Subprime Market Miseries Spread to Wall Street

Widespread problems within the subprime loan market have created havoc on Wall Street, with a cascading effect through world markets.

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SCOTT SIMON, host:

This is WEEKEND EDITION from NPR News. I'm Scott Simon.

Many of the reports from Wall Street this week used the same metaphor, a rollercoaster ride. But actually it was more like an elevator ride straight down. While the Dow ended up slightly for the week, fears remain that the market might resume its downward slide.

Our friend from the world of business, Joe Nocera, a columnist for the New York Times, joins us now from our studios in New York.

Joe, thanks very much for being with us.

Mr. JOSEPH NOCERA (Columnist, New York Times): Thanks for having me, Scott.

SIMON: What caused the downturn this week?

Mr. NOCERA: Well, you remember all those people who said that the subprime problems from the beginning of the year would not infect the rest of the market, they were wrong. This really is about a contagion that began with a fairly serious problem, having to do with the subprime market and its effect on Wall Street and which has now spread throughout Wall Street and created fairly severe credit problems and some - as we say in the trade - liquidity problems.

SIMON: It's hopped over to Europe, too, right? Weren't there some European hedge funds, yeah?

Mr. NOCERA: Has there, big time. I mean, one of the things that happened this week that really spooked the market was the announcement by a Paribas that it was freezing three hedge funds that it ran because - the way they said it was, we can't price the securities. What they meant was they couldn't find any buyers for the securities.

SIMON: Yeah.

Mr. NOCERA: The market had completely dried up. And that caused the European Central Bank to infuse somewhere on the order of a hundred billion dollars into the banking system just to keep it liquid.

SIMON: Let me ask you about this specific case of, I guess, it's Countrywide Home Loans.

Mr. NOCERA: Right.

SIMON: ...which is the biggest mortgage lender but not, as I understand it, a subprime lender.

Mr. NOCERA: Well, they do have a substantial subprime business. But they also have a sort of a regular business, too. The problem is because companies like Countrywide make their money by parceling out loans to Wall Street, selling their mortgage loans to Wall Street, which allows them to make more loans.

So all of a sudden, they can't sell their paper. So they can't make more loans because their own cash is tied up in the ones they've already made. And the fact that Wall Street isn't buying this means that there's almost a freeze in the marketplace.

SIMON: Which I guess would also explain why the Paris bank can't sell any of the properties that they bought, yeah.

Mr. NOCERA: That's right. But then it cascades, Scott, because it started with this thing called subprime. And then it moved to derivative traders and hedge funds, and then it spread to general equities. And so when you see the market fall by 300 and, I think, 80 points it was on Thursday, it's because psychology takes over.

SIMON: What could change?

Mr. NOCERA: Well, look at what happened on Friday. The market started; within 10 minutes, the market was down a hundred points, and at a certain point of the day, it was down over 200 points. And it closed down around 30. The Federal Reserve rushes in and sort of decides to infuse money into the marketplace and basically, a bunch of analysts and economists on Wall Street say, hey, you know, the economy is in fundamentally good shape and it's not the end of the world, and so on and so forth. So traders decide well, maybe things aren't so bad and they start to buy and they start to think well, maybe the worst is over.

Now, we don't really know here this morning whether the worst is over or not.

SIMON: What are you going to be looking at over the next couple of weeks?

Mr. NOCERA: Well, first of all, you're looking at the stock market itself. Second of all, you're looking at what Ben Bernanke, the Fed chairman, is going to do. I mean, he's under a lot of pressure on Wall Street to lower rates and so on, which he doesn't really want to do. And the third thing to watch really is, you know, will credit keep contracting? Will hedge funds keep starting to fail? Or, will it simply be a case of where people take losses on equities but the system sort of regains its liquidity and you're waiting to see whether it continues to lock or whether it kind of unfreezes, I don't know quite how else to describe it.

SIMON: Joe Nocera in New York, thanks very much.

Mr. NOCERA: Thanks a lot, Scott.

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Pumping Money: Financial Market Liquidity Explained

This week's frantic news from Wall Street sent central banks around the world pumping money into the financial system, providing liquidity, or ready cash. Adam Davidson talks to Debbie Elliott about what exactly this means.

Let's say you own a big, beautiful $1-million house. The pizza delivery guy arrives with your dinner but you don't have any cash. He doesn't care how valuable your house is; he wants you to give him some money right now.

Banks basically work the same way. Every afternoon, they add up all the money they owe and all the money they have. The banks figure out whether they need money to meet their obligations. The banks that have extra money lend it to the banks that need money in the form of very short-term, overnight loans.

That constant process of lending extra cash provides the liquidity that funds the global economy.

This normally works very easily, but this past week there was a liquidity crisis. A few key banks around the world announced to everyone's surprise that they had a lot of sub-prime mortgages and that their assets were worth much less than anyone thought.

Banks began to worry: What if there are other banks that aren't disclosing how much their assets have shrunk. It caused a panic among banks, and they reduced lending to each other.

Suddenly, other banks that needed the money didn't have the ready cash to pay off the people who needed it.

The Federal Reserve, the European Central Bank and other central banks around the world stepped in, pumping extra liquidity — billions of dollars — into the system. The central banks provide extra cash all the time, but this week the amounts were much larger than normal.

But there's a potential downside to the central banks' action. Eventually, the fear is that they would pump so much money into economy that it would cause inflation. So the Fed will be keeping its eye out against that possibility and is likely to stop long before inflation sets in.

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