If, like me, your knowledge of economics is only slightly better than John McCains then you may be wondering just what the hell happened on Wall Street recently that has everyone freaking out. The New York Times Freakonomics Blog have kindly put together a F.A.Q. to help us out. The whole thing is worth a read, but here’s the gist of why it matters:
I do not work at Lehman or A.I.G. and do not own much stock; why should I care?
The concern for the man on Main Street is not the bankruptcy of Lehman, per se. Rather, it is the collective inability of major financial institutions to find funding.
As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to normal firms and individuals. So even for people whose own circumstances have not much changed, the cost of the credit is going to rise. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years.
This is going to slow growth. We have not seen this much stress in the financial system since the Great Depression, so we do not have any recent history to rely upon in quantifying the magnitude of the slowdown. A recent educated guess by Jan Hatzius of Goldman Sachs suggests that G.D.P. growth will be just about 2 percentage points lower in 2008 and 2009. But as he explains, extrapolations of this sort are highly uncertain.
In short the American financial market is in deep shit at the moment and it’s going to affect all of us in one way or another.