S+B: The financial system is in a very disturbed state, and the economy has not been doing well. How bad do you consider the situation, and how does it compare to earlier episodes?
MELTZER: The biggest banking problem in modern history, of course, was during the Great Depression, when we had waves of bank failures. So far, we have had a few failures, including some very large ones, but we haven’t seen anything that could be called a wave of bank failures. The defaults we’re seeing in the mortgage finance market are the biggest problem today, and the write-offs that we’re seeing today are very large in dollar terms, but the financial system is much larger than it was in the 1930s. Today, the defaults on mortgages are 6 percent and rising; during the Great Depression, they were 50 percent.
One somewhat similar crisis was in 1920 and 1921, when there was a wave of failures of agricultural banks. At the time, farmers represented a bigger part of the economy than they do now, and it was a serious problem. Farmers had bought land during World War I, and mortgaged it at high interest rates. Then came a big deflation of about 20 percent. As a result, Congress created the Federal Land Banks, which bought up the troubled loans and extended credit. Another somewhat similar case was the failures in the savings and loan industry in the late 1980s and the beginning of the 1990s, which dragged down a lot of the banking system. That wound up costing taxpayers an estimated $150 billion. The current mortgage and credit crisis will probably cost taxpayers a lot more.
S+B: But you don’t see this as a major threat to the economy?
MELTZER: I’ve always been skeptical that the housing crisis was going to cause a deep recession in the United States. The reason is that it’s localized, for the most part, in six communities: Southern California, Southern Nevada, Arizona, Southern Florida, and, for very different reasons, Cleveland and Detroit. This is a big economy, and six local problems can cause a wider problem. A downturn? Yes. A slowing in housing construction? Absolutely. But a major depression for the United States? Not at all. It’s not likely.
S+B: Do you see further weakness in the credit markets beyond the mortgage market?
MELTZER: We will probably see difficulties in consumer credit and consumer loans somewhere along the line, but I don’t think it will be a result of the housing situation. The current problems that consumers face are high energy and food prices, and the spreading of energy price increases to everything the consumer buys that moves by truck or airplane. Those prices are going up. Plus, consumers are going to suffer in the wintertime with rising heating and electricity prices. I think that is going to keep consumption growth slow.
There’s no question that we’re coming out of a period of very lax credit standards, and they are being tightened. The bankers are probably overreacting, as they often do, going from one extreme to the other. This is hurting people with student loans, housing loans, and consumer loans — although credit, for the most part, is still expanding. Good prospects can get financed. Risky things are more difficult.
The biggest problem in the credit markets can’t be solved, and won’t be solved, until there is a pretty good idea as to where housing prices are going to settle. You can’t value mortgages until you know what houses are worth. And no one really knows yet. Recently, bankers have marked down their portfolios of mortgage securities aggressively. I think that’s a step toward a solution, so I don’t regard that as terrible. The sooner those prices fall, the quicker this thing is going to be over.