Friday Bullets

Some 7/11 links and thinks:

• While more and more people, even many industry people, believe that some type of regulation is needed in the highly screwed-up financial services sector, it’s not clear what kind of regulation would actually work. Here’s an insightful take from the Wharton School.

• BTW’s fave new economics and business blog not found on tcbmag.com: The Curious Capitalist.

•  The August issue of the Minneapolis Federal Reserve’s Region magazine is a particularly good one. If you find economics ideas useful and compelling but don’t want to geek out on the minutiae of, say, oil futures contracts, Region is a great read. Especially worth your time: The interview with John Poterba, the new president and CEO of the National Bureau of Economic Research, a review of several new books on the rationality and irrationality of the market, and the article on the pros and cons of regulating mortgage brokers. Check it out.

• The current BTW Book Club volume is Caught in the Middle: America's Heartland in the Age of Globalism, by former Chicago Tribune journalist (and Boone, Iowa, native) Richard C. Longworth. If you care about the future of the Midwest, you should read it (though, like me, you may not agree with all of his points). He is not wholly complimentary about Minnesota—and he calls one of our top companies “Medtronics” (certainly, I’ve never been guilty of a typo). I’ll say more about the book in a later post. In the meantime, you have summer-school homework. (It’s easy to read, BTW.)

Are You Crazy?

How rational are our choices? In the 21st century, at least, not very.

That’s the message we’re getting from all these recent “popular-economics” books.

Just look at some of the titles that have come out this year (I’ll forgo the links—they’re all on Amazon and Barnes & Noble):

• Sway: The Irresistible Pull of Irrational Behavior

• Predictably Irrational: The Hidden Forces That Shape Our Decisions

• The Logic of Life: The Rational Economics of an Irrational World

Perhaps the granddaddy of them all, Irrational Exuberance, by Robert Shiller. (You’ll remember that the title came from a speech by Alan Greenspan in 1996.)

All this comes on the heels of various books that have come out in the past couple of years that discuss how stupid our brains are, like:

• A Mind of its Own: How Your Brain Distorts and Deceives

• Don't Believe Everything You Think: The 6 Basic Mistakes We Make in Thinking

• Blind Spots: Why Smart People Do Dumb Things

• Kluge: The Haphazard Construction of the Human Mind

• On Being Certain: Believing You Are Right Even When You're Not

The market for books about irrational markets has also been driven by the success of Freakonomics and other contrarian books about economics, such as:

• More Sex Is Safer Sex: The Unconventional Wisdom of Economics

• The Economic Naturalist: In Search of Explanations for Everyday Enigmas

• The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor—and Why You Can Never Buy a Decent Used Car!

(Yet another trend is the monosyllabic title for books meant to uncover the deep and often irrational mental infrastructure beneath of our decision making—Blink, Sway, Kluge, Nudge.)

What to make of this madness? Two obvious things come to mind (and come with yet more bullet points):

• We’ve just come out of a couple of mighty economic bubbles (high tech and housing), where people clearly were made stupid by their greed. Turns out the laws of economics weren’t overturned after all!

• We’re also massively in debt, even though we “know” that we don’t need most of the stuff we buy—and “know” we can’t afford all of it.

In short: Yep, we are irrational.

Call it “the power of magical thinking.” In fact, maybe I’ll call that the title of my own book. There’s clearly a market for it.

Random Noodles

Some loosely conjoined observations on a tulip-killing April morning.

Is it just me, or does the current moment feel like a lull before (maybe) many shoes begin to drop?

We still don’t know who the Democratic presidential candidate is going to be, and we may not know for some time. There don’t seem to be any new explosions in the financial sector—just the soft sound of brooms and dustpans working away at those massive dust bunnies (CDOs, etc.) before they start reproducing. And though the indicators are far from rosy, we’re not sure we’re in a recession yet.

So what’s next? There’s absolutely no way to predict. Anything can happen.

• You might have seen the recent series in the Strib about the new “ghost towns” in Wright County north of the Twin Cities. These were developments put up in the building frenzy just before the bubble burst, leaving only a few people dwelling there, stuck with a big house (or more than one, in some cases), maybe an adjustable subprime mortgage, and with no prospect of making money out of the deal - or even being able to unload the place.

Call me hardhearted, but in these articles and others I’ve read recently on the housing price slump, I find it difficult to feel bad for many of these folks. In most cases, they simply wanted bigger houses than they really could afford, then used their inflated house values as a big piggy bank.

My wife, a professional observer of the real estate scene, says that during the housing bubble, there was greed on both sides. The lenders: "You can afford much more house!" The buyers: "Yeah, we deserve that big new house, and besides, house prices will rise forever!" As the Strib series notes, some people bought houses as investments or as part of get-rich-quick schemes.

Maybe the reporters are having a hard time finding real victims. There have been homebuyers who were cheated by shady mortgage lenders — those people certainly deserve government help. But should others who've been thrifty and lived within their means help out those who jumped on the latest version of the pyramid scheme?

Let Them Sink?

Yesterday (Monday, 3/31), the Treasury Department laid out a new policy for dealing with financial-industry problems. It wasn’t a get-tough policy, and didn’t want to be. Treasury Secretary Henry Paulson, a former Wall Street guy, clearly doesn’t have his heart in this.

And why should he? He can only guess where things are heading.

If Bear Stearns’ investors were (partially, at least) saved by a deal using Federal Reserve cash, then investments like collateralized debt obligations and other curious fruit from the shadow banking system should be regulated. Which they aren’t much now.

The counterargument goes: If these investments are regulated, then innovation and “creativity” will be stifled. And that, in turn, will stifle investment in general and overseas bankers will have an edge.

I wonder about the factual basis of this. Does something get to be called an “innovation” if few people (if any) really understand how it works?

And what do these kinds of investments actually do for the economy? What do they do to build it? Do they create any real value? Are they building factories or infrastructure or anything else that’s really needed?

Or are they simply manipulating imaginary piles of money and getting into billions of dollars in debt for the global “Niagara of capital” that hungers for massive returns?

That hunger drove the drive to develop subprime mortgages, pushing people into buying houses they really couldn’t afford.

I suspect that Paulson believes that these various markets—mortgages, exotic investments—should be self-regulating. If you take on too much risk—including spending money you didn’t really have, why should those who didn’t bail you out? You overextend, you pay the price. Good money drives out bad. In theory.

What’s more, many have argued that the Fed’s backing is keeping Wall Street from doing the hard work of getting its house in order. What’s more, the Fed is venturing into uncharted waters. It may work out. Or there may be sharks and undertows lurking.

As for the financial services regulation the Fed’s recent actions regarding Bear Stearns have partially prompted, Paulson’s proposal is pretty paltry—he knows “something must be done,” but he doesn’t want the government doing it. Perhaps intentionally, his proposal isn’t likely to make it through Congress.

Was the Fed’s action in “saving” Bear a good idea? We won’t know for a while. It was an open-eyed risk on Fed Chairman Ben Bernanke’s part. Nor do we know whether helping people deal with their bad mortgages would be wise.

But the point remains: If mortgage-backed securities that have been tainted with subprime deals can sicken the financial services industry, that can mean an unnecessarily weakened economy for everybody. And the federal government certainly should have some say in regulating such “creativity.”

If financial firms are willing to get federal backing, then the Fed—that is, the public—must have a say in how much risk they’re running. End of story.

Double Bubble Trouble

The tech bubble popped. The housing bubble’s popping. The financial sector is getting the beating of its life—mostly self-inflicted.

Is 2008 a rerun of 1929?

In a provocative article in Harper’s magazine, economic observer Eric Janzsen argues that bubbles are the new economic engines in our postindustrial economy. When heavy industry and consumer-products manufacturing began to disappear from the U.S. in the 1970s, its place as the guiding financial force was taken by "FIRE"—a super-sector comprising the financial, insurance, and real estate industries.

(Take a look at the component firms in the Dow Jones Industrial Average. How many are actually industrial companies? Maybe half, if you count pharmas as industrial firms. Even General Electric has a large financial unit.)

I won’t summarize Janzsen’s argument here, but his piece is essential reading. You won’t look at our economy quite the same way again. (Dave Beal, the dean of local business writers, offers his take on Janzsen’s ideas in the latest issue of TCB.)

Janzsen argues that the next big bubble will involve alternative energy. His discussion on why that might be will make you look at the whole "green" boom differently too.

(There have been other, smaller bubbles over the past decade, but they involved useless crap: Thomas Kincaid paintings, Precious Moments figurines, Beanie Babies. Those collapses, of course, had practically no effect on the economy. True, you could make a good case that mortgage securities are also useless crap, though they didn’t seem that way three years ago.)

Janszen says that bubbles have been a rare phenomenon in American economic history. But he doesn’t mention another double bubble-one that happened in the 1920s.

The first was the Florida land bubble, in which land speculators and a succession of "greater fools" drove up even swampland to absurd prices. A 1926 hurricane popped that balloon.

The story of the 1920s double bubble is well told in Frederick Lewis Allen’s history of the 1920s, Only Yesterday. As Allen wrote, "the national speculative fever which had turned their eyes and their cash to the Florida Gold Coast in 1925 was not chilled; it was merely checked." Money-crazed investors shifted to stocks, whose prices soon shot up to stratospheric heights—with company earnings insufficient to anchor those helium-filled values.

Does this little history lesson that mean I think we’re heading into a new depression? I don’t—banks are more secure now, New Deal safety nets are still more or less in place, and the Federal Reserve is willing to take on a more activist role. Our economy has been pretty stable since World War II. That said, making economic predictions is like investing: Past performance is no guarantee of future results. That may be good or bad. People didn’t believe there was a depression one year after the October 1929 market crash. By 1931, the grim reality had set in.

It’s ironic that Fed Chairman Ben Bernanke, a scholar of economic history who has called himself a "Great Depression buff," finds himself facing a similar crisis. Let’s see if he can use what he’s learned.

Commies Made My Dog Toys

Most U.S. businesses are pretty well run. But so many large ones have proven themselves to be so mindbendingly greedy or just plain stupid that they’re now having to be bailed out by the Chinese or other countries—or companies in those countries that have been much better managed.

This isn’t to say this massive infusion of foreign investment is necessarily bad. We had almost as much in 1999 as we did in 2007. And there was plenty of Japanese investment—including the building of new car plants—back in the 1980s. It’s not a new phenomenon. But given all the manufacturing jobs that have moved to China (or appear to have done so), it’s gotten a bit worrisome.

But maybe we’re simply not used to the fact that the USA is no longer in charge of things. Our dollar certainly is no longer the currency of choice. And foreign countries are starting to come to the U.S. to pick up stuff at fire-sale prices.

One thing seems certain: It’s a new world for us in the U.S.

U.S. businesses in the postwar period up to about 1973 ruled the world. They certainly made the U.S. astoundingly prosperous. But while many liberal economists and commentators get all gooey and nostalgic and talk about the 1945–1972 period as a golden age, there was no way it was sustainable.

In a sense, the American economy during that era was highly cartelized—one phone company, three or four automobile makers, giant steel makers that could send fear shivering through the economy by threatening a price increase. Small-town retailers may have not had to contend with Wal-Mart, but they had Ben Franklin and Sears to worry about. (Remember when those were big retail names?) Many of those shining corporate names of the period—Polaroid, Bethlehem Steel, RCA—were rusting out from the inside.

So now we have a global economy. Industries like automobiles and telecommunications have become highly competitive—and innovative. Close to home, Indian and Chinese companies are pouring money into the Iron Range. All this means we don’t have much control over our economy. And over time we’ll have less and less.

On the other hand, how much have we ever had?

Back in the 1960s, economists like Arthur Okun and Walter Heller, many of whom advised the federal government, had come to believe that the economy could indeed be managed—that with a scientifically chosen mix of tax and monetary policy, white-coated economists could continually make adjustments to the dials and levers of prosperity. Recessions, much less depressions, would be consigned to the landfill of history.

This kind of thinking seems to have been based on the same notion that many homeowners had earlier this decade—that things would always be as they are now. In the 1960s, prosperity and economic growth seemed endless. In the early 2000s, it was clear that house and condo prices would only go up.

And hey, remember the late 1990s? The “New Economy” had done away with those boring old rules like supply and demand. How about another cold, frosty glass of Kool-Aid, brother!

It’s true, as much as any cliché is true, that the only constant is change. But some economic truths don’t change.

We’re going to have to learn some old lessons all over again. Lessons like saving and thrift. We’re going to get used to having less and less stuff.

But then, we couldn’t pay for the stuff we had.

Holiday Fear

‘Tis the season to worry about the economy. Will people spend a lot of money buying holiday gifts? If they don’t, why? Worries over household debt? The subprime crisis? A coming recession?

I wonder whether too much of our economic health is dependent upon how much stuff we buy. But that’s a thought for another post. For now, let’s ask: Should we be worried?

A November 15th article in The Economist says we should—but opens with the caveat:

In recent years, it has rarely paid to be pessimistic about America's economy. Time and again, worried analysts (including The Economist) have given warning of trouble as debt-laden and spendthrift consumers are forced to rein in their spending.

So far, that trouble has been avoided. The housing market peaked early in 2006. Since then home-building has plunged, dragging overall growth down slightly. But the economy has remained far from recession. Consumers barely blinked: their spending has risen at an annual rate of 3% in real terms since the beginning of 2006, about the same pace as at the peak of the housing boom in 2004 and 2005.

New York Times columnist David Brooks, arguing against the populist-gloom prophecies of CNN’s Lou Dobbs, notes this:

Despite the ups and downs of the business cycle, the United States still possesses the most potent economy on earth. Recently the World Economic Forum and the International Institute for Management Development produced global competitiveness indexes, and once again they both ranked the United States first in the world.

In the World Economic Forum survey, the U.S. comes in just ahead of Switzerland, Denmark, Sweden and Germany (China is 34th). The U.S. gets poor marks for macroeconomic stability (the long-term federal debt), for its tax structure and for the low savings rate. But it leads the world in a range of categories: higher education and training, labor market flexibility, the ability to attract global talent, the availability of venture capital, the quality of corporate management and the capacity to innovate.

Most of the macro numbers for the U.S. economy have been pretty good the past few years. But how widely shared are these benefits, at the micro level?

The current New York Review of Books has a review by historian Tony Judt of Supercapitalism, the newest book by Clinton Administration Labor Secretary (and current NPR Marketplace commentator) Robert Reich. “Supercapitalism,” where “commodities, communications, and information now travel at a vastly accelerated pace,” has taken over from of the “Not Quite Golden Age” of American capitalism, from the end of World War II to the 1970s (also called the “Age of Abundance"):

The wealth gap in the US is now at its widest since 1929: in 2005, 21.2 percent of US national income accrued to just 1 percent of earners . . . If the overall economy has grown "exuberantly" [as Reich writes] but "median household income has gone nowhere over the last three decades . . . . where has all the wealth gone? Mostly to the very top." As for the intrepid boldness of the latest generation of "wealth creators": Reich lists the tax breaks, pension guarantees, safety nets, "superfunds," and bail-outs provided in recent years to savings and loans, hedge funds, banks, and other "risk-takers" before dryly concluding that arrangements "that confer all upside benefit on private investors and all downside risk on the public are bound to stimulate great feats of entrepreneurial daring.”

So how many of are really benefiting from our recent strong economy? And who will get whacked the most when it slows down?

Still, is this really an issue or a problem for the great majority of Americans who aren’t rich? We still have access to a lot of stuff. Though its demise was predicted in the stagflationary 1970s, the age of abundance has never really ended. A cell phone and a good computer by themselves confer untold benefits that our forebears could never have fathomed back in that Not Quite Golden Age (which was golden enough for a great many people, thank you).

Here's a final thought from Judt: “Abundance (as Daniel Bell once observed) may be the American substitute for socialism; but as shared social objectives go, shopping remains something of an underachievement.”

Keep that thought in mind this holiday season.

Myths, American

Being innately suspicious of most conventional wisdom—sometimes, even when it’s correct—I always particularly enjoy reading intelligent debunking of things “everyone” “knows” is “true.”

Two fairly recent cases in point:

> Social Security is in deep trouble.

At a recent meeting for my company’s 401(k) plan, attendees were asked how many expected Social Security to be there for them when they retired. Not too many younger hands went up. It’s understandable—they know that Social Security will be barely breathing by the time they’re ready to slip into their cardigans.

The evidence for this is actually far from conclusive. Robert Ball, the Commissioner of Social Security during the Kennedy, Johnson and Nixon administrations and a member of the 1983 National Commission on Social Security Reform, noted the following last month in the Washington Post:

Social Security is the nation's most effective anti-poverty program. But it's much more than that. For every worker it provides a solid base on which to try to build an adequate level of retirement income. To weaken that foundation would be grossly irresponsible.

The good news is that there's no need to weaken it. We can shore up Social Security for the future without cutting benefits—or raising contribution rates. The program can be brought into close actuarial balance over the long run…

There probably will be a shortfall in the coming century, but not very soon. Besides, it’s fixable—Ball lays out “three revenue-enhancing changes that are desirable in any case.” Read and ponder.

> Europe’s sclerotic welfare-state economies are typified by high unemployment and low productivity.

“Euro-trashing” is a popular sport among some people. OK, maybe Europeans’ health care systems are better, and they get longer vacations. But their economy is choking on its own bureaucracy. 

Steven Hill of the New America Foundation notes that the picture isn’t quite accurate. In "Five Myths About Sick Old Europe," Hill notes that:

From 2000 to 2005, when the much-heralded U.S. economic recovery was being fueled by easy credit and a speculative housing market, the 15 core nations of the European Union had per capita economic growth rates equal to that of the United States. In late 2006, they surpassed us. Europe added jobs at a faster rate, had a much lower budget deficit than the United States and is now posting higher productivity gains and a $3 billion trade surplus.

He also adds:

The European Union's $16 trillion economy has been quietly surging for some time and has emerged as the largest trading bloc in the world, producing nearly a third of the global economy. That's more than the U.S. economy (27 percent) or Japan's (9 percent). Despite all the hype, China is still an economic dwarf, accounting for less than 6 percent of the world's economy. India is smaller still.

I myself wouldn’t argue that the U.S. should copy Western European–style economies—our size and heterogeneous culture would make that difficult—though we could certainly learn from them. And there’s evidence that the U.S. is a better, easier place than most EU countries to start a business. What’s more, immigrants seem to assimilate easier here.

But what you may have believed about Europe and its “socialistic” deadness is far from the truth.

In any case, in reading these pieces and sorting through what I know and what I thought I knew about the topics they cover, two things seem clear to your humble servant and fellow citizen:

(1)    Social Security is not in trouble.
(2)    Europe is not an economic basket case.

And another thing: If we’re discussing economic policy, we should actually discuss it, and not whack each other with propagandistic rhetoric or cherry-picked statistics. In short, with conventional wisdom.

The Truth About Economics

I studied economics in college (well, two terms), and I enjoy reading economics articles (as long as there are no calculus equations included). I'm far from an expert on the topic. Still, the dismal science seems much better at explaining why something happened than predicting what will happen. Or what is happening now. And even past economic events are subject to debate. What kind of science is that?

Still, we can learn something even from something that's less than the whole truth (if such a thing exists). Two examples from my recent reading:

> Terry Fitzgerald, the senior economist at the Minneapolis Federal Reserve, has written in the Minneapolis Fed's Region publication a fascinating piece about the supposed wage stagnation that the U.S. middle class is facing. His argument: Contrary to the assertions of many economists and media commentators, wages actually haven't stagnated over the past few decades. Much depends on how you measure inflation, and whether you include benefits as well as paychecks.

It's a bit technical, but like most of the articles in the Minneapolis Fed's estimable publications, not overly so. You don't need to be an economist to get a lot out of it. Read it and see what you think.

By no means does everybody find Fitzgerald's analysis convincing. See here, for instance. The debate focuses on how things are measured, what yardsticks are used, what stats are chosen. Unless you're an econ geek, your eyes may glaze over. But at least one thing should be clear: The issue will no longer appear to be a simple yes-or-no proposition.

> This article you'll have to pay for, either at the newsstand or on line. It's a review of two new books on the Great Depression that address the issue of whether the governmental intervention in the economy that the New Deal introduced in America helped the recovery or slowed it down. The review's author, Harvard economist Benjamin Friedman, more or less argues the former, finding Bloomberg News columnist Amity Shlaes' new anti-New Deal history, The Forgotten Man, unconvincing, based on historical data.

I tend to agree with Friedman, but also have to agree with Shlaes that many of the experiments of the New Deal simply didn't work. Roosevelt's success was more apparent after the war, when economically stabilizing moves like Social Security and the SEC helped the economy take off, and freed us from the fear of another Great Depression.

Friedman won't end the debate, of course. Any more that Fitzgerald's article will silence the wage-stagnation issue.

In fact, it seems clear that the only conclusion we can draw is that arguments about economic policy will almost always be inconclusive. There are too many nuances, too many variables, too many unintended and unforeseeable consequences.

What's more, such debates will rarely have much effect on the kitchen-table budgets that the vast majority of us have to live by. Yet we still have to vote for candidates based on our highly imperfect knowledge of economic policy. Somehow, it's oddly comforting that even the highly knowledgeable can't agree.

For most of us—and I suspect this is true of many economists, too—anecdotal evidence, with a dollop of prejudice tossed in (often the recipe is reversed), trumps statistical analysis. The former, after all, leads to much clearer conclusions.

The Shape of Things to Come

"Preparing Minnesota for the Age Wave," a report released this summer under the combined aegis of the Minnesota Department of Human Services, Minnesota Department of Health, and the Minnesota Board on Aging, folds into several hundred pounds of familiar material numerous fascinating insights.

Here's a passage that cites data from the Rand Corporation's wittily titled 2007 report, Obesity and Disability: The Shape of Things to Come:

[D]isability rates among non-elderly are on the rise, with obesity as the suspected cause of these increases. "If historical obesity trends were to continue through 2020 without other changes in behavior or medical technology, the proportion of individuals reporting fair or poor health would increase by about 12 percent for men and 14 percent for women, compared with 2000. Up to one-fifth of health expenditures would be devoted to treating the consequences of obesity. And rising disability rates could offset past reductions in disability." (They also expect that the nursing home population would likely grow 10-25 percent more than historical disability trends predict.)

In other words, there'd be two health-care cost crises: an aging population and a heavier one. In fact, the latter could someday outweigh the former (sorry).

One partial solution to the coming economic challenge of the aging population is to allow people to work longer. Many employers are already embracing this. My own father worked almost to the day he died, at age 80. He enjoyed it, and his employer was very flexible about his hours and time off.

Certainly, many older workers are going to need the money, given how little they're saving for retirement.

And why is that? Because we're spending more than we make. The most recent data show that Americans have a negative saving rate, for the first time since the Great Depression. That has led some to propose a wildly radical solution—thrift.

It's not a panacea. The poor don't have any money to save. And people like Yale's Jacob Hacker have suggested that saving has declined because there's less and less money that middle-income people can save, given the rising housing, health-care, and other costs they're having to bear.

Still, I'd like to find out how the majority of people, who could put some money aside, actually spend their cash, in order to account for the negative savings rate. I have my suspicions—for instance, too much dining out. (That could also account for the rise in obesity.) But I haven't found any hard info. Any help out there?

Two other questions: Has the health of the U.S. economy become too dependent on buying stuff? What would happen if people started saving, say, 10 percent of their income rather than spending that amount? The short-term answer is, probably, recession. But long term?

One thing seems obvious: We have to watch our consumption calories.