Business Blog: Hoover’s Business Insight Zone

Former Treasury Secretary and Harvard president Lawrence Summers has a perceptive column at the Financial Times, which includes this pithy summary of market blow-ups:

First there is a period of overconfidence, rising asset values and growing leverage as investors increase their faith in strategies that have enjoyed a long run of success. Second, there is a surprise that leads investors to seek greater safety. In the current case it was the discovery of huge problems in the subprime sector and the resulting loss of confidence in the ratings agencies. Third, as investors rush for the exits, the focus of risk analysis shifts from fundamentals to investor behaviour. As some investors liquidate their assets, prices fall; others are in turn forced to liquidate, further driving prices down. The anticipation of cascading liquidations leads to more liquidations creating price movements that seemed inconceivable only a few weeks before. The reduced availability of credit then has a negative effect on the real economy. Eventually - sometimes in a few months as in the US in 1987 and 1998; sometimes over a decade, as in Japan during the 1990s - there is enough price adjustment that extraordinary fear gives way to ordinary greed and the process of repair begins.

I found the Summers column via Megan McArdle’s blog. She has a variety of smart things to say about who should get the blame for the current mess and who should be made to pay for it under the rubric of “They deserve it.”

On another front, Andrew Leonard of Slate wonders whether the credit-card industry isn’t due for a wave of defaults as a follow-on effect of the mortgage meltdown. Americans are typically overleveraged (what I would call overleveraged, anyway), often through the mechanism of credit-card debt. It would be sour news indeed for the consumer-sensitive portions of the economy if personal defaults went way up.