Sunday, February 8, 2009

Observations on the Current Economy

This post connects to two Keystone Economic Principles:
3. All choices have consequences.
4. Economic systems influence choices.

One aspect of the current recession has been the effort to compare it to past downturns. In that process, authors frequently focus on what is similar between this event and one or more past events.

Jerry Muller has an interesting insight in a recent post on The American website. Muller suggests that what may be most important is what is different about each major recession, rather than what is similar. For the current situation, he notes the differences in financial markets and financial institutions, and notes widely divergent contributing factors - innovation, regulation, incentives, and rating.

What I found most intriguing and at the same time obvious, was the idea that looking for similarities between events lends itself prescribing similar solutions. But the solutions need to be unique - based more in the culture and (in economic terms) the institutions inherent in the culture. The impetus for such solutions can come from government and the private sector.

And while both may be able to provide solutions that generate some level of confidence, something that is sorely needed at this time; my previous reading about economic institutions would indicate that for real change to take place, the economy will need to take time to evolve.

I'd be interested in your thoughts about the article.


Matt Young said...

If downturns (restructurings) are caused by unexpected technological shocks, the the key is to identify the various shocks in previous depressions, and using that path try and identify the shock for this mini-depression.

My little mini-theory says that major recessions are generally caused by unexpected information shocks, information technology running past inventory technology.

Prof. Samuel D. Bornstein said...

Treasury Secretary Timothy Geithner and the 2 Ton Elephant in the Room

In effect, the US government (taxpayers) will be bearing the loss if things don’t go as intended. The growing concern is that these losses will materialize with defaults and re-defaults. There is also concern about the 2nd Wave of Foreclosures involving the “Toxic” Mortgages and the projected 8 million foreclosures expected over the next four years.

There is a lack of confidence on the part of the banks to be willing to lend to consumers and small businesses, and there is a lack of confidence in consumers and small businesses that they will be able to pay it back. Everyone is ignoring the “2 Ton Elephant in the Room” which is “Financial Ignorance”.

Consumers, borrowers, and small business owners lack the ability to make sound and informed financial decisions. It can be argued that the borrower’s lack of knowledge in financial management was the primary cause of the Subprime Mortgage Crisis which precipitated the Credit Crunch and our current economic woes.

It seems that the key to a solution of this crisis IS THE BORROWER!

Many recognize that the contributing factor to most of our economic problems is the consumer's lack of financial understanding. He is like a "Boat without a Paddle" when it comes to managing money and making money choices. Everyone is betting that the borrower will default and foreclosures will follow. The high rate of foreclosure and Re-Default should have been expected because the borrower has no concept of managing money.

Loan modifications or any other form of bailout will not save these borrowers. These measures will fail because the borrower is still financially ignorant. Note that even with loan mods the Re-default rate is 60% within 6-8 months.

Let's finally address the real issue which requires developing a program of "Immediate and Specific Financial Guidance" to help the Borrower understand how to manage his financial affairs.

The Borrower is in desperate need of "Financial Guidance" in this complex economic environment that requires "informed" financial decision-making. The Subprime Mortgage Crisis, out-of-control consumer spending and credit card usage, and the spike in foreclosures and bankruptcies provide evidence of that fact.

We must develop a program of "Immediate and Specific Financial Guidance" that will help the Borrower "naturally" be able to make the monthly mortgage payment. This program is NOT the so-called Financial Literacy initiative that simply disseminates "information" and takes forever to complete, but rather it is a program that will help the Borrower "understand" how to manage money in the shortest possible time and avoid the pitfalls that have previously caused financial

As the Borrower is successfully guided to avoid default, the financial and housing markets will respond favorably. The result will be a reversal of the downward trend in the valuation of the “troubled assets”.

If we are successful, we can turn this crisis “all around” and stimulate the economy “naturally” rather than by “bailout” which does not guarantee success.

Instead of the expected losses, the US government (taxpayers) will benefit from the unexpected gains that will result as these investments grow in value.

Samuel D. Bornstein
Professor of Accounting & Taxation
Kean University, School of Business, Union, NJ
Tel: (732) 493 - 4799

Anonymous said...

This article proves to be most helpful to me as someone who is a newbie to the world of economics. Unfortunately, I understand the author to say exactly what I had suspected to be true. Our current calamities are resulting from too much complexity. The face-to-face business dealings with Mr. Joe Banker, the persnickety yet thorough risk assesser, are of a gone-by day. Investing is about real people in real situations moving real products. When investing is minimized to numbers and abstract people and places, the connection to accountability is robbed.