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Pearlstein: Financial Meltdown

Steven Pearlstein
Washington Post Columnist
Tuesday, October 7, 2008 11:00 AM

Washington Post columnist Steven Pearlstein was online Tuesday, Oct. 7 at 11 a.m. ET to discuss the global financial crisis.

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.

Pearlstein was honored with the Pulitzer Prize for commentary for his columns about mounting problems in the financial markets. His award was one of six Pulitzer Prizes won by The Washington Post this year.

Read Pearlstein's latest columns.

The transcript follows.

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Suitland, Md.: Steve:

I thought the Feds and the still surviving banks were working together to help our nation manage or pull out of the crisis we have on hand. I believed that when Citibank agreed to takeover parts of Wachovia for a mere 2 billion. Then when Wells Fargo came around with a better offer without seeking any help from FDIC I thought wow the open/free market is working and now Citibank wants to sue Wells Fargo and Wachovia for $60 BILLION! So Citibank feels that by not being able to take over Wachovia they will lose close to $60 Billion. So it doesn't matter what the feds are doing to stabilize the current situation the banks and surviving financial institutions are just looking for making a buck (billions of them!) for themselves!

Steven Pearlstein: It is hard, when taxpayers are taking on cost and risk to rescue individual companies or banks, to accept the idea that all these institutions and hedge funds and vulture funds are out there trying to profit from the whole process. But that's capitalism, and there is really no way to take a collective time out when every company and every investors from trying to maximize profits. In fact, we don't really want that. We want markets to recover as soon as possible, and the relief mechanisms we come up with are meant to get that to happen, to get markets working again. That's the philosophy behind the Paulson plan, which is meant to get private capital back into the market in mortgage backed securities. Put in your terms, it is to get those greedy bastards to see a bargain and begin buying the securities at deep discounts with the idea of making a killing. When they begin to do that, it will take a lot of pressure off the entire system and help home prices stabilize, free up the bank balance sheets, etc. etc.

So if you start out with the expectation that Citi is only out there to do what is best for its shareholders, and don't get upset about that, then it is a lot easier to think through this thing.

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Lyme, Conn.: I went to my local bank regarding the new law that states my account is insured up to $250,000, and I was told this was only until December, 2009. Is this correct, or is the bank wrong? If this is correct, aren't there potentially going to be a lot of people putting their accounts at risk who may not know this is only temporary?

Steven Pearlstein: I don't think that is correct, although it may be that there is a temporary program that will be replaced by a permanent program that is still not in place yet because the premiums the banks will have to pay have not been set. But you can be pretty sure that your money will be safe -- the last thing the government wants now is for depositors to be fearful and bank runs to occur.

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Nashville, Tenn.: When the president of a bank signs his quarterly Sarbanes-Oxley statement, he certifies that he understands the balance sheet and that the numbers shown are correct. Yet every other banker in town is refusing to lend to this bank saying that it impossible to determine its true financial condition because of securitized mortgages on its balance sheet. If all the other bankers are right, isn't this an open and shut case for sending the bank president to jail? Do you see why the public is having a hard time accepting Chmn. Bernanke's explanation that this crisis is being caused by the reluctance of banks to lend to one another?

Steven Pearlstein: These are not open and shut matters. That's not to say that banks have been shading the truth in their financial statements. Jim Grant pointed ou tin our paper on Sunday that the credit default swap didn't even appear on the quarterly reports of companies like Lehman and Bear Stearns and AIG in the months prior to their failure, when these instruments were a key factor. The truth is that the required quarterly reports are an exercise in obfuscation that the Securities and Exchange Commission has tolerated and turned a blind eye to for years. They are NOT focused on the most important things you would want your owners to know if you were leveling with them. They are documents meant to be the minimum amount of information necessary to fulfill what the lawyers have determined is the obligation of the company to disclose.

Now there may be instances when a company official has said things in conference calls or interview or press releases which he knew were untrue, as evidenced by what he was saying internally. And those could present open and shut cases. But you also have to remember that the valuing of these securities is hardly a precise science.

Your general point, however, is a good one. Companies basically cover up and mislead investors and get away with it all the time. And as a result, we should treat their reports and their statements for what they are, which is marketing, not frank communication with owners.

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Rockville, Md.: Hi Steve,

CBS' "Sixty Minutes" had a fascinating story this past Sunday about the role of Credit Default Swaps in the current financial crisis. It seems that there are around $50 trillion of these insurance-like contracts in effect globally and the institutions that issued them were not required to maintain reserves to cover potential claims. I don't know whether these swaps were used to insure securities other than mortgage-backed securities, but what is your view on the potential role of these swaps in the stability/instability of global financial institutions going forward?

Steven Pearlstein: Big. And we know now they were really a mechanism for financial players, like AIG, to offer insurance outside the usual regulatory framework, which would require reserves and disclosure.

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New York, N.Y.: Steve,

To what extent do you feel the current financial crisis has upended the mantra of "buy and hold?" I've been buying and holding in my 401K for the last 10 years, but the last 10 months have sent me back to the dark ages. Had I just bought some simple 5 or 6 percent Freddies or Fannies 10 years ago I'd be far ahead.

I never expected to be having a Dow 10,000 party in 2008, on the way down.

Steven Pearlstein: I am not a believer in buy and hold as an inflexible strategy. Most of the time, its a good idea -- you don't want to get distracted by the weekly, monthly and even quarterly ups and downs of stock prices. But there are times when it is obvious that there is a speculative bubble and when that lasts for several years and you start to see really unbelieve profits made by flipping companies, you know it is time to start taking your money off the table in a very disciplined way, 10 percent a month or more. Similarly, after a pretty long decline in stocks, like the one we've just had, if you had taken your money out, you might want to begin putting that cash to use again in a orderly fashion. You won't catch the exact top or bottom unless you are very lucky, but just missing the most of a 30 percent decline can really improve your longterm results.

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Annapolis, Md.: Steven, In general I agree with your recent columns. However, I think you (and other pundits) should also take a look at the steps that need to be done to prevent similar crises in the future. Looking at the people that are implementing the next steps I only see people from investment banks. Obviously these guys think that the world revolves around Wall Street and needs Wall Street. So I am afraid that the hundreds of billions of dollars are mainly used to save the businesses (and large incomes) of the financial sector but nobody is looking at the bigger picture. I am still not convinced that the best use for the 700 billion dollars is to buy up the risky assets of banks so they can go on with business as usual. For the same money you could probably solve most of our energy issues or solve world hunger. I am very afraid that the US will just continue business as usual (borrowing and printing money) instead of focusing on producing something of value that other countries might actually want to buy.

Steven Pearlstein: If the financial system collapses, you won't have the money to do anything. Its really that simple. You may not like it, you may think it is morally wrong, but that is the reality. We're rescuing the system, the circulation system, and unfortunately the way we do that is to rescue a certain number of institutions that make up the system. We do our best to wipe out investors and those who were responsible, although we can't do that every time and we can't go back and take money from people that they earned legally three and four years ago. But keep in mind we're bailing out ourselves here.

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Troy, Ohio: It seems that the commercial paper market has pushed this financial crisis into a meltdown. Is there any sign that the US and European bailout deals have given the banks confidence to start lending on the overnight commercial paper market again?

Steven Pearlstein: Yes, there is today, but it will take several weeks of medicine from the central banks to cure this.

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Scranton (yep, much maligned Scranton): Steve, in conversations, many folks are saying that the best thing to do is ride out this crisis -- don't take out cash now amid the losses, it's too late to do so; keep in your mutual funds. But then who is taking out all of these funds and enhancing the panic? Are we dumb if we follow the 'conventional' wisdom and sit tight--while those savvy financial types who got us into this mess are shifting money elsewhere? James Cramer yesterday said that if you need money 'in the next five years' to get into cash today. What's your take? Thanks.

Steven Pearlstein: It is pretty late in the process to sell stocks at this point. The market will probably go down further, but as I just said, you'll never get the bottom perfectly.

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Arlington, Va.: Are Reverse Mortgages safe? Is this another crisis in the making? Will senior citizens, who may not be able to fully understand the fine print, lose their homes?

Steven Pearlstein: The good ones are good products. But there are a lot of scammy ones out there.

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St Louis, Mo.: In your column, you say that money market funds, etc., are 'hoarding cash.' Couldn't you say, instead, that they are demanding higher rates because they perceive new risks? I, for example, didn't realize that a prime MM fund might be lending to Lehman. When I realized that, I looked at the extra 0.5 percent I was getting in the prime fund vs. the treasury fund, and switched. I said, it's not worth the risk.

Isn't the feds bailout of CP sending a bleak message to savers? It's saying, you are not allowed to demand higher rates of return on your savings. If you try to demand higher rates, we will have to step in and loan taxpayer money instead.

Steven Pearlstein: I don't think that's the way to look at it. They are hoarding because the thing they fear most is breaking the buck, which they'd have to do if they invested in paper that defaulted in any significant way. People aren't looking for yield. They are looking for safety.

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Geneva, Switzerland: One hears again and again that banks do not lend to each other because they do not trust each other. If that is the case, why should anyone on main street keep more money in a savings account than the deposit insurance limit? Why should ordinary people trust a bank with their money if other banks (i.e. presumably "experts"), refuse to lend it even for a short term?

Steven Pearlstein: Big difference: "lending" money to banks as a depositor has government insurance; "lending" to banks by buying their commercial paper, that is not guaranteed.

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The Soup Line: Hi Steve, fine article this morning. I'll give you another Pulitzer if you can explain in 50 words or less the difference between a Ponzi scheme and a confidence-based economy?

Steven Pearlstein: A Ponzi scheme is a scheme that has the value of an asset rise only because there is another investor who is willing to join the party. As soon as there is not, the whole thing collapses. A confidence based economy is not a Ponzi scheme in that it is based on people doing what they say, disclosing what they need to disclose. There is real value created beyond just the ability to sell the hollow asset at an even more inflated price to the next sucker.

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Florida: Steve, I assume that you may not be privy to the conversations among the folks who've amassed millions during the financial go-go years. But I wonder from your contacts-what are they saying among themselves? That they truly deserve all of the money they got? That they really are set apart from the ill-informed folks who toil away from Wall Street? Is ANYONE feeling any sort of remorse?

Steven Pearlstein: I've got an admission to make: I don't talk to those people and, more to the point, they don't talk to me. I'd love to know what they're saying and thinking and feeling, but right now they are refusing to pick up the phone or talk in public. And that is one of the most glaring things missing in the public conversation in recent week: Where at the guys are are really most responsible for this mess?

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Nashville, Tenn.: The series of articles which won you the Pulitzer prize predicted the current situation we are facing quite accurately a year in advance. And you have written last week how there is nothing wrong with greed. Isn't the problem that greedy lawyers have been prevented from feeding on these CEOs who took insane risks by reducing the statute of limitations on the Securities and Exchange Act? Also, the safe harbor act of 1995 all but prevents lawsuits by stockholders.

Steven Pearlstein: Overpaid lawyers. Incompetent lawyers. Lawyers who don't know that they have an obligation to the system as well as to their clients. That's the better description. Whether they are greedy or not is not a question we need to reach.

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Washington, D.C.: Hi Steve,

Thanks for the great articles/chats. This weekend, I was giving my mother an overview of the current financial crisis we find ourselves in. She had a good question about all the foreclosed properties that started this bubble-bursting chain of events which I couldn't answer: What happened to the Private Mortgage Insurance? Isn't that the reason banks require PMI on mortgages with less than 20% down?

Steven Pearlstein: There are private mortgage insurers, there was a concern several months ago that they didn't have enough reserves to cover their expected losses, they raised more capital and that concern, while not completely gone away, has receeded into the background.

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Copenhagen, Denmark: The news over here is the government takeover of banks in Iceland. It seems that country's financial system is taking a major hit. Is that a portent for the rest of us?

Steven Pearlstein: That is a relatively extreme, small case of a country whose few, relatively small banks borrowed a huge amount of money from the rest of the world and flooded its own economy with capital as well as invested the money in all sorts of risky instruments that have now gone sour. It is a version of what has happened elsewhere, but out of scale to the size of the Icelandic economy to the point that it threatens to bankrupt the country.

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Perth, Australia: Normally when a country keeps printing money, its currency is devalued, then why is the US dollar increasing in value when the Government has committed billions (it doesn't have) to prop up banks and finance companies?

Steven Pearlstein: It's actually not true that we are printing money at this point (that is possible, but we're not there yet). We are printing IOUs that people still think will pay off. That is increasing the amount of government credit even as private credit is shrinking fast.

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Chicago, Ill.: Thanks for chatting this morning. So let me get this straight. We have the stock market crash in 1929 and a Great Depression (capital G capital D) and in order to prevent those two events from happening again Congress, at least in part, passes the Glass-Steagel act that does something regulatory to the banking industry. Then about 50 years go by and someone thinks it would be a good idea to repeal Glass-Steagel and a few years later we have another stock market crash and possibly another Great Depression. Have I got this sequence of events right? Does the law that repealed Glass-Steagel have sponsors or co-sponsors who are still in Congress, so that I might try to chastise them in the ballot box this November?

Steven Pearlstein: Much as many liberal Democrats want to believe that the repeal of Glass Steagel was the key policy mistake, I must tell you that is wrong. The world of finance had changed so thoroughly that the repeal of Glass Steagel, by the time it came, was almost irrelevant, because most of the intermediation had already moved from banks to the credit market. The only question at that point was whether the banks were going to be allowed to be integrated into that new system or not.

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Hamilton, N.Y.: Hi Steven, Are "bailouts" really aberrations or do you see them as generally necessary steps that the government will have to take when big companies get into financial trouble?

Steven Pearlstein: Big companies, probably not. Big financial institutions, yes. The difference is that the latter are the mechanisms by which finance, the lifeblood of capitalism, flows through the economic system.

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Washington, D.C.: Jim Cramer, NBC's stock guru, just told his viewers that if they might need their money within the next five years, they should get it out of the stock market right now. Do you think that's a clear sign that we've reached or are approaching a bottom?

Steven Pearlstein: Jim has an impressive investment record but he has a traders mentality, not an investors mentality. As I said before, it's a bit late now to pull all your money out of the market. You might want to pull out a couple of year's worth of living expenses into cash. And if you have already sold, you might want to stay mostly in cash. But panicking now and selling everything, I'm afraid the time for that has already passed. Mind as well ride it out.

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Olney, Md.: Hello Steven,

I truly believe that the media has fueled most of the nervous feelings about the economy right now with continual comparisons to the Great Depression. Seems to me, however, that things are not nearly as bad as they were in the 30s, so why do they keep making these references and scaring people?

Steven Pearlstein: They are not as bad in the real eeconomy as the Great Depression, and won't get anywhere near that bad. We learned our lessons and have lots better institutions to prevent that. But the damage to the financial system is quite analogous.

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Greenbelt, Md: With the weakening of the U.S. dollar, are foreign countries more likely now to start dumping their dollars?

Steven Pearlstein: Its actually strengthened in the last few days as investors have sought the safety of US Treasury bonds and realized that there would be a gloabal slowdown, not just a US recession. But over the much longer term, the dollar probably has to adjust downward.

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Los Osos, Calif.: You can parse words like "greed" and "incompetence" all you want, but there comes a point where laws have to be enforced to restrain both failings. Why? Because they victimize millions of innocent bystanders as do war and disease. That makes them morally wrong as well as impractical in the long run.

Steven Pearlstein: Okay, I'll buy that.

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S. St. Paul, MN: So why couldn't this bail out money be used to help "working type" people. Use it to pay off mortgages of people who make under a certain amount of income. This would help the middle class spend more, and many other things would be corrected. I think there would be money left over. These people were taken for a ride any ways by the mortgage/financial industry.

Steven Pearlstein: I've said before that there is room for the government to help out troubled homeowners by taking an equity stake in those homes in exchange for a loan now that lets them refinance in a sustainable way. The government has already done that with the new housing bill that passed a few months ago -- the program is just beginning. There is the name HOPE in the name of the program but I forget what the rest is. But there is scope to expand that program if necessary, I agree. And nobody is ruling that out.

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Evanston, Ill.: Hey Steven, it was reported last week that in 2004, the investment banks led by Hank Paulson, lobbied the Bush administration and the SEC to remove the 12 to 1 leverage cap on their firms. Should Paulson step down?

Steven Pearlstein: No, even if he did that, which I think we don't know.

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Princeton, N.J.: But what about Credit Default Swaps where people make contracts to pay if securities they do not own default and others make contracts to pay if that contract fails and others.......

Ponzi or no Ponzi?

Steven Pearlstein: Not precisely a Ponzi, but a house of cards to the degree that there is a lot of insurance of insurance of insurance.

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Washington, D.C.: Steve,

What is your opinion of the Federal Reserve's latest move to buy up commercial paper? Is it a wise thing to do, or will it simply shift more bad debt to taxpayers from corporations?

Thanks!

Steven Pearlstein: Wise move. Very little chance of losing much money, with big upside if it works.

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Oakton, VA: Stephen,

Thanks for taking my question, and as always, for your insightful chats.

I read an article in this week's Time on the similarities between this crisis and the Great Depression. In that crisis, it seems that there was really not a big crash, but more an incremental devaluing of stocks over I think 3-5 years, to where the market ultimately lost 90 percent of its value. It seems like Bernanke is trying to head this off at the pass, given his position and scholarship of the Depression.

That said, what are your thoughts (or I daresay, predictions) for how deep this meltdown will go? How much power does Bernanke have, or how many tools in his arsenal, can he use to avoid a similar, gradual devaluation? I wonder this in light of his (and the U.S.'s) ability to control the global economy.

Steven Pearlstein: Nobody controls the economy, particularly the global economy. The Fed's powers are limited, particularly now, in terms of interest rates. But the Fed's power is great in its ability to inject money into the global financial system, which is why they are focused on that rather than on changes in the Federal Funds rate.

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Arlington, VA: Do you think it's time for the President to be honest and face the fact that were entering the beginning of a prolonged depression, perhaps even worse than the Great Depression? Wall Street realizes it, but most of the public think were in a recession, at worst. I'm preparing for a very bleak decade.

Steven Pearlstein: I don't think you have to be that pessimistic, really.

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Washington, D.C.: Do you believe there was an open and honest debate over the last two weeks about the bailout legislation? Do you believe that the advocates of the legislation accurately and clearly explained to the public how and why just this plan was the most necessary thing to do? Do you think the public understood that this plan was not designed to put out any fires immediately, but rather to work over a more extended period of time, to address just one aspect of our present crisis? Do you believe that the many public opinion leaders who cried loudly that this must be done immediately after last Monday's Dow day understood all those things?

Steven Pearlstein: There was a lot of misunderstanding about the bill and it was never well explained or defended by government officials, in my opinion. That said, the public was never really likely to like it and it was very easy to demagogue as a taxpayer bailout for rich Wall Street sharpies.

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Nashville, Tenn.: Speaking of reserves and disclosures of the insurance industry & AIG, how did it come to pass that the FDIC stopped collecting insurance premiums for nearly a decade? Accordingly, the bailout bill was forced to tap a vein into the U.S. treasury for unlimited FDIC funding, so it too has been socialized. If State Farm stopped collecting premiums in New Orleans for a decade, I'm sure someone in the press would have written about it incessantly. Why was FDIC given a pass?

Steven Pearlstein: The fund was pretty well capitalized, by historical standards, and there were so few bank failures it looked like there was no need. They are now moving to increase the premiums and over time, that should replenish the fund to where it needs to be, which is much bigger than people thought because of what we know now about contaigion and because of the bigger size of banks.

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Monkton, Md.: Can you lend me 20 bucks?

Steven Pearlstein: Funny.

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SW Nebraska: I'm a real estate agent and from what I've seen and experienced with foreclosures in our area and in Lincoln, it is very difficult to even make an offer on them. My son made an offer on a home in Lincoln and was told not to expect an answer for 3 weeks. He closed yesterday on another home. There seems to be a glut that the lenders can't efficiently handle.

Steven Pearlstein: The fact that these foreclosed properties are in the hands of mortgage service companies that never really set up to handle a problem of this size, that is a problem.

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Chicago, Ill.: Other than lowering taxes what can be done to create middle class jobs?

Steven Pearlstein: Lowering taxes doesn't create jobs, middle class or otherwise. That is a fiction perpetrated mostly by Republicans. Sometimes a temporary tax cut can stimulate demand if it is debt financed and if people spend it on goods and services produced by American workers. Lot of ifs there.

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Tallahassee, Fla.: Perhaps the biggest surprise to me as this credit crisis has developed, is the extent to which so many companies (and states such as California) depend on credit to fund their daily operations such as payroll. Even the profitable companies do this. Whatever happened to the practice of using your cash flow and earnings to fund your daily operations? Has this been the normal way of doing business, or is this relatively new (say, over the last 20 years or so)?

Steven Pearlstein: It is probably not a sign of weaknesses that any company or government occasionally has cash flow needs, particularly at a time when revenues are coming in less than anticipated when spending commitments were made.

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Columbia, Md.: Steve,Call me a pessimist, but I fear that we have been had. The cure-all that we called 'The Bailout' is now being called 'rapidly dwarfed by the size of the global crisis'. My fear was that the $700 Billion was just a bait and that it would take much much more than that to 'fix' the problem. Also, now the CDS problem is talked up as a bigger problem than the sub-prime issue with numbers as high as $55 Trillion bandied about. What are we to do? Another bailout? I fear for the worst if we don't look beyond just rescuing banks.

Steven Pearlstein: Well, that's not a totally unreasonable point of view. One clarification: although the credit default swap market involves insurance contracts on $55 trillion worth of credit instruments, some of those are offsetting, in that there is contracts on contracts that cancel each other out. Actually, a lot of that. So the real exposure is less and is unknown, because these things aren't traded on any regulated exchange.

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Steven Pearlstein: That's all the time for today folks. See you later.

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