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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (7625)	3/2/2007 9:54:56 PM
From: John Pitera	Respond to of 33421

Paul Krugman: The Big Meltdown March 02, 2007 Paul Krugman, looking back to today from March 2, 2008, analyzes the recent drop in U.S. stock prices and what it might mean for our economic future: The great market meltdown of 2007 began exactly a year ago, with a 9 percent fall in the Shanghai market, followed by a 416-point slide in the Dow. But as in the previous global financial crisis, which began with the devaluation of Thailand’s currency in the summer of 1997, it took many months before people realized how far the damage would spread. At the start, all sorts of implausible explanations were offered for the drop in U.S. stock prices. It was, some said, the fault of Alan Greenspan, ... as if his statement ... that the housing slump could possibly cause a recession ... had been news to anyone. One Republican congressman blamed Representative John Murtha... Even blaming events in Shanghai ... was foolish on its face, except to the extent that the slump in China — whose stock markets had a combined valuation of only about 5 percent of the U.S. markets’... — served as a wake-up call for investors. The truth is that efforts to pin the stock decline on any particular piece of news are a waste of time. ... In 2007, as in 1987, investors rushed for the exits not because of external events, but because they saw other investors doing the same. What made the market so vulnerable to panic? It wasn’t so much a matter of irrational exuberance ... as it was a matter of irrational complacency. After the bursting of the technology bubble of the 1990s failed to produce a global disaster, investors began to act as if nothing bad would ever happen again. Risk premiums ... dwindled away. ... For a while, growing complacency became a self-fulfilling prophecy. As the what-me-worry attitude spread, it became easier for questionable borrowers to roll over their debts, so default rates went down. Also, falling interest rates on risky bonds meant higher prices..., so those who owned such bonds experienced big capital gains, leading even more investors to conclude that risk was a thing of the past. Sooner or later, however, reality was bound to intrude. By early 2007, ... collapse of the ... housing boom had brought ... widespread defaults on subprime mortgages... Lenders insisted that this was an isolated problem, which wouldn’t spread... But it did. For a couple of months after the shock of Feb. 27, markets oscillated wildly, soaring on bits of apparent good news, then plunging again. But by late spring, it was clear that the self-reinforcing cycle of complacency had given way to a self-reinforcing cycle of anxiety. There was still one big unknown: had large market players, hedge funds in particular, taken on so much leverage — borrowing to buy risky assets — that the falling prices of those assets would set off a chain reaction of defaults and bankruptcies? Now, as we survey the financial wreckage of a global recession, we know the answer. In retrospect, the complacency of investors on the eve of the crisis seems puzzling. Why didn’t they see the risks? Well, things always seem clearer with the benefit of hindsight. At the time, even pessimists were unsure of their ground. For example, Paul Krugman concluded a column published on March 2, 2007, which described how a financial meltdown might happen, by hedging his bets, declaring that: “I’m not saying that things will actually play out this way. But if we’re going to have a crisis, here’s how.” economistsview.typepad.com