Yep, another economy question!

September 26, 2008 12:30 PM

Is the credit crunch (and every other economic crisis) an inevitable result of selfish attitudes?

Say the continued health of the economy is (gross oversimplification) about future expectations. When reality doesn't meet expectations, there's bad news for somebody (or everybody), but it's generally temporary: lower-than-expected earnings, unhappy stockholders, smaller bonues, but still minor in the grand scheme. People still have jobs, they still contribute to GDP, trade still occurs, etc. etc.

This time, a big chunk of the economy has failed to meet expectations. But that's not a big deal. I mean, really, it shouldn't be. In my head, the investment banks and the lenders and all the other players collectively say "hey, these mortgages aren't the sure-fire investment we thought they were. Sorry! We're going to suffer for a while and we are waaaay overleveraged, but we'll clean up the mess and then we'll be fine!"

Instead, everyone is running for the door and nobody wants to get stuck cleaning up the mess they're leaving behind. Is this really a "feature" of the system, that nobody is willing to lose a little money, and so everyone now stands to lose a lot more?

Thank you for letting me display my ignorance publicly. Begin the flogging!

posted by Chris4d to grab bag (6 comments total)

Say the continued health of the economy is (gross oversimplification) about future expectations. When reality doesn't meet expectations, there's bad news for somebody (or everybody), but it's generally temporary: lower-than-expected earnings, unhappy stockholders, smaller bonues, but still minor in the grand scheme. People still have jobs, they still contribute to GDP, trade still occurs, etc. etc.

This is true to an extent... The market is never entirely logical, emotion plays a huge role and when setiment towards the market drops so does the real, actual market. In a meaningful way, yes its all paper and the pursuit of making the numbers on those pages drives a lot of people - you can choose to call this greed.

Greed though may not be exactly the right word. Most stock portfolios are around 5K, and the same market forces which put the porsche-driving-street-MBA types in a bad spot also puts a lot pension funds, and small investors in danger - especially if they are nearing a point in life when they want to draw on savings. If you are mid-early career and stay employed it doesn't impact you as much and the Porsche guy can sell his Porsche, but the 64-year old worker is really counting on a strong market and the 24-year old grad can't get a mortgage because the banks are short of cash and he has to raise his family in a two-bedroom apartment gets hurt. That kind of thing impacts real people.

Paper profits also generate a fair amount of activity on their own... if your portfolio values goes up people feel "richer" even when they don't cash out - if people feel short of cash, even when they are not it impacts everything from restaurant meals, to clothing retailers, and everyone in between. Every dollar spend generates something like six times its actual value in economic activity, when some of those dolllars stop flowing the pie gets smaller and this impacts everyone from the CEO to the burger-fryer - especially if the guy just out of college needs some money and doesn't mind flipping burgers for a couple of months and puts the career burger-fryer out of work.

The sun still comes up in the morning, and yes most of us live in places which have sustained human populations for thousands of years... If pursuit of anything beyond hunter-gatherer needs is greed then yes its driven by greed. I am not sure though, that I call it greed when I sink some of my paycheque into the financial markets because I don't want to work at Wal-Mart when I am 78, and that is most people in the market.
posted by Deep Dish at 12:52 PM on September 26, 2008

That's sorta what I mean, but I don't think greed is quite the appropriate word either ... and I'm not focusing on individual investors so much as the big actors: the investment banks and the corporations who own or traffic in all this paper and are the principal cause of the mess to begin with (you could blame naive homebuyers rather than overzealous lending agents, but that's not relevant to my question). For instance: when the investment banks realized that their operations were going to take a big hit due to bad mortgage debt, why didn't they call a meeting with the other Old White Dudes in their finance sector, investigate the situation, and set up a facility to keep funds liquid? Wouldn't it have been better for all of them to weather the storm together rather than saying "uh-uh, I'm not gonna prime your pump. I don't care if it sinks the whole ship!" That's what is surprising to me. And of course it's easier to survey the situation AFTER it's unfolded than to predict these issues ahead of time, but surely the actors had to realize how interconnected their fortunes were?
posted by Chris4d at 1:35 PM on September 26, 2008

It is greed, but if you define greed as "always wanting more," greed is the engine of progress and our economic system couldn't function without it.

The problem, as in any closed system, is how you moderate tendencies toward one extreme or the other. Unmitigated greed -- ethics and duties toward others go out the window, transgressors go unpunished, secrecy is the norm -- is the deathknell of an economy, as it depends on transparency and the perception of an even playing field for the participation of all. But without some greed, you won't get innovation, you won't get rising quality and lowered costs, you won't get consumer needs quickly and efficiently met. This aspect of greed usually gets labeled "profit incentive," but it's just the proscribed, regulated flavor of the same impulse that creates our Michael Milkins and our subprime debacles.

Not just economic but all of aggregate human activity can be described as the moderated tension between two extremes. Republicans moderate Democrats, women moderate men, industry moderates agrariansim, socialism moderates capitalism, and so on. The extremes on both sides function as a circuit breakers that govern unhealthy tendencies, pushing them back the other other way.
posted by stupidsexyFlanders at 1:48 PM on September 26, 2008 [1 favorite has favorites]

You're missing one key fact. The bad assets were highly leveraged. People on Wall Street may well have been willing to take the loss for a while and build back, but in this case, they simply can't because it's not up to them: the people who lent them the money they used to buy the asset want to get paid, and the asset isn't good for the debt anymore.

By the way, there are many players in the market who bought bad assets on an unleveraged basis -- yield-seeking insurance companies, endowments, governments, retirement funds, and even some mutual funds -- and there suffering is, perhaps reassuring to you, of the sort of regretful-tendency-not-to-err-again-while-taking-one's-medicine that you think more suited to the situation.
posted by MattD at 2:47 PM on September 26, 2008

ah - let me state it differently then. In some cases, yes, the assets in question have turned out to be essentially worthless. But in other cases, the assets just aren't worth enough to cover the debt right now. In the case of an individual homeowner who walks away from the mortgage, they're "cutting their losses" and while I think it's despicable, it makes some sense. In the case of these large firms though, it is no longer in their best interest to cut their losses. Real estate goes through cycles, after all, and even if it appears worthless today it's going to go back up. So, why didn't they form some kind of agreement to extend the terms of the obligations until such time as the underlying assets regained their face value?

I think the answer must be that the market was not transparent enough for players or regulators to anticipate the problem in time to craft a good solution, so we're stuck with a last-ditch effort to stop the bleeding before the patient dies. And that leads me to believe that more transparency and oversight is needed.

Just thinking out loud, tryin' to figure out how to vote. Thanks for the viewpoints.
posted by Chris4d at 3:37 PM on September 26, 2008

Read up on moral hazard and a bit of game theory such as the prisoner's dilemma. Essentially the economy is a very complex scenario where if most people act in a certain way most people can expect certain outcomes, but if their attitudes are changed, for instance by a major financial loss, they can affect the outcome for everyone else. Even if all parties act in good faith.

A bear market, almost by definition, is one in which people are acting for self-preservation and hoping not to be the last one holding the bag. A bull market, almost by definition, is one in which people are acting to get in as fast as possible and hoping to catch the rising wave.

See also Mass Delusions and Hysterias and the ever-popular Extraordinary Popular Delusions and the Madness of Crowds.
posted by dhartung at 3:09 PM on September 27, 2008