LIANE HANSEN, host:
While the foundations of Wall Street shook this past week, some economists acted like seismologists measuring the tremors. There's a shortlist of financial indicators that can read market anxiety. And you may be surprised to learn that by at least one measure, the markets are not completely terrified. NPR's David Kestenbaum explains.
DAVID KESTENBAUM: Somewhere in the Chicago Options Exchange building, away from the noisy trading floors, there is a computer that digests the latest financial data. And every 15 seconds, using a complex formula, it calculates - I'm not kidding you - fear.
Dr. BOB WHALEY (Professor of Management, Owen Graduate School of Management, Vanderbilt University): That's what it in fact measures.
KESTENBAUM: This is the guy who invented the fear formula, Bob Whaley at Vanderbilt University's business school. The formula looks at what people are doing now and tries to figure out what they're thinking will happen to the stock market 30 days down the road, how far it might rise or fall. The computer spits out a number called the volatility index, the VIX. It's a measure of how scared people are.
Dr. WHALEY: It's the volatility we expect moving forward over the next 30 days.
KESTENBAUM: Can you actually pull it up on the computer there?
Dr. WHALEY: I sure can. Give me a second.
KESTENBAUM: The details are actually pretty complicated. But basically the VIX gets its magic number by analyzing the price of a kind of insurance policy, but an insurance policy against stock market drops.
Dr. WHALEY: Just in the same way you buy car insurance, or fire insurance, or whatever. And what VIX measures, to some extent, is the amount people are willing to pay for insurance.
KESTENBAUM: When we talked on Thursday, the market was pretty nervous. The VIX indicated people thought the stock market might go up or down by almost nine percent over the next 30 days. Would you say people are calm, scared, very scared, terrified?
Dr. WHALEY: They're scared. They're very scared. They're not terrified. You have to put it in a historical context.
KESTENBAUM: In the market crash of 1987, he says, the fear index was much higher, projecting stock market swings of up to 50 percent. Hey, so I feel pretty good.
Dr. WHALEY: Yeah.
KESTENBAUM: There are other measures of market anxiety besides the VIX. One is called the TED Spread. It measures essentially how freaked out banks are that another bank might collapse. It looks at interest rates. When the banks don't trust one another, they bump up the interest rates they charge each other for loans. Jeff Frankel, an economist at Harvard, said for years the TED Spread was tiny and steady and dull.
Dr. JEFF FRANKEL (Professor of Economics, Harvard University): It used to be very boring, so I never used to keep an eye on it at all.
KESTENBAUM: It's not boring now.
Dr. FRANKEL: Approximately June of 2007, when it shot up. And you know, for it to shoot up temporarily, OK, there's some precedent for that. But for it to stay up is really quite remarkable. It's one of the reasons why people say this is the worst financial crisis since the Great Depression, because as far as I know this has not happened before.
KESTENBAUM: There was concern this week that the markets were getting too scared. But Frankel says the real problem is what these indicators looked like before, when the housing bubble was growing dangerously large and people were taking out mortgages they were never going to be able to repay.
Dr. FRANKEL: Before all this happened many of us thought that the measures of fear were abnormally low. Why on earth was the VIX so low? It was as if people thought there was no risk in the world at all.
KESTENBAUM: You are saying there was too little fear before?
Dr. FRANKEL: Yeah, yeah. No question. I mean, that's what all of this - I don't know if the amount of fear is greater than is rationally warranted, but I do know that everything that has happened could be described as the result of the fact that there wasn't enough fear three years ago.
KESTENBAUM: You may be interested to know that the VIX, the fear index, is not merely an indicator. The Chicago Exchange does a steady business trading bets on whether it's going to go up or down. Yes, in these strange times you can essentially buy and sell fear. David Kestenbaum, NPR News.