Archive for September 18th, 2008

Financial Crisis Worse than Terrorism

Stocks are down again by hundreds of points, below 11,000, as credit fears grip Wall Street.   The credit markets, under-regulated and drunk on the lure of easy profits from a housing bubble on the heels of a stock bubble, may be collapsing.  This is possible in part because of how long the crisis has been brewing.  Ever since the early eighties, when the Reagan Administration embraced a mix of increased public debt and de-regulation of credit markets, we’ve drifted on to ever shakier ground.  This is made worse by globalization, which allowed the US economy to appear more robust than it was, financing a 6% of GDP current accounts deficit through a massive influx of foreign funds.

CEOs and banking leaders may understand business and economics, but they are also human.  The environment is complex and turbulent, and it is easy to fall victim to two converging problems: avoidance of cognitive dissonance and groupthink.

The former comes from the quarter century of generally continued economic growth in the face of repeated warnings about dangers from the budget deficits, current accounts deficits, or bloated markets.  Just as those who should have known better in late 1999 prattled on about “Dow 60,000” or “Dow 100,000,” arguing that a new economy changed all the rules, it’s really easy to get so caught up in what’s happening that gloom and doom prognostications just seem completely out of touch with reality.  And when the stock crash didn’t sink the economy, well, then the economy must be extremely resilient.  The diversity and size of the US economy became stock words to dismiss the warnings.  The economy is “fundamentally sound” they would say, as if that vague phrase simply pushed aside all the warning signs.

If you came to Wall Street in 1978 as a young 25 year old novice, by 2008 you were a 55 year old veteran of the economic storms, having heard warning after warning for decades, with the US economy always chugging forward.  It’s easy to laugh off warnings as ‘just more gloom and doom,’ and focus on the short term profit making strategies that always worked before.

Moreover, you get bolstered by those around you.  Everyone grabs on to a ‘free market ideology’ which dismisses the need for regulations and has a faith that the economy is always onward and upward.  It becomes very easy to ridicule and dismiss those with different views, rather than actually analyzing them and thinking about the reality of conditions.  Armed with ideology and decades of experience, one can imagine the Wall Street mover and shakers believing theh not only understands it all, but have seen it all.  They convince each other that the naysayers are just shrill Cassandras, forgetting that Cassandra always turned out to be right!  The result: hubris.  A pride that causes one to be blind to forces that can destroy oneself — or in this case, the economy and some major financial institutions.

However, this is not just some contained crisis that will pass and impact only big names on Wall Street.   It’s also more than a short term crisis that will ripple through the economy and create a painful but not too intense or lengthy downturn.  This isn’t 1991, nor is it 1980.  First of all, globalization has changed the nature of the game.  It allowed the US to avoid painful adjustments when they could have happened by simply financing an obscene current accounts deficit with foreign capital.  Without that influx of money, the stock market of the 90s might have stayed within reason, and there may not have been the housing boom caused in part by easy credit.  We could not have maintained the fiction of a ‘strong consumer economy,’ as inflation would brought us back to earth.

Yet the impact of globalization also means that we may still be only at the tip of the iceberg.  Economic power has been shifting over time from the US towards China and India.   The oil rich states have also benefited from high oil prices, and a massive outflow of funds from the US.  They’ve often used that money buy US companies and stocks, at least until the last year or so.  Then the inevitable happen.  The last bubble burst, oil prices rose, and the US dollar started to decline in value.  The result was a slow motion unraveling of the economy which now is starting to spin out of control.  The consequences are profoundly more dangerous than the threat of terrorism we all feared after 9-11.

Jobs will be at risk, potentially even otherwise hypersecure jobs like teaching at a state university.  Retirement plans could collapse, infrastructure building and upkeep could fall apart.  Inflation could decrease the quality of life for everyone.  Politically, this could cause a massive surge leftward, as people will be angry and demand punishing the rich.  This could also cause a massive surge rightward, if people get angry and demand punishing the foreigners whose economies fare better than ours.  Nationalist emotion has historically been a very real reaction to domestic chaos, most obviously in Germany at the time of the Great Depression.

Most people are oblivious to this.  They know there is a crisis, they know they fear for the future, are experiencing real inflation, and having difficulty making ends meet.   They may not be able to pay their mortgages, or if they can, they see their retirement accounts sinking.  The knee jerk reaction is to look for a quick fix, or to ‘blame the greedy ones,’ but blame games and quick fixes are in short supply.  This has been a crisis building since 1980, when we started heavy deregulation and increasingly irrational economic policies.  We’ve watched imbalances grow for over a quarter century, and we’re now vulnerable in ways not seen since WWII.

The dangers this entails to our way of life are far greater than anything terrorism could cause.  While fighting a quixotic “war on terror,” we’ve squandered hundreds of billions and increased our vulnerability at our true point of weakness — our economy.  While focusing on homeland security, threats from extremists abroad, and geopolitical fantasies of “spreading democracy,” the very fabric and foundation of our national strength has been eaten away, to the point that a credit crisis could push us into severe recession, and any kind of oil shortage could strangle the economy.

We focused on the obvious and easy to understand threats of “bad guys with bombs” and a President who will “keep me safe,” ignoring the complex and difficult to grasp threats coming with globalization, a fetish for deregulation caused by an ideological faith in “markets,” and corrupt ties between business and government.  The apparent economic success after the end of the Cold War hid the growing economic decay, even as some publications and pundits pointed in horror to imbalances and warning signs that in retrospect will seem all too obvious.

Is this a done deal, are in on the verge of catastrophe?  I don’t think it is a sure thing, I think there are ways to get out of this.  We’ll have to cut government spending (including major cuts in defense spending, replacing our rambo like foreign policy with true multilateralism and cooperative ventures), regulate financial markets effectively, decrease regulation that stymies economic innovation, and pragmatically put aside ideological agendas to deal with a crisis.   That might mean putting off health care reform, tax cuts, and other policy goals.  But like a family that has to tighten its belt and make sacrifices to get through a crunch, we as a nation have to pull together to do likewise, and do so in a way that doesn’t just shift the burden to an ever growing underclass.  Are we up to the challenge?

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