What's Up with the Economy? Not Much

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STEVEN INSKEEP, host:

It's MORNING EDITION from NPR News. I'm Steve Inskeep.

RENEE MONTAGNE, host:

And I'm Renee Montagne.

Of all the problems facing the economy right now, the biggest may be the state of the credit markets. That remains true after the Federal Reserve slashed interest rates. It remains true even after the Fed pumped billions of dollars into the financial system. And in this part of the program, we'll examine one thing the markets have to fear: fear itself.

INSKEEP: You may be wondering how long the economy's going to keep sliding and when it will end. So we've brought in David Wessel, economics editor of The Wall Street Journal, to talk about what might turn around in the economy whenever it happens.

David, good morning.

Mr. DAVID WESSEL (Economics editor, The Wall Street Journal): Good morning.

INSKEEP: So whether we call it a recession or not, how bad is the slide we're in right now?

Mr. WESSEL: Well, in some respects, we're OK. The unemployment rate's still below 5 percent. As the Treasury Secretary likes to say, 93 percent of American homeowners are still paying their mortgages on time.

But we've had a couple of months of down payrolls. And there's a lot of angst about how bad things could get, because the price of housing continues to fall and there're a lot of ripple effects of that affecting all sorts of financial institutions.

INSKEEP: And lots of those financial institutions seem kind of grim about the future.

Mr. WESSEL: Oh, the financial institutions are very grim about the future. Some people are calling this the most pervasive financial crisis we've had in a decade, much worse than the Savings and Loans crisis of the '80s or the Asian financial crisis of the late '90s.

I think the key to when it stops is two things. One is when will the price of houses stop falling and at least level off? And the second is when will confidence return to financial sector so that people start saying that things are not worse than we fear, but they're just as bad as we fear?

INSKEEP: There must be something of a cycle here, though, because people aren't going to start paying more for houses, say, until confidence returns.

Mr. WESSEL: Absolutely. Part of the problem at a time like this is that one thing leads to another bad thing, and that makes the first thing worse. When banks are a little bit shaky and are trying to pull back on their loans and they sell assets and then that pushes down the price of assets in the market and that makes the economy worse. And then the economy makes the price of assets worse, so the banks get a little more wary, and that makes the economy worse.

So we have what's sometimes called a positive feedback loop. And that's one of the things that's quite scary, and it's why the Federal Reserve and the treasury and the White House have been so aggressive at trying to stop the downward spiral.

INSKEEP: You've been telling us about the way the financial institutions have been pricing risk, so to speak, very high, assuming that things will go terribly, terribly if they think about loaning money to someone, investing money onto somebody. They want a much higher return than they ever did in the past, because they're afraid they're going to lose the investment.

Mr. WESSEL: Right. This is a reaction to a period of time where it now seems clear they didn't charge enough for risk. Someone who made a mortgage to a subprime borrower who didn't have to document their income, didn't have to put anything down and got a mortgage, those people we now think didn't get charged enough. They probably shouldn't have been made a loan at all. So what you have is a reaction to too much euphoria in the past, and you have now the maniac depression stage.

INSKEEP: And you now have the person who has perfectly good credit having trouble getting a loan, perhaps.

Mr. WESSEL: That's the risk. That's the big risk. When good credit can't borrow, that's the definition of a credit crunch, and that's what causes recession.

INSKEEP: So does this turn around when we get to the point where investors feel like having a little more irrational exuberance once again?

Mr. WESSEL: Yes, in part. There are a couple of things that can turn this around. One is if smart people who have a lot of money, whether it's Warren Buffet or the fellow who runs the Sovereign Wealth Fund in Abu Dhabi, decided that prices in the U.S. have gone down so far that they're a bargain and they all start to come in, we could have a reaction up almost as swift as a reaction down.

The other thing that has to happen is banks and other financial institutions need more capital, this cushion that they build for bad times. Their capital has been eroded by what's going on, and that makes them reluctant to lend, very reluctant to lend. And until they have more capital, they're not going to be able to expand their lending.

INSKEEP: David Wessel of the Wall Street Journal.

Thanks for coming by.

Mr. WESSEL: A pleasure.

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