Very Scary Things
What’s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in stuff that is normally traded all the time — in particular, financial instruments backed by home mortgages — have shut down because there are no buyers.
This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.
The origins of the current crunch lie in the financial follies of the last few years, which in retrospect were as irrational as the dot-com mania. The housing bubble was only part of it; across the board, people began acting as if risk had disappeared.
Sorry to disabuse that theory, Paul, but if monetary economists are truly scared, they aren’t worth the title by which they call themselves.
Those who live by Wall Street, either die by the Street or get out with their place in the Hamptons intact, but they know the rules. Irrational money chasing irrational investments, the building of bubbles (whether they be dotcom or housing) and loaning to the indigent were all incredibly stupid policies to anyone who cared to notice. The money to be made at all levels kept the skids temporarily greased.
Markets right themselves when they are swung too far. This market is doing exactly that and the only question is who will get hurt and how badly.