It’s been a while since I’ve written here, but with, on top of normal college stresses, the GRE, LSAT and Grad School considerations, certain other things have taken priority. So, why not start with a nice philisophical piece about the economy.
Our current economic crisis is seen by some as a failure of Capitalism, but this claim has no merit. Frankly, we haven’t been properly capitalistic for a while now–I would actually venture to say that we haven’t been truly capitalistic (not even in the crazy anarchist sense) ever, but I am going to focus on the present and our recent past for now.
It helps to define Capitalism before saying whether or not a system fits that description, but it is relatively hard to create a really neat and simple definition for what is a pretty complex system. That being the case, I’m going to set forth some criteria that I think would fit any Capitalist system, and then I’m going to say how well the US Economy fits using the standard school-style grades. This will be the first in a series of posts on this topic.
Perfect or Near-Perfect Information
As our current predicament shows, the Economy of the United States utterly fails in this respect. In the case of these troublesome loans, homebuyers were essentially mislead into thinking that they could afford houses they couldn’t afford. However, I don’t necessarily blame the lenders for this. While there were cases of predatory lending and more could have been done by lenders to educate clients about the particulars of these loans, this is mainly a problem of education.
Americans are woefully misinformed about economics and finance in our country. Until I reached college, the extent of my training in economics and finance in the public school system was a nine-week Economics course, taught by the baseball coach, jammed in between the AP classes that made up my senior year in Highschool. I had only a vague idea of how interest rates work and had to be taught by my father about how to balance a checkbook. Now, I’ve been to college and I know much, much more about how the Economy works, but I’m one of a relative few, even among college students, with this knowledge. This causes people to make bad decisions. For a country that regularly churns out Nobel Prize-winning economists (by the way, congratulations to Paul Krugman, winner of the 2008 Nobel Prize in Economics), we are pretty dumb about this stuff, and we need to educate ourselves and our children better. The place to start this is in the schools.
Back on track now, people get these mortgages that they can’t afford to pay after their low teaser rate wears off, and then the mortgages are bundled, sliced up, and sold as securities with inflated bond ratings that are supposedly based on the loans’ probability of default (to insulate lenders from risk, which I’ll address later). Investors are motivated to buy these securities by a combination of the inflated bond ratings and unreasonable expectations for the future of the housing market (showing another information problem and further reflecting our ignorance of how economics work), and they used these “safe” securities as collateral for insanely leveraged loans for new investments. So, when people started defaulting (the ridiculous notion of “no down payment” lead to dead-beats, instead of trying to renegotiate their loans, just abandoning their homes–leaving banks with a bunch of worthless houses instead of money), the collateral for all of these other loans lost all of its value, leading to the massive sell-off in the market (last January) as investors had to find money to make up the difference. As lending money became more risky and banks started failing, the credit market started seizing up, leading to the recent economic hell we’ve all been hearing about it.
Of course there were more factors than just imperfect information and information asymmetries involved in our current predicament, but one cannot deny the role that they payed. Also, the finance sector is not the only place in which problems with information wreak havoc. Problems with pricing and public perception plague other industries. Allegations of price gouging routinely hurt the energy industry surreptitious fraud and cronyism plague the public sector.
However, there are things that the Government can do to move our economy in the right direction in this issue… here’s a couple:
1.) Improve the Public Education System
This should be obvious… the best information that can be provided by a producer will only fall on deaf ears if consumers don’t know how to think, and the places we should teach them to think are Public Highschools. On top of basic economics and personal finance, critical thinking should be taught to all public school students, so they can not only absorb information, but make judgements as to its veracity.
2.) Ensure Full Disclosure
Consumers and investors must be given information to be able to act upon it and make informed decisions. While I don’t think that things such as trade secrets should be placed in the public domain, basic information such as loan default rates, Marginal Cost (that is, the cost of the next item produced), the amount that is being spent on research and investment, and other book keeping items would not only serve to better inform the general public, it would remove many information asymmetries and use social pressure as a regulatory tool. Good companies given unfair treatment by the press and politicians could be vindicated, and bad comanies with unfair and malicious practices could be rooted out and dealt with. This, within reason, should also apply to the government and the companies they choose to contract.
~~Grade of the US Economy: D+ (unsatisfactory overall, but quick improvement is possible)~~
For too long our policy has been made by people who are ignorant of economics, and the rhetoric of those neophytes is blindly accepted by a largely ignorant public. Meanwhile, good companies are wrongfully maligned and bad companies get off either scott free or do so until it is too late (think, ENRON). Let’s educate ourselves and each other, and we just might have a robust economy because of it.
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