The Fear Factor: How It Affects The Economy

11/13/2008 05:12 am ET | Updated Nov 17, 2011

The technology that transmits odors and fragrances digitally is still in the very early stages of development. But on Monday, Oct. 6, the whiff of fear emanating from the television was overwhelming. James Cramer, CNBC star, ex-hedge-fund manager, mascot of the 1990s tech boom and the recent bull market, was throwing up his hands. "There's always a bull market somewhere" has long been one of his signature lines. But Cramer admitted to the "Today" show's Ann Curry that "somewhere" was now nowhere to be found. "Whatever money you may need for the next five years, please take it out of the stock market right now, this week," he pleaded. "I do not believe that you should risk those assets in the stock markets."

Markets, we are told, continually process available information to spit out accurate gauges of reality in the form of prices. That's the theory. The reality: markets are frequently inefficient, and dominated by humans, with all their frailties. "The view that people in finance are rational is wrong," says Alex Edmans, a Wharton School of Business economist who studies behavioral finance. "They're susceptible to emotion just like anyone." In recent weeks, the emotions they have been expressing include anxiety, panic, rage and resignation. In the Depression, skittish investors would cause runs on the bank by lining up on the sidewalk to withdraw cash. In the past several weeks, we've witnessed a 24/7, digital run on financial institutions as investors, banks, corporations, borrowers and lenders worry that their assets simply aren't safe. This panic has shown similar dynamics to previous ones. But due to the rapid shift in the structure of the global financial system, it's also completely different. As a result, the amount of selling and declines are far greater than would be warranted by the erosion in the fundamentals. Call it the fear factor.

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