Sunday, August 21, 2011

Blowing Bubbles

A lot has been made of the role of the "Housing Bubble" in the current economic malaise. But I think that a large part of the problem is that there may be a much larger bubble at work here that hasn't been spoken much about.

Here's what I mean. In the run up to the most recent recession, personal incomes for most of the people in the country were flat, and in some cases, once you adjusted for inflation, they were falling. But... when home prices started to take off, people didn't pay much attention to that. Between rising home values, and the ability to turn that into cash via home equity loans, people "felt wealthier." But most of it was "paper wealth." In effect, people were taking out loans based on an opinion of the amount of money that someone would be willing to pay to buy their house - they didn't even have to have an offer in hand or a potential buyer lined up. And so things collapsed when it finally got to the point where that expectation - that someone would want to pay that price - turned out to be misplaced. And so the "paper loses" came rolling it. But no-one wants to take them. The homeowners claim it's not their fault, and the banks have more money anyway, and the banks want the federal government to take the loss, and the public is already grumbling about the money that was spent propping up the automakers... You get the idea.

Okay. With that out of the way, let me move on to another bubble that may be at work here. Right now, the United States government has, in effect, made a number of promises to people as to services it is going to provide, goods it is going to produce or secure and funds that it is going to disburse. But, at this moment, in order to keep those commitments, it is borrowing 40¢ of every dollar that it is spending. And one of the more or less unnoticed features of the current fighting over the budget is the idea that the United States economy will grow large enough and quickly enough to allow us to repay those loans - which had once been a staple of the "deficits don't matter" crowd - has quietly been abandoned. And so, eventually, the expectation that government will fulfill its promises will turn out to be misplaced. And to the degree that those promises have been converted to "paper wealth," there are going to be losses.

And I don't think that many people realize just how much their standard of living has been propped up by public spending. While people are quick to point out things like Medicare and Medicaid or Social Security, the fact is that there are a lot of other programs. One is the FDIC. One thing that you sometimes hear people saying is that "Savings is investment." To the extent that this is true in the United States, it is only true because the Federal Deposit Insurance Corporation has turned bank savings accounts up to a certain size into a zero-risk investment vehicle. Otherwise, any savings that you absolutely needed to be able to draw upon later couldn't be made available for investment. And in invest, you'd have to accept the possibility that you'd loose your principal and/or (likely and) not having access to your funds on your own schedule. And simply storing money for safekeeping would involve a cost. But there are other costs as well, that we often don't think about - I have more free time than I otherwise would because I don't have to keep careful track of what's going on at my bank - if they go under due to bad loans, that's not my problem.

To a degree, this is just a factor of a moderately socialized economic structure - certain risks are spread throughout, and that brings certain benefits with it. But then that 40¢ rears its ugly head again, and we realize that this can't go on forever. Again this is just the nature of the beast. Where the problem arises is the extent to which people have structured their finances and their lives around the expectation that these programs are going to continue. Going back to my example of the FDIC, when it was created, back in 1933, it was intended to be temporary. Granted 77 years isn't exactly forever, but it's unlikely that it's going to be wound down any time soon, and so people have come to make commitments based on the idea that it will always be there. This paper wealth, and the paper wealth created by other government programs, is no less a part of people's lives than home prices. And so if the expectations that underlie that paper wealth unravel, there will be losses. And the fight over who winds up holding the bag will go on, and the economy will founder until it's resolved.

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