Hang the villains
There is a common trend in human history. When something bad happens, the
first reaction is to find the villains. The second consists in hanging them in
an infamous manner. The same happens with the current crisis. The media readily
provides us with a long list of bad guys:
- Alan Greenspan, for encouraging moral hazard when he affirmed Fed’s “readiness to serve as a source of liquidity to support the economic and financial system”, and for cutting the Fed’s interest rates in 1998,
- Bush, for encouraging Fannie Mae and Freddie Mac to support the subprime market,
- The shortsellers, who earned money by speculating on the crisis, the economists, who failed to create accurate models, and more generally all those who made money in good faith when the markets were good.
In essence, anybody who enriched him/herself out of the bubble is a
potential villain. Let’s hang the villains, everything should be good again. The
issue is that the financial history is full of crisss and bank failures. Public
hanging (or shaming) has not prevented the occurrence of new crisis. However,
villain-hanging performs a social function. The search of the perfect villain
is a good way to avoid asking ourselves about our own guilt. Ava Zhao started addressing this issue last week when
questioning the home ownership goal. Nial Ferguson refers to the limits of the
“notion that property ownership enhances citizenship”. It’s the “we have all
played a part” idea highlighted by Karen Bradshaw and further developed by David Yi.
Here come the incentives
So, we have many incentives to find others more guilty than we are. But
what led us here? As stated last week, I understand the incentives that urge
people to own their roof (further described by Cathy Hwang). However, subprime loans have given people
incentives to spend more in real estate investments than they should have.
As mentioned by Karen Bradshaw, the overconsumption phenomenon is not
limited to home ownership but also applies to cars, electronic devices, etc.
True, it is a legitimate goal for each family to try to improve its material
situation. However, I do not think it is a good policy to encourage people to
consume more than they can afford. When I purchase any item in a big shop (such as Bloomingdale’s,
Macy’s, or Target), I can obtain a shop card that will entitle me to defer the
payment of my purchases. Furthermore, I would get a discount should I decide to
use the card to pay tomorrow what I get today. The system is such that we have
all incentives to consume as much as possible, regardless of our financial
capacity. Indeed, politicians and economists tend to see consumption as the
panacea against any crisis. In bad times, the mojo is “be responsible,
consume”. Nobody however seems to wonder how to finance such consumption.
Are we paying today what we
consumed yesterday?
It is well known that the United States’ growth in recent years has been
largely financed by China and other developing countries (The Economist, 01/24/2009). These investments were sustained by the
implicit understanding that the United States would not let some entities, such
as Fannie Mae, fail. We have discussed at length on this blog whether bailouts
create moral hazard. However, in the case of Chinese financing, it is precisely
the guarantee that the institutions would not default that led it to invest in
the U.S. Removing this moral hazard would also have limited foreign investments
in the U.S. It seems that we would all be better off if Americans’ willingness
to over borrow had not been sustained. However, one could consider that the
bailouts of American companies by American taxpayers are the repayment of past
debt incurred by overconsuming.
Moral hazard, again
If this is the case, the bailouts may have a “reverse” moral hazard
effect. Usually, moral hazard relates to the prospect that “a party insulated
from risk may behave differently from the way it would behave if it were fully
exposed to the risk” (Wikipedia). The
moral hazard concept conveys a notion of bad faith. But what about reasonable
taxpayers? Lets assume that Joe the Plumber always invested wisely before the
crisis. He purchased a medium size house, he had an average car, and his family
had a very limited indebtedness. Now, our friend Joe has to bail out the
externalities of others. He is fully exposed to the risk taken by others. Wouldn’t
Joe have incentives to stop acting reasonably? Not to impose his externalities
to others, but to stop bearing theirs.
Reshape the American Dream?
The issue of home ownership has been widely used to criticize the
American Dream. However, I agree with Cathy Hwang that there is more into the American Dream
than only homeownership. The sentence “life, liberty, and the pursuit of
happiness" in the American declaration of independence do not limit the
American Dream to the achievement of a greater material prosperity. Over time,
it seems that the American Dream has gone wider, becoming more focused on
material goals. Industries shrink and shift; maybe it is also time for the
American Dream to do so. Life, liberty and happiness are not determined by the
size of the HD television and the number of cars available for the family.
There is little doubt that the world resources are not sufficient to feed 6
billion human beings living the current American Dream (“Too many people, too much consumption”, Yale Environment 360, 08/04/2008). Reshaping
the American Dream may be part of the task of the new U.S. president.
From a political standpoint, the American Dream also performs a social
function. It helps Americans focus their energies on a common goal to step out
of the crisis. In the past, the United States have managed to get out of financial
crisis faster than other countries. Europe, on the other hand, suffers from the
lack of coordination between the member States. If the American Dream sustains the United States, maybe Europe should shape its
own dream.
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