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Working Papers

The Capital Markets Disarray

Working paper #616
Peter Linneman

The credit crunch triggered by egregiously poor sub-prime residential underwriting in 2005-2006 is the fifth time in the last twenty years when fear is winning over greed in the capital markets. The mismatch of long-term assets and short-term investment capital, combined with widening credit spreads across all debt instruments, is forcing margin calls, which further exacerbate market fears of declining asset values. The good news is that the current capital market crisis will not spill over to the broader economy—namely job and corporate profits of non-financial firms. As with the four previous instances of capital market crisis triggers—the 1987 stock market crash, the savings and loan debacle of the early 1990s, the 1998 Russian ruble crisis, and the 9/1, 2001 terrorist attack-this cycle will be broken when greed re-emerges over fear. When this occurs, investors will believe that asset values are no longer in jeopardy and are in fact a “steal.” Count on greed to be back on the scene sooner than you think.

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