Thursday, October 9, 2008

Confidence in the Future

The common assumption about the current economic crisis is that bad loans were made and there is not enough money coming in. But this is only part of the problem. The real breakdown is one of confidence.
This is what a credit crisis looks like. It's not like a stock market crisis, where the scary plunge of stocks is obvious to all. The credit crisis has played out in places most people can't see. It's banks refusing to lend to other banks — even though that is one of the most essential functions of the banking system. It's a loss of confidence in seemingly healthy institutions like Morgan Stanley and Goldman — both of which reported profits even as the pressure was mounting. It is panicked hedge funds pulling out cash. It is frightened investors protecting themselves by buying credit-default swaps — a financial insurance policy against potential bankruptcy — at prices 30 times what they normally would pay. (Washington Post)
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We are in the midst of what the academic Charles Kindleberger called the "revulsion stage" of a crisis - indiscriminate and contagious selling of distressed assets that leads "banks to stop lending on the collateral of such assets."

When such fear grips the markets, investors (and speculators) are quick to generalize, punishing many for the sins of few. That's the most dangerous phase of any crisis - when market implosions start to take on a self-reinforcing life of their own.

The most important thing about financial panics is that they are all temporary. They either die of exhaustion or are overwhelmed by the heavy artillery of government policies. (Washington Post)
This is a particular kind of crisis of confidence. I can think of others that are more basic and really endemic at this time: e.g. the fear to commit to marriage or to have a(nother) child.

Despite the freefall of retirement savings accounts, there is a fair amount of equanimity. Anger yes, but not as much panic, at least on Main Street as we now know it.

Tom Grant, editor of The Metro Spirit in Augusta (as quoted at a friend's blog) observed that we would do well to invest in a real future:
Now, as we mortgage our grandchildren with some $10 trillion in national debt, it’s time to reassess. We invested in self interest and it failed us. Those leaders who took multi-million dollar checks then led their companies to ruin look little like great role models today.Rather, I think you’ll find a better model in the likes of teachers, youth pastors, little league coaches and scouting leaders — all of whom invest their time, energy and money in the people who will have to pay our debts: our children.
Karen Blumenthal at the Wall Street Journal also puts the situation into a more human light.
Put your losses in perspective. This isn't easy. I know: I'm feeling genuine pain after losing my entire investment in Washington Mutual and watching a mutual fund I bought in March for one of my retirement accounts drop by 36% -- and that's before this week. I absolutely cannot bear to tally up all my losses.

This is my reality check: For more than a decade, I have gone to my local elementary school to tutor. There I spend time reading with children who own no books of their own, whose families can't afford school supplies and who have never been to a dentist. For the price of 45 minutes a week, I return to my desk feeling as wealthy as any one person needs to be.

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