Financial meltdown: Psychology of the crisis and what we should do

Traders working in the S&P 500 pit at the Chicago Mercantile Exchange are worried about the financial crisis, and so are the rest of us. But what can the average person do?
REUTERS/John Gress
Traders working in the S&P 500 pit at the Chicago Mercantile Exchange are worried about the financial crisis, and so are the rest of us. But what can the average person 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?

David Vang
David Vang

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.”

Kathleen Vohs
U of M
Kathleen Vohs

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.

Comments (4)

  1. Submitted by Leslie Davis on 10/07/2008 - 11:53 am.

    The media foolishly continues to ask people who (by their own admission) missed the economic boat, when they think the boat will arrive. The media must think that a person with an economics degree, bestowed upon him or her by an institution that got paid to issue the degree, knows something about money. Bah humbug.
    Mr. Vang says, “if you’re younger, it’s best to hang on to equities because they will rebound.” How does he know the equities will rebound? Which equities is he referring to? All of them? It seems to me that Mr. Vang is simply making a statement based on wishful thinking.
    http://www.LeslieDavis.org
    Minneapolis

  2. Submitted by Aaron Petty on 10/07/2008 - 12:04 pm.

    Market Crash?!…tic,toc,tic,toc…Economic Collapse?!…tic,toc,tic,toc… or more likely just a continuation of a drip that kills.
    Are you better off than you were ten, twenty, thirty years ago? Inquiring minds want to know…

  3. Submitted by Ross Williams on 10/07/2008 - 07:29 pm.

    Mr. Vang knows the market will rebound, because it always does eventually, in the long run. No one knows how long that will take.

    In the case of real estate prices, the inevitability of a rebound isn’t at all obvious. In fact, it is very unlikely that real estate prices will ever rebound to anything near their peak levels in real terms. Those losses are permanent.

    There have been trillions of dollars permanently lost in real estate values. Someone will have to own those losses. No one knows whose shell that pea will be under. But it is apparent that it will include many financial institutions. Those institutions are heavily leveraged with those real estate losses taking a huge chunk out of their equity.

    And then there are the other businesses that those financial institutions have borrowed from. When Lehman was allowed to go belly up, suddenly a money market fund that owned its debt could no longer redeem its shares. It had no idea it was exposed to the real estate market.

    The result is that banks aren’t lending to anyone because borrowers aren’t credit worthy. Their balance sheets are not transparent and the companies themselves don’t know what they are worth. Like Lehman, some of them will likely discover the answer is they aren’t worth anything. Who loans money in that environment? Especially when they don’t know how many assets they have themselves.

    The New York/ Washington axis has always thought it can invent a reality. But this situation does not lend itself to public relations and psychological ploys. I think the economists are all clueless about what to do. Paulson et al are the ones in a panic, just throwing as much money as possible at the problem and hoping something sticks.

    But the problem here is not psychology or liquidity. The problem is solvency.

  4. Submitted by Jonathan Kovaciny on 10/09/2008 - 11:11 am.

    Nobody saw this coming? Are you kidding me? Just because you’ve been reading the wrong books and listening to the wrong pundits doesn’t mean that no one’s predicted this.

    Economists of the Austrian school have been warning about this for literally decades. Mises, Rothbard, Hayek, etc. have all written extensively about the economic realities which are all-to-often ignored by our Keynesian-dominated political atmosphere. Peter Schiff, CEO of Euro Pacific Capital, has been warning specifically of this autumn’s events throughout the recent boom times. He was mocked as a doom-and-gloomer then, but looks remarkably prescient now.

    I encourage you, professors, to dig into Austrian economics and discover what you’ve been missing. You won’t be disappointed.

    Start with this: http://freedom-school.com/money/how-an-economy-grows.pdf

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