DBcooper
08-08-2007, 02:02 PM
And you guys thought the sheep arent getting it.
Steven Pearlstein
Washington Post Columnist
Wednesday, August 8, 2007; 11:00 AM
Washington Post business columnist Steven Pearlstein was online Wednesday, Aug. 8 at 11 a.m. ET to discuss the Federal Reserve's decision and the continuing turmoil in the financial and credit markets.
Read today's column:
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<TABLE style="FONT-SIZE: 0.7em; COLOR: #000000; FONT-FAMILY: arial" cellSpacing=0 cellPadding=0 width=185 bgColor=#ffffff border=0><TBODY><TR><TD>Wednesday's Sessions
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Earlier Today
• Politics (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/02/DI2007080201596.html): Matt Mosk
• Credit Markets (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/07/DI2007080700841.html): S. Pearlstein
• Ask Tom (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/01/DI2007080101122.html): Tom Sietsema
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</TD></TR></TBODY></TABLE>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.
His column archive is online here (http://www.washingtonpost.com/wp-dyn/content/linkset/2005/03/24/LI2005032400138.html).
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Fairfax, Va.: Can you explain how something so fundamentally flawed as the lending practices of mortgage brokers in recent years and the absolutely predictable results that we are seeing have supposedly caught so many so-called financial experts by surprise as they seem to say?
Steven Pearlstein: It is, indeed, a mystery. And it is a recurring mystery. You saw it in the junk bond debacle of the late 80s. The S&L crisis of the early 90s. The dot.com and telecom busts. Very smart, sophisticated people looking at crazy behavior and somehow rationalizing it. Why? Because when these crazy things first crop up, and people like me write that they are crazy and that it will all end badly, and then it doesn't end badly for year after year, even smart people suspend their normal disbelief and say, "Well, the market says its okay so it must be okay. Who am I to second guess markets?" And just when the sentiment finally swings totally in that direction -- that is when it all comes unravels.
So if you ask people now, how could you make loans without documentation and downpayment, they say: well, people did it for two years and there were record low defaults. The people doing it were making a fortune and stealing market share from me. So I had no choice but to do it as well.
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Boston: How surprised were you to see a "sophisticated" hedge fund like Sowood collapse so quickly after bets on senior corporate debt went south and hedges in junior corporate debt didn't act as they predicted? Any other large hedge funds in trouble? Goldman Sachs Alpha Fund? How does Bear Stearns remain a credible financial entity when it plays tricks by liquidating its two failed mortgage hedge funds in the Caymans?
Steven Pearlstein: All good questions. You are from Boston, so maybe you have better information on Sowood than I was able to find the other day. If you know more about this senior and junior corporate debt, please send in another note and let us know about it.
What struck me in the Sowood announcement is a brief mention that hedges they thought they had did not operate as anticipated. I called to find out more about that, and got no response. But if hedges aren't working because counterparties are no longer available, then that is a big, big deal.
As to your other question, I'm sure we will have rolling hedge fund failures in the coming months, the one triggering another. The thing you have to understand about this new credit market is that all borrowers are lenders and all lenders are borrowers. And that makes it a very stable system as long as the shocks are minor, but can very quickly come unwound if things really start to get unwound. By the time we get to Thanksgiving, you are going to see lots of pain all around.
I spoke with a top securities regulator yesterday, and that person was praising how well Bear Stearns has handled things and how well their risk management system had worked. I don't know what to say about that. It seems loopy to me. They ought to be very embarrassed, people who have money in other Bear Stearns instruments ought to be very cautious, and you can bet that they or their funds won't find they have very easy access to credit going forward from other banks and broker dealers.
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Hong Kong, China: Would you foresee a more serious 1997-alike financial crisis in Asia and the US? Why or why not? If yes, when?
Steven Pearlstein: This is going to unwind differently than Asia, for a whole variety of reasons: it starts in the US, the world and the global markets have changed in very fundamental ways since then, and the macroeconomic imabalances are now lmuch larger. My guess is that we'll be in the throws of things by Christmas if not before.
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Dunn Loring, Va.: Steve: Will try to make this question as fair as possible . . .
A few years ago President Bush spoke often of the "ownership society" and boasted of how more minorities during his administration had purchased homes than ever before. Now houses are being foreclosed by the millions on those same minorities. So, in your opinion, did this administration consciously or unconsciously seduce families who had no business buying a house into purchasing one using "no money down" and "no payments for a year" and "no doc loans" structured with an artificial ARM?
Steven Pearlstein: The Bush administration had very little to do with it all, other than providing the lax regulatory environment that allowed it to happen.
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NYC: I am not sure how to ask this question since I am not an economist, etc., just an average Joe with a mortgage (low fixed) and bills.
Reading about the US debt and China holding most of it, the cost of the war, mortgage problems, bonds, etc seems to paint a rather serious picture. Then you see the market reacting as if nothing is going on. Earnings of companies seem good. Jobs are steady.
What do you believe? We are in a time of manipulated media and information. Can I really trust the market and corporations? What is really going on? My gut tells me there is going to be the devil to pay soon.
Steven Pearlstein: Look, the line that the economy is strong is a red herring. The economy is always strong before an asset bubble or a credit bubble collapses. One reason it is strong is because of the euphoria and growth created by the bubbles. But once the bubbles burst, the economy suffers. So the causality works from the financial markets to the real economy, not the other way around.
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Falls Church, Va.: Do we even know that Fannie and Freddie are operating normally? When was the last time they published clean reports?
Even setting aside their internal-control problems, if we allow Freddie and Fannie to take on a more risky portfolio, aren't we just transferring risks from private investors onto the taxpayers? Why is that a beneficial result?
Steven Pearlstein: Look, this line that anytime Fan and Fred buy a paperclip, it is transferring cost or risk to taxpayers is just malarky. These two entities have never, ever cost the taxpayer a dime. In fact, they make money for the taxpayer because they make lots of money and pay taxes on it. Yes, they have an implicit government guarnatee, and yes, that is worth something to their shareholders and their customers. But if they didn't have that, the taxpayer wouldn't save any money. It is a non-cash benefit, if you will.
Their internal control problems are fixed. They still have to go back and restatate some of their books, but that is an accounting issue, not a cash flow issue. They are sound. They are well run. They know what they are doing. And they could be of tremendous help right now if they were allowed to be aggressive and creative in providing liquidity to a whole bunch of mortgage markets that have now frozen. They could also provide money and standards and mechanisms that would faciliate the workout process between subprime borrowers who are in default and the entitites that hold their mortgages. Rather than Fan and Fred having to push the government for permission to do these things, regulators should be beating down their doors to get them to do more faster. The analogy I used this morning to katrina is very apt.
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Falls Church, Va.: Will marking to market really have much of an effect? Hasn't the smart money already discounted the value of these companies' asset portfolios already? Are there really investors out there who are pricing these companies according to the book value of their assets?
Steven Pearlstein: No, investors and lenders have not fully accounted for marking to market because they couldn't: they don't know what these entities hold and nobody knows what the real value is. And in the coming reporting period, if these entities are forced to take the most conservative valuation techniques, it is going to make the situation worse. Trust me on that.
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College Park, Md.: Do you know of a good source to learn about the credit markets and how they affect the "real economy"?
Steven Pearlstein: No, this is all new territory, and as Bob Samuelson wrote this morning in the Post, the textbooks and the literature hasn't caught up. In fact, the Fed hasn't caught up, which is a problem.
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Anonymous: first thank you for your clear honest important article. why does the post not seize the opportunity now that the corporate dictators control almost all the media, to get into wsj shoes and become to financial new leader. i suggest the put you in charge. i would be glad to put my money where my mouth is. i think with the economy being even more important than this evil war in the upcoming election. i think it can be a money maker. that is important. thank you, sol
Steven Pearlstein: Hey, the Wall Street Journal is doing a marvelous job at writing about all this. How do you think I know much of this stuff?
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Princeton, NJ: Hi Steve. What do you think of today's NY Times Editorial? Is there enough blame to spread around?
August 8, 2007, Editorial - NY Times
A Weak Dollar and the Fed (http://www.nytimes.com/2007/08/08/opinion/08wed1.html)
Steven Pearlstein: The editorial is right to point out that macroeconomic imbalances are too large and cause all sorts of problems, including credit bubbles. But there are lots of other micro policies that have caused the specific problems we are dealing with here in terms of mortgage markets and loosey-goosey lending for leveraged buyouts.
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Manhattan, Kan.: how are the credit markets affecting expansion plans of companies like kohl's, bed, bath and beyond, et al? bob
Steven Pearlstein: It is causing a backup in investment here and there at this point. It is not to the point of being a corporate credit crunch and a collapse of corproate investment. Far from it. But it is moving slowly in that direction.
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Austin, Tex.: I work in commercial real estate and we have seen a huge increase in interest rates with commercial mortgages recently. Is this a direct or indirect result of the residential mortgage crunch or can it be attributed to other factors? Thank you!
Steven Pearlstein: You betcha. And wait until that results in a collapse of the commercial real estate bubble. That will be very, very messy.
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Arlington, Va.: Any thoughts as to how significantly the prime mortgage market and even the commercial loan market will be impacted by the sub-prime meltdown? In that, as investors continue their "flight to quality", will the reduced demand for subprime be offset by a strong supply of the "prime" collateral?
Steven Pearlstein: The key dynamic here isn't a flight to quality. It is that the same funds and banks and broker dealers who have gotten burned with subprimes are often big participants in other markets. And so their problems in one area will change their behavior and willingness to lend and ability to hold assets in other areas. And that is how it will spread. It is the commonality of lenders and investors in these supposedly separate markets that provides the mechanism for contagion.
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Arlington: Another factor besides low default rates that were sucking lenders in was that housing prices were rising at an incredible rate so even if they handled a default, they had a piece of property they could sell off for more than they had lent.
Steven Pearlstein: Actually, they didn't need to sell it off. They could simply refinance it at a higher level, making the ultimate problem even bigger when the bubble burst.
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San Diego, Calif.: Hi Steven: Apparently the "credit community" now thinks the way to clean up its mess is to deny (or make it much more difficult) for people with good credit to obtain loans. To me this behavior seems illogical. How does that "fix" anything? Thanks.
Steven Pearlstein: Hey, why do you think they call it a credit crunch? That's how it always works. It is irrational. But -- surprise, surprise -- markets are irrational sometimes. Lots of times, actually.
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Arlington, Va.: Reading Dunn Loring's question, it's interesting to reflect that it used to be considered a scandal to withhold loans from minorities, whereas now it is apparently reprehensible to extend too much credit.
Steven Pearlstein: Yes, extending too little or too much is a problem. That's not a unique situation. That's why you want good financial intermediaries -- those with the smarts and experience to know when its too little or too much.
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Washington, D.C.: Mr. Pearlstein, I respect your commentary about the Fed's apparent shortsightedness, or lack of insight. However, I think you are in many ways sitting farther away from problems than the central bank is.
Federal Reserve banks have extremely close working relationships with the banks in their districts, and have inside information that any journalist would kill for. The Fed has also been skeptical about relying on the media--even sound financial media--for information behind hard empirical numbers. The New York Fed, in fact, does its own intelligence gathering on New York markets, and since they do not share this information, financial market participants are in many ways more open with its staff than they are with journalists.
My impression is that it is hard to really understand what the Fed is looking at perhaps until the FOMC meeting transcripts come out many years after the fact, and even these are just a drop in the ocean of the Fed's internal information. I think that rather than assuming that the Fed is looking at the facts incorrectly, it would be better to wonder about what it knows that you don't. You'll find out that it's a lot!
That in itself, though, may signal other real problems. Central bank independence is supposed to free the Fed from political interference. However, our central bank has used this to excuse itself from accountability and transparency. The Fed has its own data secrecy designation akin to national security data--a CIA-type of attitude toward economic data--and exempts most of its information from FOIA requests.
So good luck ever figuring out what the Fed really knows! They might be spot on.
Steven Pearlstein: They look at more data and facts and anecdotes than I do. But they do so through colored glasses, with blinders on.
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Annandale: A federal bailout of those who created the real estate bubble should not be in the cards, for many reasons. The discipline of failure should be imposed on those who have built homes in ridiculous places (like among the rattlesnakes of the California desert), for ridiculous prices and sold to people who did not have the financial ability to pay for them in the first place. The behavior of the financial sector distorted the market, and distorted the budgetary practices of municipalities such as Fairfax County who thought that the party would never end. Just as I had to accept the hit to my 401k from the dot.com burst, so should those who made the wrong economic assumptions.
Steven Pearlstein: I hope they get their just dessert, just as you do. Nobody wants a bailout. But nobody wants the Great Depression, either. That's always been the delicate balance of economic policy in times like these. Make thos people pay as much as possible for their bad bets, but do so without putting the entire system into a downward spiral that it can't pull out of.
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La Plata, Md.: is it possible that if things really unravel the Fed would choose to allow more inflation in order to help people with debt?
Steven Pearlstein: That's an old saw that really misses the major point. The kinds of holes people have dug themselves into (subprime borrowers, hedge funds, etc) won't be filled simply by a bit of inflation. Inflation isn't the mechanism by which the problem is solved. Pumping liquidity into the financial system is. The unintended byproduct of pumping liquidity into the financial system, however, is that causes a bit of inflation. It is a secondary effect, not the primary one.
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Alexandria: I have to defend "those" people who bought a place with no money down as I am one of them. Being a first time home buyer, it is near impossible to save up 20 percent for a place, especially considering how fast places appreciated in this area. So I bought a condo using an 80/20 7 year arm with no pre-payment penalty. Here is the think - I have no credit card debt, car is paid in full, and very little student loan. I knew exactly what I could afford because I ran the numbers a million times over and tried to live on that budget for a while. I also told the realtor who kept pushing me to buy a more pricey place to stuff it, and when the mortgage company I was working with tried to force me into an interest only, 2 year arm with major penalties, I walked away. I ended up with my credit union and paid 1 percent higher overall, but much much happier. But I feel bad for friends who are in my exact situation and are now permanently out of the housing market around here because of a few bad eggs.
Steven Pearlstein: I'm glad it worked out for you. But I still think it is a bad idea to make no money down home loans. It doesn't have to be 20 percent in all circumstances, but it should be at least 10 percent. Why? Because the home price could fall that much, putting the loan underwater. And because sometimes bad things happen and you can't make your monthly payments for a time and you need some cushion or something to borrow against. Call me old fashioned, but I don't see the great danger or shame in renting for a few more years while you save up for a downpayment.
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My guess is that we'll be in the throws of things by Christmas if not before: Love your columns ... So, you see an unraveling of the markets around Christmas?
Steven Pearlstein: By Christmas. And i'm talking mostly about credit markets. Stock markets will be the collateral damage.
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Bridgewater, Mass.: According to a story in the Daily Telegraph (happily picked up by some Russian papers), the Chinese are upset enough about the US pressuring them on the yuan and trade sanctions to have begun hinting about liquidating their Treasury bonds and crash the dollar. Is this possible? likely? a slow news day?
Steven Pearlstein: If the dollar falls, the second biggest losers will be the Chinese, since they hold so many. So they are not interested in causing such a collapse.
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Washington, D.C.: given the state of the credit bubble collapse, is this a really stupid time to buy a home? If we are planning to stay in the house for more then 10 plus years, then are we safe to buy a home right now?
Steven Pearlstein: The price of houses will continue to decline. But the cost of a mortgage will increase over the next year. It's hard to know, without having a lot more information, which factor is greater at this point. But if you have good credit and income, I might be inclined to wait for a bit more correction in real estate prices. We haven't seen the bottom by any means.
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Falls Church, Va.: Does the line between "bubble" and "business cycle" still have much meaning? Looking back at your list of crises, it's important to remember how quickly each one was shrugged off. Junk bonds (a largely made-up scandal), and the S&L crisis, wherein the taxpayers paid the tab for decades of over-regulation of home mortgages, led into a short recession. The dot.com bomb hit harder, but it left behind a newly-wired electronic economy, and the markets and the industry recovered in only a couple of years.
History thus supports a guardedly optimistic view of the mortgage meltdown. There will be a spike in foreclosures and spate of failures among mortgage companies and their backers. But this bubble will leave behind a significant expansion in home ownership, as the large majority of subprime borrowers (who were shut out of the traditional market) continue to pay their debts just as they're doing now.
Steven Pearlstein: There is a view that the economic cycle of the 50s and 60s has given way to a more old fashioned type of cycle driven less by monetary policy and inventory buildings than by booms and busts in asset markets. I agree with that. This same view holds that these are natural market correction mechanism and the recessions that follow the busts are shallow and short lived. I think this is a legitimate view, although I don't share it. There are ways regulators can slow or hold back bubbles as they are developing which would keep markets more healthy and make it less likely some people would get very very rich, and there are ways for policymakers to reduce the pain of the busts to ordinary working people. In my mind, those are things that are worth doing, even though they won't completely eliminate the booms and the busts. Moderating them, and protecting those at the bottom, ought to be the goal.
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Baltimore, Md.: In reference to the first post and your roundup of historic bubbles: Howard Kurtz noted in his online chat this week that the dot.com runup was fueled in large part by the media, which continually trumpeted the fact that folks were getting rich owning and buying stocks in companies that kept increasing in value despite having, uh, no earnings or profits. Howard said that, after a while, a reader would begin to feel stupid for not jumping on the bandwagon.
Do you think the media bear some responsibility for the subprime mortgage mess, in that the press kept talking about everyone getting rich in real estate and, hey, you better get in on the ground floor. Thanks.
Steven Pearlstein: I know Howie's line of argument. There is some truth to it. And there are also journalists who have rather consistently warned of such things. I would be careful about ascribing too much blame to the media for this or many other things (like the Iraq fiasco, for example). The media's power is often exagerated, particularly by media critics, who have a vested interested in making you think the media is all powerful. And please fell free to pass that comment on to Howie.
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Silver Spring, Md.: What did you mean by in the "throw of things by Christmas or sooner?" We'll see more signs of inflation due to the credit crisis?
Steven Pearlstein: Markets will be in greater turmoil.
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Maryland: Love the column. What effect might the credit squeeze and fallout have on the local DC market, with strong employment, etc? Do you foresee a massive decrease in prices across the area or can our local economy sustain the high housing prices. There have already been decreases in prices since the peak two or three years ago. If we haven't reached the bottom, will the market recover at some point over the next 10 years?
Steven Pearlstein: Further decline in real estate prices, slowing of economic growth.
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Tampa, Fla.: I see CDOs (collateralized debt obligations) as one of the major causes of this, plus Wall Street's standard fixation on the next bonus.
As I understand it, many, if not most, of the sub-prime mortgages went into CDOs. CDOs have been extremely lucrative for Wall Street. Money managers snapped them up to get an increased yield with supposedly no extra risk. So the markets had a voracious appetite for CDOs and indirectly the assets which were securitized in them. Once the assets left the balance sheets of the originators of the mortgages and sponsors of the CDOs, those people thought they'd be off the hook if the game lasted long enough so that they wouldn't have to buy back the mortgages. The bankers got big bonuses for creating CDOs, so they created as many as they could so they could maximize their bonuses. No one cared about next year until they got this year's bonus.
Some banks even pitched equity tranches, the riskiest slices of CDOs, to pension funds and state and local governments. One bank that shall remain nameless was caught telling local gov't CFOs that the ratings agencies "approved" equity tranches as investments! Incredible! And totally fraudulent.
Anyways, that's my take.
In other words, everyone made a lot of money off subprimes via CDOs. What happened next was not their most pressing concern.
Steven Pearlstein: You got that right!
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Washington, D.C.: Hi Mr. Pearlstein, My wife and I plan to buy our next home (currently renting) soon. Our FICO scores are 774 and 755. But we're quoted at 6.625 w/ 1 point for a 30-yr fixed $480K loan. It really isn't a great rate. My question is, right now lenders are extra cautious (for good reasons), but with fewer people buying, don't they have to compete for new business? I'd think we would be considered 'low-risk' customers and should get good rates. Am I too naive? Thanks!
Steven Pearlstein: Look for a lender who is local, in your community, who actually will hold your loan rather than sell it. That's where you might get them to act more rationally. Right now, they're scared.
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Interest only loan: I have a fixed mortgage on my home which I bought a year ago, but know a lot of my friends took an interest only loan in 2005/2006. These friends and surprisingly, my mortgage broker, all said I was too conservative. With the credit crunch and declining home values, I am thinking, I made the right decision. How are interest only loans affected in this environment? Thank you!
Steven Pearlstein: Interest only loans are good for people with higher wealth and income. They are inappropriate for middle income people making a big stretch to buy a home with little or no downpayment and little income cushion. They were sold to the wrong people in many instances. I don't know your circumstances, but you may have been very smart in taking the more conservative approach.
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Steven Pearlstein: Thanks, folks. Good discussion. "See" you next week, I hope.
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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
Steven Pearlstein
Washington Post Columnist
Wednesday, August 8, 2007; 11:00 AM
Washington Post business columnist Steven Pearlstein was online Wednesday, Aug. 8 at 11 a.m. ET to discuss the Federal Reserve's decision and the continuing turmoil in the financial and credit markets.
Read today's column:
Missed Opportunities</PERSON> (http://www.washingtonpost.com/wp-dyn/content/article/2007/08/07/AR2007080701931.html) (Post, Aug. 8).</P><TABLE cellSpacing=0 cellPadding=0 width=238 align=right><TBODY><TR><TD width=10></TD><TD width=228>http://www.washingtonpost.com/wp-srv/liveonline/icons/lol_todayqa.gif
<TABLE style="FONT-SIZE: 0.7em; COLOR: #000000; FONT-FAMILY: arial" cellSpacing=0 cellPadding=0 width=185 bgColor=#ffffff border=0><TBODY><TR><TD>Wednesday's Sessions
• Gossip (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/07/DI2007080701138.html): Reliable Source LIVE
• Federal Diary (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/02/DI2007080202202.html): Stephen Barr LIVE
• W.H. Watch (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/07/25/DI2007072501626.html): Dan Froomkin LIVE
• The Nationals (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/02/DI2007080201685.html): Barry Svrluga LIVE
• Free Range (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/01/DI2007080101475.html): Food Section LIVE
• Books (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/02/DI2007080201701.html): Michael Dirda, 2 <!--LIVE -->
Earlier Today
• Politics (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/02/DI2007080201596.html): Matt Mosk
• Credit Markets (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/07/DI2007080700841.html): S. Pearlstein
• Ask Tom (http://www.washingtonpost.com/wp-dyn/content/discussion/2007/08/01/DI2007080101122.html): Tom Sietsema
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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.
His column archive is online here (http://www.washingtonpost.com/wp-dyn/content/linkset/2005/03/24/LI2005032400138.html).
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Fairfax, Va.: Can you explain how something so fundamentally flawed as the lending practices of mortgage brokers in recent years and the absolutely predictable results that we are seeing have supposedly caught so many so-called financial experts by surprise as they seem to say?
Steven Pearlstein: It is, indeed, a mystery. And it is a recurring mystery. You saw it in the junk bond debacle of the late 80s. The S&L crisis of the early 90s. The dot.com and telecom busts. Very smart, sophisticated people looking at crazy behavior and somehow rationalizing it. Why? Because when these crazy things first crop up, and people like me write that they are crazy and that it will all end badly, and then it doesn't end badly for year after year, even smart people suspend their normal disbelief and say, "Well, the market says its okay so it must be okay. Who am I to second guess markets?" And just when the sentiment finally swings totally in that direction -- that is when it all comes unravels.
So if you ask people now, how could you make loans without documentation and downpayment, they say: well, people did it for two years and there were record low defaults. The people doing it were making a fortune and stealing market share from me. So I had no choice but to do it as well.
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Boston: How surprised were you to see a "sophisticated" hedge fund like Sowood collapse so quickly after bets on senior corporate debt went south and hedges in junior corporate debt didn't act as they predicted? Any other large hedge funds in trouble? Goldman Sachs Alpha Fund? How does Bear Stearns remain a credible financial entity when it plays tricks by liquidating its two failed mortgage hedge funds in the Caymans?
Steven Pearlstein: All good questions. You are from Boston, so maybe you have better information on Sowood than I was able to find the other day. If you know more about this senior and junior corporate debt, please send in another note and let us know about it.
What struck me in the Sowood announcement is a brief mention that hedges they thought they had did not operate as anticipated. I called to find out more about that, and got no response. But if hedges aren't working because counterparties are no longer available, then that is a big, big deal.
As to your other question, I'm sure we will have rolling hedge fund failures in the coming months, the one triggering another. The thing you have to understand about this new credit market is that all borrowers are lenders and all lenders are borrowers. And that makes it a very stable system as long as the shocks are minor, but can very quickly come unwound if things really start to get unwound. By the time we get to Thanksgiving, you are going to see lots of pain all around.
I spoke with a top securities regulator yesterday, and that person was praising how well Bear Stearns has handled things and how well their risk management system had worked. I don't know what to say about that. It seems loopy to me. They ought to be very embarrassed, people who have money in other Bear Stearns instruments ought to be very cautious, and you can bet that they or their funds won't find they have very easy access to credit going forward from other banks and broker dealers.
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Hong Kong, China: Would you foresee a more serious 1997-alike financial crisis in Asia and the US? Why or why not? If yes, when?
Steven Pearlstein: This is going to unwind differently than Asia, for a whole variety of reasons: it starts in the US, the world and the global markets have changed in very fundamental ways since then, and the macroeconomic imabalances are now lmuch larger. My guess is that we'll be in the throws of things by Christmas if not before.
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Dunn Loring, Va.: Steve: Will try to make this question as fair as possible . . .
A few years ago President Bush spoke often of the "ownership society" and boasted of how more minorities during his administration had purchased homes than ever before. Now houses are being foreclosed by the millions on those same minorities. So, in your opinion, did this administration consciously or unconsciously seduce families who had no business buying a house into purchasing one using "no money down" and "no payments for a year" and "no doc loans" structured with an artificial ARM?
Steven Pearlstein: The Bush administration had very little to do with it all, other than providing the lax regulatory environment that allowed it to happen.
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NYC: I am not sure how to ask this question since I am not an economist, etc., just an average Joe with a mortgage (low fixed) and bills.
Reading about the US debt and China holding most of it, the cost of the war, mortgage problems, bonds, etc seems to paint a rather serious picture. Then you see the market reacting as if nothing is going on. Earnings of companies seem good. Jobs are steady.
What do you believe? We are in a time of manipulated media and information. Can I really trust the market and corporations? What is really going on? My gut tells me there is going to be the devil to pay soon.
Steven Pearlstein: Look, the line that the economy is strong is a red herring. The economy is always strong before an asset bubble or a credit bubble collapses. One reason it is strong is because of the euphoria and growth created by the bubbles. But once the bubbles burst, the economy suffers. So the causality works from the financial markets to the real economy, not the other way around.
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Falls Church, Va.: Do we even know that Fannie and Freddie are operating normally? When was the last time they published clean reports?
Even setting aside their internal-control problems, if we allow Freddie and Fannie to take on a more risky portfolio, aren't we just transferring risks from private investors onto the taxpayers? Why is that a beneficial result?
Steven Pearlstein: Look, this line that anytime Fan and Fred buy a paperclip, it is transferring cost or risk to taxpayers is just malarky. These two entities have never, ever cost the taxpayer a dime. In fact, they make money for the taxpayer because they make lots of money and pay taxes on it. Yes, they have an implicit government guarnatee, and yes, that is worth something to their shareholders and their customers. But if they didn't have that, the taxpayer wouldn't save any money. It is a non-cash benefit, if you will.
Their internal control problems are fixed. They still have to go back and restatate some of their books, but that is an accounting issue, not a cash flow issue. They are sound. They are well run. They know what they are doing. And they could be of tremendous help right now if they were allowed to be aggressive and creative in providing liquidity to a whole bunch of mortgage markets that have now frozen. They could also provide money and standards and mechanisms that would faciliate the workout process between subprime borrowers who are in default and the entitites that hold their mortgages. Rather than Fan and Fred having to push the government for permission to do these things, regulators should be beating down their doors to get them to do more faster. The analogy I used this morning to katrina is very apt.
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Falls Church, Va.: Will marking to market really have much of an effect? Hasn't the smart money already discounted the value of these companies' asset portfolios already? Are there really investors out there who are pricing these companies according to the book value of their assets?
Steven Pearlstein: No, investors and lenders have not fully accounted for marking to market because they couldn't: they don't know what these entities hold and nobody knows what the real value is. And in the coming reporting period, if these entities are forced to take the most conservative valuation techniques, it is going to make the situation worse. Trust me on that.
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College Park, Md.: Do you know of a good source to learn about the credit markets and how they affect the "real economy"?
Steven Pearlstein: No, this is all new territory, and as Bob Samuelson wrote this morning in the Post, the textbooks and the literature hasn't caught up. In fact, the Fed hasn't caught up, which is a problem.
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Anonymous: first thank you for your clear honest important article. why does the post not seize the opportunity now that the corporate dictators control almost all the media, to get into wsj shoes and become to financial new leader. i suggest the put you in charge. i would be glad to put my money where my mouth is. i think with the economy being even more important than this evil war in the upcoming election. i think it can be a money maker. that is important. thank you, sol
Steven Pearlstein: Hey, the Wall Street Journal is doing a marvelous job at writing about all this. How do you think I know much of this stuff?
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Princeton, NJ: Hi Steve. What do you think of today's NY Times Editorial? Is there enough blame to spread around?
August 8, 2007, Editorial - NY Times
A Weak Dollar and the Fed (http://www.nytimes.com/2007/08/08/opinion/08wed1.html)
Steven Pearlstein: The editorial is right to point out that macroeconomic imbalances are too large and cause all sorts of problems, including credit bubbles. But there are lots of other micro policies that have caused the specific problems we are dealing with here in terms of mortgage markets and loosey-goosey lending for leveraged buyouts.
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Manhattan, Kan.: how are the credit markets affecting expansion plans of companies like kohl's, bed, bath and beyond, et al? bob
Steven Pearlstein: It is causing a backup in investment here and there at this point. It is not to the point of being a corporate credit crunch and a collapse of corproate investment. Far from it. But it is moving slowly in that direction.
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Austin, Tex.: I work in commercial real estate and we have seen a huge increase in interest rates with commercial mortgages recently. Is this a direct or indirect result of the residential mortgage crunch or can it be attributed to other factors? Thank you!
Steven Pearlstein: You betcha. And wait until that results in a collapse of the commercial real estate bubble. That will be very, very messy.
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Arlington, Va.: Any thoughts as to how significantly the prime mortgage market and even the commercial loan market will be impacted by the sub-prime meltdown? In that, as investors continue their "flight to quality", will the reduced demand for subprime be offset by a strong supply of the "prime" collateral?
Steven Pearlstein: The key dynamic here isn't a flight to quality. It is that the same funds and banks and broker dealers who have gotten burned with subprimes are often big participants in other markets. And so their problems in one area will change their behavior and willingness to lend and ability to hold assets in other areas. And that is how it will spread. It is the commonality of lenders and investors in these supposedly separate markets that provides the mechanism for contagion.
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Arlington: Another factor besides low default rates that were sucking lenders in was that housing prices were rising at an incredible rate so even if they handled a default, they had a piece of property they could sell off for more than they had lent.
Steven Pearlstein: Actually, they didn't need to sell it off. They could simply refinance it at a higher level, making the ultimate problem even bigger when the bubble burst.
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San Diego, Calif.: Hi Steven: Apparently the "credit community" now thinks the way to clean up its mess is to deny (or make it much more difficult) for people with good credit to obtain loans. To me this behavior seems illogical. How does that "fix" anything? Thanks.
Steven Pearlstein: Hey, why do you think they call it a credit crunch? That's how it always works. It is irrational. But -- surprise, surprise -- markets are irrational sometimes. Lots of times, actually.
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Arlington, Va.: Reading Dunn Loring's question, it's interesting to reflect that it used to be considered a scandal to withhold loans from minorities, whereas now it is apparently reprehensible to extend too much credit.
Steven Pearlstein: Yes, extending too little or too much is a problem. That's not a unique situation. That's why you want good financial intermediaries -- those with the smarts and experience to know when its too little or too much.
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Washington, D.C.: Mr. Pearlstein, I respect your commentary about the Fed's apparent shortsightedness, or lack of insight. However, I think you are in many ways sitting farther away from problems than the central bank is.
Federal Reserve banks have extremely close working relationships with the banks in their districts, and have inside information that any journalist would kill for. The Fed has also been skeptical about relying on the media--even sound financial media--for information behind hard empirical numbers. The New York Fed, in fact, does its own intelligence gathering on New York markets, and since they do not share this information, financial market participants are in many ways more open with its staff than they are with journalists.
My impression is that it is hard to really understand what the Fed is looking at perhaps until the FOMC meeting transcripts come out many years after the fact, and even these are just a drop in the ocean of the Fed's internal information. I think that rather than assuming that the Fed is looking at the facts incorrectly, it would be better to wonder about what it knows that you don't. You'll find out that it's a lot!
That in itself, though, may signal other real problems. Central bank independence is supposed to free the Fed from political interference. However, our central bank has used this to excuse itself from accountability and transparency. The Fed has its own data secrecy designation akin to national security data--a CIA-type of attitude toward economic data--and exempts most of its information from FOIA requests.
So good luck ever figuring out what the Fed really knows! They might be spot on.
Steven Pearlstein: They look at more data and facts and anecdotes than I do. But they do so through colored glasses, with blinders on.
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Annandale: A federal bailout of those who created the real estate bubble should not be in the cards, for many reasons. The discipline of failure should be imposed on those who have built homes in ridiculous places (like among the rattlesnakes of the California desert), for ridiculous prices and sold to people who did not have the financial ability to pay for them in the first place. The behavior of the financial sector distorted the market, and distorted the budgetary practices of municipalities such as Fairfax County who thought that the party would never end. Just as I had to accept the hit to my 401k from the dot.com burst, so should those who made the wrong economic assumptions.
Steven Pearlstein: I hope they get their just dessert, just as you do. Nobody wants a bailout. But nobody wants the Great Depression, either. That's always been the delicate balance of economic policy in times like these. Make thos people pay as much as possible for their bad bets, but do so without putting the entire system into a downward spiral that it can't pull out of.
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La Plata, Md.: is it possible that if things really unravel the Fed would choose to allow more inflation in order to help people with debt?
Steven Pearlstein: That's an old saw that really misses the major point. The kinds of holes people have dug themselves into (subprime borrowers, hedge funds, etc) won't be filled simply by a bit of inflation. Inflation isn't the mechanism by which the problem is solved. Pumping liquidity into the financial system is. The unintended byproduct of pumping liquidity into the financial system, however, is that causes a bit of inflation. It is a secondary effect, not the primary one.
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Alexandria: I have to defend "those" people who bought a place with no money down as I am one of them. Being a first time home buyer, it is near impossible to save up 20 percent for a place, especially considering how fast places appreciated in this area. So I bought a condo using an 80/20 7 year arm with no pre-payment penalty. Here is the think - I have no credit card debt, car is paid in full, and very little student loan. I knew exactly what I could afford because I ran the numbers a million times over and tried to live on that budget for a while. I also told the realtor who kept pushing me to buy a more pricey place to stuff it, and when the mortgage company I was working with tried to force me into an interest only, 2 year arm with major penalties, I walked away. I ended up with my credit union and paid 1 percent higher overall, but much much happier. But I feel bad for friends who are in my exact situation and are now permanently out of the housing market around here because of a few bad eggs.
Steven Pearlstein: I'm glad it worked out for you. But I still think it is a bad idea to make no money down home loans. It doesn't have to be 20 percent in all circumstances, but it should be at least 10 percent. Why? Because the home price could fall that much, putting the loan underwater. And because sometimes bad things happen and you can't make your monthly payments for a time and you need some cushion or something to borrow against. Call me old fashioned, but I don't see the great danger or shame in renting for a few more years while you save up for a downpayment.
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My guess is that we'll be in the throws of things by Christmas if not before: Love your columns ... So, you see an unraveling of the markets around Christmas?
Steven Pearlstein: By Christmas. And i'm talking mostly about credit markets. Stock markets will be the collateral damage.
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Bridgewater, Mass.: According to a story in the Daily Telegraph (happily picked up by some Russian papers), the Chinese are upset enough about the US pressuring them on the yuan and trade sanctions to have begun hinting about liquidating their Treasury bonds and crash the dollar. Is this possible? likely? a slow news day?
Steven Pearlstein: If the dollar falls, the second biggest losers will be the Chinese, since they hold so many. So they are not interested in causing such a collapse.
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Washington, D.C.: given the state of the credit bubble collapse, is this a really stupid time to buy a home? If we are planning to stay in the house for more then 10 plus years, then are we safe to buy a home right now?
Steven Pearlstein: The price of houses will continue to decline. But the cost of a mortgage will increase over the next year. It's hard to know, without having a lot more information, which factor is greater at this point. But if you have good credit and income, I might be inclined to wait for a bit more correction in real estate prices. We haven't seen the bottom by any means.
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Falls Church, Va.: Does the line between "bubble" and "business cycle" still have much meaning? Looking back at your list of crises, it's important to remember how quickly each one was shrugged off. Junk bonds (a largely made-up scandal), and the S&L crisis, wherein the taxpayers paid the tab for decades of over-regulation of home mortgages, led into a short recession. The dot.com bomb hit harder, but it left behind a newly-wired electronic economy, and the markets and the industry recovered in only a couple of years.
History thus supports a guardedly optimistic view of the mortgage meltdown. There will be a spike in foreclosures and spate of failures among mortgage companies and their backers. But this bubble will leave behind a significant expansion in home ownership, as the large majority of subprime borrowers (who were shut out of the traditional market) continue to pay their debts just as they're doing now.
Steven Pearlstein: There is a view that the economic cycle of the 50s and 60s has given way to a more old fashioned type of cycle driven less by monetary policy and inventory buildings than by booms and busts in asset markets. I agree with that. This same view holds that these are natural market correction mechanism and the recessions that follow the busts are shallow and short lived. I think this is a legitimate view, although I don't share it. There are ways regulators can slow or hold back bubbles as they are developing which would keep markets more healthy and make it less likely some people would get very very rich, and there are ways for policymakers to reduce the pain of the busts to ordinary working people. In my mind, those are things that are worth doing, even though they won't completely eliminate the booms and the busts. Moderating them, and protecting those at the bottom, ought to be the goal.
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Baltimore, Md.: In reference to the first post and your roundup of historic bubbles: Howard Kurtz noted in his online chat this week that the dot.com runup was fueled in large part by the media, which continually trumpeted the fact that folks were getting rich owning and buying stocks in companies that kept increasing in value despite having, uh, no earnings or profits. Howard said that, after a while, a reader would begin to feel stupid for not jumping on the bandwagon.
Do you think the media bear some responsibility for the subprime mortgage mess, in that the press kept talking about everyone getting rich in real estate and, hey, you better get in on the ground floor. Thanks.
Steven Pearlstein: I know Howie's line of argument. There is some truth to it. And there are also journalists who have rather consistently warned of such things. I would be careful about ascribing too much blame to the media for this or many other things (like the Iraq fiasco, for example). The media's power is often exagerated, particularly by media critics, who have a vested interested in making you think the media is all powerful. And please fell free to pass that comment on to Howie.
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Silver Spring, Md.: What did you mean by in the "throw of things by Christmas or sooner?" We'll see more signs of inflation due to the credit crisis?
Steven Pearlstein: Markets will be in greater turmoil.
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Maryland: Love the column. What effect might the credit squeeze and fallout have on the local DC market, with strong employment, etc? Do you foresee a massive decrease in prices across the area or can our local economy sustain the high housing prices. There have already been decreases in prices since the peak two or three years ago. If we haven't reached the bottom, will the market recover at some point over the next 10 years?
Steven Pearlstein: Further decline in real estate prices, slowing of economic growth.
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Tampa, Fla.: I see CDOs (collateralized debt obligations) as one of the major causes of this, plus Wall Street's standard fixation on the next bonus.
As I understand it, many, if not most, of the sub-prime mortgages went into CDOs. CDOs have been extremely lucrative for Wall Street. Money managers snapped them up to get an increased yield with supposedly no extra risk. So the markets had a voracious appetite for CDOs and indirectly the assets which were securitized in them. Once the assets left the balance sheets of the originators of the mortgages and sponsors of the CDOs, those people thought they'd be off the hook if the game lasted long enough so that they wouldn't have to buy back the mortgages. The bankers got big bonuses for creating CDOs, so they created as many as they could so they could maximize their bonuses. No one cared about next year until they got this year's bonus.
Some banks even pitched equity tranches, the riskiest slices of CDOs, to pension funds and state and local governments. One bank that shall remain nameless was caught telling local gov't CFOs that the ratings agencies "approved" equity tranches as investments! Incredible! And totally fraudulent.
Anyways, that's my take.
In other words, everyone made a lot of money off subprimes via CDOs. What happened next was not their most pressing concern.
Steven Pearlstein: You got that right!
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Washington, D.C.: Hi Mr. Pearlstein, My wife and I plan to buy our next home (currently renting) soon. Our FICO scores are 774 and 755. But we're quoted at 6.625 w/ 1 point for a 30-yr fixed $480K loan. It really isn't a great rate. My question is, right now lenders are extra cautious (for good reasons), but with fewer people buying, don't they have to compete for new business? I'd think we would be considered 'low-risk' customers and should get good rates. Am I too naive? Thanks!
Steven Pearlstein: Look for a lender who is local, in your community, who actually will hold your loan rather than sell it. That's where you might get them to act more rationally. Right now, they're scared.
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Interest only loan: I have a fixed mortgage on my home which I bought a year ago, but know a lot of my friends took an interest only loan in 2005/2006. These friends and surprisingly, my mortgage broker, all said I was too conservative. With the credit crunch and declining home values, I am thinking, I made the right decision. How are interest only loans affected in this environment? Thank you!
Steven Pearlstein: Interest only loans are good for people with higher wealth and income. They are inappropriate for middle income people making a big stretch to buy a home with little or no downpayment and little income cushion. They were sold to the wrong people in many instances. I don't know your circumstances, but you may have been very smart in taking the more conservative approach.
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Steven Pearlstein: Thanks, folks. Good discussion. "See" you next week, I hope.
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