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A Market Run on Rationality

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics and Director of the Maurice R. Greenberg Center for Geoeconomic Studies
August 20, 2007
Washington Post

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The most vivid image amid last week’s financial turmoil came from Calabasas, Calif., home to the nation’s biggest mortgage lender, Countrywide Financial Corp. At a retail branch down the street from Countrywide’s headquarters, depositors reportedly “besieged” a representative on Thursday, demanding to get their money out. The next day similar scenes played out at other Countrywide branches, conjuring those grainy black-and-white images of Depression-era bank runs. “I know a little about what happened in the 1930s,” one customer told Reuters. “It smells like it could be the same.”

These vignettes may have been swollen out of proportion by the journalistic magnifying glass, but they capture the essence of the moment. For the chaos in the markets has become as scary and as arbitrary as an old-fashioned bank run. Fear has taken over, and sound institutions are suffering along with poorly managed ones. It is a reminder that the markets are an exquisite instrument for pricing risk and allocating capital — except during those brief periods when they go stark raving nuts.

Consider the case of Countrywide, which finances nearly one in every five home mortgages, almost all of them to “prime” borrowers, rather than the riskier “subprime” sort. Despite that commanding position, Countrywide’s stock price has been halved since the start of this year. In fact, it’s fallen so much that you could buy the entire firm for less than it would cost to buy its assets: It’s as though the market were valuing a piggy bank at less than the value of the coins it held.

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