Creative Class

The ever-growing financial bailouts have produced a growing sense of outrage in America. Simon Johnson, professor of economics at MIT and former chief economist at MIT, writes in The Atlantic that America’s financial elite are putting their won interests ahead of their country and essentially looting it to enrich themselves and enhance their power.

Johnson compares America’s new financial oligarchs to their Russian counterparts, and says that their considerable political clout amounts to a “silent coup” which paralyzes the country from undertaking much needed sweeping reform of its banks and financial institutions.

The solution is obvious to anyone who has been part of the IMF or understands the financial crises that have affected other countries. Johnson writes, nationalize the banks and limit the power of the financial elite. But he fears this cannot happen because of their unvarnished power.

Johnson seems convinced that if the financial roots of the the current crisis are not dealt with it will end up worse then the Great Depression.

Sobering stuff. Read it closely.

In a word - no.

Citing Justin Fox’s terrific chart of unemployment then and Kevin Drum’s comments, the always-insightful Matt Yglesias writes:

Populists on the left and opportunists on the right have taken to condemning the series of “bailouts” the government has undertaken since the fall of Lehman Brothers. And certainly I think these situations have been mishandled in a number of respects. And beyond that, I think these situations are inherently problematic in a variety of ways. But there’s a strong case to be made that the policy response to the recession has made things better than they might otherwise have been. When I say something like that, people tend to pester me in response for specifics: What, exactly, would have happened if we’d just let AIG and Citi and Bank of America and others collapse? The problem is that it’s impossible to say, in detail, what would have happened.

Yglesias is right: It’s hard to say exactly what might have happened without the bailouts and stimulus.

But something much bigger is at work today then in the 1930s. It’s the structure of our economy that’s the key – and that dwarfs the effects of government bailouts, stimulus, and related policy.

Our economic class composition and occupational structure have changed dramatically over the past several decades. In the 1930s, the majority of Americans worked in manufacturing and related industries. We had an enormous working class. These industries and jobs are very vulnerable to recessions and business cycle shifts with tremendous ups and downs. Recessions – never mind bigger events like the current crisis – devastate manufacturing and working class jobs -  as Michael Mandel, Ryan Avent (which Yglesias more recently cited), and our own research at the Prosperity Institute has detailed. The creative class, which now accounts for some 40 million workers and about a third of the workforce is much more flexible and resilient. It is this changed economic class and occupational structure which are keeping us from Depression-level unemployment rates.

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs.  On the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink. The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy – and consumer demand – for a new round of growth. The financial and banking sector grew massively bloated – in terms of employment, share of GDP and wages, as the detailed research of NYU’s Thomas Phillipon has shown – and likewise have to come back to earth.

On the other hand, there is the classic question: What better and more effective things might have been done with these trillions? That’s for historians to ponder and decide. But the combination of the massively misallocated resources produced by the bubble (plus the costs of military adventures) combined with humongous bailout spending puts the U.S. behind the economic eight-ball in a way it has not been in more than a century. Having hold on the reserve currency helps, but it cannot absolve all these compounded sins.  Sooner or later the money will run out; bills will come due.

That creates a wide open structural opportunity to accelerate what Fareed Zakaria has dubbed the “rise of the rest” to accelerate. Crises are periods where the relative position of nations and regions can and do change dramatically. (Do I think the U.S. will lose its hegemonic position: Of course not. My hunch is that the U.S. is in the same position structurally as England at the onset of the Long Depression of 1873. It was not until the next major crisis – the Great Depression of 1929 and the onset of WWII that it lost its position to the United States. So worst case: The U.S. has one more long-cycle at the top of the heap). But, just think of all the ways the trillions of bailout money could be used to build the economy of the future. And while you’re doing that imagine that some other places outside the United States that have been patiently building and conserving their resources may start to figure out how to do just that.

The clock of history ticks on. Over time, it tends to leave behind those places who get stuck, get trapped, or try too hard to breathe life back into the old order, neglecting the new one that is emerging. And that’s what really worries me.

Like many people, I was uplifted by President Obama’s speech Tuesday night. But, today it’s back to the real world. I find myself in total agreement with this assessment from Seeking Alpha.

You have undoubtedly heard of the Case-Shiller Index. It is a commonly cited index for tracking housing prices. The December read is now out showing a YoY drop of 18.5%, worse than predicted. That is not what is scaring me … He has an index of American home prices going back to 1890. According to this index, the housing bubble we just experienced was by orders of magnitude worse than any other we have ever seen in this country. Moreover (you better be sitting) housing prices have a lot further to drop … He believes we are only halfway back to fair value and usually during a correction we overshoot fair value. You add into this equation the effects of a global downturn, job losses, reduced wages and the like and one can easily imagine us overshooting the trend line significantly.

I firmly believe we will not find a bottom on the economy until we find a bottom on housing. From this data, that bottom is still a long way off, as in 3-5+ years off, and it is a lot lower than most have predicted. That is far worse than this doom-and-gloomer was thinking.

So that puts recovery out to say 2012 or 2014. From where I sit, that may even be too optimistic. Both the Long Depression and the Great Depression lasted some two decades before real recovery came about. I could be in my 70s before this thing turns around. And unless he has four terms or so, Obama will not preside over recovery. My heart may feel differently, but my head tells me there is a long, long road ahead of us.

Ed Glaeser says it’s time to kill – or at least maim – the tax deduction for interest paid on mortgages.

The Great Depression provided an opportunity to rethink old policies in a major way. In the current morass, everything should, once again, be open for debate. One sacred cow that has long been in need of a good stockyard is the home mortgage interest deduction. So, in the spirit of libertarian progressivism, I suggest gradually reducing the upper limit on the deduction to loans of up to $300,000, and then refunding the tax revenues in a more productive manner.

He’s right – especially on the broadest point. Do away with the mortgage interest deduction. But the reset provides the opportunity to really rethink and restructure the housing system more broadly.

The only way toward long-run and sustainable recovery is a dramatic change in where and how we live. What ultimately got us out of the Long Depression of the late 19th century and the Great Depression of the 1930s wasn’t just new technology, or creative destruction, or government spending, it was a phase-shift in the way we live – in our economic geography. The recovery after the Long Depression took shape around the rise of the industrial city and its streetcar suburbs. The recovery after the Great Depression was powered by suburbanization. We need a massive shift not just in our infrastructure but in our housing system.

The reform and restructuring of the housing system needs to be much deeper and go much further than reigning in the mortgage interest deduction. We need to bring our mortgage-lending practices into line with those of other advanced countries, like Canada or Sweden or most of Europe. That means much larger downpayments and penalites on prepayments; shorter term loans; and all the rest – just like my very own mortgage in Canada. Sure that means increased cost and shared risk, but it comes with a much more stable  housing market (where you can still get a mortgage and buy and sell homes) and a much more stable banking system. And we have to encourage other forms of housing tenure, like renting, which are in sync with the labor market flexibility and residential mobility the adavnced creative economy requires.

Worse than the Great Depression of the 1930s, that’s what high-level UK government officials are predicting according this story in The Independent (h/t: Alison Kemper).

In an extraordinary admission about the severity of the economic downturn, Ed Balls even predicted that its effects would still be felt 15 years from now. The Schools Secretary’s comments carry added weight because he is a former chief economic adviser to the Treasury and regarded as one of the Prime Ministers’s closest allies…

Mr Balls said yesterday: “The reality is that this is becoming the most serious global recession for, I’m sure, over 100 years, as it will turn out.”  He warned that events worldwide were moving at a “speed, pace and ferocity which none of us have seen before” and banks were losing cash on a “scale that nobody believed possible”.

“The economy is going to define our politics in this region and in Britain in the next year, the next five years, the next 10 and even the next 15 years,” Mr Balls said. “These are seismic events that are going to change the political landscape. I think this is a financial crisis more extreme and more serious than that of the 1930s, and we all remember how the politics of that era were shaped by the economy.”

At 93, he provides razor-sharp insights into the current crisis in this interview in Japan’s Asahi Shinbum (via Mark Thoma).

I think it is definitely the worst crisis since the 1929-1939 Great Depression, both in America and globally, and I think it was an unnecessary breakdown as there was no need for America to have a meltdown.

When George W. Bush became president in 2001, he inherited a country with quite sound (fundamentals) from President Bill Clinton with an overbalanced budget. … George Bush will go down in the history books as the worst president that America has had in more than 200 years. And, that couldn’t have happened if the voters had not moved to the right …

One is the Iraq war, which is a disaster. It’s as bad as the Vietnam War and the Vietnam War entangled four or five presidents and there was no victory. … But the other reason is because people on Main Street in America are hurting. The reason they’re hurting goes back to 1995 when Alan Greenspan, as the chairman of the Federal Reserve Board, made no efforts to curb the stock market bubble.

So the American electorate is very unhappy. Free trade and globalization add to world productivity. It also adds to the potential standard of living of many people, but unequally … The whole history of capitalism has had up-bubbles in real estate and down-bubbles after something different. This time the new fiendish Frankenstein monsters of financial engineering blinded the eyes and the minds of everybody.  The CEOs and the chief financial officers are the most surprised people. Nobody learned any lesson from Long-Term Capital Management. And what happens with this “new financial engineering” is an incredible “super over-leveraging” and you don’t even know you’re doing it. You know, it’s as if you’ve been blindfolded. And nobody learned any lesson from that. …  And this all could happen only because Bush, with his “compassionate capitalism” appointed incompetent people …

This is a new crisis because if you look at its bottom it says, “Made in America” (laughter). It’s not Thailand. It’s not Mexico. It’s not Argentina. It’s America. And, of course, it spread from there. Could you believe that the whole country of Iceland is bankrupt? Icelanders were the happiest people two years ago. They’re the unhappiest people today. …

Rome was not built in one day, and Franklin Roosevelt did not get full employment. It took about seven years. Now I don’t say it’ll take seven years this time, but it won’t be done with a balanced budget and it won’t be done with “inflation targeting” …

Spending in the direction of the poor part of the population (is important) because those are the people who are most likely to re-spend. If you primarily spend in the direction of your millionaires, that won’t make any difference.

The New York Times notes that the crisis is turning design from decoration and frivolity to function.

The pain of layoffs notwithstanding, the design world could stand to come down a notch or two — and might actually find a new sense of relevance in the process. That was the case during the Great Depression, when an early wave of modernism flourished in the United States, partly because it efficiently addressed the middle-class need for a pared-down life without servants and other Victorian trappings.

Patrik Jonsson in The Christian Science Monitor notes that the crisis may be ending the McMansionization of the suburbs and some cities (via Planetizen).

With housing prices off by 18 percent in 20 US cities in the last year and new home starts at a 26-year low, bulldozers have slowed their march across American cities and towns. In Westport, Conn., teardown permits are down in the last year by 33 percent – a figure that experts say can be extrapolated nationwide, though teardown trends do have significant regional variations. Analysts expect the lull to last at least five years, perhaps 10.

My own hunch is that we are witnessing a sharp turn toward quality and functionality. The Great Reset will mean smaller, better, more efficient spaces, and an emphasis on higher quality design from the artifact to the city and regional scales. Call it wishful thinking, but the logic of the economy is at least pushing in the right direction.

Here’s a quick run down of some 2009 economic forecasts. I am sort of amazed at how gloomy they are.

Paul Krugman on the second Great Depression:

The fact is that recent economic numbers have been terrifying, not just in the United States but around the world. Manufacturing, in particular, is plunging everywhere. Banks aren’t lending; businesses and consumers aren’t spending. Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression. …

Tim Duy titles his recent Fed Watch, “Starting on an Ugly Note”:

The only certainty for the New Year is that policymakers will continue to pull out all the stops to keep a floor under the US economy. And recent data highlights the difficulty they will face. Hope is high that the incoming Obama Administration can provide the stimulus necessary to generate economic growth by the second half of 2009. The numbers being floated look sufficient to do the job. But will the package provide little more than short term relief or a lasting fix?

Willem Buiter at the Financial Times:

The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally. Even the most hard-nosed, Guantanamo-bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed. Key wholesale markets are frozen; the internationally active part of its financial system has either been nationalised or underwritten and guaranteed by the Federal government in other ways. Most market-mediated financial intermediation has ground to a halt, and the Fed is desperately trying to replace private markets and financial institutions to intermediate between households and non-financial operations … The legal framework for the regulation of financial markets and institutions is a complete shambles. Even given the dismal state of the legal framework, the actual performance of key regulators like the Fed and the SEC has been appalling, with astonishing examples of incompetence and regulatory capture.

There is no chance that a nation as reputationally scarred and maimed as the US is today could extract any true “alpha” from foreign investors for the next 25 years or so. So the US will have to start to pay a normal market price for the net resources it borrows from abroad. It will therefore have to start to generate primary surpluses, on average, for the indefinite future…

There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place. The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of “dark matter” or “American alpha” is not credible.

And, Jim Kuntsler:

We’ll turn around early in 2009 and discover that we are a much poorer nation than we thought because from now on credit will be extremely hard to get for anyone for anything. The businesses that survive will have to keep going on the basis of accounts receivable. This is the area where the crash of giants will be heard. I’ve been saying since publication of The long Emergency that comprehensive downscaling in all our activities, from farming to business to schooling to governance, will be the categorical imperative of the years ahead. Giant enterprises requiring giant loans to get from quarter to quarter will tend to not make it. Borrowing from the future will become a practical impossibility as past bad debts from previous borrowings continue to unwind, cease performing, and get written off. This argument implies that the federal government will tend to flounder just as General Motors, Citicorp, Target Stores and other gigantic enterprises will tend to flounder. It would be sad to see a President Obama so hamstrung and helpless, and it is largely why I see his role as largely symbolic — as a reassuring presence encouraging the distressed public to bravely bear their hardships, and to be kind and helpful among their neighbors.

Households, like businesses, will have to pay as they go from earned income. The house as ATM is over. Credit cards are maxed out and credit ceilings are lowering like the ceiling in “The Pit and the Pendulum,” preparing to slice-and-dice the old “normal” of family life in America. Bankruptcy will be the new Nascar. A lot of families will lose everything. They will sift and disperse into the housing owned by other family members — parents, siblings — and a strange new not-altogether comfortable kind of togetherness will become common. Over time, a lot of people will go looking for casual work “under-the-table”( and probably low-paying). To some degree, these workers will begin to look and act like a new servant class, and before too long they may be absorbed into the households of people who employ them. There will be plenty of room for them there.

Counties, municipalities, and states will join in the bankruptcy fiesta. It would be reasonable to expect collapsing services as a result. This would be a situation fraught with danger — of rising crime, of public health emergencies as water systems are not kept up and sewage treatment becomes unaffordable. I don’t imagine the federal government stepping into every Podunk or Metropolis from sea to shining sea and propping up these services. People will have to cope with danger and deprivation.

While part of me is drawn to the “going-to-hell-in-a-handboat” perspective, I am also amazed at how the economy is holding up in light of 2008’s multiple body blows. Have we managed the worst and been able to turn the corner, or is this just the beginning of the Great Reset?

Rich has already written about how 1930s New Deal stimuli projects will not help this country prepare for the 21^st century global economy. Bloomberg has an incredibly insightful article on the Obama stimulus package. In effect, all the funds that will be appropriated for infrastructure will go for fixing old roads and building new ones to open new open spaces to crackpot development. Whatever one believes about global warming, this is certainly environmentally irresponsible and a step in the wrong direction. Moreover, it will cost cities, which, as Rich, Ed Glaeser, and many others have shown, have subsidized suburban development in the past. Now, U.S. “leaders” want to give us another dollop of past solutions. Optimistically applying old solutions (like ever greater indebtedness) for a debt and insolvency crisis is definitionally “crackpot.”

Can Obama translate his vague promises of change into a real change of direction for this country? To those that responded to my posting about taxation decisions, thanks.

I hope you all have great holidays. Rest, have fun, and prepare to put your thinking caps on because next year will be the most important for the global economy since 1933. We need to be there with alternative solutions and open the space for debate. Otherwise, the economists with old failed theories, some of whom claim to understand the Great Depression, will continue to provide crackpot solutions… to be discussed in the next posting.

In a marvelous and thought-provoking essay, Drake Bennett speculates:

By looking at what we know about how society and commerce would slow down, and how people respond, it’s possible to envision what we might face. Unlike the 1930s, when food and clothing were far more expensive, today we spend much of our money on healthcare, child care, and education, and we’d see uncomfortable changes in those parts of our lives. The lines wouldn’t be outside soup kitchens but at emergency rooms, and rather than itinerant farmers we could see waves of laid-off office workers leaving homes to foreclosure and heading for areas of the country where there’s more work – or just a relative with a free room over the garage. Already hollowed-out manufacturing cities could be all but deserted, and suburban neighborhoods left checkerboarded, with abandoned houses next to overcrowded ones.

And above all, a depression circa 2009 might be a less visible and more isolating experience. With the diminishing price of televisions and the proliferation of channels, it’s getting easier and easier to kill time alone, and free time is one thing a 21st-century depression would create in abundance. Instead of dusty farm families, the icon of a modern-day depression might be something as subtle as the flickering glow of millions of televisions glimpsed through living room windows, as the nation’s unemployed sit at home filling their days with the cheapest form of distraction available.

Any other thoughts our there on what a depression of the 2010s might look like?