If Paul Krugman says it, I tend to believe it. Or rather I would believe an economist and columnist at the New York Times before the current occupant of the bunker. He says the economy is safe and sound. Krugman says that the reason the market has not responded to the infusion of cheap money by the Fed--two rate cuts since August--is that investors are playing Texas Hold'em. Normally the market lives or dies on margin and a reduction in the discount rate is Viagra(R) to speculators. The Fed, as I pointed out before, did the same trick when Russia defaulted back in 1998. The influx of cash helped steady the market during the temporary liquidity crisis caused by Long Term Capital Management going belly up. Its different this time. A lot of nonbank financial institutions have made a lot of loans that are going to go bad and everyone is waiting for the mines to go off. Adjustable mortgages are ratcheting up, and housing prices are subsiding after the thrill of the real estate bubble in mid decade is gone. This is why liquidity has dried up.
The Mortgage Bankers Association reported in March that 13% of subprime borrowers were behind on their payments. Some 30 of America's subprime lenders have closed their doors. Fourteen million mortgagors will end up with negative equity if home prices fall twenty percent according to one estimate. And that figures out to a lot of losses for financial institutions. Even a Swiss bank, USB, has been hit by the crisis, and 'Fedspan' is calling for
borrower bail outs. Bank losses in the range of 100 to 200 billion would seriously curtail lending behavior. Goldman Sachs economist Jan Hatzius says his "back-of-the-envelope calculation" now suggests "losses of around 400 billion dollars" for global banks and investors. That is much bigger than the S&L collapse. The sub prime disaster is affecting market sectors normally not associated with real estate lending. Which may explain why my tax advantaged municipal bond is going backwards. When long term interest rates fall as they are now, long term bond prices are supposed to go up, not down. Buddy, can you spare a loan?