Stock market provides woes and wisdom

By ARTHUR I. CYR

SCRIPPS HOWARD NEWS SERVICE

Global stock markets are in turmoil. The principal catalyst is the large amount of debt based on real estate, originating in the United States, which has gone bad. Current Wall Street losses related to the credit problems are estimated at more than $100 billion.

In response to the sharp drop on Wall Street and overseas markets, the U.S. Federal Reserve has lowered the benchmark interest rate by three-quarters of a percentage point. This was handled outside the usual schedule of the Fed’s Open Market Committee meetings. Also, the Bush White House and Democratic-controlled Congress agreed on a rushed stimulus package to include individual income-tax rebates and tax cuts for business.

In popular media, bad news usually drives out good. The alarmed voices of TV commentators provide the contemporary counterpart of tabloid scare headlines. This tone reinforces public anxiety. A special rate-setting meeting by the Fed also fuels concern.

Lower interest rates will ease pressure on financiers and home owners under stress. Servicing and retiring loans of all sorts will entail less cost.

But a focus on Washington and media behavior overshadows the basic truth that authentic free markets go down as well as up. Markets can be inefficient, irrational, manipulated and badly regulated. By definition, however, they reflect basic realities, including public psychology. We should be primarily concerned not that equities markets have dropped, but why this has happened — and how best to react.

General prosperity

Despite our enormous general prosperity, many have remained frustrated in pursuit of the American dream of private home ownership. The collective response by too many lenders has been to throw the rulebook out the window. In a time of easy money, or readily available credit, borrowers unqualified in terms of assets and financial history nonetheless were embraced with “subprime” loans. Also very germane is that a lot of money moved into real-estate speculation after the dot-com stock-market bubble burst in 2000.

The proliferation of types of lending organizations has facilitated the process, but some large established commercial banks clearly put greed before good judgment. The growth of an extremely complicated global financial-derivatives market greatly expanded possibilities for financial mischief as well as loss. Derivatives have become engines of risk creation as well as risk management.

Individual home loans traditionally based at local banks have been packaged into big bundles of bonds and other debt instruments, peddled literally around the globe. The scale and complexity of these arrangements mean that small individual loan defaults are much less likely to be noticed quickly.

Homespun rural style

During the Great Depression, American humorist Will Rogers became enormously popular because of timing as well as wit. His sense of humor was inherently engaging. Beyond that, however, his homespun rural style provided a self-conscious contrast with the East Coast big-city financiers blamed for the nation’s economic problems. Those problems were unprecedented, before or since, including an unemployment rate of 25 percent.

Inspired by Rogers, here are three direct down-to-earth points.

First, as a worker, take pride. The United States — you and me — has the most productive and largest economy in the world. Our gross national product now totals well above $13 trillion.

Second, as a citizen, be concerned. Current tense government intervention directly reflects public sentiment that any significant market downturn is intolerable. Instead, there should be serious analysis of reintroducing more government oversight of financial activities.

Third, as an investor, do homework. A good guide is “Security Analysis” by Benjamin Graham and David Dodd, first published in 1934 during the Depression, revised and republished regularly since. You can even read the book while the TV is on.

X Arthur I. Cyr is Clausen Distinguished Professor at Carthage College and author of “After the Cold War” (NYU Press and Palgrave/Macmillan). Distributed by Scripps Howard News Service.