Why Aren’t Markets Clearing?

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Karl Smith is trying to figure out what the real problem with the economy is:

Prices on the NASDAQ, for example, go up and they go down. That can be good or bad for you. But, the market clears. It doesn’t matter what happens in tech or to Pets.com or if we weren’t as wealthy as we thought we were or all kinds of other junk. The market clears.

Why aren’t markets clearing? This is the question. Why do I have houses piling up for sale? Why do I have workers filling out resume after resume? Why did I at the worst of the recession have inventories of real goods piling up at record rates? Why do I still have 2009 model year cars on my lots? Why do I have assembly lines that are not turning?

Why aren’t my markets clearing?

We lose a bunch of wealth fine. We got the balance sheets wrong fine. There is no new tech fine. There is not enough oil fine. All fine, whatever.

Why aren’t my markets clearing?

One reason, perhaps, is that markets aren’t clearing by design. I’m stealing this idea from somewhere that escapes me at the moment, but if a bank is holding, say, equities in its portfolio, it marks those equities to market when the market goes down. Everyone does this. The price of a stock is whatever the stock market says it is on any given day.

Not so for housing. Banks will insist that we’re just going through a “rough patch,” and eventually housing prices will rebound. So they resist marking their real estate holdings to their true value and accepting the consequences. This is understandable, since in some cases the consequences are insolvency and complete failure. Still, with this toxic waste clogging their balance sheets, credit doesn’t flow and markets don’t clear.

This, of course, is something that was a hot topic of converstation back in 2008 and 2009, but if I had to guess, I’d say there’s still a lot of delusional thinking like this in corner offices all over the financial world. Credit channels are blocked up because we still haven’t faced up to the extent of the housing bust. Markets in general aren’t clearing because one market in particular isn’t being allowed to clear. I don’t think that “fixing” the housing mess is the holy grail of getting our economy moving again, but it’s probably a big part of it. Mark down the toxic waste, renegotiate underwater mortgages, and recapitalize the banks if necessary. It would be a good start.

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