• Evidence of recovery so far is thin.
• The stimulus package will kick in and provide a short period of growth.
• But as the stimulus wears off, growth will fade away again.
• The Obama Administration’s policies are pointed in roughly the right direction but not big enough to turn the tide.

Here’s his conclusion:

The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery.

Having said that, these policies are still works in progress. If they are strengthened in the months ahead – to increase demand, fix the banking system, and stop the fall in house prices – we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping.

By James Kwak

In my last post, I compared Obama’s plan for the automakers to that of the Chinese government. I concluded that the two shared goals, but that these goals fit poorly into the traditional American ethos of free enterprise. For better or worse, the administration will have to remedy this mismatch sometime soon, either by letting the automakers fail or by openly stating that jobs, national pride, and a green fleet justify a government-backed industry.

Some of the comments to that piece strongly favored the latter course of action. Accordingly, I think it is worthwhile to take a normative look at directed industrial policy generally. In the abstract sense, this system is the opposite of laissez-faire capitalism – the government owns enterprises and dictates both the nature and quantity of their output. This description naturally evokes images of the USSR, Cuba, or the People’s Republic of China (before 1992), all countries with “command” economies. The distinctive characteristic of these nations, however, was not the presence of state-owned enterprises (SOEs) per se, but the absence of a legal, noticeable private sector.

Countries like Sweden, South Korea (before 1988), and, indeed, the modern China have demonstrated that directed industrial policy is not an all-or-nothing game.

The state can own some firms while the private sector owns others; these groups can compete in the same industry or service different sectors of the economy. Examples of the middle-ground approach also abound in developed economies: in Norway, the government owns over 60% percent of Statoil, the country’s largest employer (now part of Statoil Hydro); in France, the government owns over 80% of the giant power company EDF; Germany, France, and Spain effectively control the management of the defense contractor EADS, despite the fact that 41% of the company’s stock is publicly held; until 2006, the Republic of Ireland held 85% of the shares in Aer Lingus, the country’s largest airline, a share that has since fallen to 25%; and Canada’s government owns dozens of so-called Crown Corporations. Of course, these statistics have lost much of their panache now that the US Treasury owns 80% of AIG, but the figures still show that (intentionally) state-owned industry is not altogether unusual.

That is not to say that SOEs are entirely benevolent. Over the years, economists have identified several key flaws. First, the absence of the profit motive, which often runs along with the guarantee of lifetime employment, removes incentives for employees to work hard. Second, the people involved in managing these conglomerates may retain their profit motive and act on it, even if the companies officially do not, leading to widespread corruption. Third, a company that decides what to produce based on official decree, not market demand information, will have an extremely difficult time determining the “right” amount of output. If said firm makes widgets, it will make either too many or too few widgets, creating waste in the first instance and shortages (assuming that the government regulates price) in the second.

A government committed to firing lazy workers, who could then fend for themselves in the remaining, robust private sector, would seem to be able to solve the first problem with SOEs. A robust criminal code that punishes corruption, when coupled with politically ambitious prosecutors, would probably mitigate the second. The third flaw, however, appears immutable, not merely because of societal momentum or even the laws of human nature, but because mathematically, pricing information appears to be the only way to measure efficient output.

Where do the above observations leave us? Conventional wisdom argues strongly against government control of industry if this control leads to an outcome different than what the market would otherwise dictate (passive taxpayer ownership poses a somewhat different set of problems). Yet the last 24 months have forced everyone, including old-guard, free-market purists in charge of the Fed to reexamine conventional wisdom. If the central bank can selectively lend to industries that appear to be failing in the open market, one would think that Treasury or the Department of Commerce could also selectively push certain industries to generate products that they believe would improve the national economy.

Such intervention could come in one of two forms. The government could try to dictate business strategy to firms that receive a substantial amount of bailout money, but as I explained before, this would amount to stacking an inefficient bureaucracy on top of a underperforming business. Alternatively, the President and Congress could fund brand-new entities that would lay high-speed rail, construct nuclear power plants, and build a modern national electric grid. These companies would be staffed with regular employees and managers who would have to answer directly to someone high up in the executive branch. They would also compete alongside their private sector peers, who could choose to provide variations on the basic product (like UPS or FedEx) or attempt to displace the basic product altogether (like private charter school operators).

Normally, this setup would raise concerns about “crowding out” private-sector capital or innovation, but this theory applies equally to indirect government spending, not just direct industrial participation. True, private firms may be reluctant to compete with organizations backed by “infinite” treasury pockets willing to absorb a loss, but this fear cant get much worse than it is now. Moreover, Congress could fix this problem by specifying early on that these new enterprises will have to shut down after posting 3 years’ worth of consecutive losses.

Here’s the crux: current strategies for economic recovery focus on stabilizing financial institutions and melting credit markets, but they fail to provide an internal engine of growth for the American economy. Theoretically, this growth should continue to come from private-sector innovation, but the private sector is in deep and worsening trouble.   According to the latest Fed report, consumers continue to be saddled with roughly as much revolving (non-mortgage, non-auto) debt as they were in Q2 of 2008. This debt load would have to decrease by 17% to get us back to 2004 levels, when an average household owed around $6500 on their credit cards. At the current rate of revolving debt change, the adjustment would take at least two years, but this calculation does not account for the decrease in individuals’ personal income, which is falling at around 1.5-3% a year. A sharp decline in domestic production means that the US will also continue to be a net importer. These characteristics are part of the reason why the country got to where it is in the first place. Without a new strategy, it is unlikely that the ingenuity of a few individual entrepreneurs will be sufficient to pull us out of this depression.

Of course, the government shouldn’t pick its areas of economic involvement arbitrarily. A smart policy would be to attack problems that the private sector has traditionally been unable to address (producing cars doesn’t fall into this category). The new enterprises should first engage projects that suffer from free-rider and coordination issues which only a central authority can overcome – public works and infrastructure. No one wants to build the first mile of a road to a store if the guy at the other end can get its benefits for free. Next, the government should invest heavily in pharmaceutical, engineering, and biotech research, both at universities and newly invigorated national labs. Since anyone can build on fresh advances, basic science carries many of the same unpleasant investment characteristics as physical public goods.

The above programs aren’t that far from the status quo. Congress already chartered Fannie and Freddie; the Pentagon already subsidizes an enormous defense sector. It is time, however, to try and change federal involvement in industry from covert efforts to promote opaque policy goals to thought-out measures designed to help firms and workers prosper. In the worst-case scenario, we privatize our way back to the present.

B y Ilya Podolyako

On the headline level, median income fell from $47,500 to $47,300 (all figures are in constant 2007 dollars), while median net worth (assets minus liabilities) grew from $102,200 to $120,300. No surprise there: we already knew wages stagnated, while real estate and stocks appreciated. However, since the survey was conducted in 2007, median net worth fell by 17.8% according to the Fed estimate, to $99,300, and that’s just to October 2008. Given that the cumulative returns of the stock market have been about -15% since October 31, and that housing prices have fallen as well (and the Fed used a housing index that has fallen less than the Case-Shiller index*), that net worth is probably between $90,000 and $95,000 – significantly less than in 2004, and back around 1998 levels ($91,300).

I wanted to come up with a composite picture of the median family, to see how they are doing. This is actually impossible to do precisely, because of the way the survey data are presented in the report: for each category of assets (or liabilities), they say what percentage of families (in each income quintile) have that asset, and then the median value owned among families that have that asset.**  So I came up with the following compromise: for each asset or liability, I include it if more than 50% of the families in the middle income quintile have it; in that case, I record the median amount held by families who hold that asset. This isn’t the median family, but we might call it a “typical” family. (If you didn’t follow this, don’t worry about it.)

The picture I get, with some basic assumptions,*** looks like this:

The picture you get is surprising. From 2004 to 2007, the typical family only took on $4,900 more debt – mainly in mortgages, but some for installment loans (primarily for cars and education) – but its assets grew by slightly more, a little bit because of home values but more because of increased retirement savings, presumably due to the rise in the stock market. (For those wondering at that small increase in home values: the median value of all homes increased from $175,000 to $200,000, but the median homeowner is not in the 50th percentile in income; he or she is somewhere in the 60-80th percentile range, so he has a more expensive house than the typical family.)  In this picture, the typical family looks reasonably prudent, although taking on 4% more debt with no increase in income is not necessarily recommended.

When the crisis hit, though, the typical family took large hits in retirement savings and in home equity that cost over one-third of its net worth. So even though the typical household still has the jobs it had before the crisis (unemployment is still “only” 7.6%), it is much more worried about saving for whatever it has to save for – college tuition, retirement, etc. – and hence much less willing to spring for the proverbial flat-screen TV.

(Bear in mind that this picture tells us nothing about the foreclosure crisis, since the typical mortgage holder is not delinquent at this point. The foreclosure crisis and its impact on mortgage-backed securities is about the ability of problems at the margins to have severe impacts on certain kinds of securities and the institutions that hold them.)

At the end of the day, I think we knew all this already. But seeing it in numbers does help illustrate the crisis from the household perspective.

Notes:

* The Fed used the state-level purchase-only Loan-Performance Home Price Index, from which they derive a decline in value of 9.2% from the survey date (sometime in 2007) until 10/31/08. By contrast, the Case-Shiller Composite 20 fell by 14.5% from December 2007 to October 2008, and 16.4% from December 2007 to November 2008. Since inflation was positive during this period, the real fall in the Case-Shiller index was even greater.

** For example, of families in the middle income quintile (40th to 60th percentile), 71.6% own their primary residence, and of those the median house value in 2007 was $148,300 – but that’s just the median value for the 71.6%, not for all 100%.

*** For 2009, retirement savings reduced by 25% (stock market is down ~45%), housing by 16.4% (from Case-Shiller), other values the same as in 2007.

Update: Tom Cunningham did some similar calculations using the data from the Survey of Consumer Finances, and he finds that households in the 50-75th percentiles by net worth (not income, which I used) have seen a 29% fall in their net worth, which is similar to what I got. He also finds that on a percentage basis, the richest households have suffered the least (primarily, I believe, because they are more diversified and have less leverage, which is what really hurts you when asset prices fall).

• You can waste a lot of time looking over GDP statistics. Go to the news release page and download the Excel tables in the right-hand sidebar.
• The “consensus” is that the reason for the positive surprise was an unexpected increase in inventories. (Goods added to inventory count as production, even if they aren’t bought off the shelves.) But . . .
• With any set of numbers that add up to their totals, you can’t really find true causality. All you can do is point out numbers you think are particularly interesting. Another way to look at it is that the numbers were helped out a lot by short-term deflation, particularly due to falling gasoline prices. Personal consumption expenditures (PCE) , the biggest component of GDP by far, fell at an 8.9% annual rate in nominal terms. But the price deflator for PCE fell by so much – an annual rate of 5.5% – that in real terms PCE only fell at a 3.5% annual rate. That fall in prices was almost entirely due to the fall energy prices, which is highly unlikely to be repeated. But do people consciously reduce their spending in nominal or real terms? Nominal, I would think. So, as I “predicted” in December (I always have so many caveats that it’s not really fair to say that I ever predict anything), Q4 was better than expected, but Q1 is likely to be worse than predicted (before today, that is, since everyone is revising their Q1 forecasts down right now), since people will keep ratcheting down spending in nominal terms, but we won’t be bailed out by such a steep fall in prices.
• The savings rate climbed from 1.2% to 2.9% – but it still has a long way to go (it was over 10% in the 1980s).
• Real expenditures on food were down 4% (that’s not an annual rate, that means people spent 4% less on food in Q4 than in Q3). Ouch. I hope that was mainly a shift from restaurants to eating at home.

Back to more useful things.

To summarize (all numbers are November’s change from October), personal income went down by 0.2%, and disposable personal income (after taxes) went down 0.1%, but in real terms (after adjusting for inflation, or deflation in this case), disposable personal income went up by 1.0%, which is huge (remember, that’s month over month). This was entirely due to falls in food and energy prices (mainly gasoline), since the core price deflator (excluding food and energy) was flat. Of that 1.0% increase in real disposable personal income, 0.6% turned into increased consumption, and 0.4% turned into increased saving, raising the savings rate from 2.4% to 2.8%.

What’s good about that? First, since personal consumption is most of our economy, an increase in real personal consumption – even if it is entirely due to the falling price of oil – puts a floor under how much the economy as a whole can contract. Based on the October-November data, Calculated Risk is estimating that real PCE (personal consumption expenditures) will decline “only” 2.9% this quarter, which is better than consensus forecasts.

Second, the personal consumption data were better than expected, which is what we need if we want the stock market (and consumer confidence) to start heading upward again.

Third, the increase in savings indicates that American consumers are returning to a more sustainable balance between consumption and savings. For the long-term picture, click on the chart in this Calculated Risk post. (What does it say that when I need a nice, clear chart of economic data, I turn to a blog?) Where should the savings rate be? There is no perfect answer to that question, so for now I’m going to defer it to a future post.

On the downside, this bit of good news is not sustainable, for the simple reason that oil prices have to stop falling sometime. And with oil in the $30s, that time might be right about now. So December gasoline will turn out to be cheaper than November gasoline, but we probably can’t rely on any further month-over-month improvements. Furthermore, the rest of the economic picture looks as bleak as ever, so incomes will probably continue to fall even as prices level out. The net effect could be that this quarter (Q4) will be better than forecast, but next quarter and the one after that will be worse. (If you look at the aggregated forecasts on the WSJ’s main Economy page, 2009 looks pretty optimistic.)

Looking for other things to be optimistic about, here are a few possible silver linings:

1. Food prices. The run-up in food prices earlier this year threatened  hundreds of millions of people with malnutrition or starvation. These are March 2009 corn futures:

However, as James Surowiecki discussed in The New Yorker last month, we are still a long way from having a reliable food system.

2. Changes in Americans’ consumption behavior. There is a good chance that this crisis will frighten many or most people into lower debt levels and increased saving. Given that we were already headed for a potential retirement savings catastrophe before the stock market fell by 40%, this is a good thing. The big question is how to get to a new, higher-savings equilibrium without taking a big chunk out of the economy in the process. More on that later.

3. Shift away from the financial sector. Over the past two decades, the financial sector – first investment banks, then private equity, then hedge funds – has been soaking up a larger and larger proportion of our nation’s smartest, most talented, and most ambitious young people. While I am no Luddite when it comes to financial innovation, I do think we were well past the point of zero marginal returns. Even if those would-be masters of the universe go into management consulting instead, I still think our society will be better off. If all those physicists who turn into quantitative modelers stay in physics, we’ll be even further ahead.

4. Investment in productive infrastructure. One thing that amazed me about the long boom of the 1990s and 2000s was that it happened at the exact same time as a decline in the quality of our nation’s infrastructure. I was amazed every time I drove through New York – one of the most financially fortunate cities in the world for the last decade – and saw that the bridges and roads were every bit as decrepit as when I grew up there in the 1970s. Now, however, with the Obama Administration looking for things to spend money on, we will finally start investing in infrastructure.

I’m sure there are other silver linings out there, some we won’t realize for decades.

It’s easy to argue for bailing out the auto industry, with its hundreds of thousands of factory workers, as opposed to the financial sector and its Wall Street bonus babies. (It’s less easy to argue for bailing out Cerberus, which is a private equity firm.) But I want to point out one difference.

The business of a bank is borrowing and lending money. Banks currently face two problems. The first is a crisis of confidence: people who lent them money aren’t sure they will get it back, because no bank – no matter how sound – could pay back all its creditors at once. (The whole point of a bank is to borrow short and lend long.) If this were the only problem, government deposit insurance and the new loan guarantees would take care of it, and the banks would be fine. The second problem is a potential solvency crisis: it’s possible that banks’ assets have declined in value to the point where they are worse less than, or not much more than, their liabilities. The answer here is recapitalization: giving the banks more capital, in exchange for ownership shares. If you give banks enough capital to offset the losses on their assets, there’s no  general reason to believe they can’t go forward and make profitable loans, especially with the cost of money as low as it is. They don’t have to do anything particularly intelligent or risky with the money; it’s just to compensate for past mistakes. If you do have a reason to believe that a specific bank will not have a viable business in the future (for example, its whole business was subprime lending), you don’t recapitalize it – and we know that Paulson has been turning at least some banks down.

The auto business, like most businesses, is more complicated. You have to design and manufacture cars that people want, and for which people will pay more than they cost to manufacture. You have huge investments in fixed assets (factories that can’t be easily converted to new uses), technologies (hybrid engines, or the lack thereof), and human capital that constrain your ability to develop new products and offer them at competitive prices. In this kind of business, it’s possible that no amount of cash will make a company viable going forward. GM is currently losing about $1 billion of cash per month, according to analyst estimates. If you loan GM $10 billion (or make a $10 billion capital injection), and nothing else changes, all that means is GM survives for 10 months longer before everyone gets laid off. The $10 billion loan only makes sense if that money, or those extra 10 months, will enable GM to somehow become a profitable company on a going-forward basis.

This is a different kind of question than you have to ask about a bank before recapitalizing it. Bank of America and JPMorgan may need more capital in the future to compensate for the deterioration of their past loans, but few people expect that they won’t be able to make money in the future. With GM, there is a real question as to whether it can become a profitable company at all. The story is they just need to buy time until the Chevrolet Volt comes out, but there’s not a lot of evidence that by the time it does, it will be competitive with whatever Toyota and Honda have engineered by then.

I’m no expert on GM, so I’ll leave it there. It’s possible that GM is on the brink of a turnaround and it just needs $10 billion more in loans. I really hope that’s true. (And in any case, the Energy Department has already allocated $25 billion in low-interest loans for US auto manufacturers.) The point I want to emphasize is that the criteria to use in deciding whether to bail out GM are different than the ones to use in evaluating banks – and have nothing to do with which one we have warm and fuzzy feelings about.

I want to point out one more source of information that might shed light on this question. Every quarter the Federal Reserve conducts a Senior Loan Officer Opinion Survey which asks how bank lending practices have changed over the past three months. In the July survey, every single measure of either willingness to lend or loan spreads (price of loan, less cost of funding) was at or above the tightest values (least willingness to lend, highest prices) seen in the last twenty years. Granted, these are measures of change in lending practices, but they still show a rapid shift in sentiment at banks. The October survey should be underway now, and it’s hard to see how it won’t look even worse.

1. Bank lending to nonfinancial corporations and individuals has declined sharply.
2. Interbank lending is essentially nonexistent.
3. Commercial paper issuance by nonfinancial corporations has declined sharply and
   rates have risen to unprecedented levels.
4. Banks play a large role in channeling funds from savers to borrowers.

In short, they are saying that despite all the hand-wringing about banks not lending to consumers and businesses, it just ain’t true, and even if it were, most lending isn’t done by banks anyway. The implication, to simplify somewhat, is that we are in a media storm of hype that may itself have negative effects.

While I would love to believe this, I don’t think they make the case conclusively. A few quibbles (for this to be understandable, you may have to look at the original paper):

1. Total bank credit has not decreased (Figure 1): This measure includes everything on the asset side except vault cash, so any shift from, say, corporate bonds to T-bills is not reflected here.
2. Lending has not decreased (Figures 2-4): First, total lending is a sticky number. When a bank has loaned you money for 30 years to buy a house, they can’t call it in. Similarly, it takes time to reduce credit limits on credit cards. Lehman failed on September 15. Assume it took a week for banks to change their underwriting guidelines in the field (and that would be extraordinarily fast). It takes time for a loan application to flow through the system. How big an impact would you expect to see by October 8, when the authors pulled the data? I would be more convinced by a chart of new lending than one of total loans outstanding. Second, the chart says nothing about duration; one very real possibility is that banks are lending money for short durations but not for long ones.
3. Interbank lending is not down that much (Figure 5): Again, this conflates overnight lending with 3-month lending. There is a big gap in LIBOR between those durations right now (although it is smaller than a week ago).
4. Non-financial commercial paper is not down that much (Figure 6): This one shows a drop from 9/15 to 9/29 and then no data after that, so I’m not sure. Again, a fair amount of longer-duration commercial paper would not have expired yet, so the number is inherently sticky. Also, it hides any shortening of durations.
5. Commercial paper rates are not up (Figure 7): The chart hides a huge jump in commercial paper rates for lower-grade companies. The spread for A2/P2 companies versus AA companies is 4.45 percentage points, up from historical levels of 20 basis points and just 80 basis points this summer. (Thanks to Calculated Risk for this indicator.)
6. Banks provide less than 20% of the lending to nonfinancial companies (the rest is in bonds held outside of banks): Yup, this is true. But it ain’t so easy to issue new bonds these days, either.

Besides, like most people, I know that I should be convinced by data, but I place an irrational weight on conversations I have with other people. I just talked to my contractor (bathroom remodel), and he said that he’s been having a tough time all year. One client recently backed out of a job because her bank wouldn’t lend her the money because the equity in her house had dropped. So there. (Yes, I know this paragraph is completely irrational.)

I certainly haven’t proven that they are wrong. It’s possible that there is different data that will prove them right. In particular, if they could show me Figures 2-4, for a few more weeks, showing just new lending activity, I might be convinced. And I want them to be right. But I think it’s too early to blame it all on the media.

Update: Mark Thoma at Economist’s View and Free exchange (The Economist) also think think the Minneapolis Fed paper isn’t all it’s cracked up to be.

However, all is not rosy. Mortgage rates unexpectedly shot up last week – from 5.87 to 6.38 percent for a 30-year fixed-rate mortgage in the US – in a demonstration of the law of unintended consequences. Apparently, what happened was this. During the panic, investors lent money only to the US government, not to banks. However, since the nationalization of Fannie Mae and Freddie Mac, they have been regarded as as safe as the US government, and hence benefited from abnormally low funding costs. As banks become more attractive places to lend money – particularly because of the government guarantee on new senior debt, which means existing debt gets safer (banks can issue new guaranteed debt and use it to pay off the existing debt) – Fannie and Freddie become relatively less attractive. So their borrowing costs go up, and because they play an enormous role in the US mortgage system, mortgage rates go up.

The short-term jump is probably not something to get too worried about, since it basically corrects an anomalous feature of the last few weeks. However, it points out a larger problem. The Fed and Treasury are like firefighters. They decided that the top priority was preventing a collapse of the financial sector, and I agree with that priority. But now that banks are beginning to lend to each other, the next priority is resuscitating the real economy, and for that banks will have to lend to real people and real companies. We aren’t there yet.

Bloomberg reported that almost 100 corporate treasurers held an emergency conference call yesterday to discuss the challenges they are facing rolling over lines of credit with their banks. In some industries, lines of credit are the lifeblood of even completely healthy companies. They operate like home equity lines of credit: you draw down money when you need it (like to make payroll), and you pay it back when your customers pay you back. (In most business-to-business transactions, money changes hands some time after goods are delivered; hence the pervasive need for short-term credit.)

Now, however, banks are demanding much higher interest rates, lower limits, and stricter terms when lines of credit expire, or are even pouncing on forgotten clauses in contracts to force renegotiations of terms. Lines of credit are priced in basis points (a basis point is 1/100th of a percentage point) over LIBOR, a rate at which banks lend to each other. One company saw the price for its line of credit rise from 90 basis points to 325 basis points over LIBOR, which is itself running at high levels. The banks aren’t doing this because they think their borrowers are in any danger of not paying them back; they’re doing it because they want to hold onto the money because they are afraid of liquidity runs. “These are very different circumstances than many of us have dealt with before,” said one treasurer. “We’re all having to learn every day about provisions that were buried in documents executed 15 years before.”

This is how fear in the banking sector translates very quickly into higher costs and less cash for healthy companies in the real economy. Fortunately there are clear steps that Washington can take to bolster confidence in the banking sector, which will cause the flow of money through the real economy to pick up.

First, let’s start with deposit insurance. In general, your checking accounts, savings accounts, and CDs are guaranteed by the FDIC up to $100,000 per account holder per bank, and that is likely to go up to $250,000 shortly. Some people have been pulling money out of banks even though they are below this limit, because they don’t know about the insurance, don’t trust it, or don’t want to deal with the hassle. Now this is something with which I have personal experience. I had a CD (<$100K) at IndyMac Bank when it failed earlier this year. The FDIC took over the bank over the weekend and by Monday everything was exactly the same as on Friday: same web site, same call centers, same CD account, everything. The only change was that the name had changed from IndyMac Bank to IndyMac Federal Bank. I didn’t have to file a claim or even call anyone. My CD is still there, earning interest (at 4.15%, by the way). So if you have an insured account, you shouldn’t worry about it. (Some people have pointed out that the FDIC could run out of money if too many banks fail, but it’s a certainty that the government would put more money in the FDIC in that case.)

Second, you may have investments in stocks or bonds. Individual securities could be wiped out, and some have been already; not only did Lehman shareholders lose their money, but bondholders lost most of their money, too. But stocks are ownership shares in real companies, and most companies are not going to stop operating overnight. They will continue to buy, build, and sell whatever they buy, build, and sell today. Some will go bankrupt, as always happens, and some will lose value, but some will gain value. And it’s not likely that every company in the U.S. will lose all of its value at the same time. So you should be diversified, but you should always be diversified.

Third, there are your debit and credit cards. As long as you have money in your bank account, you will still be able to get at it using your debit card. It is unfathomable that a bank would need cash so desperately that it would block access to deposit accounts (and remember, those accounts are insured). When banks are at risk of failing, they want to preserve as much value as they can to sell to an acquirer. A large part of the value is the base of depositors and the ongoing banking operations. As for credit cards, it is possible that banks will gradually reduce the amount of credit they have extended by offering fewer cards, tightening the terms, reducing credit limits, and even unilaterally canceling some people’s cards. This could affect some people. But again, there is no reason why the credit card system as a whole would fail.

Now, if there is a recession, and that is certainly a possibility, it could have serious consequences for you: you could lose your job, your rate of salary increases could go down, your house could continue to lose value, your investments could lose value, and so on. As we’ve said, there are concrete steps that governments can take to minimize the duration and severity of any recession. In any case, you’re not going to wake up one day and find out that your money is gone. (Unless you keep your money under your mattress, in which case someone might steal it.)

The connection is that much of the ordinary activity in the real economy relies on credit – think no further than the volume of purchases made using credit cards. (Although banks have been reducing credit limits, there is little risk for now that credit cards will stop working overnight.) And in today’s conditions, when many financial institutions are potential victims of liquidity runs, lending has virtually ground to a halt. The New York Times has an article today about the impact that the current crisis is having on local governments suddenly unable to raise money for ongoing projects such as highway repairs and hospital expansions. Across the country, local governments issued $13 billion in fixed-rate bonds in the first half of September – and $2 billion in the second half. A sudden 87% drop in a major source of municipal funding is a very real impact of the financial crisis, and one that will necessarily result in both fewer services and fewer jobs for taxpayers.