of the devaluation of the dollar) going to be felt most severely? Further, do you see a 10-20% inflation within the year , as in the times of Reaganomics?

Steven Pearlstein: No, those inflation estimates are way too high, thank God. And its also not clear that monetary aggregates are increasing, since lots of credit is now being withdrawn from the market by the credit markets. Also, these swaps actually do not represent an increase in money supply, in a technical sense.

_______________________

Washington, D.C.: Thanks for today's column. As you say, the timing of market meltdowns and Fed rescues is impossible to predict--though you expect things to slide downward untill fall or so. For someone in mid-career who took 401K money out of stock funds when they were 10% higher, would it be sensible to get back into stocks in regular installments (dollar-cost-averaging for new money) in a mix of stock index funds? Or hang tight until the crunch is clearly over and the indexes are rising?

Steven Pearlstein: I don't think you'll miss upside if you hold off and wait for a while. I know that's only half-helpful, since I'm not saying when. But you'll probably have a good idea when that is.

_______________________

Arlington, Va.: So who are the winners and losers of these two bailouts? I have a vague feeling of rage, and I don't know why.

Steven Pearlstein: You should feel rage at Wall Street, but the rage should be the lousy judgment they showed in getting themselves and the rest of us into this mess. And if you want to be mad at the Fed, be mad at its failures as a regulator during the last decade, not for what it's doing now.

_______________________

Danvers, Mass.: Some have pointed out that non-financial companies are piling up cash at a rapid rate, are buying back shares, and have seemingly boundless credit at low prices. Yet the structured arena is bound up. To what extent is this crunch related to questionable lending practices and would we be better (or worse) off without these practices?

Steven Pearlstein: The world would be better off without some of these structured products, or at the speculative use that has been made of them that has driven their growth.

_______________________

Bethesda, Md.: I already sent an email directly to Steve, but was so impressed with this morning's piece that i wanted to repeat myself. It was a tremendous synthesis of the crisis and how it affects all of us, not just Wall Street. I have been a professional investor for 21 years and have been quoted in the Post quite a few times, so I am no novice and have seen a lot come and go. Friday morning I sat down with my wife and explained to her why this would be the worst economic period in our adulthood. The entire mortgage securities market had essentially locked up. By the end of Monday, there were probably hundreds of financial institutions that were technically insolvent. While the Fed cannot solve the problem, they have bought critical time. As we have seen over the past year, there is no predicting the next crevice that this would leak into. After all, who would have thought that a sub-prime mortgage debacle could have such profound effects on the municipal finance market? And yet it has. In my opinion, predicting what is next is futile, save that it won't be good.

Steven Pearlstein: Thank you. And amen.

_______________________

Washington, D.C.: Could the moral hazard effect of the Fed's actions be worsening in the long run, rather than it not being so "creative?"

Steven Pearlstein: Yes, there is a moral hazard, but the "cost" of the increase in moral hazard is less than the "benefit" of avoiding a market meltdown. Moreover, the Fed and SEC can reduce the moral hazard through their regulatory and enforcement powers going forward, creating even more disincentive for reckless risk taking by top executives and traders in the future.

_______________________

Minneapolis, Minn.: Thanks for doing these chats. Have you seen the new book by Charles R. Morris: "The Trillion Dollar Meltdown"? If so, what do you think of it?

Steven Pearlstein: Sorry, haven't seen it yet.

_______________________

Lynch Station, Va.: Steve, if the GDP does not rise to the estimated 1-1.5% level for this year how do you estimate that the debt will begin to effect the mandatory funding portion of future budgets submitted? In your opinion, will the debt requirements begin to scare off foreign funding, especially since the world cash excess may take a hit with the present financial crisis? Thanks.

Steven Pearlstein: The recent fall in the dollar and the refusal of interest rates to fall despite cuts in the federal funds rate are both indications that it will be harder (i.e. more expensive) to finance our current account deficit going forward. Which is one reason the deficit will come down, albeit with real consequences to our standard of living.

_______________________

it will take some time for sellers to accept the fact that their homes aren't worth what they used to be and agree to sell at the lower prices. : Aren't sellers already realizing their homes aren't worth as much? I've been house hunting the past month, and I keep seeing sellers who have dropped their prices by large amounts. Maybe what I'm seeing is sellers who were expecting a huge profit and are now just lowering so they'd get a small profit. Are you talking about sellers will realize they actually need to take a big loss when they sell?

Steven Pearlstein: Not sure you can frame the question quite that way, but I do think it true that sellers who were expecting huge gains may now have to settle for so-so gains or even no gains, depending on when they bought. Here's a rule of thumb: You shouldn't be surprised, as a seller, to have to give up the price appreciation of the two previous years. And remember that in some places, that could amount to 30 percent.

_______________________

The Hague, Netherlands: Thanks again for an interesting piece that summarizes the situation and accents the important points. You noted in your article that come fall we can expect more ugly action. What is driving that? Reset schedules for subprime seem to peak in the spring of 2008. Is this the lag between resets and defaults or are you talking about a different problem? On a different note, the problem with auction rate securities is amplified by the current crisis, but relying on short term yields to finance long term projects seems like a recipe for disaster. When long term rates are low, why not lock in? It's a bit like getting an ARM to save an extra 1/4%. That only works until rates climb. Shouldn't bond issuers know better?

Steven Pearlstein: Borrowing short to spend or lend long has a long tradition in finance, I'm afraid. In fact, many of the muni and non-profit issuers of auction rate bonds always have the option of refinancing long, which is what many are now doing. The only problem comes when they all go to do it at the same time, it has the effect of temporarily driving up rates.

_______________________

Laguna Beach, Calif.: Is the latest fed move likely to improve the residential home sale and refinance markets?

Steven Pearlstein: Yes.

_______________________

Arlington, Va.: The longer the Fed keeps injecting money and lowering the rate, the longer this recession and problem they created will last. The best medicine is hard medicine. Raise the rate, teach people a lesson--especially Wall Street and its billion dollar leaders that are putting companies under--and let the dollar and inflation get under control. Inflation is the real danger everyone seems to be missing.PS: You can't make banks lend money no matter how much you put up for auction and if you continue to insist, you will have another housing/credit problem.

Steven Pearlstein: Look, you're right that we need to work through this quickly, take our losses and let the market clear at lower prices. No question. But please don't be cavalier about what happens during a market meltdown. Lots of irrational things and there is lots of collateral damage to people and businesses and institutions that bear very little responsibility for creating or even participating in the credit bubble. From my conversations with people at the Fed, I think they understand the need not to get into Japan-like denial. But they also understand the need not to get into the kind of tough, Calvanistic monetary policies that lead to the Great Depression. You got to strike a balance here.

_______________________

Arlington, Va.: Looking back, were there signs that this was going to happen that we just ignored? Also, with gas/oil prices continuing to go up, jobs being lost and the value of the dollar declining, what can be done to prevent a loss of confidence in the American economy? I can't imagine anybody around the world thinking that this is the economy of the world's super-power.

Steven Pearlstein: We have lots of strong companies and a good economic system here, perhaps the best in the world. And investors around the world still know that. We have had some huge financial excesses that need to get worked off, but let's keep this in perspective. The world isn't ending but there is going to be a period of pain and adjustment ahead of us for the next couple of years. And it will go faster if Wall Street types can stop their incessant marketing and cheerleading about how a bottom has been reached. It hasn't. Moreover, those people right now have no credibility. None. Nada.

_______________________

Richmon, Va.: Where did the Fed get the $200 billion? We're broke. Did they borrow it from China or some other country? Do the banks have to pay it back?

Steven Pearlstein: I love this question because the answer is so deliciously simple:

They print it.

_______________________

New York, N.Y.: Steve, I've got a comment and a question. If the Fed decides that certain short term moves are necessary to preserve order in the financial systems, I can't really argue against them, even if these moves help out investment banks. I'm just bothered by what seems to be the kabuki routine every couple of years when the investment banks take stupid and inordinate risks and expect everyone to bail them out.On a separate note, I can't help but think that the vast discrepancies in pay between what one can earn on Wall Street and what one earns in practically every other field is setting us up for bad things down the road. It's totally absurd that a college kid starting out at Goldman Sachs earns $100,000+, while someone graduating medical or engineering school would be lucky to earn half of that. It's true that market forces have created this absurdity, but I can't help but think that investment bankers don't really add much to our society. Thanks!!!!

Steven Pearlstein: Indeed, I wrote that column about a month ago and it is still getting lots of pass-around, according to the folks at washingtonpost.com. There is something wrong with our labor markets when that compensation is so out of whack and we need to figure out what that is and how to fix it.

_______________________

Crossville, Tenn.:"In the face of what is turning into the most serious financial market crisis since the Great Depression, the Fed has been more aggressive and more creative in using its limitless balance sheet--in effect, its ability to print money--than at any time in history." I was intrigued by your characterization of the present financial crisis as the 'most serious financial market crisis since the Great Depression" because as an old U.S. history student and teacher that had been my impression, only I had not heard anyone else describe it that way.

Steven Pearlstein: First off, we haven't had too many real financial crises since the Great Depression, so maybe that isn't as dramatic a statment as you might think. But second, this is bad. We're talking about $1 trillion in losses for financial institutions. That's a lot of money and it will wipe out a few before its all over.

_______________________

Fort Washington, Md.: A simple (minded?) question from a non-economist, physics major (from many years ago): 'Where was that $400 billion last week?'

Steven Pearlstein: half of it was in Treasury bills that, figuratively, were being stored in the Fed's vault. The rest was fresly printed.

_______________________

Great Falls: I'd agree with your root cause analysis in an earlier question/answer, but I'd take it back one step further. The various financial entities felt free to create these massive overhangs of debt only when they got the sense that the Fed would do anything to prevent an economic collapse. I think you have to trace the root cause back to the Greenspan Fed (or should I say the Greenspan put?), with plenty of secondary blame to the financial institutions (using that term broadly.)

Steven Pearlstein: As I've said before, there is plenty of blame to be handed out to the Greenspan Fed, but that is mostly in the area of bank and market regulation, where, because of Greenspan's ideological blinders, the agency fell down on the job.

_______________________

Dallas, Texas: I work at a big investment bank in the mortgage warehousing division. We lend to mortgage lenders, with their loans as collateral. We have 40% of the number of clients as we did a year ago, due to the industry problems. The question: should I stay in this industry or move on? Clearly, there is a continued need for mortgage loans. However, production is a fraction of what it was a year ago. What is your outlook for this industry a year from now?

Steven Pearlstein: Probably better than today, if you can hold on till then.

_______________________

Housing prices: Don't housing prices need to fall before the market can rebound? It seems that housing prices outstripped income growth for the past 5 years (yes, even in income rich D.C.). Prices need to come back in line with income before sellers enter the market. Regardless of what rates are, if you have to put 20% down now that takes a lot of people out the market who don't have the money necessary to secure financing. If the Fed encourages easy money again it might halt the slide but won't it just encourage more reckless borrowing?

Steven Pearlstein: Not necessarily. It is simply to provide the liquidity so that non-reckless lending can continue.

_______________________

Richmond, Va.: If you look out your window at high noon today, you'll see Bernake's helicopter flying over D.C. heading to New York City to drop billions of dollars off to bail out banks and investment firms that knew what they were doing when they accepted the risky sub-prime mortgages as collateral. Give Bernake credit for knowing how to print tons of money we don't have.

Steven Pearlstein: Bernanke will never be able to shake the monitor of Helicopter Ben. And in a crude sense, that is what he's doing, although I think it is a bit more nuanced than that: so far, he's lending this money, not giving it away.

_______________________

Gaithersburg, Md.: I am one of those "no money down" teaser rate mortgagors. But the reality is with D.C. housing prices it was the only way I could afford my first place. I think only one of two things can revive housing: either prices come down considerably to allow more people in and incomes rise significantly to catch up with the increase, or banks will have to return to no-money-down mortgages.

Steven Pearlstein: You got that right.

_______________________

Tallahassee, Fla.: Brad DeLong said one way out of the sub-prime dilemma is to inflate--this cuts the value of the fixed mortgage-backed securities and makes investment in real assets (like real estate) more attractive. A dirty pool but likely effective.

Steven Pearlstein: A tried and true technique, however. And remember, this is an old debate, going back to William Jennings Bryant Cross of Gold speech and Andrew Jackson's crusade to close the national bank.

_______________________

Annapolis, Md.: Just wondering: we had the internet bubble, then the housing bubble, do you think we will enter another bubble or will common sense come back?

Steven Pearlstein: There will always be bubbles, alas. But there is no reason regulators have to let them grow as large as they have recently. None.

_______________________

Steven Pearlstein: That's all the time we have today, folks. "See" you next week.

_______________________

Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.