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An Idiot’s Guide to Financial Crises

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Well, that sounds bad.

To put it in simpleton’s terms: The problem is credit. For a long time, people got it too easily (to buy houses they couldn’t afford). Now it’s hard to get any (for anything). And credit lubricates the economy. “People need to borrow money to buy cars or run businesses,” says James Hamilton, a professor at UC San Diego and the co-author of the blog Econbrowser. “The explanation as to why credit got shut down—credit-default swaps, mortgage-backed securities, all that stuff—that sounds very abstract. But the consequences are going to be very real for all kinds of normal people.” For example, no credit means new business won’t open up while existing ones might have to close down. So after I get laid off, and I head out with my worthless cash to buy $6-a-gallon milk, I might find that my local deli has been driven out of business.

And here’s some more bad news: Usually an economic slowdown stunts inflation, because no one’s spending. But the commodities driving inflation right now are staples like fuel and food, the demand for which remains relatively constant, no matter how bad the economy gets. Which, for you nostalgia buffs, could mean seventies-style stagflation (stagnancy plus inflation). “This isn’t like the 2001 recession, where businesses stopped buying but consumers kept spending,” says Ritholtz. “This is more like the seventies, when businesses stopped spending and consumers really cut back.”

Does anyone have some good news for me before I attack my local bank manager like in It’s a Wonderful Life, then get fitted for a barrel and suspenders? “When people say, ‘It’s the worst financial crisis since WWII,’ you have to keep in mind that we haven’t had a really bad one since then,” says Cowen. “And once a recession is over, the economy tends to grow faster to make it up.” Which sounds like a great comfort to me three years from now. As for three months from now, I’m feeling a little stressed. “You shouldn’t be worried. You should be angry,” says Ritholtz. “We’ve just come off a multiyear orgy of irresponsibility and recklessness that’s unprecedented in the history of finance. Where was the government? Where were the regulators? How did this happen?” In other words, while I was trusting the fire chiefs to keep my house from burning down, they were asleep and arsonists were splashing the town in gasoline.

So I should be worried (but not too worried—yet). And I should be angry (quite angry, in fact). The sky may not be falling, exactly, but it’s not going to be sunny for a while. All thanks to some obscure financial manipulations, which led to massive miscalculations, which led to panic, perpetrated by people who should have known better but, as it turns out, didn’t know much at all.

Okay. I guess I understand. Right now, though, I’m not going to think about it.


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