Liquidity Versus Solvency—Deconstructed for Twentysomethings
Yesterday morning, the economist Nouriel Roubini sent out the following tweet: "Greece & Ireland are solvency not liquidity."
Professor Roubini of course was referring to the European debt crisis.
And his meaning was perfectly clear: The financial situation in Greece and Ireland isn't the result of a short-term cash crunch—rather, its causes are deep and profound economic failures that can't simply be fixed through short-term monetary policy.
But what exactly is the difference between a liquidity crisis and a solvency crisis? Like many other concepts in economics, the terminology can be challenging, and best described metaphorically. So I began searching for a way to adequately capture the bad planning, ludicrous assumptions, and occasional inexcusable behavior that led to the crisis in the first place. After twenty minutes of skimming through the Financial Times, the obvious allegory presented itself to me: My own life during my twenties.
Think of it this way: A liquidity crisis is when you have to call your parents and ask them for a couple of hundred bucks to help cover the rent. Short term. It's a terrible phone call to have to make. You put it off as long as you can. But while it's a pretty bad situation—there's no denying that—it could be a lot worse for you.
(For some reason, writing about New York in my twenties makes me write in the second person — like Jay McInerney.)
You have to look on the bright side: You've got a really good job at a bank. And you're definitely making some decent coin. Sure, the rent is high—you live in Manhattan, after all – but your apartment is a third story walk-up in Yorkville. (Sometimes, guys who work at other banks throw up in the hallway of your building on the weekends—but it's a rent-controlled sublet, and you're paying way below market. And best of all, there are no roommates.) You're also in decent shape with your no-longer-deferred student loans, because you paid them down with the cash you got from selling your Honda Accord when you moved to the city. While you're having a seriously good time, you try not to do anything too stupid. For the most part, you're succeeding.
Three things just went wrong the same month.
First, Jamie Dimon's call center minions at Chase Bank kept calling you every day—every 12 hours, in fact—asking you to set up a payment for your Chase Visa card, which you're overdue and overdrawn on. You tried to ignore them. You actually stopped picking up the phone. But they kept calling—and eventually you said yes to the payment. Anything to stop the phone calls: They were like Chinese water torture. So that's a grand, right off the top, to Mr. Dimon and Chase bank, debited automatically on the first of the month. The cash is gone from your checking account before you even see it hit the tape.
Second, you stupidly bought a plasma television. Just three days earlier, you'd sat in on an earnings call with your boss—and listened to the CFO of a money center bank dismiss half a billion dollars in losses as a "one-time charge". Something about that term sounded alluring—romantic, even. If it's good enough for a Fortune 500 executive, you think, why not put the concept of a "one-time charge" to work for you? (Besides, it's humiliating to have your friends see your apartment with an enormous CRT television set sitting in the middle of what really is just one room. Your parents watched The Cosby show on it—and the tube alone took up half of what you choose to call your 'living room'. )
Third, and worst of all, you got stuck with an enormous bar tab after a night out in the meatpacking district. After tax and tip, the total was a nausea inducing $1,200.
The story is basically this: Your work buddy Steve introduced you to three beautiful Russian girls who could get you passed the bouncers at The Hotel Gansevoort. (Not the roof-deck — with the pool and the drunk kids from Bergen County. Not at all. It's straight to the back of the hotel and into the celebrity-soaked club 'Provocateur', hidden around the corner.)
You walk into the bathroom, and when you get out Steve is nowhere to be found. But the waitress is standing at your abandoned table, holding a check for your bottle service bill. And worst of all, of course, the Russian girls are nowhere to be found. You never see them again. (But you won't tell your father this, even if he asks you to itemize the damages—because this last part would only break his heart.)
Big picture—the bottom line is this: You promise your parents you'll get the money back to them as soon as your next paycheck clears.
Monday afternoon. Tuesday morning at the latest. It's a done deal. And you promise it won't happen again. You're going to be more responsible in the future. You've definitely learned your lesson.
And, hopefully, your parents—or the EU/IMF—agree. And that's it.
Liquidity crisis solved. Until it happens again. Which may be the case for both you and Greece or Ireland.
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