Okay, I know that they don't really need my help, but why not take advantage of a rare opportunity to be on their side. Ben Stein somehow got his hands on a paper by Jan Hatzius, an economist at Goldman Sachs. According to Stein, the paper outlines a scenario for a financial market meltdown stemming from a collapse in the housing market. Stein reports that Hatzius projected a 15 percent decline in house prices. Stein then goes on to essentially dismiss the report based on the fact that house prices have never declined by 15 percent since the great depression. Furthermore, he assures readers that the Federal Reserve Board will ensure that the banks will always have enough money to keep the economy rolling. Since he has decided that Hatzius's scenario is implausible, Stein then concludes that Hatzius is pushing scare stories to promote Goldman Sachs trading strategy which has involved extensive shorts of collateralized mortgage obligations (CMOs). He then calls for Goldman Sachs to be investigated. Stein may have missed it, but in the years from 1995 to 2006 the United States had the largest run-up in house prices in its history. This is why it is very reasonable for Hatzius to draw up scenarios assuming a 15 percent decline in house prices. The run-up makes the crash possible and even likely. That's the way markets work. The stock market had the largest decline since the great depression in 2000-2002 because it had reached the highest price to earnings ratios since 1929. While the Fed can take many steps to offset the impact of a housing crash, it is not the all-purpose rescue vehicle that Stein seems to think. It is supposed to make loans to solvent institutions, it is not supposed to give money to insolvent ones. If a huge spate of bad loans pushes many banks to the brink of insolvency, the Fed will not be able to just hand them cash to make them financially viable The evidence that bailouts of a collapsing financial structure is not always easy can be found on a little Asian island nation near China called "Japan." Japan endured more than a decade of stagnation following the collapse of its stock and housing bubble in 1990. Clearly its central bank and government could have pursued better policies that would have hastened the recovery, but the fact that the recovery took so long should demonstrate that it is not easy to recover from the collapse of a bubble. I would hope and expect that the Fed would do a better job than Japan's central bank in responding to the fallout from the housing crash, but it is not ridiculous to imagine it will still be a very difficult process. In short, Stein gives no reason whatsoever to doubt that Hatzius wrote a serious analysis of the current state of the U.S. economy. Of course Goldman Sachs should still be investigated.
--Dean Baker
