Questions For. . . Nancy Kimelman

1223066117Both the headlines and our nightmares have been dominated by the ever-deepening financial crisis, but we’re still not sure what it all means. So we called Nancy Kimelman, an economist and author of Common Cents: How the Economy Really Works—from the Global Market to the Supermarket, to get a deeper understanding of what’s happening.

Nancy told us about what caused the mess on Wall Street, what it means for the economy, and what Joe Six-Pack should do with his money.

Boston Daily: We’ve been reading the coverage of the financial meltdown, and we’re still not sure we’re exactly sure what went wrong. What happened?

Nancy Kimelman: Wall Street made a number of fairly large errors of judgment. Most of them probably would never have been uncovered had it not been for the collapse of the subprime mortgage market. When that particular market imploded, it’s as if it took the veil off all the other immoral and somewhat illegitimate activities that Wall Street was pursuing. Wall Street really had been running amok, nobody knew the extent of it and so the subprime mortgage was the initial domino and the rest of it just opened up.

The subprime market itself has to do with mortgage bankers who aren’t particularly regulated and going after consumers and homeowners with a vengeance.

BD: How much are the people who took these subprime mortgages to blame for this mess?

NK: No one forced them to sign a mortgage, so one has to accept the fact that the people that signed these mortgages signed them willingly and they should have known better. Now, if you’ve ever signed a mortgage, you know damn well that you’re not going to read the fine print. Even if you read it, you wouldn’t necessarily understand it. People would sign a mortgage that they didn’t quite get because the carrot hanging in front of their nose was so wonderful. It was the house of their dreams.

Another thing that’s changed in the housing market—years ago, you wouldn’t have thought of going through a mortgage closing without a lawyer looking over all the documents. But in the ’90s, when people were going through those massive refinancings, it became a rarity rather than a common practice to have a lawyer sitting there with them. Had they had a lawyer, the lawyer would have helped them avoid getting trapped in mortgages that were too expensive for them.

BD: Do you think there will be a push for regulation now that the bottom has fallen out?

NK: There’s definitely going to be a push for regulation. But as an economist, I’m going to add a really loud “but” to that. One of the things that I think that has been very, very mistaken about the current situation is that people are now assuming that securitization is a bad thing. That’s wrong. Securitization has made the mortgage market more efficient and much more available to middle-class Americans. The problem is securitizing securities that shouldn’t be securitized because the risk is too complex.

We also definitely want to regulate how these mortgages are presented to homeowners. If you look at a mortgage, there’s a whole bunch of paperwork that’s supposed to be in plain language—it isn’t. We need to get people into a situation where they understand the agreement they’re getting into.

But we don’t want to handcuff capitalism. One of the things I’ve heard in the last couple weeks is that this is proof-positive that free markets and capitalism don’t work. Yes, in this instance, free-market capitalism and a financial market that was unregulated went way too far. But everyone in this country enjoys the standard of living that we do because of capitalism and free markets. Look at Russia. Look at China. Look at India. They’re now embracing free-market capitalism because it’s the only economic system that works.

BD: To borrow a phrase from a vice presidential candidate, how much should Joe Six-Pack be worried about the stock market? And does Joe Six-Pack’s age have any bearing on how worried he or she should be?

NK: Joe Six-Pack should be worried, and I just wish that the Joe Martinis in Congress were as worried as Joe Six-Pack is. Hockey moms are worried. I’m a hockey mom myself, and we’re worried.

BD: Are you wearing lipstick?

NK: No, no lipstick. But I am a hockey mom for my 13-year-old daughter. Here’s the thing. This is a financial market crisis. It started in the U.S., and it’s rapidly spreading around the world. We are precariously close to the edge of the abyss. You can’t say it any other way. When you have a financial system that can no longer supply credit to everyday companies to allow them to maintain their everyday routine then you have a very very serious crisis.

When you have a credit market that can no longer finance the purchase of homes and cars, you have a very serious crisis. We are in that situation. The fact that the stock market has declined as much as it has is proof positive that the people who own securities and invest in this country know this crisis is a very serious crisis.

Everyone’s affected by this. Our investments are clearly affected by this, and it’s going to take a long time before our investments recoup the losses that we’ve sustained. If you’re older, you have less time to recoup, so it obviously hurts you more.

But there’s one more reason Joe Six-Pack has to be worried—the economy’s in a recession, and it’s not going to come out anytime soon.

BD: Do you have any predictions on when it will come out?

NK: No. I actually believe the economy started in a recession in the first quarter of this year. Some data showed it, other data did not. When the authorities look back, I suspect that either in the first or second quarter of 2008 is when they will officially start the recession. It has quite a ways to go. Think of it—what we have right now is simply the fear factor impacting job growth and sales. We haven’t even gotten to the point yet where companies have to do layoffs because they can’t produce because they can’t borrow. Unless this financial crisis is solved appropriately and quickly, it is going to lead to a much more severe recession than we’re already in, and a much longer recession than we expected.

BD: So should we be stuffing our savings into our mattresses? How can we prepare for this?

NK: What is required at this point is a good dose of common sense. First off, you don’t want to put cash in a mattress. You don’t want to put it in the cookie jar at home. Those are not safe places for your money. You could have a fire, you could be robbed. Don’t expect to earn a lot by putting it elsewhere, but don’t put it in the mattress.

Solid money market funds that are not investing in bonds, securities, or more risky bank CDs are perfectly fine. Bank CDs are perfectly fine. At this point, with the limit for the FDIC insurance being raised to $250,000, the bank is a wonderful place for your cash. Some of these banks are offering CDs with the flexibility to get your money out of them early without a penalty. We certainly have places to invest our short-term savings.

As far as people’s investments in the stock market, the urge at this point in time is to bail out. The market’s been horribly affected by this crisis. We know we’re entering into a more serious recession, and nobody has any confidence that the market is going to be able to hold its own. What you want to do in your gut is to get out. The problem is that working on those urges, it is doing something professionals call “timing the market.” When you time the market, you try to get in at the bottom and get out at the top. It’s what individual investors are convinced professional investors know how to do, but the truth is nobody can do it.

Being able to get out of the market before it turns down and get back in the market just as it’s about to turn up is an impossibility. What happens over and over again is that people will get out of the market, and then the market turns very abruptly. Because they’ve gotten out of the market, these investors have experienced all the decline, but they’re not there for the upswing.

At this point in time, it is not really a great idea to get out. It’s time to think about the fact that your investments should be long-term investments. They should not be in stocks if you need the money in the next three years.

The thing you need to do is have a glass of wine when you read the financial pages every night. Make sure it’s a scotch when the mutual fund report comes along. Take a deep breath, because this is going to be a difficult time for your investments. But I think we’ll come out of it.