By Richard Gambino
Triggered by an unprecedented credit crisis, the economic scene since September has been something we’ve never experienced in the U.S. Or the world. Whether one likes it or not, we are in fact in a global economy, and America’s economy, measured by GDP (Gross Domestic Product), of $14 trillion in 2007, accounted for about 25% of the world’s GDP of about $55 trillion, and in many other respects America drives the world economy. So when the U.S. economy sneezes, the world economy catches a cold. What should to be done? To consider this question, we need, first, briefly to account for how we got into the present, then come to possible courses of action. And do both in plain English, something many economists and politicians either can’t do, or won’t.
Thomas Carlye in the 19th century called economics a “dismal science,” meaning a life-limiting science (e.g., I may want to live like Bill Gates, but …), as distinct from a joyous science, one that would enhance life. Well, whatever he meant, for three reasons I think economics is not a happy “science” (meaning a “disciplined attempt at knowledge”) nor an exact one, e.g., like physics which makes very precise predictions). One, economics is driven by the marketplace, rather than by morality or any other human values. In fact, economics is totally indifferent to human values and concerns. Two, although economics has patterns, or as economists like to call them, “laws,” economists can’t quite agree on many of them, nor, as I’ve said, are the laws precise, as are the laws of physics. For example, for many years most economists believed in something called “The Phillips Curve Law,” namely that as unemployment went up, inflation had to go down, and when unemployment went down, inflation had to go up. Then we had both unemployment and inflation up at the same time in the 1970s, and in the 1990s both were down at the same time.
In sum, the ability of economists to make accurate economic predictions, and so to plan the future with confidence, is, to put it mildly, not good. As an old joke has it, “Economists have been very good at predicting five of the last three recessions.”
Three, because economics is market driven and our ability to predict or affect it is limited, economics is always the plaything of politics and politicians who reflect, and often pander to, their less than rational needs, wishes, desires and fears concerning wealth, and our needs, wishes, desires and fears regarding wealth.
Here’s a simple statement that many people resist because it offends our moral sense and many of our other noble human sensibilities: Wealth is created by markets, and solely by markets. An illustration is sufficient to understand this. In his lifetime, Vincent van Gogh was not able to sell a single one of his paintings in the marketplace. Therefore the economic worth of each of them was zero. Not each’s aesthetic value (“it is so beautiful”), or moral value (“we should appreciate and support such great art”), or labor value (“van Gough worked so hard at his paintings”) or other values, but its economic value, was zero. Today, some of his paintings sell for tens of millions of dollars each. Thus, these prices actually paid on the market define the economic value of the works today. If someday, let’s say in 100 or 200 years, people will pay only a hundred dollars per van Gough painting, then at that time, each painting’s economic value will be precisely $100. If no one will pay anything at all for any one of van Gough’s paintings, then the economic value of each will be again be zero, as in his lifetime.
In short, the amoral, indifferent, philistine economic market alone determines wealth, and not any of our human values, “good” ones, as in moral and aesthetic ones, or “bad” ones, as in our desires for money, security, power or whatever.
Now, how did we get to today’s economic crisis? By imposing good intentions on the market. A very brief look as history explains it. In 1938, Congress and President Franklin D. Roosevelt created Fannie Mae (the Federal National Mortgage Association), with the expressed good intention of making it easier for less-than-rich people to get mortgages and thus buy houses. In 1970, Congress and President Richard Nixon created Freddie Mac (the Federal Home Loan Mortgage Corporation) with the same expressed good intention. Still again with the same good intention, in the 1990s, conditions for getting easy mortgages were very liberalized, so that even poorer people could buy houses. Thus, a very great deal of money over a number of years was lent to very many people whose ability to pay it back was very low indeed. Those who tried to raise alarms about this, especially in the 2000s, were called heartless, or, because many of the people getting mortgage loans they could not pay back were non-white, objectors were called racists. “Affordable housing” is a good-intentioned shibboleth not only in Washington but in every village and town on the East End, not to mention much of the rest of the U.S. And certain politicians assured us in televised statements from Congress that Fannie Mae and Freddie Mac were financially sound, and pressured lenders to make more loans to lower-income people. In short, good intentions, perhaps mixed with political pandering and vote buying, violated the economic market.
Fannie Mae and Freddie Mac then bundled these bad mortgages together with good ones and sold them to banks and other financial institutions around the world. All lenders were pressured to do more and more of this by politicians and advocacy groups. “Wall Street greed”? You bet. CEOs saw an opportunity to make a lot of money in Congress’ demands upon them to give bad mortgage loans. Is anyone truly surprised that many of them in Fannie Mae, Freddie Mac and other financial institutions took the opportunity and made out like bandits? But the fact remains that this (mostly) legal banditry was a result of government policy. The credit crisis came as a result of the government-mandated policy of giving bad mortgage loans. That is, when the market was falsified, it eventually corrected itself. (If you lend me $10,000 on my word that I will pay you back, when I don’t pay you back, the market imbalance corrects itself — and you are ten grand poorer.) Thus, no financial instution in the world knows how many of the mortgages it holds are good, or how many are bad. So no given financial/banking institution was a few weeks ago willing to give loans to another because it didn’t know if the borrower would be able to pay back. No credit, so the economy froze, the stock market which reflects confidence or non-confidence in the economy, plunged, and people cut their spending.Â Recession anyone? And if Washington poorly handles the situation, the recession we are probably in will be long and painful. (Despite political misuse of the word, “recession” is a technical term meaning two consecutive quarters of negative growth.)
So what now?Â I’ll consider this question in Part II of this essay, next month, after the national elections on November 4, and I’ll address what I say to whatever political realities exist in Washington after those elections.
RICHARD GAMBINO for eleven years moonlighted all night every Thursday night helping to edit and write an economics newsletter at the Research Institute of America in Manhattan, during which time subscriptions to the newsletter rose to more than 500,000.
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