Regular readers know that I am not a fan of the WSJ Op Ed page. In addition to their playing fast and loose with facts, I find their rhetorical tactics intellectually dishonest. I also suspect that excessive usage of the drug exctasy has left most of their editorial staff crispy remnants of their former selves, subject to frequent delusional flashbacks, delirium tremens and incontinence.
But I must put those intellectual reservations aside and direct you to Martin Feldstein‘s utterly dead on piece in today’s Journal. In a straight-forward, no nonsense manner, Feldstein perfectly sums up how we got to where we are today:
"Three separate but related forces are now threatening
economic activity: a credit market crisis, a decline in house prices
and home building, and a reduction in consumer spending. These
developments compound the general weakening of the economy earlier in
the year, marked by slowing employment growth and declining real
The current credit market crisis was started by
widespread defaults on subprime mortgages. Borrowers with poor credit
histories and uncertain incomes had bought homes with adjustable-rate
mortgages characterized by high loan-to-value ratios and very low
initial "teaser" interest rates. The mortgage brokers who originated
those risky loans sold them quickly to sophisticated buyers who bundled
them into large pools and then sold participation in those pools to
other investors, typically in the form of tranches with different
estimated degrees of risk. Many of the buyers then used these to
enhance yields in structured bonds or even money market funds.
Many subprime borrowers eventually had difficulty
making their monthly payments, especially when teaser rates rose to
market levels. The resulting defaults exceeded what investors in the
mortgage pools had expected.
Credit risk in financial markets had been underpriced
for years, with low credit spreads on risky bonds and inexpensive
credit insurance derivatives provided by investors seeking to raise
their portfolio returns. With such underpricing of risk, hedge funds
and private equity firms substantially increased their leverage.
mortgage defaults have triggered a widespread flight from risky assets,
with a substantial widening of all credit spreads, and a general
freezing of credit markets. Official credit ratings came under
suspicion. Investors and lenders became concerned that they did not
know how to value complex risky assets.
In some recent weeks credit became unavailable. Loans
to support private equity deals could not be syndicated, forcing the
banks to hold those loans on their own books. Banks are also being
forced to honor credit guarantees to previously off-balance-sheet
conduits and other back-up credit lines, further reducing the banks’
capital available to support credit of all types."
Feldstein notes what many TBP readers will recognize as big themes: The significance of housing to the prior "boom," the ongoing risk of inflation, the dangers a slowing economy presents, and of course, moral hazard.
We have seen and heard a lot of anti-free market, who-was-Schumpeter-anyway?, begging for a Fed bailout. Unlike that group of socialist whiners, Feldstein makes the most eloquent and persuasive case I have yet to come across . . .
WSJ, September 12, 2007; Page A19