The Stock Market's
Wild Ride
March 21, 2008
USC professors look at the causes of stock market volatility, and what it will mean for the candidates and the next occupant of the White House.
“The current market volatility is because no one knows what sub-prime mortgage risks financial institutions’ portfolios are hiding,” says Aris Protopapadakis, associate professor of Finance and Business Economics at the USC Marshall School of Business. “So rumors and small changes in individual firm fortunes cause the market to reassess the risk of all other financial institutions. The volatility spreads to non-financials, because what may happen to the financial markets changes the forecasts of the severity of the economic downturn.
“The Federal Reserve has been trying to facilitate the functioning of the financial market while reassessment of risk and the necessary unwinding and re-pricing are taking place, but it can’t change the facts,” Protopapadakis adds. “The facts are that many institutions took on more and riskier debt than they realized, and they got hit with a bad event. Some of them will have to go out of business. The trick is to keep the crisis from spreading to otherwise healthy institutions and to encourage continuing lending to ‘worthy’ companies and against good collateral.
“The presidential candidates will clearly have to respond and pontificate on this issue, and they will have to make statements and promises to fix this and that and perhaps to punish the ‘perpetrators.’ And their statements will be judged by the electorate, along with all the other things they say and do,” Protopapadakis explains. “The challenge is for them to not rope themselves into policies that may sound good on the campaign trail but which will be bad news for the economy if implemented. There isn’t a lot a president can do to improve the current situation, but there is plenty he or she can do that will make this and future events worse.
“The future challenges are to improve the regulatory environment, which was clearly inadequate in this case, without reducing the vitality and innovativeness of the financial markets,” Protopapadakis says. “Since we generally fight the ‘last’ crisis, the next one will be come from unforeseen circumstances for which we will not be well prepared. But while fighting the last war, we run the risk of hamstringing the financial system and impeding its growth and vitality now.”
Protopapadakis is an expert on stock market volatility, monetary and fiscal policy, international finance, and foreign exchange risk.
Contact him at (213) 740-6537 or aprotopapadakis@marshall.usc.edu.
Lawrence Harris, Fred V. Keenan Chair in Finance at the USC Marshall School, believes the concern for presidential candidates lies not so much in the stock market fluctuations as in the economic forces that are generating them.
“Because we’re in a recession — or will soon be — it will make it much more difficult for the Republicans, because they’ll be running on their records, whereas the Democratic candidate will be the candidate of change,” Harris notes. “A bad economy will always be bad for the incumbents.”
However, Harris forecasts an outcome that will be largely the same, whether it is a Democrat or a Republican who ends up in the White House.
“If the next president is a Democrat, they’ll immediately blame everything on the Republicans, on George W. Bush,” Harris predicts. “And they’ll adopt some reforms. But whether the reforms are effective or not, there will be a recovery, and they’ll take credit for it.”
“If the next president’s a Republican, after he’s elected he’ll probably blame it on Bush — even the Republicans are blaming Bush now — and there will be a recovery, and he’ll take credit for it.”
The bottom line is that the economy naturally tends to fluctuate up and down, Harris notes. “And when it’s down, no one wants to take credit.”
Harris, a former chief economist for the U.S. Securities and Exchange Commission, is director of the Marshall School’s Center for Investment Studies. He is also the author of a seminal text on securities exchanges and markets, and an expert on investor relations, security market structure, market competitiveness and regulation.
Contact him at (213) 740-6496 or lharris@usc.edu.