Psychology of the crisis and what we should do

Stocks are tumbling in the United States and Europe. Congress passes a $700 billion Wall Street rescue plan. Unemployment is up. People are worried about their retirement savings and their jobs. Confidence is shaky.

As the financial crisis spreads from Wall Street to Europe to middle America, MinnPost asked two local professors in separate interviews to help us understand the psychology of the crisis and what, if anything, the average person can do about it.

MinnPost: Did anyone see this crisis coming?

David Vang, chair of the Finance Department at the University of St. Thomas in St. Paul and an economist by training: "I don't think too many people saw all the pieces coming together all at same time. Some people saw the Fannie Mae and Freddie Mac crisis coming years in advance. A lot of people in financial services knew that the subprime mortgages would continue to have problems because they knew when the reset dates for [adjustable rate] mortgages would happen."

Kathleen Vohs, associate professor of marketing and McKnight Land-Grant professor at the Carlson School at the University of Minnesota and a psychologist by training: "No one knew in advance. Now you read the Economist and they write, yes, the signs were there. We could have seen it coming, but truly no one really did see it. It's broad and deep and then it deepens. The ripple effect [in Europe and Asia] is a sign of the surprise."

MinnPost: How big a factor has globalization and the interconnectedness of markets been in the spread of the crisis?
 
Vang: "We're extremely well connected now and that's been both good and bad for Americans. Cynically, what was good for Americans is that a lot of toxic securities had already been unloaded to international investors so the U.S. is not hurting as much as European countries are. The bad news is that the U.S. has to do lots of exporting and because those countries suffered losses they might not be buying as much from us."

Vohs: "I think that it [the markets tumbling] really brings home how interconnected we are. Globalization is going to get a huge black eye from this. Globalization affects in a negative sense consumers all over the world. People didn't realize globalization was in their lives, too. When there's a large cannonball in the pool, the ripples really hit home."

MinnPost: What is the psychology of all this bad news? How do we see it play out in everyday life?

Vang: "The markets try to anticipate what will happen next and sometimes people over react or under react. That's why there are so many wild swings back and forth. I see the volatility continuing for another week or two. The typical guy on street notices it if he peeks at his 401K. It's finally starting to dawn on Main Streeters that this has implications for current employment when we don't have credit liquidity. Gas prices have come down, but lots of people are concerned about whether they'll be employed, so they are putting off large purchases. Ford and General Motors have experienced major drops in sales and so have major appliance makers."

Vohs: "If you're a consumer not affected by the mortgage crisis, you think that 'my house price [or value] is  not great, but it will come back.' But now with layoffs on Wall Street and the falling market, there's a lot of gloom and people have trouble guarding against the despair. It's been boom, boom, boom: domain after domain having problems, a lot of uncertainty."

MinnPost: How should the average citizen respond to the crisis?

Vang: "There's probably nothing any individual can do. If someone overspends and we have recession and you lose your job, you probably wish you hadn't overspent. If a person is going to err, you should err in the direction of being cautious about spending. It's too late to do anything about investments. If you're in stocks, let it ride. It won't be a fun ride, but if you try to market time, odds are you will lose worse. This is where financial planners earn their money, by handholding, sticking with their strategy. Hopefully, advisers were telling them to switch into bonds, but if you're younger, it's best to hang on to equities because they will rebound."

Vohs: "If a consumer can take small but doable steps towards not spending in excess, that's a good thing. Consumers have long been spending more than they save. In some sense not spending will have consequences for the economy. But the economy is not built off luxury items. People will still buy a car if they need one."

MinnPost: Should we be really worried about this economic situation?

Vang: "We really haven't had a true recession in so long. People are getting more afraid than maybe they should be. The definition of a recession is two quarters back to back of negative growth, and we haven't had one yet. But that is no consolation to anyone who has lost a job."

Vohs: "This is worrisome because it's spread to so many different arenas. People have trusted the market. No one feels that the fundamentals are strong. I think it's serious."

MinnPost: Does the news coverage contribute to people's fears?

Vang: "The media coverage does contribute to negative psychology, but I wouldn't blame the media. People have to have some experience to assess how serious something is. Some 2,000 financial institutions closed during the 1980s. We spent hundreds of billions of dollars bailing out savings and loans, and most of that time we still had economic growth. This [the Wall Street rescue] is unique in terms of size, but not unique in terms of an event."

Vohs: "The media coverage probably does have a negative impact, but I'm not sure it's spreading panic or uncertainty or just reflecting or in some sense comforting us that we're all in this together. The media are reflecting what's happening rather than making the crisis bigger than it should be."

MinnPost: When might we be turning the corner?

Vang: "The subprime mortgage crisis is the gift that is going to keep on giving. It will take another year to work its way out. It will still be influencing news reports for at least another year. The bailout is more than a Band-Aid, but not a true solution. There will need to be changes in regulation to keep this from happening again. Even though the bailout passed within a week, there are time lags to implement it. For example, it will take more than a month to hire staff [in the Treasury Department]."

Vohs: "Things are changing drastically. I imagine that by Thanksgiving things might have evened out. The surprise factor in all this heightens the negativity. Over time, there is more acceptance that we are in a seriously bad turnabout."

MinnPost: How will the crisis affect the next president and Congress in their ability to initiate plans and new programs?

Vang: "With the bailout we've temporarily used up our credit [in the  public's mind] so that will limit some spending. One side or the other in Congress will invoke the bailout as reason not to engage in their spending. I would expect not to see new spending."

Vohs: "The bailout and the financial crisis will limit funds and the progress of other projects. Even Democrats, who favor social spending, will want to put the brakes on something because it will seem so out of control. There will be more reaction from Main Street about spending money on other projects."

Doug Stone is a former reporter for the Minneapolis Tribune and assistant news director at WCCO-TV. He writes on national and international affairs.