Pearlstein: Financial Meltdown

Steven Pearlstein
Washington Post Columnist
Tuesday, October 14, 2008; 11:00 AM

Washington Post columnist Steven Pearlstein was online Tuesday, Oct. 14 at 11 a.m. ET to discuss the global financial crisis.

Read today's column: It's Wall Street's Turn to Bolster Confidence.

A transcript follows.

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.


Tampa, Fla.: What ever happened to rules of thumb? when did it become okay for lenders and borrowers to enter a mortgage contract for 6-7 times the borrowers' gross annual income? People cannot afford to buy more than about 3 times their income, unless they don't drive, eat, have babies, dogs, or wear clothes.

Steven Pearlstein: It got thrown out during the boom years with the standard boomtime refrain: Everything's different now. In fact, it isn't much different and now we know better, once again.


Washington, D.C.: Mr. Pearlstein, Your column today I think speaks to the frustrations many of us have with those on Wall Street who would maintain their standard of living and sense of superiority while the economic house of cards they built falls all around them. But unlike elected officials and their appointees, we the people have no real control over who gets to keep their job and who gets fired and therefore cannot hold Wall Street accountable for past and future actions. What can an average citizen do to push Wall Street to step up to the plate as you describe in column? Are there any provisions in the bailout bill that would give Paulson et al the authority to force Wall Street's hand?

Steven Pearlstein: Paulson was a bit wimpy in setting the conditions for the capital injections. He could have been much harsher in setting pay limits (My vote: $1 million salary, $1 million bonus and $1 million in stock, which sounds like a lot to you and me but would be a big comedown for the big guys). Reducing dividend payments. Requiring maintenance of effort in local lending. Providing forbearance on foreclosures where a workout/refinancing is possible. In this respect, he's still too much of a Republican to push hard on those. We'll have to wait until the next administration for that.

As to what you can do going forward, we all need to keep sending the signal that we don't accept the inevitability of the Wall Street oligopoly, that we won't do business with them and favor regional banks and investment banks with our business. We in the press shouldn't lionize them and should give very little weight to what they say because they are, frankly, proven losers. We should tell our pension managers not to do business with them whenever possible. And we should treat them as social, political pariahs. They won't like that, I can assure you, since they have a very high opinion of themselves, of their talents and of their public spiritedness. We might even insist that the next Treasury secretary, while having some background in finance, not be a Wall Street big wig, and if one is nominated, give him (and of course it will be a him) a good roughing up during confirmation hearings.


L'Enfant Terrible: GREAT column today.

Steven Pearlstein: Thanks.

_______________________ It's Wall Street's Turn to Bolster Confidence ( Post, Oct. 14)


Takoma, D.C.: Mr. Pearlstein, thanks so much for your insights. Based on your columns last fall and my retirement schedule, I moved all but 15 percent of my TSP into the safe G Fund so my losses during this year have been much reduced. As of Friday, my G fund balance was 89 percent of the total. I really enjoyed today's column and hope it gets circulated among its targets!

Steven Pearlstein: You're welcome.


Arlington, Va.: I couldn't agree more with your column today. For weeks now, I've been asking myself (and my wife and friends): where are the $1 a year men we had in WWII who stepped forward to serve their country? What we get instead is profiles in greed rather than courage.

We need leadership from the private sector to boost our hope that we will work this out, TOGETHER. I think the "main street" anger directed towards Wall Street is not really about their excessive compensation per se as much as it is towards their sense of entitlement and their obvious disdain towards us regular hard-working folks.

The only thing I'd add: we need ALL private sector CEOs, not just the Wall Streeters/Bankers, to step forward with similar promises/initiatives for their industry to help the country battle back against the recession -depression?]. Buy back stock, keep workers employed, pledge to work with new Administration and each other on solutions rather than blame/carping, etc, etc. My thoughts on specifics for other CEOs are probably weak but you get the idea. Maybe you could suggest better ideas?

Steven Pearlstein: All it will require is a few leaders to step forward and do the right thing and the others will be shamed into it. So far, however, I see no leadership in sight other than Warren Buffett.


Baltimore, Md.: Steven: I heard on the CBS Morning News today that the British government, in return for pumping cash into needy banks, will require the firing of the bank's top officials and elimination of any golden parachutes and bonuses. Do you think this is justified and do you think it is possible we will see the same thing in the U.S.--under what it still a Republican administration for the next 2.5 months? Thanks.

Steven Pearlstein: Britain is putting much larger amounts of money into the eight biggest banks, which are in much deeper trouble than hours, so the analogy is more to what we did with Fan, Fred, AIG than we did this morning to Goldman and JP Morgan. It is still possible the Treasury will have to do much bigger rescues for large regional banks that are on the verge of collapse, and in those cases, Treasury will surely insist on the harsher, punitive measures you mention.


McAllen, Texas: They should appoint a special prosecutor to investigate and punish those responsible for this financial mess, and it's human consequences. What is your opinion regarding this matter?

Steven Pearlstein: The FBI, Justice, SEC and the NY attorney general's office are on the case.


Danvers, Mass.: Houses are down, stocks are down, commodities are down. Is this now deflation? Not depression, but deflation?

Steven Pearlstein: Asset deflation, which sometimes can lead to price deflation, sometimes not. We should be able to avoid the latter with smart policy, although if this gets global enough, it will be a bigger challenge.


Falls Church, Va.: Thanks for taking my question.

London Interbank Offer Rates are down today, but have been and still are relatively high. Many loans--including adjustable mortgages--reference Libor when they reset.

What do you see happening with this, and when will such loans generally reset?

Steven Pearlstein: I think it is an imperfect measure and that, for the item being, banks may be using the central bank as a primary source of overnight funds rather than each other. Also, the guarantee programs may not be yet in place.


Washington, D.C.: Tell me again why we need credit? What would happen if everyone, business and individuals, saved and paid cash? Growth would decline? Well, so what?

Steven Pearlstein: You need credit. Households need it to buy cars and houses and deal with big emergencies, like medical bills. Businesses need it to buy inventory and deal with the lag between providing a good and service and getting paid. All credit is not bad. Just excessive credit for consumption that is consistent above income.


Geneva, Switzerland: Is the real reason that banks do not trust each other that they do not know each others positions on the Credit Default Swap market? If that is the case, how should this market be regulated? Are Credit Default Swaps essential for our economy or mostly a tool for hedge funds and investment banks to make money?

Steven Pearlstein: This may be hard for Wall Streeters to accept, but in fact you can run a successful modern capitalist society without credit default swaps. We have examples of this phenomenon in history. Civilization as we know it doesn't depend on them. In truth credit default swaps are simply a game to get around insurance regulations. They should be treated as insurance and regulated like insurance. And believe me, if they were, there wouldn't be such a big market in the swaps.


Alexandria, Va.: Mr. Pearlstein, What advice would you give the investor who has stayed out of the stock market for the past year? Would this be a good time to start putting money back into stocks a little at a time? If not, would you suggest putting the money into 3-month Treasury securities? Or keeping the money in cash, in case a sustained recovery is just around the corner? Thank you.

Steven Pearlstein: It is not a terrible idea to begin buying small amounts on the big dips, but you shouldn't be fooled. This is a bear market rally we've just seen. The market will "retest" the lows of 8000 on the Dow and at that point, you should consider buying again. But the bottom, once tested, may not hold at 8,000. That's why its called a test. In any case, if you sit tight, its not much of a risk. It will be at least a year before profits bottom out, which should have something to do with when stocks begin a credible, sustained bull market again.


Houston, Texas: Steven, You've made a pretty significant turnaround over the last two weeks. Can you explain your changing views? In your column on October 2, you dismissed those suggesting raising the deposit insurance limits and injecting direct capital into failing banks as 'smooth-talking salesmen with hidden agendas peddling magic potions.' In today's column you laud Henry Paulson as moving 'aggressively and more deftly than any of his international counterparts in doing whatever was necessary to stabilize the financial system.' What did he do? Raise the deposit insurance and inject capital into failing banks, among other actions. At the surface level, it really looks like you're merely falling in line with the Treasury Department - when Paulson was against these ideas, so were you. Now that he's for them, so are you (and Paulson's a hero for implementing them). I had really hoped for more from you as an independent journalist in a complex area. No Silver Bullets Here (Pearlstein, Oct. 2)

Steven Pearlstein: Very good question. I still don't think injecting capital into large number of banks is a top priority at the moment in terms of getting the system working again, but apparently it has become important in restoring confidence and dealing with the negative market psychology. So you do what you have to do. The big news today is that the FDIC will set up a new insurance fund for new bank debt, which is the most important step in solving the liquidity problem, along wit the various Fed actions on commercial paper. Then we need to deal with the weakest banks that have systemic importance, and in those cases, injection of capital may be necessary. But injecting capital into the fourth largest bank in South Dakota, which isn't particularly stressed right now--I'm not sure what that accomplishes.


Vienna, Va.: Mr. Pearlstein,

Your coverage of the financial situation over the last 2 years has been impressive. You've also been outstanding in your ability to explain many of the more confusing events to us. In September the government gave AIG $85 billion in return for warrants covering 79.9 percent of its equity. We were told that the government was limited to under 80 percent. In October the government gave AIG another $38 billion. Does the government now own all of AIG? And its total investment in AIG seems to dwarf its outlays for any of the banks it is taking an equity stake in today. Why such a large investment in one company? What is this money going towards? Can we expect to get back most of this money?

Steven Pearlstein: You can expect most of the money back, although I don't know the details on that. AIG is systemically important -- that is, it is so entwined in the finances of so many other financial institutions, mostly through credit default swaps, that its failure could have a bad domino effect. The government is now trying to sell off its strong divisions to raise the cash to pay off the government debt. But at the end of the day, those assets may not be enough to cover the losses from the one division that has been the source of the problem, the one that did all the credit swaps. We'll just have to see. I think at this point is is a rather academic question of whether the government owns 80 percent or 95 percent, since the equity may well be worthless. 80 percent of zero is the same as 95 percent of zero.


Thoiry, France: It seems that the sword of Damokles in the form of Credit Default Swaps is hanging over the financial system. The bust of Lehman and Iceland is only a foretaste of what to expect in the future. What would be the consequences if governments would make all CDSs that are not between primary parties illegal ? Would it have any negative effects outside the boardrooms of hedgefunds and investment banks ?

Steven Pearlstein: There is no reason why people should be able to "insure" financial instruments that they don't own. That's just gambling. It does nothing to add capital into the system. it's destabilizing to the system. And it makes regulating the system more difficult than it already is. There would be no harm in outlawing this practice, in my opinion.


Maryland: Good morning Steven. You seem to disagree with Paul Krugman about Paulson's approach to this crisis. So who should we listen to (or, to say this a different way, does a Nobel trump a Pulitzer?)?

Steven Pearlstein: Well, Nobel trumps a Pulitzer when it comes to economics and economic modeling, that's for sure. I'm not sure that Paul has any particular advantage in managing markets during a crisis, although he is one smart and articulate dude. All economists like the "inject capital" idea, but the problem with it is that it has limited value during periods when the banks can leverage that additional capital and borrow against it to lend out. It has limited value when banks continue to take their free cash and pay dividends with it. And it has limited value when banks are so scared about the financial prospects of their borrowers that they'd rather lend it to the US government than to local homeowners and businesses. So the trick is to deal with the problem through a variety of means, like guaranteeing their new borrowing and putting a floor under the economy with a stimulus plan and making sure that they can sell their mortgages and mortgage-backed securities at a reasonable price that reflects rising default rates but not necessarily market panic. The do-everything option is turning out to be the best one. And on that point we need to be clear: we are on uncharted territory here. As I've written repeatedly during the last few months, that means you need to give policy-makers flexibility to experiment and see what works and what doesn't. This isn't a contest to see who was right first -- that's a rather silly way of thinking about things at this moment.


Seattle, Wash.: After receiving this large infusion of funds, will there be any real controls to stop the banks engaging in the same sort of risky behavior that got us into this mess in the first place?

Steven Pearlstein: They've pretty much stopped that, and the regulators are looking over their shoulders in any case.


Washington, D.C.: When do we hit what the third phase of our "great demotion" economically (to use the Carl Sagan phrase), where the fiscal impact of all these bailouts -- and more importantly the entitlement train wreck that both Presidential candidates desperately want to ignore -- means that the federal government will itself need a bailout, and the foreign governments and investors who had previously funded our profligate spending (both private and public) refuse to pony up?

Personally, I think whoever wins in three weeks is going to spend his first term trying to solve the financial crisis, and his second term (presuming he gets there) dealing with the fiscal crisis...

Steven Pearlstein: The third phase comes in a few years when the government raises taxes to a level consistent with what government has promised to do and what people want the government to do. That's why all this competition between the parties to show which is a better tax cutter is so dangerous. People need to understand that their taxes will be going UP. Rich people certainly, but middle class people as well. And that means their living standard -- the amount of money they have after taxes to spend on other stuff -- will be going down. That's what happens when you go from living beyond your means to living within your means.


Rockville, Md.: Are financial institutions who don't need or can't get a capital infusion harmed by the bailout of competitors who otherwise would have continued to keep margins high to put their balance sheets in order?

Steven Pearlstein: Nobody is being bailed out by today's actions, first off. And I think we're pretty far away from the banks that receive a capital injection having so much money to lend out that they compete away the profits of other bank lending. A theoretical worry, but at this point not much of a practical one.


Falls Church, Va.: Banks like JP Morgan and Wells Fargo appear to be relatively healthy. Why did the government force them to participate in this nationalization program?

Steven Pearlstein: So that other banks would not be stigmatized if they show up and participate in the program as well.


Campbell, Mo.: Is the government rescue plan the beginnings of the dreaded "S" word in American politics, socialism?

Steven Pearlstein: It is a socialistic step. A temporary step, but there's no getting around it. But let's be careful not to think of socialism as some sort of dirty word. It is a way of organizing economic activity that has some advantages and, when combined with a basically capitalist economy, has provided a very high standard of living to many European countries. It's often confused with communism, but it is not that.


Alexandria, Va.: Dear Mr. Pearlstein, Thank you for this morning's column. May I ask two questions? First, how do you assess the likelihood that the "financial elite" is reluctant to make public statements about the financial crisis, based on their lawyers' fears of lawsuits? Please note that I agree with your assessment of the behavior of the "financial elite" and have no wish to defend their behavior. Second, what should be done to encourage (or compel) banks benefiting from government recapitalization to "deploy" the capital, rather than retain it? It's Wall Street's Turn to Bolster Confidence ( Post, Oct. 14)

Steven Pearlstein: Not sure of what you mean by the second question. As to the first, they would argue that the reason the executives can't talk is that they will be investigated by the government and sued by those terrible plaintiffs lawyers on behalf of shareholders, and can't afford to admit to any error or lapse of judgment.


Falls Church, Va.: You have done a fine job of saying the right things and keeping a calm head during everything that has happened the last few weeks. I also think the Paulson group has done a fine job in steering us to a way out of this. That said, I do feel they have a huge amount of culpability for the root causes of this mess or at the very least failed to stop the madness when the danger was clear, do you agree?

Steven Pearlstein: I criticized the Treasury for its "Katrina-like" response to the "subprime" crisis in the summer of 2007. In hindsight, its clear they didn't move aggressively enough then. But I'm not sure the political predicate was there back then, and that they would have been accused of "bailing out" this party or that if they had done anything. Notice that, in the last few weeks, the focus has turned from a debate on whether bad people should be "bailed out" to whether the government has been "behind the curve." Only now is there the public recognition of the urgency of the situation that makes dramatic action politically possible.


You are so right, today: It's not all their fault, but Wall St should assume some responsibility. Goldman Sachs gave out $12 billion in bonuses last year, and all of it was structured on short-term sales incentives, not the profitability of their customers or some longer term measure. And it was half their revenue, so the stockholders got screwed too.

Iconic mgmt consultant Peter Drucker spent the last 20 years of his long life looking at corporate governance issues. What are some ideas on the table for getting Wall St. incentives straight, seeing as how we can't count on any ethics?

Steven Pearlstein: I don't think we need any brilliant ideas. Pay them less and make the payments contingent on long-term performance rather than short-term sales goals--those are the keys. We also have to explore why these markets are so imperfect in their competition that companies are able to earn ridiculous profits compared to the amount of time, effort and ingenuity involved. It is clear that Wall Street is an oligopoly that has successfully limited price competition, and the FTC needs to launch an investigation of that.


Reston, Va.: Hi Steven, love your articles. Can you explain why was Wells Fargo, the bank that just beat out Citi in the purchase of Wachovia, was included in the list of banks that the Feds invested in? It would seem, on the surface, that they are doing just fine.

Steven Pearlstein: It would seem so, and they didn't want the money. But as I said, the government wants the big boys to give cover to the next tier of regional banks that may well need this money but be reluctant to ask for it because in doing so, will cause of run by its depositors, lenders and investors. Making Wells participate also brings them automatically into the program to guarantee their debt, which is the most important element of today's actions.


Alexandria, Va.: Nomination for the next Treasury Secretary -- Michael Bloomberg, Mayor of NYC

Steven Pearlstein: I think he'd rather be mayor.


Cashing in ...: What kind of people MAKE money during this kind of financial crisis?

Steven Pearlstein: Smart ones who are also lucky.


McLean, Va.: Okay, so what about the dreaded "D" word? What are the chances of a depression now? And what should we be doing to protect ourselves?

Steven Pearlstein: We're doing a lot, and Congress and the next president will be doing more.


Cherry Hill, N.J.: If the government is guaranteeing the liabilities of banks and injecting capital at the same time, what's the point of having a bank? It seems like the middle man just adds cost.

Steven Pearlstein: Well, you've got a point. But you want to keep the institutions operating and the capabilities there so the government can ease out as quickly and easily as possible.


Washington, D.C.: Re: a recession, I'm starting to feel like we're waiting on yet another "storm of the century" blizzard, with the markets playing the role of TV weatherman. Is all this confusing stuff with banks, capital and market swings all there is to this crisis, or will there be worsening conditions for average citizens?

Steven Pearlstein: The economy will get worse. Count on it. Prepare for it. Accept it.


Portland. Ore.: Mr. Pearlstein --

Could you please explain the term "mark to Market" -- what does it mean and why do some (evidently) in the financial community not like it? Please excuse my ignorance.

Thanks for your interesting and informative articles -- you're educating all of us, sir.

Steven Pearlstein: Mark to market means that a financial institution is required, every quarter, to value the assets on its book not at what it bought them for (historical value) or even what it thinks they are worth if they hold on to them for some time (fair value, economic value, hold-to-maturity value) but what those assets would fetch if they were sold in today's market (mark to market).


Arlington, Va.: SP: "People need to understand that their taxes will be going UP. Rich people certainly, but middle class people as well."

It's the part about "Your taxes are going up ... to save rich bankers and deadbeat homeowners" that makes it a tough political sell. Those of us who haven't been living beyond our means are quite naturally going to balk at being asked to support those who have.

Steven Pearlstein: Its' not to save rich bankers. That's a misreading of the situation. It's because Americans have demanded a certain level of government service and been unwilling, up to this point, to pay for those services. Either they will have to reduce what services they demand or they will pay more taxes. It's just simple accounting. The rescue costs, such as they are, are only a small part of that gap.


Troy, N.Y.: Why should Wall Street apologize when so many other people (mortgage originators, borrowers, ratings agencies, our representatives in government) who should apologize will not either. Not accepting responsibility is the black. If we want people to be responsible we could go for an Australian system -- where if you default on your mortgage the bank comes after you for whatever they were unable to recoup.

Steven Pearlstein: Because it is their institutions and the system that allows them to operate that the government is now having to rescue with extraordinary amounts of money and risk taking.


Arlington, Va.: Steven, do you agree with the following quote, and can you name the fiscal conservative who said it?

"Part of the reason this crisis occurred is that everyone was living beyond their means -- from Wall Street to Washington to even some on Main Street. CEOs got greedy. Politicians spent money they didn't have. Lenders tricked people into buying home they couldn't afford and some folks knew they couldn't afford them and bought them anyway.

We've lived through an era of easy money, in which we were allowed and even encouraged to spend without limits; to borrow instead of save. Now, I know that in an age of declining wages and skyrocketing costs, for many folks this was not a choice but a necessity. People have been forced to turn to credit cards and home equity loans to keep up, just like our government has borrowed from China and other creditors to help pay its bills. But we now know how dangerous that can be. Once we get past the present emergency, which requires immediate new investments, we have to break that cycle of debt. Our long-term future requires that we do what's necessary to scale down our deficits, grow wages and encourage personal savings again."

Steven Pearlstein:100 percent in agreement.


Why Not a Bank Holiday?: Instead of infusing all sorts of cash into this crisis, why not do what FDR did? Declare a 10-day bank holiday in which all banks were audited and close down all insolvent banks? It got us out of the Great Depression...

Steven Pearlstein: I suggested that last week. Apparently, no takers -- at least not yet.


Rome Italy: Hi, my "regional" banks in the U.S. are Sovereign, just taken over if I understand it correctly by a Spanish bank, and Citizens, which is owned by a Scottish bank. Are any U.S. banks going to remain truly regional? Thanks.

Steven Pearlstein: Yes


Wait a minute: A few weeks ago, you said that a bailout could punish or it could save the economy, but not both. You made it seem as though they were totally and irrevocably mutually exclusive. Anyone that disagreed with you and didn't give complete fealty to Paulson didn't know what they were talking about. Now you are talking about salary caps and dividend cuts; calling Paulson wimpy for not punishing more. It appears there isn't some mutually exclusive solutions...can we have an apology?

Steven Pearlstein: You can do little bit of punishment, but you can't save a bank (to save the system) and at the same time let a bank fail (to teach executives and lenders and investors a lesson). Those two things, by definition, are mutually exclusive.

But its a clever debating point you bring up. Congrats.


Pau, France: Mr Pearlstein,

Do you care to venture a guess as to whether this latest stock up-tick will hold? You have been quite accurate so far!


Steven Pearlstein: As I said above, we will have an opportunity to "test the lows" sometime in the next six months.


Geneva, Switzerland: I agree with our friend from Houston that you have come across as a cheerleader for Paulson lately. That is a pity since you are clearly one of the better, if not the best, economic columnist around. Is it so bad out there that you cannot level with us anymore ?

Steven Pearlstein: No, I'm leveling with you. The crew at Treasury and the Fed are doing a great job under difficult circumstances where there are no easy or sure policy answers to a situation that is changing every day. It's a war, and during a war its not particularly useful to keep second guessing generals who are smart and well intentioned and have a lot more information than you have. I criticize when appropriate, I prod when appropriate but I'm also not so stiff necked that I can't defend and praise people doing a good job under very difficult circumstances. It's my willing to dish out praise as well as criticism, I hope, that gives me credibility, rather than being relentlessly negative or a partisan hack.


Steven Pearlstein: That's all for today, folks. We'll resume again tomorrow at the same time.


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