Headlines say things like "Fed Watchers at a Loss . . . : Rare uncertainty." Financial journalists scratched their head all weekend all over the world. Le Monde offered a compendium of non-knowledge about how Societe Generale could have lost $7.2 billion because of the bad bets of a single 31-year-old low-level trader - they don't even try to figure it out. The Yale economist and famous bubble-pricker Robert Schiller goes back to the New Deal and offers a vague meditation on the possible value of regulation.
At the weekend edition of the UK's Financial Times, the interesting "Short View" columnist John Authers wrote a classic thumb-sucker called "I've got a funny feeling about negative sentiment," in which he says that tracking the frequency of the use of the word "recession" often indicates the approach of a recession. He then describes the opposite view - that when editors figure out something like a recession is coming, it may already have happened. I call this piece "classic" because it makes visible the logic of most popular financial discussion: how markets work is completely clear - until the opposite becomes clear.
Trapped people are stupid. That's a lot of the recent story, in which the middle-classes of the US and UK respond to decades of stagnating wages with the hope for investment income - stocks in the 1990s, real estate in the 2000s. In their time, each would obviously go up and each was obviously a good investment. If you didn't buy Internet stocks in 1998 and real estate in 2003 you were an idiot - you had hurt your family, your kids' education, your retirement security. The crucial point is that at the time the delusion was totally rational, indeed mandatory. Skepticism was a huge mistake. It cost you big money. In real terms, it actually did.
Also in the FT, Sharlene Goff noted in passing that “A year ago, some 30 lenders were offering mortgaes of at least 100 per cent of the value of the property. A number were regularly handout out up to 125 per cent. This market has substantially dried up. Almost a third of lenders have withdrawn, and those left in the market are charing eye-popping interest rates." Who would ever lend 125 percent of the value of the collatoral? Well, anybody in 2004 who could count, since the property would escalate by that much in a year in much of the US and UK.
The veteran financial jounralist Joe Nocera describes what he sees as the middle-class problem.
Starting with the crash of 1987, every time there has been a market break, it always snapped back, usually sooner rather than later. Every time housing prices faltered — as they did in the early 1990s — they quickly snapped back as well. As a result, those twin engines, stocks and homes, became the assets we absolutely came to depend on to live the life we wanted. Our employers made the broad transition from pension plans — where the risk was spread broadly and the companies were responsible for their employees’ retirement — to 401(k) plans, where the risk was shifted entirely to the employees. But we were O.K. with that, weren’t we? We were happy to assume that risk because the market’s inevitable rise would secure for us a decent retirement.All this is true. It is all regrettable - a series of bad decisions based on biased information and dumbness about how markets don't actually love the little people. But in real time, and not in hindsight, what was the middle-class supposed to do? To demand that corporations stick with defined-benefit pensions? That was pointless since even Democrats rushed to embrace the wealth-machine of market-dependent pension investments. When that went bad, was the middle class supposed to stick it out and NOT revert to the asset it actually understood, housing? All of its intellectuals, like Joe Nocera, were describing the trends as inevitable. To be intellectually independent, and to buck trends, is the single best way in markets to get royally screwed.
Similarly, our home offered us the ability to buy things we wanted — vacations, for instance, or second homes — because we learned that we could borrow against the equity. The rise in the value of that asset made the prospect of repayment relatively painless. It also allowed us to avoid facing the fact that our incomes weren’t keeping pace with our desires.
The real point is that people's financial security and quality of life should NOT be dependent on their powers of financial prophecy. They're supposed to do their jobs, spend time with family and friends, see and do and think new things, and have their lives, not spend 40-60 hours at work and another 20 on stock and real estate analysis - which even then means nothing about the outcome.
The financial markets are having the same problem. It's not just sub-prime loans. It's not only a liquidity crisis. It's not just temporary mutual suspicion. It's a crisis of knowledge. People don't know how to value credit and risk anymore. They don't believe in the math in the same way.
What should we do? It's actually not that complicated. We should bring finance into the socially-responsible economy by taxing it like everything else. That means
- Pass Tobin taxes on financial transactions, which are untaxed, in contrast to your purchase of food (in most states) or movie tickets.
- Return capital gains taxes to the same level as taxes on wages.
Both of these would generate a lot of income for social development all over the world. They would raise the cost of incessant betting and random arbitrage, lowering its unbelievable rate. And they might get a lot of people focused on inventing things and making stuff that we need all over again. All this money is a huge distraction from actually saving our asses from global warming and world poverty and other fairly pressing things.