by Alan Reynolds
Alan Reynolds is a senior fellow with the Cato Institute.
Added to cato.org on April 11, 2008
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Media hysteria over the mortgage crisis is almost certainly misleading countless people about prospects for the real economy.
The US economy is likely in recession. Yet even that conclusion may be premature — it rests on a short sample of slim evidence. Industrial production has fallen for only one month. First-time claims for unemployment insurance touched recession levels for just one week.
Of course, housing starts are down 1.1 million since early 2006, but nearly that entire problem is behind us — starts couldn't drop much in the future, because homebuilding would then be well below zero.
The focus of the gloomy economic news is on a "credit crisis" or "financial crisis." Yet postwar US financial crises have never resulted in economic disaster. Think of the savings & loan (S&L;) crisis of 1986-1995 — a period that also saw Black Monday (Oct. 19, 1987), when Dow stocks fell 22.6 percent.
The S&L; crisis lasted from 1986 to 1995, and was undoubtedly the worst US financial crisis since World War II. Yet the real economy grew by 2.9 percent a year over that period.
Yes, an eight-month recession began in July 1990, when Iraq invaded Kuwait and oil prices jumped 113 percent. But that real shock is hard to blame on S&L; financial problems that were winding down by then.
Yet the Los Angeles Times, for one, has gone so far as to ask (March 20) "Could another Great Depression be lurking over the horizon?" This is nonsense on stilts.
"Then, like now," the article noted, "stock prices were highly volatile." So what? Stocks are only down about 10 percent in the United States — a much milder drop than most other markets.
Some papers can't get anything right. An April 6 New York Times piece ("Almost as if The Sky Were Falling," on stock prices) claimed that the "focal point for the stock market's difficulties" is that "banks have been reluctant to lend money to one another, or to anyone else."
Absurd. If banks have been reluctant to lend money to one another, then interest rates on such loans, like the six-month London Interbank Offered Rate (LIBOR), wouldn't have fallen to 2.6 percent from 5.3 percent a year earlier.
And if banks were reluctant to lend to "anyone else," then bank loans wouldn't have increased by 8 percent (as Fed data say they have) since last August, when the mortgage crisis first emerged.
The phrases "credit crisis" and "credit crunch" are not about bank loans, as most suppose, but about difficulties in selling or valuing exotic securities.
Even there, the hysteria mounts. "IMF Puts Cost of Crisis Near $1 Trillion," screamed a Washington Post headline April 9. Yet that estimate wasn't for the United States alone, or mortgages alone. It covered worldwide future accounting losses (amounting to 4.1 percent) on all sorts of loans and securities, from junk bonds to hedge-fund speculations. For mortgages alone, the IMF estimates losses of $115 billion.
And, again, we're talking accounting losses — many of them only temporary.
These are paper losses on mortgage-related securities — taken because accounting rules require financial firms to mark the securities down to some estimated "fair value." These securities still generate ample cash from mortgages — but, as the IMF explained, "Heavy discounting during the crisis . . . produced fair values much lower than their underlying expected future cash flows would imply."
That is, many such securities are likely to be written up sooner or later.
Some perspective is necessary, too. According to Standard and Poors, write-downs of mortgage-related securities "may reach" $285 billion. Yet losses from the S&L; crisis amounted to 3 percent of gross domestic product — which would be nearly $450 billion today.
And, unlike the S&L; mess, many of today's are in foreign banks such as UBS, with only indirect effects on the real US economy.
Even economists are going overboard. Paul Krugman recently told Fortune, "We're probably heading for $6 trillion or $7 trillion in capital losses in housing."
Hmm. The Federal Reserve estimates that the value of household real estate was $22.5 trillion in the fourth quarter of last year. If you assume house prices fall 30 percent and multiply that times $22.5 trillion, then you arrive at Krugman's wealth loss of $6.8 trillion.
But both parts of that calculation are flatly wrong.
First, the $22.5 trillion of real-estate wealth isn't just single-family housing. It includes all commercial, farm and rental property owned by households and nonprofit institutions.
Second, the fact that the S&P; Case-Shiller index of house prices has dropped 10.7 percent doesn't even begin to justify a nationwide forecast of a 30 percent drop. That index covers prices of single-family homes in only 20 metropolitan areas — with LA, San Francisco and San Diego, accounting for more than a quarter of the total.
Data from the Office of Federal Housing Oversight — which covers the whole country — show home prices down just 3 percent for the year ending in January. Between the fourth quarters of 2006 and 2007, house prices rose by an average of 3.8 percent in 29 states that are excluded by the Case-Shiller index, falling in just two.
Others compare today's mortgage mess to the tech-stock collapse of 2000-02. Yet the recession associated with that burst bubble was mild and brief.
Moreover, economic problems back then, like today's $110-per-barrel oil, weren't merely financial. Oil prices nearly tripled in 1999-2000, and the Fed pushed the fed-funds rate to 6.5 percent in the last half of 2000 while industrial production fell. Then came 9/11.
In short, all these historical comparisons give us no reason to fear a recession any worse than those seen during the S&L; crisis or the tech-stock collapse — the two mildest slumps on record. Attempts to convert such comparisons into anxieties about another Great Depression are lunacy.
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