An Idiot’s Guide to Financial Crises

Illustration by Kagan McLeod

I don’t know anything about money. I don’t mean that I’m not a financial expert. I mean that, when it comes to money, I’m functionally illiterate. I don’t like to think about finances, and on the rare occasions that I do, my thought process goes like this: I have a job. I earn money. I spend most of it. The rest I put in a savings account. That’s it. People who know about money are always yelling at me, because they can’t believe I’m still throwing away money by renting (mortgages are confusing) or not diversifying my portfolio (what portfolio?). And I freely acknowledge that people who think a lot about money will invariably accumulate more of it than I will. And I’m okay with that, since the trade-off is, I don’t have to spend my time thinking about money.

But even I understand that, when people who think a lot about money get worried, I should get worried, too. Which is how I found myself anxiously scanning through articles that consisted of 90 percent gobbledygook (credit-default swaps?) and 10 percent startling quotes such as, “The situation is very bad, the situation is getting worse, and the risks are that it could get very bad” (National Bureau of Economic Research president Martin Feldstein) and “The current financial crisis in the U.S. is likely to be judged in retrospect as the most wrenching since the end of the Second World War” (Alan Greenspan—that guy’s smart, right?). Because for me, finding out that an 85-year-old investment bank nearly failed is like waking up to the headline fire department burns to the ground. And then turning on the TV to find the fire chief saying, “Yeah, this is a pretty bad fire. It could well be out of control. And no one really knows how many more houses will burn down.” Really, Fire Chief? Aren’t you supposed to be keeping tabs on that kind of thing? And is this the point at which I should start getting worried that my tiny little house is going to burn down, too?

So I did what I normally do when I don’t know anything about something, which is to call up some people who do. Of course, when it comes to the economy, there are many, many people who claim to know a lot about it, yet they don’t agree with each other at all. Except for right now. Because while people disagree on who started the fire, or how long it will burn, everyone seems to be on the same page about one thing: The house is definitely on fire.

“Here’s the simple version,” says Tyler Cowen, professor of economics at George Mason University and author of Discover Your Inner Economist. “The real-estate bubble collapsed. There needs to be a big sectoral shift into other things. The Fed can’t help that much. So we’re in a recession. And all the meanings of that—lower retail sales, higher unemployment, and so on—odds are we’ll get those. That’s the bad news for the person on the street.” And, if your street happens to be in New York, the news is even worse for you. That’s because all those people in the financial sector who are now losing their jobs live here, and spend a lot of money here, and pay taxes here. This means less money in the system, which means everyone feels the pain.

Thus far, much of the talk about this “crisis” has centered on failed mortgages and falling housing prices, which I don’t care about, since I don’t own a house, especially not one built ten minutes ago in Arizona. But this crisis isn’t about houses anymore. “Say you bought a house two years ago for $450,000,” says Barry Ritholtz, CEO and director of Equity Research at Fusion IQ. “And it’s worth $425,000 this year, and $430,000 next year—ultimately, who cares? It’s not going to zero. Your house isn’t the problem. The way this will really impact people is the prices you pay for goods. And we’re starting to see it affect employment as well. You know, the traditional economic worries: Stuff costs more money and you may get fired.”

So let me get this straight. I might lose my job. And right when I lose my job, I’m going to find that my savings are worth less, and that prices for things are going up. Like gas. And milk. “The reason this has become such a mess,” says Ritholtz, “is because the housing market imploded, and now the credit crunch is affecting the ability of businesses and individuals to borrow money, which has caused the Fed to do what they do best: lower interest rates, print money, and try to inject cash into the system. But there’s a cost to that. The cost is inflation.”

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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An Idiot’s Guide to Financial Crises