Have you ever had a good friend? This friend you know you can trust, you have faith in them, you feel as if you can tell them anything. This friend was there for you when there was a family death, and always went out of the way to ensure you were happy. However, lately your friend has been acting strange. They don’t communicate as much with you, and when they do it’s abrupt and brief, often going weeks without saying a word. The little surprises you had grown accustomed to are now gone; although wondering what’s occurring in your friend’s life you decide to not ask feeling it’s too much of a burden.
However, suddenly you discover your friend has been in trouble. After a sudden event, drugs and alcohol had consumed your friend in a depressive state. Again, you decide that it is best to do nothing and continue on. Then you discover that your friend has been borrowing quite a bit of money to fund bad habits, and is in heavy debt. Again, doesn’t matter. However, the event that gets you involved is when you find out your friend has forged your signature for a line of credit they cannot pay.
Now you’re involved.
The result of this is probably little to no trust in your friend anymore, while at the same time an epiphany that you should have been there from the start – when the warning signs were present.
This is an analogy of a word that is repeated in financial news quite a bit –confidence. Consumer confidence, market confidence, is basically a measure of how much faith there is in the economy. Like the anecdotal friend, if the population has less confidence in the market the less chance individuals will take risks associated with improving or creating business.
The story also shows how trust between financial institutions and govern and the consumer have fallen. At first, banks were well trusted before 2007, and the consumer had been appreciating the relatively easy credit that could be gained through financial instruments such as line of credits or reverse mortgages. However, despite their being heavy warning signs of many living outside their means, the consumer continued to take the ‘gifts’ from the bank without hesitation. Then, 2008 occurred and suddenly the banks were bailed out by the government. The consumer distanced themselves from the banks and decided to let them figure it out themselves. Trust has continued to fall with the LIBOR scandal and various trading scandals such as UBS. This is the ‘drug and alcohol’ part of the analogy, as these scandals are eroding what faith the consumer had in financial institutions.
However, the consumer is starting to realize how they are tied to the banks. The governments rely on banks in many cases to provide budget funding to deliver on social programs that the consumer appreciates, or pay wages or supply pensions to the consumer. All of a sudden, austerity causes these programs to be slowed down or completely cut out. Again, this is when you realize the friend from the initial story has forged your signature – and now you must take action.
This analogy is far from perfect, but it does show the connection. Financial institutions are heavily connected to Western daily life, and their decline is beneficial to no one, except anyone who has been shorting them for the past 4 years. Instead of ignoring the issues and simply not trusting financial institutions, educate yourself about proper financial planning in your own life instead of simply taking the advice of someone else at face value.
Market confidence, like trust in friends, is very difficult to revive. With the past scandals that have taken place and especially with something as massive as LIBOR, it could take years. What happens without market confidence? Well let’s suppose I wanted to open a business. To open, I need capital of around $50 000, and could apply for the loan. However, I am unsure that the interest rates will stay the same, and with a worsening economy am less unsure that people will purchase my product, which would cause me to fall far into debt. Therefore, I do not take the risk – and decide to continue working at the government.
If I would of have had faith in the economy, I would of taken the loan and paid interest to the bank resulting in profits for them. I would have hired a few employees resulting in less governmental dependents, and my business (should it be profitable) provides more taxable revenue.
It’s all about confidence.
So, what can we do? Continuing with the analogy, instead of waiting for your friend to deteriorate into a worsening state, call them and ask what’s up – or maybe surprise them somehow. The meaning behind this is education about basic financial terms instead of simply taking a line of credit without full understanding. Do some research before making a financial decision such as purchasing a house, instead of buying one based on emotion without fully understanding the difference between a fixed or floating mortgage, or having a proper down payment. By being a more responsible consumer, you are assisting your friend, or the financial institutions in the long term.
If you add stress to a bank, employees whose livelihoods depend on their divisions profit lines will feel forced to make wrong decisions that will most likely be profitable in the short term but devastating in the long term. No, I am not blaming the consumer for the illegal actions of others. However, I am assigning a value to ensuring you are financially responsible, and making sure you are not classified as a toxic asset on a bank’s balance sheet. Additionally, there is value to not supporting additional lending by government agencies in order to continue unsustainable social programs that add a marginal benefit to your life.