CREDIT

THE NEW CONSENSUS

The speed with which a consensus has emerged about the underlying cause of our current financial crisis tells us that it was something we knew all along – but didn’t let ourselves know we knew it. The unwanted truth now is clear: we have been spending beyond our means. It was not just homeowners taking out mortgages they couldn’t pay for and consumers running up astounding levels of credit card debt, it was banks, hedge funds, mortgage companies, investment firms and governments that discovered how easily the traditional limits of debt could be ignored.

This presents as an economic problem, to be sure, but fundamentally it is a problem of mass psychology. Beliefs become validated as truth when opposing ideas became silenced or disparaged, when they become the only ideas that can be espoused without the fear of ridicule. Two forces contribute to bringing this about: the desires that pull people into convictions they want to believe, and then the fears that drive people away from alternative ways of thinking – the fears that rule out the doubts that might otherwise cross their minds. If everyone believes something is true – or appears to -- how can you stand up against it?

In this case, of course, the clear desire was for more wealth and more purchasing power. In a consumer society who could object? The consumers purchasing more goods and services? The manufacturers expanding production? The merchants increasing sales? And then the American dream of home ownership was activated for those at the lower end of the economic spectrum. The ambition to acquire great wealth and status kicked in at the top.

Moreover, after the defeat of communism, other ways of thinking became proscribed. The victorious ideology of the market silenced critics who thought markets needed to be monitored or regulated. Even Alan Greenspan in his recent congressional testimony now admits there was a “flaw in his ideology.” His faith in the market’s ability to self-correct was too great.

Realizing that government could not afford to sustain basic levels of security for all its citizens, we created an Ownership Society in which everyone could aspire to the goods and services they wanted. We didn’t cut back on our desires, we simply found a new way to pay for them. Leveraging assets, borrowing from abroad, hedging bets, bundling and securitizing debt, we created an alternative to the defunct promise of the Welfare State. Once, people were worried about being in debt, but now debt now became normal, even a source of profit. No one would be left out of the opportunities that debt created. We persuaded ourselves that the risks could be safely managed -- and democratized.

It became our biggest bubble ever – and no one raised a warning cry. To be sure, doubts were expressed about the housing market, and concern about the credit swaps, but no one thought it would led to the disaster we now face. And yet, in retrospect, it is all too clear.

But no amount of correction and reform learned from the lessons of this disaster will protect as against future bubbles. We continue to be vulnerable to the hopes and fears reflected in Mass psychology.

Panic

WHY IT HAPPENS AND WHAT WE CAN DO ABOUT IT

Stocks are plunging. Investors can't fulfill their commitments to buy. Borrowers can't pay back loans. We have come to call such conditions in the financial markets "panic."

What it means is "sudden, uncontrollable fear or anxiety," and that fits current conditions. It has come upon us quickly, catching us off-guard. Moreover it seems that events outpace us; no matter what we do, we can't catch up. But if we look more closely at the definition, we see that it is the fear or anxiety that is out of control, not the events themselves. Indeed, we often enjoy the thrill and the challenge of fast-paced, unexpected change: skiing, running rapids, hockey games. What makes the difference with panic is that uncontrollable anxiety destroys the capacity to think. People panic when they lose their minds.

Markets too. In the midst of seemingly chaotic change, the group of people that makes up a market becomes stunned, paralyzed -- or they resort to stereotyped and ritual acts that only make things worse. In short, the group has lost it leadership, the voices of those who provide guidance and direction, the minds those who can still think about appropriate responses.

We see that all too clearly today. Last week's $700 billion bailout did very little to stem the panic. It was cobbled together as if mere action on the part of government itself could restore confidence. The more recent concerted action of European finance ministers and heads of state stands a better chance because, for one thing, it is concerted action. In a globalized economy, one country's actions alone is insufficient -- a lesson one might have thought we might have learned from the Iraq War.

The second thoughtful aspect of their plan is that it addresses directly the problem of assets and liquidity. Rather than simply buying up debt and hoping the market will do the rest, it pumps capital into the market, shoring up the institutions so they can function while at the same time giving government new control over their management. This counters the ideology of the free market, of course, but it addresses the reality of what is happening.

So we are beginning to reclaim our minds. Maybe we can then rebuild our bank accounts. What we don't know we know about panic is how dependent we are on leaders who can think.