Pearlstein: The Recession
Wednesday, November 12, 2008; 11:00 AM
Washington Post columnist Steven Pearlstein was online Wednesday, Nov. 12 at 11:00 a.m. ET to discuss the quickly unfolding recession and its impact on everything from automakers to retailers to Starbucks.
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.
Washington, DC: Once again, we see another story about AIG executives on a $300K retreat while they press for $40B more in taxpayer dollars. Quite frankly, this is as ridiculous as it is repetitive and exhausting. Sadly, and I say this as someone that respects your prior work, you have used your position as an award-winning journalist to defend the billions in Wall Street bonuses and an unchecked continuation of this type of behaviour in your columns. Please Mr. Pearlstein, when does it end? Do we have to get to the horrifying point where a modern day Robespierre rises up and leads us in hostile revolt against these unrepentant robber barons? I, for one, hope that we never see something like that in this country but I'm starting to think that the safe money is in pitchfork and torch manufacturers at this point. Our only hope would seem to be a revitalized media focused on shining a bright and disinfecting light on this situation - will you finally condemn these criminals and help us get our country back?
Steven Pearlstein: I haven't followed this particular story, but I am familiar with the previous one, and it is important to think through these things clearly. The previous retreat, at a luxurious resort, was not for AIG executives. It was for independent agents who had sold the most AIG policies, which are a key tool that insurance companies use to motivate independent agents and brokers to use their products, as opposed to the competitions. It's been done by lots of companies for many years.
Now think about this. We, meaning all of us taxpayers, now own AIG. This is a proven way to maintain the profitability of AIG's ordinary insurance businesses, which have continued to be strong and profitable (and regulated!) and whose sale will allow AIG to pay back the government for its loans and its investment. Do you really want AIG to stop holding these events, which are meant to induce new business, because you're upset that some people get to go to luxury resorts on AIG's tab and you don't? That's just being very petty and short-sighted. If these events work, you want them to have MORE of them, not less, because its generating profits for YOUR business and will help insure that you get YOUR money back, WITH INTEREST.
Now if you think you know how to run an insurance company better than the people at AIG, who by the way have been running plain vanilla insurance companies very well for a long time, then let's hear your ideas. But let's stow this misinformed outrage about how the insurance companies are using and misusing "our" money. It's getting silly.
McLean, Va: I've read a number of times that the only way this financial crisis ends is through debt destruction. Short of a discharge in bankruptcy, how does that actually happen? It seems that there are always (shadier and shadier) participants in the secondary markets who are willing to buy the distressed debt.
Steven Pearlstein: We are, indeed, now deep into the workout stage of this crisis, which means a heavy dose of writing down and writing off debt by creditors so that households and businesses can be put on a financially viable footing and move on. Bankruptcy is one of the processes that we use for that, but so are the credit markets, where people who made a loan at one dollar realize their mistake and sell that debt (bond) to other investors at 80 cents, or 50 cents or even 20 cents on the dollar. That is helpful because when the borrower goes to the new creditor who bought debt at 20 cents, and offers to pay 25 cents on the dollar to settle up, the new bondholder is more inclined to say yes since it would involve a 25 percent profit.
Columbia Md.: What in the world happened to the public auditors missing a $700 billion deficit in the books of AIG? Isn't that the role of the annual accountant certification?
Steven Pearlstein: Its really not like you describe it. The value of certain instruments, particularly credit default swaps, changes rapidly in environments like this one. It is true that AIG did not adequately inform its shareholders of the risks that it had taken on in its credit default swap operation, and the SEC, in my, opinion, should make a real example of this company by suing executives and maybe even putting a few in jail for investor fraud. The quality and level of disclosure by public companies, particularly financial institutions, is appalling, and the SEC has turned a blind eye to this for years. I'd hope Obama's SEC would launch a big effort in this case, and have a few public hangings, so to speak, to send a stern message to the corporate lawyers that falling back on the meaningless boilerplate that they use in investor communications is no longer acceptable, and that investors should be treated like real owners and told what's really going on, and what the real risks are on the balance sheets of the company.
Reno, Nev.: Dear Mr. Pearlstein, thank you for your insightful comment on MSNBC Monday, Nov 10, regarding that the US citizenry must tighten up on spending practices and continue to weather the shock waves from the financial crisis before expecting a turn for the better. My question is: "Can this economy realistically return to some balance between payments/liabilities for past debt (all the way back to 1913 when the Federal reserve was formed) and the committing of future labor/resources to generate "fiat money" for their payments?" Some economists believe our society has reached the steepest portion of the exponential "hockey puck" curvature related to debt generation - just last 5 years to generate $5 Trillion of our national debt. President-elect Obama's fiscal policies must address past debt generated from inflationary epochs from the last century of our nation's history. Thank you. Bill T.
Steven Pearlstein: I'm not really up on all that, nor am I a big believer in monetarism, so I'm going to duck your question. We will have to borrow more money before we can get to a point where we can borrow less. And it may be true that, through inflation, we wind up screwing creditors a bit in terms of the real value of what they are paid back. Nothing new there -- its been done by many countries many times. But you should remember that this is a big and wealthy country with tremendous ability to produce and innovate and there is nothing about what we owe, and what we have promised in terms of retirement benefits to future generations, which renders the entire country bankrupt.
Florida: What advice to 30ish 401k investors who back in January-February (due to mom reading your columns) moved almost everything (approx $25K) to short-term, fixed-rate securities (and some in bonds too) and avoided almost all the downhill losses of the past year?
It's still there, so what to be looking for? Should we start dollar cost averaging back into index funds stocks w/low admin fees, international, back into bonds? What do you think is next in the upheaval wars? Thanks so much.
Steven Pearlstein: I've said that its not a terrible idea to begin buying back into the market a bit each month or each quarter, as long as you understand that the market could and probably will go lower in the coming months. You've missed a big part of the drop, and that's about all you can hope for -- catching the exact bottom is a fool's errand. Or you could wait another six months and begin such a program of slow return to the market with your new 401k contributions. At some point, you should take some of that money you parked in cash and bonds and put it back in the market, but I think this it is still too early.
Jurancon, France: Mr Pearlstein,
Could you explain to me whether or not the stock market has already factored in the looming/existing recession. As a former believer in the efficiency of the market, I am continually astounded at how the market reacts to confirmation of already generally anticipated economic news.
Also, how important is it that daily volume is low and is this an indication that no one is really ready to commit to going in or out of the market?
Thanks very much.
Steven Pearlstein: Low volume is a warning sign when stocks rise in a bear market, which has been the case over the previous couple of weeks. I don't think the market has fully factored in the recession because the scope and depth of it are just becoming clear.
Concord, N.H.: I have been tightening that budgetary belt, as have many Americans. This is good for us financially, and also satisfying on a deeper level, I think. My question to you is - isn't this global economy largely based on people and businesses spending money they don't have? The need to unclog frozen credit lines so business can start humming again is a main reason given for the continued large payments to ailing industries. Auto dealerships can't sell cars if shoppers with "good" credit are being denied loans.
There is also all of this talk about needing to stimulate the economy - pass another package to get people shopping again! So how do we stimulate the economy without hurting our wallets . . . or how do we help our wallets without this collapsing economic house of cards bursting into flame?
Thank you for your enlightening columns - not being an economist, it's difficult to suss out reality in this mess of what seems to be conflicting information.
Steven Pearlstein: Not being an economist, it is difficult for me too.
Your question obviously gets to the heart of the dilemma -- how do we stimulate the economy to prevent a bad dynamic from developing (the dreaded vicious cycle) while at the same time beginning to make the adjustment in our consumption habits to get them in line with what we produce? It's hard.
Just because you want to reduce the overall level of debt doesn't mean that all debt has to stop. Cars wear out, people with jobs and income need and want new cars, and there is no reason why there shouldn't be credit available to buy those cars and pay for them over time, as people have always done. Loans to qualified borrowers, be they households or businesses, need to continue and banks and other lenders ought to be grown up enough not to act like a herd and suddenly cut off all borrowing in whole categories because they can't figure out the good risks from the bad risks. That's what lenders are paid to do.
On the other hand, to the degree that companies or households are overleveraged and rely on borrowing to maintain a level of spending that cannot be justified on the basis of expected income, then they need to reduce consumption.
So like cholesterol, there is good spending and bad spending, good borrowing and bad borrowing, good lending and bad lending, and people have to be better at distinguishing the one from the other.
The other thing I would say, and have said in the past, is that there is plenty of room now, with its borrowing costs so low, for the government to borrow and INVEST in things with large long-term payoffs, like building out a bigger and better PUBLIC higher education system, or investing in fuel-efficient mass transit or doing deferred maintenance on schools or roads and bridges. My best idea in this area is investing heavily in health care information technology -- computerized medical records -- which can save tens of billions of dollars a year in the world's most expensive health care system. And that kind of spending is also stimulative of the economy in the short run, so you get a double benefit from it.
College Park, Md: This may be an odd question, but I think there are thousands of people out there like me. Has there been any discussion on the ability for people to refinance unsecured debt?
I think the unspoken taboo of this entire situation is consumer debt. I agree with your premise that WE Americans overspent, got into too much debt, etc. You can add to that the challenge of rising utility and gas prices. However, I'm not in danger of a foreclosure or bankruptcy. I can still afford my house and pay my debt, but I cannot help but note the financial relief going to the banking and housing sector.
The fed is giving the banks money at reduced rates and I do not see that relief being passed on to consumers. My credit card went up to 28% after I paid 3-5 days late. (I have never defaulted on a loan, but will admit to paying 3-7 days late on occasion.) It was at an ideal rate of 3.9%, which worked exactly with your premise. I spent and transferred balances to that card for the super low rate. Fortunately I could get a loan from my credit union at a much lower rate (but not 3.9%) to avoid the long-term challenge of 28%. I do not want to walk away from the unsecured debt, but it's somewhat frustrating to see that people paying their bills are not getting a break. I have learned my lesson. But, my debt is eliminating my savings for retirement, my investment in college education for my kids to the degree I really should, etc. I'm still trapped in college loans at rates in the 1990's. It might be a form of socialism, but I hope this aspect of consumer debt is addressed.
Steven Pearlstein: In the longer run, it will be addressed through competition among lenders for good risks, like yours. But in the short run, the lenders are in a panic and doing things like you describe, in the hope that you do take your business elsewhere and they can shrink their balance sheet (their book of loans) to compensate for the decline in the value of the capital base on which their loan book is based. Just remember, as difficult as this is, it is all short term. You can pay down the debt, you can refinance some of it through other means at a lower rate, etc. This too will end.
Paterson, N.J.: If GM were to declare Chapter 11 and re-organize what would be the fallout for GM vehicle owners? How would a Chapter 11 re-organization effect the GM dealer network?
Steven Pearlstein: It would probably result in a shrinkage of the dealership network, which is needed to make the company more competitive (because there are too many dealers, none of them can make enough money and the cost of supporting all of them saps the finances of the mother ship). But as an owner of a car, you should not be affected much. In fact, you should be happy, since the company that emerges will be stronger and more reliable and will be less desperate to stick it to you every time you bring the Buick in to have something fixed.
Panicked in Ann Arbor, Mich.: All the "experts" say you shouldn't panic, shouldn't sell off all your stock, and should continue to contribute as usual to your 401k. They all say, "Do this if you won't need the money for at least 5-10 years." But they never say what you should do if you WILL (or might) need the money sooner. I'm 59, and had hoped to retire within a year or two. What are all of us early baby boomers supposed to do?
Steven Pearlstein: Well, if you haven't sold your stock yet, its probably a bit late with that strategy. But just so we can set the record straight, you should have avoided the advice of never selling a year or so ago when it was quite obvious that there was a bubble and that it would burst and that you would be safer in cash. It is simply not true that you can never time the market. You can't see the little swings, but you can see the big ones.
As for now, it's a tough situation and you just have to ride it out, look for a bit more safety now and more higher-yielding instruments in the short run and think of ways to delay the day when you have to start selling your stocks and bonds in order to generate the income you need to live.
Revisionist histo, RY: Amity Shlaes has gotten much attention for her book's criticism of FDR's response to the Depression (trying to do too much, she says). Paul Krugman says FDR's problem was not doing enough. What's your take?
Steven Pearlstein: Paul Krugman is probably more right, in my opinion. Not everything would have worked, but in these situations its hard to know in advance. Bold moves to keep people productive and prevent throwing people out of their houses or closing down companies that produce goods and services that people still want to buy -- that's generally a good idea, even if it means borrowing money. You really do want to avoid getting in a self-reinforcing negative dynamic -- the vicious cycle -- which takes things down much farther than they need to go to accomplish the necessary rebalancing and adjustment.
Washington, D.C.: GM is obviously in a bad way, but is there any real chance that it would be allowed to collapse, or is a government bailout a near certainty? And if one is to believe that a bailout is in order, doesn't GM stock look attractive at around $3 a share? Seems like a relatively low risk (at least in that it doesn't have very far to fall) - high reward gamble.
Steven Pearlstein: I don't think GM looks attractive at $3 a share because any reasonable rescue ought to involve wiping out the equity holders and having the government and the creditors take over ownership of the company under a bankruptcy-like restructuring.
Arlington, Va.: At what point can we say that the bailout is close to becoming a free for all? If the government attempts to "bail out" the auto industry, what is to stop any large company from demanding bail-out money, in the name of saving jobs?
Steven Pearlstein: Nothing will stop them from asking, but reality will stop the government from saying yes to many such requests. You have to remember that in circumstances like this, fairness is not the point of the exercise. Everything the government is doing now is unfair. The question is what is the best thing the government can do with a limited amount of resources?
Pittsburgh, Pa.: Thank you for the questions you raise in your column about bailing out businesses.
Do you see any possibility that the government, in exchange for gifting billions of dollars to folks who can't manage their own businesses, will demand board seats?
At least that way, we taxpayers, who are being asked to foot the bill for what is in most cases gross incompetence, could theoretically have some impact on those industries?
Steven Pearlstein: We're not going to gift anything. We need to invest or loan money on tough terms, and if the Democrats fail to insist on tough terms, including things like board seats, then all they are doing is giving a political payback to the United Auto Workers Union. We need to be very clear about this. If the Democratic Congress just gives a $25 billion loan to these companies without any strings, it is a gift, since the money will NEVER be repaid. And that would be just a political payoff -- nothing more, nothing less. And I can assure you that there will be many of us in the press who won't let that issue drop for a very, very, very long time. Having said that, I don't think Barney Frank, who has been deputized by the House speaker to lead this effort, and Dan Tarullo, the adviser that Barack Obama has deputized, will make that mistake.
Anonymous: Some thought has been given to breaking up GM into it's 'brands', into five separate car companies, as a way of curing the company of 'big company disease'. Shouldn't this remedy be considered in place of a bailout?
Steven Pearlstein: Some thought needs to be made to eliminating brands, not breaking them up into separate companies. As separate companies, they are probably not viable.
Pittsburgh, Pa.: We all need to cut back and save, but if we cut back too much, won't that just deepen the recession?
Where do you think it is most important for consumers to continue to spend their dollars?
Steven Pearlstein: Its good for consumers to spend 95 percent of what they make, and save the rest. That doesn't mean you can't take out a loan to buy a house or a car, if you can afford the monthly payments within that 95 percent. But it is not in the national interest for everyone to continue this fiction that they can live beyond their means year after year and run it up on the credit card or draw it down from home equity.
Aspen Hill, Md.: If GM and Ford are forced to file for bankruptcy, what will be the outcome? If these automakers survive in a rearranged form, what will it mean for the UAW? And what will be the cost -- considering the hundreds of thousands of jobs tied to the automakers -- to the U.S. economy in the interim?
Steven Pearlstein: Bankruptcy is not the same as liquidation. It means reorganization in this case, or forcing creditors and shareholders and workers and pensioners all to take less than they think they are due so that the company, with reduced obligations and perhaps at a reduced size, can emerge from bankruptcy as a viable and competitive outfit. Yes, some jobs may be lost as a result, but fewer than if the company merely went bust and closed its doors. It is the lesser of bad outcomes.
so, tell me: OK, I guess I'm just too dumb to get it. If AIG has been successfully running companies for years and these big events "work," why again do we have to bail them out? They're in trouble why??
Steven Pearlstein: There was one division that was very, very, very unsuccessful, and that was the one that was offering insurance that bonds and loans wouldn't default -- the so-called credit default swap business. It was a division run out of London. And it made so many bad bets that it ruined what was otherwise a pretty good insurance company with many, many lines of business that were vibrant and profitable.
It's not a whole lot more complicated than that. The whole company is NOT rotten to the core (although there were some sleazy business practices at some of the insurance divisions, but those practices actually increased profits).
Anonymous: I believe the US must save its auto industry, but at the same time their business model is just horrible and destined failure just seems to be readily apparent. What should the US government require of the big 3, and more importantly how do they monitor it?
Steven Pearlstein: One way you monitor it is by putting public directors on the board and putting in new management, which is what the government did at Fannie and Freddie and AIG and what it should do if it bails out any of the auto companies in any significant way.
Significant way? What's that? Well, if you put $10 billion into a company whose current market capitalization or value is $3 billion, then I'd call that significant, as in: we own it.
Atlanta, Ga.: How do you feel about AmEx asking for federal bailout money? I am outraged that a credit card company would ask for federal money.
Steven Pearlstein: It's a more complicated company than just a credit card company, and it isn't being bailed out, in the sense you use that term. The government would be investing in preferred shares, which carry a good dividend and might also entitle the government to stock options that could be worth significant money if the stock revives from its current low levels. There may be other terms as well -- I'd hope so, because the deals struck so far with the first group of banks was too easy a deal, in my opinion. But its not like we're just giving money to people.
Amex is eligible for the program because it owns a bank. As I've written before, I don't particularly think this is the best use of the "bailout" money, spreading it around to banks that are strong. Obviously Treasury Secretary Paulson and Fed Chairman Bernanke, and many economists, disagree, and think that "recapitalizing" the banking system is a good use of the money. So there's a debate on that, and while I disagree with them, their position is not ridiculous or unreasonable.
Silver Spring, Md.: At what point should I start learning to farm the land?
Steven Pearlstein: I'm afraid land in Silver Spring is still so expensive that farming is probably not an option. But north of Frederick would be good.
AIG: You are arguing that AIG executives and employees know how to run a company well? We are currently bailing them out because they are so far underwater they are threatening to drag the whole economy down. If that is well run, I sure hate to see poorly run.
Steven Pearlstein: Again, the top executives have been fired, and the executives who run some of the regulated insurance units actually do know how to run businesses well. The guys in London were a disaster. They're also gone, but unfortunately their reckless decisions pushed the company into insolvency.
Bethesda, Md.: Mr. Pearlstein. I find it troubling that Congress is considering coming to the "rescue" of the automobile industry. We have some of the most progressive bankruptcy laws in the world, aimed at re-structuring. This will be throwing money right down the rat hole in my view. What is wrong with a re-structuring to include the firing of incompetent management that got them and their shareholders where they are today?
Steven Pearlstein: I wrote a column two weeks ago calling for a prepackaged bankruptcy for GM and the others, including some government investment in the restructured companies. I still think that is the best approach.
Davis, Calif.: Mr. Pearlstein,
A fan from the left coast!
I have a question on the ten of trillions of Credit Default Swaps. When an insurer, such as AIG, writes one of these contracts to insure a bond with a principal amount of X, is it liable for the entire X, plus interest, if the bond issuer defaults? In most instances with derivatives, the "exposure" is only a fraction of the notional value. Are CDS's the exception?
Thanks for your chats. I learn a great deal from them.
Steven Pearlstein: Thanks.
Washington, DC: You used the word "fungible" to describe the bailout money received by banks (as did a recent WaPo editorial). It seems that govt. cash injections are firstly going to shore up the books of private investors (with the assumption that they will continue to invest into the economy). Is it inevitable that any govt. cash injections will first go towards investors? This seems like a scenario for Naomi Klein's book Shock Doctrine.
Steven Pearlstein: I'm no Naomi Klein fan. Government investment goes into the pot of an on-going, profit-maximizing organization, which means its ultimate purpose is to make money for shareholders. The way it does that, in the case of a bank, is to borrow money at one rate, lend it out at a higher rate, and make a profit on the spread. In the process, it provides capital to a capital-starved economy.
With that setup, I'm not sure I understand your question, or for that matter, Ms. Klein's critique of capitalism.
NoVa: Not that we were much of a capitalistic country anyway, but do these bailouts finally cement the extra "S" (socialist) in the USA?
Steven Pearlstein: No, its means we're practical and do what we have to do when markets fail to get the capitalist system back working again. Sometimes government needs to step in and save capitalism from its own excesses.
Asheville, N.C.: Mr Pearlstein ,
Please address the destruction of TRUST, which used to be a pillar of our capitalistic system, now irreparably undermined by Wall Street, our political and corporate system, statistics are manipulated, off-balance sheet items are commonplace in what has become a culture of deception. WE CANNOT TRUST THE NUMBERS ... Is the US going the way of Argentina ?
Starting with our fiat currency, up and down the line we face a crisis of trust unprecedented and affecting our economic system, WE JUST DO NOT BELIEVE LIKE WE USED TO ................
Steven Pearlstein: A good point to end on. Time has run out. "See" you all next week, I hope.
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