Category: Culture and Finance

THE ECONOMY

For two hundred years our economy has endured vicious cycles of boom and bust, huge surges of capital accumulation followed by devastating contractions.  This not only profoundly affected investors (formerly known as capitalists) but shaped the lives of workers and all those who supplied them with food, clothing and shelter.  Looking back, if there is one thing which we learned from this was the need for regulation and oversight.  The investors, too preoccupied with the lure of profit,  do not attend to that, and the workers, of course, too dependent on others, cannot change the course of events.

How did we forget what we have learned?  How did we neglect the lessons of our economic history?

Now as we are discovering this lesson all over again, trying to put into place the oversight and controls needed to manage this essentially unruly system, we need to think about why we forgot.  What we don’t know we know is how investors cannot be entrusted with the job of overseeing the system.

There are I think two prominent reasons.

After the collapse of the Soviet Union, the ideology of the free market clouded our collective judgement.  More accurately, those who stood to profit from the expansion of business opportunities, deregulation, and privatization, used that ideology to inhibit any attempt to control their profits.  James Galbraith has brilliantly outlined how this happened in his new book, The Predator State.

Gradually we all became invested through pension funds, savings accounts, etc. etc.  As a result we too became blinded to the risk.  Those who took out subprime mortgages or home equity loans, those who ran up credit card balances, who overextended themselves in our new credit economy — they all lost the objectivity needed to keep in mind our economic history and the risk built into it.

As Obama puts together his new economic team and as we individually struggle to get out of this recession, how can we work to remember what we so easily forgot?

What You Don’t Want to Know

Countless numbers of people in the past few weeks have confessed to me they are not able to look at their balance sheets.  Mostly these are not professional investors — but the list does include several portfolio managers I see regularly.  They can review their client’s positions, of course, particularly when their clients call up in panic, but they can’t seem to look their own losses in the eye.  Why?

Obviously bad news is unwanted.  On the other hand, little is to be gained from ignorance — and more can be lost.  I think that when people confess to avoiding the facts, they are relying on this common sense idea that the news is just too painful to bear.  But if we dig deeper there are other motives, several in fact.

An obvious one is that knowing the extent of the damage creates a demand for action. It reminds people that they could do something about it, that they have the ultimate responsibility to act on their own behalf.  In many cases, though, this responsibility can be more frightening than simply accepting the loss, especially if don’t let yourself know exactly  how much of a loss it is.  Vagueness and uncertainty can be preferable to feeling incompetent or irresolute.

Then there is the defense of optimism.  We can deny the fact of the damage or the extent of our losses if we believe that it will all work out in the end.  Markets go up and then they go down — and then they go up again.  And our recent history seems to confirm that fact, along with the fact that when they go up again they eventually go up even higher than before.  All you need is patience — sometimes a lot of patience and enough cash to wait it out.

I think there is a third and less obvious hidden motive here:  solidarity.  When someone confesses he hasn’t looked at his portfolio, he is letting you in on a secret, assuming a certain complicity.  The hidden message is that “we are all in this together.” It is a version of the fellow feeling that accompanies natural disasters.  We feel closer to each other because we share a common misfortune.  It is not so much that we help each other out, though we sometimes do.  It is that sharing the experience makes the world feel less alien — at least that portion of the world that includes you and me.  There is a comfort in belonging to a larger whole.

These motives contradict the notion of a market driven by rational interests.  At least they modify it significantly.  Moreover, collectively, they suggest the power of inertia to curb the precipitous decline of markets.  As a psychologist, I would not begin to know how to calculate the effect on prices, though I am sure that armed with decent survey data someone could.  But it is obvious to me that markets would collapse even more thoroughly than they do were it not for the investor forces of avoidance, denial and shared misery.

That may be bad for the individuals who do not act, but it may be good for us all.

THE NEW CONSENSUS

The speed with which a consensus has emerged about the underlying cause of our current financial crisis tells us that it was something we knew all along – but didn’t let ourselves know we knew it. The unwanted truth now is clear: we have been spending beyond our means. It was not just homeowners taking out mortgages they couldn’t pay for and consumers running up astounding levels of credit card debt, it was banks, hedge funds, mortgage companies, investment firms and governments that discovered how easily the traditional limits of debt could be ignored.

This presents as an economic problem, to be sure, but fundamentally it is a problem of mass psychology. Beliefs become validated as truth when opposing ideas became silenced or disparaged, when they become the only ideas that can be espoused without the fear of ridicule. Two forces contribute to bringing this about: the desires that pull people into convictions they want to believe, and then the fears that drive people away from alternative ways of thinking – the fears that rule out the doubts that might otherwise cross their minds. If everyone believes something is true – or appears to — how can you stand up against it?

In this case, of course, the clear desire was for more wealth and more purchasing power. In a consumer society who could object? The consumers purchasing more goods and services? The manufacturers expanding production? The merchants increasing sales? And then the American dream of home ownership was activated for those at the lower end of the economic spectrum. The ambition to acquire great wealth and status kicked in at the top.

Moreover, after the defeat of communism, other ways of thinking became proscribed. The victorious ideology of the market silenced critics who thought markets needed to be monitored or regulated. Even Alan Greenspan in his recent congressional testimony now admits there was a “flaw in his ideology.” His faith in the market’s ability to self-correct was too great.

Realizing that government could not afford to sustain basic levels of security for all its citizens, we created an Ownership Society in which everyone could aspire to the goods and services they wanted. We didn’t cut back on our desires, we simply found a new way to pay for them. Leveraging assets, borrowing from abroad, hedging bets, bundling and securitizing debt, we created an alternative to the defunct promise of the Welfare State. Once, people were worried about being in debt, but now debt now became normal, even a source of profit. No one would be left out of the opportunities that debt created. We persuaded ourselves that the risks could be safely managed — and democratized.

It became our biggest bubble ever – and no one raised a warning cry. To be sure, doubts were expressed about the housing market, and concern about the credit swaps, but no one thought it would led to the disaster we now face. And yet, in retrospect, it is all too clear.

But no amount of correction and reform learned from the lessons of this disaster will protect as against future bubbles. We continue to be vulnerable to the hopes and fears reflected in Mass psychology.

NO LONGER GOOD

Greed has now become the preferred explanation for the Wall Street debacle. John McCain and much of Congress have joined in the chorus. There is no doubt that there are huge disparities in wages and bonuses between those working on Wall Street and those working elsewhere, and many have said to me in recent years that the compensation and profits made from hedge funds and investment banks are “crazy,” “obscene,” “unfair,” etc. That has been true for some time. But why is this being called “greed”? And why now?

Standing back from the events of the last month makes it clear how many factors contributed to the crisis: the mortgage lenders who saw only more business for themselves, the investment banks who packaged the securitized debt, the investment advisors following the herd, the regulators who stayed on the sidelines, and, of course, the poor suckers who took out loans they couldn’t pay. So we need someone to take the hit.

But it is not just the complexity of the problem that leads to this search for oversimplified explanation. We don’t want to know how flawed and how risky our financial system is — at the point when “free markets” and triumphed and all out pensions, health plans, college funds, and savings are invested. We want to believe that we should be secure. And if it turns out that we are not as secure as we thought, that risk has not been managed down to a negligible factor, someone must be to blame.

Gordon Gekko is famous for suggesting that greed is good. This is our revenge. Not only is greed not good, he himself and his ilk are bad. They let us down.

UPDATE (SEPTEMBER 15)

With the collapse of Lehman over the weekend, the distress sale of Merrill Lynch and the looming collapse of Washington Mutual and AIG — and who know what else — the urgency of imposing some form of regulation is beginning to be more widely recognized. It is increasingly apparent that, without it, we are facing a financial disaster of unprecedented proportions.

Paul Krugman writes in this morning’s New York Times: “The real answer to the current problem would, of course, have been to take preventive action before we reached this point. Even leaving aside the obvious need to regulate the shadow banking system — if institutions need to be rescued like banks, they should be regulated like banks — why were we so unprepared for this latest shock?”

He accuses our financial leaders of playing “”Russian Roulette,” but that is simply another form of denial. Taking such chances is based on believing that you really can’t lose.

WHAT WE CAN’T THINK

The mortgage crisis brings home again our need for some form of market regulation.  Without it there is little check on speculation or manipulation and great danger of markets running amok.  But regulation seems now to be in that great dead zone of ideas that we can’t get our minds to engage.

So haunted with associations to old style capitalism, so discredited, such a bad idea, we stop thinking as we get close to it.  Whether it is the fear of ridicule from our peers, or the fear of being ostracized, or just the fear of being seen as stupid or out of touch, we keep our minds at a distance from the danger.  The surge of growth that followed deregulation, the victory of capitalism with the breakup of the Soviet empire, the power of special interest and their lobbyists on Capital Hill, the evisceration of existing regulatory agencies — all have become sources of intimidation to anyone interested in curbing the power of corporations to compete freely in the market.

“Groupthink” has familiarized us with how groups censor and proscribe thoughts that deviate from an emerging consensus.  The failure of Kennedy’s advisors at the Bay of Pigs, Nixon and Watergate, even Bush and the famous WMD — all are good examples of how thought gets obliterated.  This dead zone of thought operates on a larger scale — but it too is fueled by anxiety and fear and is no less pernicious to rational solutions to the problems we face.

To be sure, old style regulation did stand in the way of growth, and deregulation did seem to fuel significant growth.  Moreover, critics will add, there remain a host of regulatory rules that businesses and banks must comply with. But, surely, there is a middle way now in playing an active role to guide the private sector away from the disasters of unbridled competition.  If Washington can’t do a good job of it, perhaps a quasi-private amalgam of senior financial statesmen, ratings agencies, and foundations could step up to the plate.  But in order for that to happen, we would have to face the need — and to do that we would have to keep the need in mind.

What we don’t know we know about deregulation is how frightened we are to do that.