In addition to answering questions in the comments on each post, we try to do a weekly roundup of questions that may be of general interest. Some are in comments we didn’t get to, some in emails. Please continue giving us questions – they help us understand what is important to our readers.
What can we (readers) do to help?
This one got its own post all to itself.
Three questions from a prescient reader
One of our readers goes by “pk” on our blog. On September 27, he sent us an email asking three questions:
- Is the size of the bailout (independent of the technical aspects) sufficient?
- Will what has happened in the US be repeated across the globe?
- If economies come unhinged across the globe, what are the geo-political implications?
Since that date, the general consensus is that original bailout was too small (at least on its own), and we have clearly seen the U.S. experience echoed in other countries. And the third question is the subject of our Washington Post article. (pk also predicted a global interest rate cut, which has since happened; in my comment, I said that would be nice but not sufficient to stem the crisis, which I still stand by.)
What are credit default swaps?
We got a few requests for an explanation, which I have since added to the Financial Crisis for Beginners page. There were also questions about when they will expire, or even potentially making them illegal.
Credit default swaps are a form of insurance, and as such can play a valuable function. The two most commonly cited problems with them are (a) the fact that they can be bought independent of the underlying securities and (b) they are completely unregulated, so you can have no assurance the seller will actually be able to pay them off. My opinion is that they need to be regulated – and there are already discussions of creating transparent exchanges for them. They did not cause this crisis on their own, and at this point the crisis has reached a point where magically making them disappear would not solve our problems.
On credit default swaps – what was the thinking behind selling insurance products to people who didn’t own the insured asset? Maybe the answer is “because they could, and there was no one there to stop them, and they got filthy rich doing it.”
I think that’s exactly right. I could make an argument that allowing more people to participate in the market provides more liquidity and hence more pricing efficiency. But I’m not sure I see any compelling reason for it, given the trouble you can create for yourself. The other argument would be if that you use regulation to eliminate this kind of gambling, it will only show up someplace else – which may be true.
How much of this downward spiral is unfettered panic? I realize that there is a real decrease. But like speculators who drive a price up, I see the same happening in reverse. Any there any signs to be able to better judge this?
Probably a lot of people are interested in how far the stock market will fall, where it “should” be, and when it will start going up again. We try to scrupulously avoid anything that might be interpreted as personal finance advice, because we don’t have any particular expertise in that area. But for those interested in this question, I can point you to an article by David Leonhardt – a smart financial journalist – in the New York Times. He points out that, based on P/E ratios, stocks are below their long-term average now. However, he also points out that, in market declines, the market often swings well below the long-term average before rebounding.