2008 in review - The Credit Crunch (March)

Since this blog didn't begin until the end of 2008 (thanks for the push, Ben), all of the good stuff I wrote before then has been composting on the hard drive.  So here as a series of posts are commentaries that were written through 2008.

In March I took my first look at the evolving credit crisis:

The national media recently made an interesting discovery - that the current financial crisis is actually impacting the economy, that Wall Street’s losses and the subprime mortgage debacle are actually beginning to make people buy less and talk about feeling less secure.  Stories have begun circulating about how the dicey economy is causing people to cut back on the size of their weddings or where they shop or maybe even, perish the thought, not buy that new car.

Now that the shopping habits of such exotic places as Knoxville, Tennessee are being examined, I think it would be a useful service to Manhattan and Washington to explain why these folks are behaving so.  After all, just a few years ago the dot.com bubble burst and stock prices went into a tailspin, but no financial panic ensued.

My explanation: this time, it’s not just a night in a casino.  It’s real money.

The dot.com boom and bust were entertaining stories about capitalism and the economics of hope over experience, but they did not resonate far beyond the stock market and the small alien world of Silicon Valley.  The rest of the economy, where people make things and sell things and buy things, kept going.  Some paper wealth got wiped out, but only the very few people whose monthly income actually depended on the stock market or the dot.com companies were genuinely shoved to the curb.  People watched their 401k nose-dive, but it wasn’t real money.  It was gambling money.

Real money implies real consequences.  Real money is the reason we don’t all splurge on a spa retreat or golf vacation or trip to Kenya monthly.  Real money is why we clip coupons and compare prices and want prescription drug coverage in our health insurance.

Gambling money isn’t real money.  It’s entertainment money.  Once you convert that money to chips, it isn’t your money anymore.  You bought a night’s entertainment.  Only fools and gambling addicts bring their house payment to the casino.  You never bet what you can’t afford to lose.

Money in stock market, for most people, was not their house payment, and so when the market dropped, it hurt like a losing your chips at the blackjack table.  You wanted to win, and for a while you did real well, and you kick yourself for not cashing in at the peak.  But it wasn’t the house payment.  It wasn’t real money.

This time, though, millions of people have discovered that real money is on the table.  (I’ll not torture this analogy further by noting that almost no one understands the game being played - that’s a commentary for another time.)  Suddenly across America, people have discovered that what they thought was financial planning actually involved bringing their house payment to the casino.  It turns out that we’ve all been betting that home values would keep rising.

The recession, and the roller-coaster financial market, is all about home values and monthly mortgage payments.  Consumers bet on continued rises in value to allow them to refinance into a more affordable monthly payments and the financial world bet on continued rises in value to protect the collateral on which the loans were made.  The folly and the blame are for another time.  The impact is clear - untold millions of Americans have far too much riding on the bet that the value of their home was going to keep increasing.  Collectively, we forgot not to bet what we couldn’t afford to lose.

“This is the bedrock asset for the lion’s share of the population of the United States,” Robert Barbera, chief economist for the trading and research firm ITG, said earlier this week in The New York Times.  “It’s not like dot-com stocks, where I bought Webvan for 1,000 times the imaginary earnings, and now it’s worth nothing but I go and have a beer.”

The dot.com bubble didn’t involve real money.  Stock prices fell, and uncertainty chilled the economy for a spell because the “new economy” suddenly was found to have the same rules as the “old economy” - such rules as the purpose of business is to make money.  But it was short-lived.  At the end of the day, most people could continue on exactly as they had the day before their stock tanked.  Not this time.  

Even people who are not on the verge of foreclosure find that the security which they felt is slipping away.  For too long, Americans have used their houses as virtual ATMs – whether they were buying necessities or luxuries or borrowing to send their kids to college or to re-finance the last round of purchases and school tuition.  

Suddenly, because the lenders at the very top of the financing chain no longer consider every house, or possibly any house, to be sufficient collateral - buyers have to come up with more cash, and sellers can’t expect eager buyers to compete for their homes, and only fools and addicts think that re-financing can get them ahead of the game.