Pearlstein: Financial Meltdown

Washington Post columnist Steven Pearlstein was online Wednesday, Oct. 15 at 11:00 a.m. ET to discuss the stock market's return to a state of relative calm and where we go from here.

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.

____________________

Woodbridge, Va.: You said something yesterday to the effect of "the economy will get worse. expect it. prepare for it." How do you know this and what signs should we look for?

Thank you.

Steven Pearlstein: Obviously, nobody "knows" it. It's a guess based on a fair amount of observation and experience, which after all is what economics is. You can look at the current data on retail sales today, or industrial production and payroll and unemployment data and pretty much conclude that growth is somewhere around zero now. And you can look at the trendlines, and what's happening in financial markets, and reason that we've not hit the bottom yet. The one bright spot is that energy and other commodity prices are falling fast and this will take a good deal of pressure off family budgets and help to bolster consumer confidence a bit. But given the impact of the financial crisis on confidence and behavior of households and companies, the good news on commodities will probably get swamped.

_______________________

Rockville, Md.: So many people are racing to blame either Republicans or Democrats for whatever happens. Do you think there is a chance that coming changes in Executive branch and Congress will stop (or, at least, reduce) this and people in charge will start concentrating on the real issues and solutions rather than continue this pointless fighting?

Steven Pearlstein: Between now and the election, that would be like asking politicians to act like saints. Not a likely possibility. .After that, I think there is a good chance that political leaders will behave in a more constructive,bipartisan, problem-solving way. The country is sick and tired of the years of bickering and gridlock, and so, frankly, are the politicians. The crisis is upon us. They know their longterm future is tied to their success in getting government working again and showing some leadership (which in many cases involves intelligent followship). And whatever you think about their programs, both of the presidential candidates have real leadership abilities and a willingness to ignore and challenge the special interest groups that have been the source of the gridlock. So I am actually very hopeful of what we can expect from Washington after the election.

_______________________

New York, N.Y.: Mr. Pearlstein, How likely do you think it is that the Dow will go below 8000 before this is all over? Thank you.

Steven Pearlstein: I think it is likely it will get close to 8,000 to test that as the new floor. From what I saw last week, there are a lot of computerized buying programs that kick in when it reaches 8,000 right now. But if economic conditions deteriorate further, it is possible that the humans who put in those buy orders and set up that programmed trading will change their minds and put the number even lower. That is what we have to test. But 8,000 would surely be a moment to begin making some selected purchases and seeing what happens. Don't expect that there will be one moment where you should jump back in with everything. You're not that smart -- nobody is. You need to think about making purchases in small batches at different levels, to hedge things a bit.

_______________________

Manzanita, Ore.: Steve, It seems that this financial crisis won't be over until the shadow banking system is dismantled. On Charlie Rose and in other media appearances you've called for establishing a CDS Clearing House. But don't we need to unwind the alphabet soup of high risk investment vehicles in the shadow banking system before we can really move forward?

Thanks for your clear and helpful comments in the Post and elsewhere!

Steven Pearlstein: There is no putting the genie back int he bottle when it comes to the shadow banking system. It will be part of the financial architecture because there are efficiencies and risk-dispersion characteristics that make it attractive. What we have to do is bring the system out of the shadows, shine some light on it, adopt some rules and regulation so that the decision of whether to go through the banks or through the markets is based on the relative business merits of each channel, not based on regulatory arbitrage.

_______________________

Brest, France: Nouriel Roubini, whose forecasts about the credit cycle to date have been frighteningly accurate, says that the next president should fire Bernanke, Paulson and spend like mad on public works projects to create jobs that shore up the US economy. Do you agree, and would you please give your reasons?

Steven Pearlstein: I don't know if Nouriel spoke of firing Bernanke. Paulson is a short timer, by his own request but Bernanke actually is appointed for a term and can't be removed and surely shouldn't be, if for no other reason than the last thing you want at this moment is to politicize the Federal Reserve. Nor does Bernanke deserve to be fired -- he's doing a fantastic job under difficult circumstances. Nouriel and I both have criticized Bernanke for being slow to acknowledge the housing and credit bubble and take steps to deal with it, but that is water under the bridge at this point. He's been moving very aggressively in recent months and actually pushed Bush and Paulson farther and faster than they would have otherwise gone.

Yes, as I said today, the focus needs to be on direct job creation by the federal government, both in terms of providing cash to state and local governments so they can keep vital services flowing (and state workers employed) and through SMART investment in badly needed infrastructure. It doesn't have to be just roads and bridges. Surely public transit should be a priority, which means building tracks and trolley lines and ordering rolling stock. It means upgrading the air traffic system, from air traffic control to the airports. It means investment in new regional electric transmission line, building new power plants and oil refineries, drilling for natural gas, erecting lots of windmills. It could also mean expanding the physical plant of state university systems to accomodate more students. Since this is going to be ra relativeloy long downturn, the usual criticism of such "public works" projects -- that they take too long to get up and running-- isn't as valid. If they get going a year from now, that will be good, because that is about when the economy will be flat on its back.

_______________________

Asheville, N.C.: Recession is good. Finally this problem has gotten our attention, but what will it take to really fix the problem? I'm not hearing the "D" word yet but maybe that is what is needed. I just heard Kevin Phillips on NPR this morning and you both seem to see this thing clearly. I am advising friends and relatives "Be Prepared" and keep up with Steven Pearlstein and Kevin Phillips as this thing develops.

Steven Pearlstein: If there is any place I'd like to be riding out a recession, it's Asheville, N.C., particularly in the fall. The thing about Kevin Phillips is how clever he has been about reinventing himself and seeing the next big issue before other people. I'm a big admirer, too, although I think he is sometimes over the top. But I admire that about him too, his willingness not to be constrained by conventional wisdom.

_______________________

Cabin John, Md.: Warren Buffett says in his letters to the shareholders of Berkshire Hathaway that he expects the next generation to repudiate the debt incurred for our follies. Does this mean that the 11 trillion never gets paid back and that holders of government paper should beware? Is this why the Chinese stopped buying our bonds?

Steven Pearlstein: I don't know what he means -- he doesn't consult me, alas. I suspect what he may mean is that we'll let inflation rise, which is a way of screwing creditors without actually defaulting.

_______________________

Santa Cruz, Calif.: What do you think of owning some gold (e.g. GLD) as a hedge against inflation and dollar devaluation?

Steven Pearlstein: There are lots of ways to "own" gold, but that sounds like a good plank in any investment strategy for the next several years.

_______________________

Kensington, Md.: From your Oct. 14 column: "Then comes commercial real estate, where values are already plummeting, vacancy rates are rising and permanent financing is difficult to find. A collapse in this sector would be particularly bad news for regional banks and insurance companies." Can you elaborate on the bad news for insurance companies? How will this be bad news for insurance companies? I may want to ditch my insurance stock before this news hits the fan.

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

Steven Pearlstein: A lot of commercial real estate is owned and financed by large insurance companies -- its one of the thing they do with all those premiums between when you pay them and when you die or make a claim.

_______________________

Falls Church, Va.: Your column was fine today, until the part at the end where you say we can revitalize the economy through transfer payments and road-building. This has been tried many times, and it's never worked. It didn't work for FDR (the economy didn't pick up until WWII), and it didn't work for the Japanese (a decade of doldrums and a network of empty highways). Please, let's not turn a crisis into ten years of disaster.

washingtonpost.com: Buckle Up -- We Haven't Reached Bottom Yet ( Post, Oct. 15)

Steven Pearlstein: Transfer payments to people who have lost their jobs works very well. They spend it, it helps to put a floor under aggregate demand and its a humane thing to do. And in the current situation, intelligent investment in public works is just smart. The cost of money is low, the longterm payoffs can be very high and it also helps to put a floor under aggregate demand. The Japanese didn't invest wisely -- it was all political and very boring stuff with low payoff. As to whether it worked during the New Deal, two things: first, you don't know how bad things might have been without it; and, second, it is likely not to have as good an effect in priming the pump when the financial system is bankrupt. I don't think that is the case now.

_______________________

Boulder, Colo.: I felt that the worst thing about how much housing prices rose in the past few years was how hard it made buying a house for the average, prudent-spending working person - who 'DIDN'T' feel comfortable committing to a huge amount on a monthly mortgage. I am hoping that house prices will fall, fall, fall, back to the level where a normal person (making, say, $45,000 a year) could buy a small, decent house in a pleasant neighborhood with a fixed rate mortgage and be able to sleep well at night. What is your best guess as to where home prices may fall to?

Steven Pearlstein: We should all hope that housing prices fall back to a level where they make sense in terms of the cost of other goods and the incomes of the people who live in them. There are places now where prices have fallen as much as 40 percent, and others, like my street in Washington.DC, where they haven't fallen at all. So its hard to generalize. But it's fair to say that even if prices have fallen to reflect the oversupply and the increased cost of money and the lack of speculative buying, they still don't reflect the reality of an economic recession in many parts of the country. So it is unlikely that prices have bottomed just yet, although they may have stabilized temporarily in some places.

_______________________

Severna Park, Md.: Good morning Steven - first, thanks for chatting with us so often (although it is a shame there is so much to talk about).

In your article today, you actually mentioned that stock prices should rise and fall with corporate profits -- this is a point that I think has been lost in the discussion of bailouts, meltdowns and recessions. I know that emotions have always had a role on Wall Street but that corporate health was what drove the market. Lately though it seems that emotions are driving the market, and the decisions being made about how to handle this crisis. Do you agree, or has it always been like this, just exaggerated right now?

washingtonpost.com: Buckle Up -- We Haven't Reached Bottom Yet ( Post, Oct. 15)

Steven Pearlstein: Yes, there is always an emotional/psychological component to stock market pricing, and there are times when that is the dominant driver, as over the last several weeks and during the final year of the Internet bubble. But over longer terms, the fundamentals tend to reassert themselves, which means corporate profits and profit growth. Until two months ago, the stock market was simply not factoring in a serious enough recession and most analysts were much too optimistic in their profit projections, which is why you had these "bottom up" forecasts of double digit growth in the S&P 500 from some of the major investment houses for the coming year. For some reason, it just takes them a long time to get real about the macroeconomic outlook and actually have that reflected in their micro-projections.

_______________________

Fairfax, Va.: I understand the desire to help homeowners with unaffordable mortgages, but how can the government do it without rewarding bad behavior? Interest rates were at historic lows and anyone who bought on an interest- only ARM should have known better, of course rates would rise. Does moral hazard not apply here?

Should a mortgage buyout plan include a condition directing any potential profit from a future home-sale back into taxpayers hands?

Steven Pearlstein: As I've written before, we need sometimes to suspend our moral indignation and our concerns about moral hazard and do things that will make the rest of us better off. There are ways to "help" struggling homeowners without costing the government too much and without letting people totally off the hook. The best way I know is, where possible, refinance an adjustable mortgage into a fixed rate mortgage at 85 percent of the current market price of the property. That requires the original lender to take a writeoff of the principal, and it should require the homeowner to give the government a share of any profit he might make from the eventual sale of the property. And the economy benefits from not having a lot of people thrown out of their houses and a lot of forelcosed houses thrown on the market all at the same time. That was the logic behind the housing bill pushed through by the Democrats in Congress and signed by the President, and it should provide the template for what we do in this area going forward.

_______________________

Manassas, Va.: Mr. Pearlstein,

As someone not well versed in the stock market, perhaps you can clear up some of my confusion. Stocks are essentially ownership in the companies listed on that given board, correct? Thus, a drop in stocks, particularly a precipitous drop, reflects some guestimation that those companies are either about to or will suffer significant drops in profit and may even lose money, correct? So the market drops serve as an indicator of the broader potential damage to the economy? Perception of the market then is a leading indicator, even in the absence of hard, fast numbers that show lost profits? If that is the case, how can we be sure what portion of the perception may be manipulation by some?

Thanks!

Steven Pearlstein: I don't think there is much manipulation here, but there is panic. Your construction assumes more rationality than we have seen in recent weeks. Rationality will eventually reassert itself.

\ That said, stocks are a good leading indicator, and to some extent the recent panic reflected a belated realization by investors and traders that the economy, the global economy, was headed into a worse recession than they had believed.

_______________________

Alexandria, Va.: During the Panic of 1893, Wall Street bailed out the Fed by supplying it with $65 million in gold and floating a $100 million bond. A hundred years later, their patriotism has evaporated like so much summer dew and today's titans of finance scurry around to hide as cockroaches after the light has been turned on.

Steven Pearlstein: Hey, have you thought about becoming a business columnist. You can write!

_______________________

NW Washington, D.C.: Now I know who is getting the bailout money, it must be with all these hours you are working! I sincerely hope you are getting some rest. Back to back discussions, columns and TV can be tiring! Please don't have me drop names. Enjoy your work, but take good care of yourself.

Steven Pearlstein: As it happens, I'm off to Europe for a long planned vacation with my wife and some friends. Brining along a laptop, however, just in case. But thanks for your concern.

_______________________

Reston, Va.: Not to get too political here, but you hinted at something in today's column that I have been studying in the candidates' platforms: the need for investment in infrastructure as a means toward creating jobs. I don't know much about the Great Depression, but I believe that this could be vital to restoring the economy. Obama has put this concept forward (sort of a WPA for the modern era), but I can't find anything comparable from McCain. You may have already addressed this in a column that I missed (I try to read them all), but would you share your opinion of the candidates' current -- it seems to change -- postions on economic stimuli?

washingtonpost.com: Buckle Up -- We Haven't Reached Bottom Yet ( Post, Oct. 15)

Steven Pearlstein: McCain is so invested in fighting "pork" that is is very difficult for him to come out in favor of a big program of government infrastructure investment. What he should say, in my opinion, is something like this:

"We are in a terrible economic situation and we are going to have to use all the tools available to us, including stepped up infrastructure spending, to help put a floor under this economy. And who is better suited to make sure that that spending is done wisely, apolitically, done in a way that gets the greatest bang for the buck, than me, John McCain, the most credible fighter of political pork in the United States Congress. Because you know, and I know, that when governor X or senator Y or labor leader Z calls up and says, Mr. President, we need some of that public works money to build a bridge to nowhere, I'm going to be the guy that suggests that the person hang up the phone and forget this conversation ever took place, because otherwise I'm going to go right out there to the press room and tell the world what you just asked me to do."

And, you know, that would be a very powerful campaign theme. Unfortunately, McCain has taken the old Republican line that the way you revive the economy is throwing tax breaks at everyone -- households, businesses, investors. Frankly, those are pretty dumb ideas, given the circumstances. I'm a bit disappointed in that.

_______________________

Urbana, Ill.: Steven: Thanks for taking my question and also for your well reasoned articles on our economic crisis. My question is, with the global economy clearly entering recession won't there be additional material amounts of "toxic assets" on financial companies balance sheets from car loans, credit card debt and other types of home mortgages besides subprime? And how will the home market ever reach bottom in this environment? Are we going to need another $700 million to bailout the first tranche? I realize everyone wants to believe that we have turned the corner but all I see is more problems until at least 2010 and very likely for longer. My grandmother who lived and worked through the Great Depression called it whistling going past the graveyard. Thanks

Steven Pearlstein: It may well take more money and that money won't prevent a recession -- it will only prevent it from being worse than it needs to be because of the bad dynamics that can develop where selling begets selling, losses beget more losses and things spin out of control.

_______________________

College Park, Md.: Steven,

In your Tuesday article you said Paulson has been more nimble than his European counterparts in this crisis. However the plans to inject capital directly into banks for equity, add loan guarantees and increase deposit insurance seemed to follow similar moves in Europe, not lead them. Is that not true?

Thanks.

Steven Pearlstein: For some reason, people seem to have gotten all fixated on the fact that some other people suggested bank capital injections first and that Paulson has had to change his mind on that, so isn't he a fool.

First of all, the Americans were taking dramatic action to stem this crisis long before any other country, starting with Bear Stearns and continuing through the rescues of AIG, Fannie, Freddie, etc. The Fed was the first to set up the new facilities to pump liquidity into the banking system. Other countries followed our lead. There is a reason we were first, of course: a lot of the problems started here. But to suggest that we've had to be dragged kicking and screaming into government ownership and control of financial institutions is simply factually wrong. Remember, it was Paulson that took control of Fannie and Freddie against their will.

Second, if Paulson saw that the situation had quickly deteriorated and changed course in response to that, should we criticize him for being flexible or even admitting he was wrong? I thought those were qualities we want in a leader, like Franklin Roosevelt switching from wanting to balance the federal budget to ditching that for Keynsian stimulus.

Third, this is not Britain or Europe. We have many more banks and those banks are not as important in realm of financial intermediation as they are in Europe, so it is aquite possible that in Europe, recapitalizing banks is more important than it is here. In the case of Britain, for example, some of the biggest banks were in serious, immediate trouble and capital injections and nationalization were the ONLY answer. We don't have that situation, at least not yet. So the idea that there needs to be one solution for all countries is silly.

Final point: injecting small amounts of capital into hundreds of small banks in the US is, frankly, a waste of time and money, in my opinion. Nobody has explained yet why this is such a great idea. And surely nobody knows yet whether it is going to have much effect. This is still to be proven. So to argue that it is a FACT that is a better idea than reviving the market for mortgage-backed secufrities is just premature. That may turn out to be true, but we don't know that yet, do we?

_______________________

Evanston, Ill.: Hey Steven, what do you think about the capital gains tax exemption for the first half million dollars on real estate? This was instituted in 1997, precisely the time the housing market broke from its long term price trend. Do any politicians understand (save Ron Paul) the distorting effects of such tax policies?

Steven Pearlstein: DUMB.

_______________________

Dripping Springs, Tex.: Mr. Pearlstein and the Washington Post. Thank you for spending the time and money to answer questions directly through these chats. They are the best source of news anywhere! I've lost 80K in the last few months because I only took most of my money out of the market last year. Thank goodness I at listened "mostly" to your advice!

Steven Pearlstein: Thanks. Didn't know we had an audience down there in Dripping Springs.

_______________________

Rehoboth Beach, Del. : Every time I think I have come to a rudimentary understanding of the financial crisis and the interests of various financial groups in proposed solutions, it escapes me. Until I read your columns yesterday and today, I had assumed that the banks would have welcomed infusions of cash from the government whether in the form equity investmentsor the purchase of toxic debt. Apparently the banks are reluctant to do so. If, in the bankers' view government intervention is NOT the answer, what is? Wouldn't banks welcome infusions of new capital so they can go about the business of lending -- which is after all how they make a profit

Steven Pearlstein: The banks that don't need it don't see it as the solution, the ones who do will welcome it. And the ones who don't need it now may change their tune in a few months -- or not. The banks tended to like the idea of jump starting the market in mortgage backed securities so they could sell some of the bad stuff on their books at a discount, but less of a discount than was available from a market with no buyers. And that is an idea that is still worth trying, despite the objections from academic economists, the financial press and the left wing blogosphere.

_______________________

Bethesda, Md.: What if we, as a household, have been living within our means. Do we have anything to fear from a protracted recession?

Steven Pearlstein: Yeah, you could lose your job!

_______________________

Cleveland Park, Washington, D.C.: Steven,

You've proven over the past few months/year that you're a great analyst....and a great analyst should know what the weakness are in his or her opinion and analysis. So what are the possible and impossible surprises and possibly flawed assumptions that would make your prognostications in today's column wrong?

Steven Pearlstein: That's a very good question and I need to come up with a good answer, because I know there is one. But I'm not sure what it is.

_______________________

Richmond, Va. : Do you believe the smaller community banks that are sound should be forced to give the government an equity position "for the good of the country"?

Smaller Banks Resist Federal Cash Infusions ( Post, Oct. 15)

Can they legally be complelled to do this?

Steven Pearlstein: No, they won't be forced to do this and most won't. In theory, regulators could force them to by raising capital requirements. If that capital couldn't be raised privately, than the government might be the only source.

_______________________

Atlanta, Ga.: If the banks continue to resist lending to each other and the rest of us, what measures are available or should be considered to get this started?

Steven Pearlstein: The government could get into the direct lending business somehow, or find other channels to provide credit.

_______________________

Washington, D.C.: Back in June/July, you said you were going to be surprised if the market dropped below 10,000. Obviously, we've crossed that line. Do you think last week was the bottom of the readjustment -- or in your opinion -- are we likely to drop further as more people realize begin to see eye-to-eye with new realities?

Steven Pearlstein: Did I really say that. Wow. Too optimistic for once. As I said, 8,000 is the new bottom and it will be tested. Whether it holds or whether it falls farther, I can't really say. Depends on the economic situation and the market psychology, which I know is a big dodge.

_______________________

Denver, Colo.: I love your columns and these chats! I notice you often make the point that before this can really be fixed every day Americans have to cut back their standard of living and that seems to be an extremely important point that a lot leave out. Could you clarify what that means though? Is this simply going back to the way we were always advised to live i.e., keeping our cars for at least 7 years before we replace them, saving 10 percent or more of our income for a rainy day or retirement etc? Or are we talking about really serous cut backs like only eating meat once a week?

Steven Pearlstein: It means only spending 95 percent of your income and saving the rest, to put it in simple terms. How you adjust to that lifestyle is up to you and depends on what things you most value. But it is important to remember that we have a very high living standard and there are lots of things we can "cut out" while still being very comfortable and happy and satisfied, materially and in other ways.

_______________________

Steven Pearlstein: I'm afraid we're out of time for today. "See" you all in a couple of weeks. Cia0.

_______________________

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.