Fighting a Crisis of Confidence

by Joseph · 3 comments

in The Economy

Many people have been comparing the current economic crisis that we’re facing to that of the Great Depression. While we are seeing some similarities between the Depression and the economic crisis of today, they are largely a different beast. In fact I’d like to argue that while the Great Depression seemed to have been largely caused by a lack of liquidity in the financial markets, this economic crisis is being fueled by a lack of confidence.

The Depression versus The Economic Crisis of 2008

In the Great Depression bank after bank failed when their customers, afraid of losing everything to a bank failure, ran on their banks. With an emergency increase in liquidity (such as the bailout that was passed last year) most of these banks would have survived, but they didn’t because of the Fed’s failure to act. While some banks have indeed failed in this Economic Crisis they are largely intact due to a little something called the FDIC (and of course the NCUA).

The Crisis of Confidence

Today the beast we’re fighting is much different than that of the Great Depression. The Economic Crisis of 2008 will be known as a Crisis of Confidence. Banks are afraid that if they lend to other banks and consumers that they won’t be paid back. I took the liberty of bolding the operative word in that last sentence to emphasize my point. Banks are not confident that they will be paid back if they lend, so instead they choose not to lend. Their fear is caused by a lack of confidence, and how do you fight a crisis that’s being fueled by a primarily psychological reason?

The Federal Reserve and the Treasury Department have been trying to fight this crisis of confidence by increasing liquidity. They’ve lent billions upon billions of dollars to banks upon the assumption that these banks would then use said “bailout money” to lend to other banks and to consumers. By and large, however, this has not been what the banks are doing. The Fed likewise has been doing what it can to get banks to lend to each other. By dropping the Federal Funds Rate to .25% they were hoping to give the banks more incentive to lend to each other (because it’s cheaper to borrow money with a low rate). Read this quote from TIME Magazine about the Fed’s recent decision to drop rates to near 0%.

With rates already effectively trading near zero despite the Fed’s previous target of 1%, the decision does not actually change rates and only sends a negative message about the state of the economy. That worsens confidence.

There we have it. I’m not the only one who believes that the Fed has made some seriously bad decisions while fighting this Crisis of Confidence. By lowering rates below 1% (where they’ve NEVER been before) they effectively told the American people, banks and businesses that they’re scared and don’t know what else they can do. By lowering rates below 1% they may have prolonged this recession that we’re facing today.

The Past is Not the Present

The current Federal Reserve Chairman, Ben Bernanke, is known by many as a scholar of the Great Depression, but I’m afraid that he literally thinks the Depression is what he’s fighting right now. I don’t know if he’s delusional or just wants to screw our economy up in the long-run, but I will be the first to admit I’m not happy with the job he’s done since taking the role of Fed Chairman. Here’s hoping that somebody with power realizes that in order to fix this current economic crisis they need to address the confidence issues that are plaguing America.

{ 3 comments… read them below or add one }

Abigail January 26, 2009 at 11:36 am

I think the major difference here is FDIC, which was created because of the Great Depression.

The problem is that people still don’t really trust the government. More and more people are buying safes rather than keep their stuff in banks.

So while I’m angry at the banks for holding onto all those government funds, clearly the crisis of confidence works both ways.

Abigails last blog post..A good dillyeo…

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Joseph January 26, 2009 at 3:02 pm

Great point Abigail. Most people still don’t trust the government – but why should they? The U.S. government has done nothing to earn our trust. To be honest with you I don’t really trust them myself. Unfortunately the alternative to not trusting them is to not trust my money is safe and to put all of my cash in a safe. This to me is a much worse option. I’ll take my chances.

You are right though, there is more to blame here than just one group, or individual. This crisis can only be blamed on just about everyone – banks, consumers, the government and of course crooked loan officers (the subprime mortgage fiasco).

Thanks for the comment!

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Kristy @ Master Your Card January 26, 2009 at 10:33 pm

I agree with everything you’ve said here, Joseph; however, it still goes a bit beyond being a “crisis of confidence.” It is also a “crisis of greed.” This whole mess started with the subprime fiasco…where banks were quite willing to turn a blind eye on those who couldn’t afford houses in the first place. The promise of a big payout was too tempting and they deliberately made bad loans . Then, there’s the fact that those same individuals are still working for the companies they ran to the ground, and are receiving their high compensation for it. There’s also the banks who took their portion of the bailout and are using it to expand their assets rather than it’s originally intended purpose. On the other hand, we can’t really lay all the blame at their feet for that as the government who approved the exorbitant expense didn’t see fit to set forth specific guidelines for what the banks could and couldn’t do with their shares.

Confidence in our economy is definitely down, and Bernanke certainly isn’t helping matters. But, the greed emanating from the housing market and Wall Street have played a large role in this mess, as well.

Kristy @ Master Your Cards last blog post..Weekly Round-Up

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