If you are confused about what happened to all that money banks are losing, you aren’t alone. A lot of people simply have no idea what happened to the billions of dollars in wealth that’s been erased in the past year or so. How could this happen? Where did the money go?
Tim Carney* has a very clear explanation of what happened to us. “What the heck happened to all that wealth that was lost? For the most part, the answer is, The wealth wasn’t really there — it was all in our heads. But real wealth was lost because people invested and loaned money based on the assumption the imagined wealth was really there — and by there, I mean in our homes. This misallocated wealth was wasted,” he writes.
But far more entertaining is his extended metaphor explaining the financial crisis in terms of a bar and a mixed up lottery ticket.
Imagine Joe the Plumber is sitting at Mickey’s Pub in Allentown, Pa., on a Friday night when the Lottery numbers scroll across the bottom of the screen. Joe lets out a holler. He thinks he’s won $12 million. Come Monday, he strolls over to the Lottery office, and they point out that he made misread the TV screen Friday night—he was one number off, and so he only wins $2,000.
Has Joe lost $11,998,000? His bank account is no worse on Monday than it was on Friday. In fact, it’s $2,000 better off.
On paper, however, he has suffered that seven-figure loss. On Saturday morning, you see, Joe went through his family budget and divvied up that $12 million—planning to pay off the mortgage and the credit card bills, buy a lakefront cottage, and fill up his children’s college fund. When he comes home Monday with the bad news and sits down with the family budget, he needs to subtract nearly $12 million from that notebook where he records the family’s finances.
But if Joe’s home economy worked like the U.S. economy, there would have been far greater harm from his misevaluation of his lottery ticket. First, Joe would have ordered a round of the top-shelf stuff for everyone in Mickey’s Pub, promising to pay back Mickey once he’s cashed his $12 million check.
The news would spread all over Allentown that Joe was now a multimillionaire, and local businessmen would see an opportunity. On Saturday morning, Vinny the car dealer might give Joe an Escalade in exchange for an IOU. Vinny’s an enterprising chap, and so he sells the IOU to the local banker, Mr. Whittington, giving Vinny cash to buy more cars. Mr. Whittington, required by regulators to hold some capital against all the loans he makes, uses Joe’s IOU as an asset against which he can make a few new loans to some folks around town.
Joe’s wife, meanwhile, goes nuts with the credit card. She buys an Armani trench coat, Christian Louboutin stilettos, and a Fendi handbag, and tops it off with a champagne brunch — all on the American Express.
In this scenario, Monday morning in Allentown comes down a little harder. First, Joe is looking an $8,000 credit card tab in the face, with only $2,000 in winnings. Second, while Vinny the car dealer already got paid for his Escalade, Mr. Whittington is sitting on a worthless IOU that Joe could never pay. When regulators realise that IOU is worthless, they call Mr. Whittington and tell him he doesn’t have enough assets held against his outstanding loans — he has to call back some loans now. And the entrepreneurs hoping to borrow from Mr. Whittington this week—they’re out of luck, too.
And poor Mickey. He’s never going to get paid for all that Glenfiddich, Hangar One, and Courvoisier the boys downed on Friday night. His inventories have been depleted while his tiller never got a bump.
Then there’s the ripple effect. Joe can’t afford to pay his plumbing assistant anymore, and so that kid loses his job and defaults on his car payment to Vinny. Mickey fires the busboy, who in turn fires the kid who mows his lawn. Those borrowers whom the bank is calling on now are suddenly deprived of their capital. The hardware store owner was going to borrow on Monday to make payroll on Tuesday, but the bank has closed its lending window now.
You see where this is going.
* Editors Note: Yes, he’s also my brother.