« Retribution, by Max Hastings | Main | God's Servants Do Play Dice »
Bottom line
What's really going on? What's going on is that perhaps $6T of mortgages with a duration of a decade that had been priced at a 1% per year chance of default (with a 1/3 value haircut in the event of default) are now being priced at a 4% per year chance of default. That's a loss of $600B in market value--and if your share of that $600B is greater than your capital, or is thought to be greater than your capital and so impedes your operations, you are gone.
But truth be told it is a zero-sum game--not a real destruction of wealth. The real rates at which cash flows of constant risk are being discounted haven't changed much: there hasn't been a big redistribution of wealth between the present and the future. What has happened was that a bunch of people believed that the default risk was 1% when it was actually 2% and reported gains of $200B (of which they took 2-and-20 on the hedge fund slice, perhaps $20B, for themselves), and that now a bunch of people believe that the default risk is 4% when it is actually still 2% (unless, of course, the assembled central banks of the world fail and unemployment heads rapidly upward). So in aggregate hedge fund partners have gained $20B, hedge fund investors have paid$20B to their money managers for the privilege of losing another $200B that they never had, and there are $400B of transitory paper losses that will turn into real losses for those overleveraged and caught by the credit crunch and so forced into fire sales, and into real gains for those with steel nerves and liquidity.
Unless, of course, Ben Bernanke and company fail to contain the crisis, and we wind up in a severe depression. But then we would have much, much bigger things to worry about than $600B of missing paper mortgage value. 4 years x 3 percent excess unemployment x Okun's Law coefficient of 2 x $13T economy means a $3.1T cumulative Okun gap in lost real wages, salaries, and profits. That's the thing to worry about.
That's Brad DeLong, here is the link.
Posted by Tyler Cowen on March 30, 2008 at 08:19 PM in Economics | Permalink
Comments
I describe to my friends as a roll of the dice sometime in the near future. If it comes up as a one through five, the global markets will stabilize, and all values will quickly go back up to their long-term multiples. If it comes up a six, the Fed and other central banks have failed to contain the credit crises, and the global financial markets collapse.
Right now, stocks somewhere between the values associated with long-term multiples and total collapse. The current volatility we're seeing is due to new information coming along that supports or contradicts the likelihood of rolling a six, which is a lot more than the volatility associated with normal economic news, like interest rate changes or earnings projections.
Posted by: M. Hodak at Mar 30, 2008 9:10:12 PM
Love the neighbor. But don't get caught
Posted by: jnlongwei at Mar 30, 2008 9:23:17 PM
Allow me to offer
Posted by: bjseek at Mar 30, 2008 9:30:12 PM
A trillion here, a trillion there, pretty soon, you're talking real money.
Posted by: at Mar 30, 2008 9:41:16 PM
Those paper losses may be transitory, but not as transitory as the comments of those who disagree with Mr. DeLong!
Posted by: y81 at Mar 30, 2008 9:59:09 PM
All very well. But this doesn't change the fact that we need government action. We need massive government intervention to protect the assets and incomes of the wealthy. We need libertarians to give hectoring lectures about how most Americans have declining incomes because they lack the skills to compete in the world economy, and then to turn around and advocate use of taxpayer money to protect Wall Street.
Posted by: Dirk at Mar 30, 2008 11:12:51 PM
What are you saying Dirk, that libertarians and laissez-faire economists approve of bailouts? *Nobody* is disapproving?
Posted by: Jacob Oost at Mar 30, 2008 11:46:03 PM
I'm curious about the economic consequences should the 4% default rate be the reality over the next 2 years before it reverts back to a 2% default rate. Is it possible Brad DeLong is right in the long term, but it won't matter if the short term of the next few years is bad?
Posted by: kdp at Mar 31, 2008 12:34:31 AM
What if the default rate climbs above 4%? And which class of mortgage is Brad DeLong referring to? Some mortgage stats via CR:
"As of the end of last year, 5.82% (!) of all mortgages were
delinquent, the highest level in 23 years. 0.83% were in the process of foreclosure, also
an all-time high. When you look at just subprime mortgages, you find that 20% are
delinquent (the number is rising rapidly), and almost 6% were in foreclosure... Given Burn’s forecast for prices, as well as that of T2 Partners, all these statistics
are going to get worse."
http://www.frontlinethoughts.com/pdf/mwo032808.pdf
Posted by: Mercutio at Mar 31, 2008 2:42:40 AM
y81 - that is certainly the case. I think the good professor feels that measured debate is for equals, and those who disagree with him simply aren't his equals.
Makes for a bit of administrative overhead in managing the comments section, but such is the life of scholastic toil along this mortal coil.
Until he can get another government position, that is.
Posted by: not_scottbot at Mar 31, 2008 3:03:07 AM
But truth be told it is a zero-sum game--not a real destruction of wealth.
The truth is that the destruction of wealth already happened when these houses were built. Now the question is if it should be admitted or not. Obviously, some people still believe that if you don't admit the problem it disappears - while the opposite is true. If you don't admit the problem now, you'll have to admit it later. If you don't admit that you are running out of money, you will have to admit it in the moment you won't have any money to pay your bills. You cannot deny reality forever.
Unless, of course, Ben Bernanke and company fail to contain the crisis, and we wind up in a severe depression.
Ben the great, the best economist in the world...except that nobody has a clue how is he supposed to 'contain the crises'. The sentence above should be read: Unless Ben Bernanke fails to use dark magic and attain the impossible, we wind up in a severe depression.
Posted by: andy at Mar 31, 2008 6:35:13 AM
Dirk totally won the debate with that dumb guy in his head..
Posted by: Keith at Mar 31, 2008 9:17:28 AM
That is why I have been accumulating stocks of beat up financial companies.
Posted by: Floccina at Mar 31, 2008 9:52:16 AM
Andy has it completely correct- the destruction of wealth has already occurred. What the Fed and most politicians are engaged in at the moment is an attempt to hide this fact (by destroying more wealth), and to spread the losses to everyone without their knowing it.
Posted by: Yancey Ward at Mar 31, 2008 10:07:08 AM
Isn't the whole issue of "wealth destruction" interesting if we look at it from an individual's point of view?
When housing prices were rising to bubble levels -- wasn't part of my 26 year old, schoolteacher daughter's wealth being destroyed because there's no way she could afford to buy a house. So she rented
Now that housing prices are coming down, they may decline to a level at which she would be prudent to buy as a means of enhancing her wealth.
And, in terms of destruction of wealth, what about my 84 year old father, living off CD's that now are paying 2.5% or so? That's half the income he was getting when they were paying 5%. That strikes him as wealth destruction, it's a direct result of the actions to deal with the crisis, but nobody much talks about that.
These both seem to be cases that aren't being considered in (what seem to me to be esoteric) arguments about wealth creation.
I liked Andy's comment about Ben B needing magical powers.
Posted by: zbicyclist at Mar 31, 2008 3:52:05 PM
Tyler--
Are you tacitly agreeing with DeLong that there needs to be government intervention to stem the crisis?
I've been reading Marginal Revolution for over a year. I seem to remember many more posts against government interference in markets before December 2007. In particular, I remember a post about how banking is already overregulated. Since the economic crisis has gotten underway, it seems like you've been quiet about protesting government intervention even as other economists have been more vocal in promoting it. Why is this?
Posted by: MostlyAPragmatist at Mar 31, 2008 10:44:47 PM
花蓮旅遊,花蓮租車,花東旅遊,花蓮租車,花蓮租車,花蓮旅遊,租車,花蓮旅遊,花蓮,花蓮旅遊行程,花蓮旅遊地圖,花蓮租車,花蓮租車,花蓮租車旅遊網,花蓮租車,花蓮租車,花蓮租車,花蓮旅遊景點,花蓮租車,花蓮租車,租車,租車,花蓮,租車,花蓮租車,花蓮賞鯨,花蓮旅遊,花蓮租車,花蓮旅遊,花蓮租車,花蓮租車,花蓮租車,花蓮旅遊,花蓮租車,花蓮租車,花蓮賞鯨,租車,花蓮租車,賞鯨,花蓮泛舟,花蓮溯溪,花蓮旅遊,租車,花蓮租車,花蓮租車,花蓮租車,花蓮租車,花蓮一日遊,花蓮租車公司,花蓮租車,花蓮租車,花蓮一日遊,花蓮租車,花蓮旅遊地圖,花蓮租車,花蓮旅遊行程,花蓮旅遊
Posted by: 花蓮租車資訊 at Aug 5, 2009 2:38:58 AM
