For months, Americans have been subjected to a sort of economic water torture -- a maddening drip of bad news about jobs, gas prices, sagging home values, creeping inflation, the slouching dollar and a stock market in bumpy descent.
Then came Bear Stearns. One of the five largest U.S. investment banks nearly collapsed in a single day before the government propped it up by backing emergency loans and a rival stepped in to buy it for a paltry $2 per share.
As economists and Wall Street types grope for historical perspective, which is another way of saying a road map out of this mess, Americans are nervously wondering about retirement savings, interest rates, jobs that had seemed safe.
They are surveying the economic landscape and asking: Just how bad is it? They are peering over the edge and asking: How far down? And the scariest part of all? No one can say for sure.
Businesses are feeling the pinch. Clients are cutting back and sales are going down. People are treating themselves less often. Restaurants are reporting declining traffic and eating at home has increased for the first time since 2001.
Parents are calling Financial Planners for advice on how to deal with grown children who have moved back in with Mom and Dad after losing a job or just to save money.
Less trash is being set on the curbs of Mesa, Ariz., where surging home foreclosures are leaving more houses empty. That means fewer homeowners paying the city $22.60 a month for pickup. People are sticking with what they have.
On top of an economy that was already groaning under the weight of a downturn, Bear Stearns came down like an anvil. Understanding how things got so bad means rewinding to the start of the housing boom. Wall Street and the banks made it far easier for people with shaky credit to get a mortgage -- known as a subprime loan. Investors wanted a piece of the fast-growing mortgage pie, so there was plenty of money sloshing around the market to pay for the loans. Financial firms sliced up the mortgages and sold them as complex investments, finding eager buyers among pension funds, hedge funds and more who were chasing higher returns and willing to overlook risks.
As long as housing prices went up, the strategy worked. When they began to crumble, so did financial stability. The housing problem set off the dominoes: Surging defaults meant the mortgage-backed securities plunged in value. That dried up the money to fund new home loans, and lenders everywhere became tighter with credit.
Bear Stearns found itself in the cross hairs. Market rumors began to swirl about the size of its exposure to mortgage securities, whether it had ample reserves to cover potential losses. Clients and investors began to demand their money back.
The last time the U.S. economy tilted into recession was 2001. And it was an entirely different animal. Investors bore the brunt of that downturn as the stock market shook off the excesses of the late-'90s technology boom. Encouraged by their government -- and fortified with tax rebates in their pockets -- Americans kept spending. Perhaps most importantly, there was no reason for anyone to doubt the stability of the financial system. There was no credit crisis to speak of, and the housing boom had yet to begin.
This time around, no one has declared a recession just yet: By the generally accepted rule, that takes two consecutive quarters of shrinking economic activity. The economy came close to stalling late last year but eked out small growth. The Fed dusted off other Depression-era tools, too. It allowed securities dealers to borrow directly from the Fed, a privilege once restricted to commercial banks. And it announced it would lend up to $200 billion to investment banks in exchange for the banks' beaten-up mortgage-backed securities. The idea is to maintain confidence in the American banking system. If that fails -- if more Bear Stearns episodes emerge -- it could gum up the entire economy, historians note.
So what's the way out?
Already, the Fed has slashed interest rates. It has cut the closely watched federal funds rate, the overnight lending rate for banks, six times since September, from 5.25 percent to 2.25 percent -- two-thirds of the cut coming in the last two months alone. But the Fed can't work alone. Upcoming tax rebates for millions of people and tax breaks for businesses may give a little relief, but economists think that something will have to be done soon to slow down the number of foreclosures, a cornerstone of the economy's woes.
Economists and market historians seem to agree that this is more than a typical, cyclical slump. And the X-factor that sets it apart -- determining how deep the wounds from the mortgage mess really are -- also makes it impossible to map the path of the downturn.
Story contributed by BusinessWeek: Read More
Then came Bear Stearns. One of the five largest U.S. investment banks nearly collapsed in a single day before the government propped it up by backing emergency loans and a rival stepped in to buy it for a paltry $2 per share.
As economists and Wall Street types grope for historical perspective, which is another way of saying a road map out of this mess, Americans are nervously wondering about retirement savings, interest rates, jobs that had seemed safe.
They are surveying the economic landscape and asking: Just how bad is it? They are peering over the edge and asking: How far down? And the scariest part of all? No one can say for sure.
Businesses are feeling the pinch. Clients are cutting back and sales are going down. People are treating themselves less often. Restaurants are reporting declining traffic and eating at home has increased for the first time since 2001.
Parents are calling Financial Planners for advice on how to deal with grown children who have moved back in with Mom and Dad after losing a job or just to save money.
Less trash is being set on the curbs of Mesa, Ariz., where surging home foreclosures are leaving more houses empty. That means fewer homeowners paying the city $22.60 a month for pickup. People are sticking with what they have.
On top of an economy that was already groaning under the weight of a downturn, Bear Stearns came down like an anvil. Understanding how things got so bad means rewinding to the start of the housing boom. Wall Street and the banks made it far easier for people with shaky credit to get a mortgage -- known as a subprime loan. Investors wanted a piece of the fast-growing mortgage pie, so there was plenty of money sloshing around the market to pay for the loans. Financial firms sliced up the mortgages and sold them as complex investments, finding eager buyers among pension funds, hedge funds and more who were chasing higher returns and willing to overlook risks.
As long as housing prices went up, the strategy worked. When they began to crumble, so did financial stability. The housing problem set off the dominoes: Surging defaults meant the mortgage-backed securities plunged in value. That dried up the money to fund new home loans, and lenders everywhere became tighter with credit.
Bear Stearns found itself in the cross hairs. Market rumors began to swirl about the size of its exposure to mortgage securities, whether it had ample reserves to cover potential losses. Clients and investors began to demand their money back.
The last time the U.S. economy tilted into recession was 2001. And it was an entirely different animal. Investors bore the brunt of that downturn as the stock market shook off the excesses of the late-'90s technology boom. Encouraged by their government -- and fortified with tax rebates in their pockets -- Americans kept spending. Perhaps most importantly, there was no reason for anyone to doubt the stability of the financial system. There was no credit crisis to speak of, and the housing boom had yet to begin.
This time around, no one has declared a recession just yet: By the generally accepted rule, that takes two consecutive quarters of shrinking economic activity. The economy came close to stalling late last year but eked out small growth. The Fed dusted off other Depression-era tools, too. It allowed securities dealers to borrow directly from the Fed, a privilege once restricted to commercial banks. And it announced it would lend up to $200 billion to investment banks in exchange for the banks' beaten-up mortgage-backed securities. The idea is to maintain confidence in the American banking system. If that fails -- if more Bear Stearns episodes emerge -- it could gum up the entire economy, historians note.
So what's the way out?
Already, the Fed has slashed interest rates. It has cut the closely watched federal funds rate, the overnight lending rate for banks, six times since September, from 5.25 percent to 2.25 percent -- two-thirds of the cut coming in the last two months alone. But the Fed can't work alone. Upcoming tax rebates for millions of people and tax breaks for businesses may give a little relief, but economists think that something will have to be done soon to slow down the number of foreclosures, a cornerstone of the economy's woes.
Economists and market historians seem to agree that this is more than a typical, cyclical slump. And the X-factor that sets it apart -- determining how deep the wounds from the mortgage mess really are -- also makes it impossible to map the path of the downturn.
Story contributed by BusinessWeek: Read More
