Credit, Credibility and Credulousness

As you might have guessed, the word "credit" comes from the same Latin root as a variety of other English words, such as "credibility," "credence," "creed" and even "credo," which is the Latin word itself. Indeed, the Latin verb credo, meaning "I believe" or "I trust," also has the meaning "I lend money."

In this vocabulary and etymology lesson lies an observation about the current financial crisis. It is, at its roots, a crisis of confidence, a breakdown in trust. Investors are losing trust in the ability of financial institutions to safeguard their money. They withdraw their money en masse and this causes the institutions to fail. Financial institutions are losing trust in the ability of their borrowers to pay back loans. They refuse to lend, so the wheels of commerce grind to a halt, preventing other debtors from earning what they need to pay off their loans. It has become a vicious cycle, with fear feeding upon fear. To borrow the words of FDR, perhaps all we have to fear right now is fear itself.

That's the problem on the way down, in this current bear market period. On the way up, during the most recent bull market, it was the opposite problem, too much trust. Indeed, what is called either credulousness or credulity (excessive, unwarranted trust) was the problem. Thus, borrowers got in over their heads, expecting that home prices would continue to skyrocket. Lenders were gripped by the same delusion, and thought that easy bucks could be made by relaxing lending standards. Politicians pooh-poohed fears of a housing bubble, and encouraged yet more easy credit. Then the bubble began deflating, and here we are today, with a run-on-the-bank mentality gripping investors and savers.

Avoid irrational exuberance (to quote Alan Greenspan) or credulousness in good times, in bull markets. In bear markets, don't panic or or despair. Too often, financial institutions forget to run their own shops on this basic principle, which they are so fond of reciting to their clients. Now they (and we) are paying a heavy price for manic-depressive management and investing styles.