Thu Mar 26th, 2015 at 07:50:39 AM EST
If economic crisis were a venereal disease, would we continue to engage in risky economic behavior?
Does short-term gratification always trump long-term health?
Are we just children in the marshmallow experiment?
Are our economic systems doomed by the insufficiently stoic character of the majority of human beings?
Eight years and eighteen days ago, das monde wrote a diary titled Is Civilisation A Pyramid Scheme? in which he remarked:
As I write, financial markets are having a bad day across the world, after a rocky week. Can we make more sense of this than a combination of factors?
The hypothesis is that the modern economy is dominated by ever increasing and ever expanding speculation in stock and real estate markets. These markets will grow just as long as the volume increases. The markets are vastly overvalued due to a pyramid-style growth of the number of players. The markets will fail when there won't be any bottom to add to participants' pyramid.
promoted by afew
Sixteen days later, he posted another diary in which he wrote:
I am content to find out that my suspicion is not a wack unseen to human mind. Please enter Prof. Hyman Minsky (1919-1996), and his Financial Instability Hypothesis.
and concluded asking:
... Is a colossal collapse of all bubbles eminent [sic]? Perhaps there is still enough room for critical bubbles to grow for a few years, or yet another election cycle. But it would be downright immoral and dangerous to rely on that. Something more intelligent can be done, I believe.
It is pretty amazing that knowing so much about financial cycles, the Bush and other world administrations encourage precisely a path to a sharp crisis. Yes, the path does produce excitement of easily growing wealth - just as a pyramid scheme.
Can we enjoy a financial meltdown now?
How delighted I was to find in this old EuroTrib diary a prediction of the 2008 financial meltdown laid out with clear logic, a good full year in advance of the meltdown. I had stumbled upon das monde's Hyman Minsky diary after reading Paul Mason's "To move beyond boom and bust, we need a new theory of capitalism" in The Guardian (published eight years to the day after das monde's Is Civilisation A Pyramid Scheme? diary), in which Mason writes:
There's a global conference at the Organisation for Economic Co-operation and Development in Paris, where the giants of radical economics - including Greek finance minister Yanis Varoufakis - will get their biggest ever mainstream platform. And there's a film where a star of Monty Python talks to a puppet of Hyman Minsky. ...
Minsky's genius was to show that financially complex capitalism is inherently unstable. ... Bust becomes inevitable.
This logical and coherent prediction was laughed at until it came true. ...
In the aftermath of the crisis - which threatens some countries with a phase of stagnation lasting decades - Minsky's insight has been acknowledged.
Good catch, das monde!
And yet, lo and behold, this morning I am listening to the latest episode of the Planet Money podcast, and I can't believe what I'm hearing:
Planet Money host Robert Smith: ... when it comes time to undo QE, to start taking that money out of the economy, the Fed is still going to be making it up [i.e. winging it].
David Blanchflower: They don't have a nice chapter in a textbook to tell them what they should do. They've never done it before. They're struggling.
Planet Money host Jacob Kestenbaum: So the Fed doesn't know what's going to happen when they finally wind down QE?
Blanchflower: Absolutely not. Sorry! They absolutely don't know.
Jacob Kestenbaum: That sounds terrifying.
Blanchflower: It is terrifying.
Planet Money reporter Stacey Vanek Smith: ... U.S. taxpayers are on the hook for 72% of new U.S. mortgages. So in other words, if the people borrowing money to buy houses don't pay those loans back, the federal government will step up to make sure that lenders get paid back.
Planet Money host Robert Smith: 72% of new mortgages?
Stacey Vanek Smith: Yes.
Planet Money host Robert Smith: Yeah, didn't we learn this lesson? I'm getting a weird déjà vu about this.
Stacey Vanek Smith: Right. Well, this all goes back to 2008: the government bail-out of Fannie Mae and Freddie Mac. You might remember, Fannie and Freddie were these two big mortgage companies, and they would buy mortgages from banks and sell them to investors. But this is the key part: they guaranteed those loans, so if people paying those mortgages loans defaulted, Fannie and Freddie said to investors, "We're on the hook for those mortgages, we will back them up."
Planet Money host Robert Smith: And then of course, when the housing bubble crashed, Fannie and Freddie were in trouble.
Stacey Vanek Smith: Yes. They went bust, the government swooped in, bailed them out for $187 billion: essentially took them over, essentially took over the mortgage market.
Planet Money host Robert Smith: And everyone at the time said, "This is temporary, this is just crisis thinking here, we're going to bail them out temporarily, and then we're going to get the government out of the mortgage business. And yet, you're telling me that 72% of mortgages are still guaranteed.
Stacey Vanek Smith: Yes, exactly. And these are new mortgages. Three out of four new mortgages the government is guaranteeing. So I wanted to find out find out what's going on: why the government still basically owns this business. ... So basically, ... right now without government support, it would be really, really hard for most people to get mortgages. And those mortgages would probably be more expensive, higher interest rates, things like that, if the government weren't guaranteeing that they would buy them up from banks. That, in turn, would push housing prices down. And I talked to Adam Levitin about this; he's a professor of financial regulation at Georgetown University.
Adam Levitin, Georgetown professor of financial regulation: The problem is that we've built a market, and you know, home prices are based on an assumption of tremendous government support for the housing market. And that basically becomes an entitlement for the middle class. Socially, politically, and economically, withdrawing that entitlement would be disastrous. The housing market has become really a market that's too big too fail.
Stacey Vanek Smith: What would happen if the government got out of the mortgage business?
Adam Levitin: We would have Great Depression. Not Great Recession, Great Depression.
(I thought das monde's poll question at the end of his Hyman Minsky diary -- When is the Second Great Depression coming? -- was a little over the top, but maybe not.)
Quoting das monde from 2007 again: It is pretty amazing that knowing so much about financial cycles, the Bush and other world administrations encourage precisely a path to a sharp crisis.
So, if as Minnesota Vikings athletic trainer Fred Zamberletti once said, "The definition of insanity is doing the same thing year after year and expecting different results", how do we put an end to this hamster wheel of madness? Does salvation, as Paul Mason believes, lie in theory?
So the pursuit of theory is obligatory in economics. The holy grail is not a new orthodoxy, cobbled together from Minsky and the remnants of mainstream thought so that bankers can construct trading models to iron out problems created by the way our brains work. The aim should be something bigger to model capitalism's current crisis within an understanding of its destiny.
For me, the most fundamental question in economics still concerns the 2008 crisis. Was this event the last in a series of shocks needed to allow a third technological revolution to take off? Or was it evidence that capitalism's tendency to adapt and reshape in response to technology has stalled, or is even finished? That is the shadow we have to jump over in economics. Amid a mania for "new economic thinking", it is what we need to think hardest about.
As das monde put it back in 2007 March: Can we make more sense of this than a combination of factors?
But what if we do come up with a more powerful, more accurate theory of capitalism / economics, "something bigger to model capitalism's current crisis within an understanding of its destiny"? What happens then? Will that somehow translate into wiser, more constructive social policy and public "common sense"? How so? Also, even if we could translate better theory into better policy, are there any candidates out there right now for such a theory?
Alas, behavioral economics -- or maybe just plain psychology -- is not encouraging on that score:
Planet Money host Robert Smith: ... And you know, we have talked about this before on Planet Money. And it's something that no one really wants to talk about, which is: the federal government actually makes a profit off of Fannie and Freddie, because people are paying off their mortgages, and then the mortgage business makes money. It's a successful business right now.
Planet Money reporter Stacey Vanek Smith Smith: Right. Right now it is a successful business: they've paid back the $187 billion bail-out, and the government's made a profit off of them of about $40 billion. So right now, we're kind of sitting pretty. But, if things take a turn for the worse, if the housing market bottoms out again like it did, taxpayers will be on the hook for 72% of mortgages once again.
Planet Money host Robert Smith: Now <sigh> I can understand, as someone who owns a house, I don't want anyone passing some sort of legislation that'll make my house worth less. 10, 20, 30% less, I would be quite upset. But at the same time, I mean, come on people, the whole point of going through a crisis is to learn that prices have to reflect reality. So is anybody just saying, like, "Look, we gotta bite the bullet, we can't build another housing bubble"?
Planet Money reporter Stacey Vanek Smith Smith: Well, that's the other side of this. There's the economic side, and now there's the political side. There are a number of proposals in Congress to take steps to privatize Fannie Mae and Freddie Mac. But they're basically not going to go anywhere, according to Guy Cecala [publisher of Inside Mortgage Finance]. There's just no political will for this.
Guy Cecala, publisher of Inside Mortgage Finance: Cause I've had, you know, discussions with staffers of a number of key Congressmen, and they've all said that they've looked at this issue, and once they do, they say, "Oh my God, we'd be nuts to take a position on this. Let's avoid it at all costs." There's not a lot of upside to tackling this as a legislative issue.
And there you go. What brilliant new economic theory will save us from our inveterate, lazy, risky behavior? If not, we can always try spiking the water systems with psilocybin.