Creative Class

A BC reader comments on my Globe column:

I don’t think we’re in a recession so much as we’re in a revolution – and it seems closely linked to age and generation lines.

Anyone born after 1996, has experienced resistence settling into a career, paying off student debt, financing a house, a car, etc. The idea of working for one company during one’s working life is far fetched.

Having been denied the single family homes in the suburbs and it’s trappings, alternative values and lifestyles have emerged. There’s no loyalty to automakers, phone companies, or TV networks.

The new generation and economy has forced individuals to adapt to cheaper technologies, means of mobility, communication and a global marketplace. Raising families has been put on hold if not abandoned altogether. Even nationhood has become obsolete.

It’s a brave new world, but corporate boards and political parties have yet to figure it out – or are in a blissful state of denial.

As the new generation abandons traditional middle class mores and lifestyles, who will pay the taxes on increasing medicare costs? Who will purchase the homes built during this last boom and the baby boom generation? Who wants to finance a vehicle in which gas, insurance, maintenance costs continue to rise?

Click here for an interactive map of unemployment by county (via the New York Times).

BazzFazz sums it up:

Americans are still in a fair amount of denial about how bad things are going to get. In the leafy bucolic Boston suburb where I still have a house and the offspring continue to bring me delightful grandchildren, there are still lots of houses on the market for what are clearly delusional valuations … And it’s bad in so many places, and it’s going to get so much worse, that you have to wonder what, if anything, will help. Sadly, until the great asset write-down runs its course, not much will. And this process will take several years – which is why I think the U.S. will not be the first out of the current recession – it will probably be the last. Because the U.S. over the past two decades has tied up so much wealth creation – which has fed through the entire global financial system, mind you – in real estate in bad places. And the amount of denial here remains painfully high.

Yep.

Richard Florida will be on NPR’s Talk of the Nation today, February 18, from 3-3:45pm EST:

On the next Talk of the Nation: To Richard Florida, this recession follows the first rule of real estate: location, location, location. When the economy turns around, where you live might be more important than what you do.

Listen to the full broadcast here and share your thoughts with us.

Image from Justin Fox. It’s bad already. My guess is it will overshoot ‘81 by a considerable margin, especially taking into account Carmen Reinhart and Ken Rogoff’s research which finds that unemployment rises, on average, by seven percentage points over four years in the wake of serious financial crises.

Your thoughts?

New housing starts are down to a little more than 300,000 units. That’s the lowest level ever recorded by the U.S. Census starting back in 1963. Have a gander at this graph (via Calculated Risk).

Oh, and just for fun, housing supply is also at record levels (also via Calculated Risk).

So, what’s in store for the housing market – with all those jumbo (expensive house) loans in default, the economy worsening, and the mortgage market for anything beyond a conforming loan ($417,000 most places; $625,000 in some higher-priced locations) requiring 30-40 percent down payments and rates of seven and eight percent or more?

Some members of San Francisco’s creative class are taking advantages of bargain prices being produced by the crisis, according to this San Francisco Chronicle report.

For the younger employed set who lack crushing debt, mortgages or families to support, the recession has a silver lining: Previously out-of-reach items are suddenly affordable. As consumer prices fell 1.7 percent in November, the biggest monthly drop on record, some have decided to take advantage of the deals – though not without caution …

“In a year where we would have expected the consumer to say ‘no’ to spending, this younger generation – the young adults who have not had to divert all of their discretionary spending to other family members – continues to self-indulge,” said NPD Market Research Chief Analyst Marshal Cohen. “It’s not a new concept,” Cohen added, noting that “mobile young adult consumers” have always wielded buying power. “It’s just a surprise that people are doing it when they are told not to.”

Cynthia Jaspar, a consumer spending expert at the University of Wisconsin-Madison, said that although young people are vulnerable to job loss in a recession, they will continue to be an important retail sector. Indeed, both the Wall Street Journal and Forbes magazine have reported on the youth-driven bright spots in retail: American Apparel, Urban Outfitters and Buckle stores are some of the only clothing companies to see sales rise in November. Analyst Cohen points to the video game industry as a sign that young adult buying power remains strong …

But just because young consumers may be able to afford holiday sales doesn’t mean they are spending with abandon. Certainly, the culture of excessive spending itself has been called into question by the current recession. Many report a newfound sense of guilt or unease about buying things. “But I’m young, single and don’t have the burden of property. This sounds really sad, but maybe we’re like the carpetbaggers of the horrible economic situation.”

The new issue of BusinessWeek (December 22) finds economist, Michael Mandel digging into the jobs data. What he finds is very interesting: jobs in manufacturing, transportation, construction, and extraction are tanking – what he calls the “tangible sector” and we call the “working class” have cratered, but jobs in professional fields, management, and science and technology – he calls them the “intangible sector,”we say “creative class” – continue to grow. The U.S. economy has lost nearly two million jobs in the past year, close to the 2.2 million jobs lost in the 1973-75 recession (we’ll go past that benchmark soon if we haven’t already), and unemployment (as officially defined) stands at 6.7 percent. But unemployment in manufacturing is 9.4 percent and even higher, 12.1 percent in construction and extraction. Here’s the rub. Of nearly all the 1.9 million jobs lost, 1.8 million of them  were tangible sector jobs. The intangible sector actually added 515,000 jobs. The economic effects of the crisis remain very uneven for socio-economic classes and for regions.

A recession can be a good time to re-think corporate strategy, products, and especially R&D approaches.  Indeed, what many companies want to achieve is the next breakthrough that launches the organization forward or in a new direction – a disruptive innovation.

The challenge can be to, (a) get enough people on board and (b) actually shake things up enough that change can happen.

In a recent Knowledge@Wharton article, the author highlights a presentation from Jeong Kim, President of Bell Labs at Alcatel-Lucent which describes in detail these challenges as well as how he has managed to surmount them.

The problem is that success creates a virtual construct, a paradigm of “How to Do Things,” inside of which new thinking cannot flourish. Kim calls it “The Curse of Knowledge.” Cross-discipline teaming “is one way of breaking the Curse of Knowledge,” he says. Another is “experience pairing,” or matching a senior employee with an individual who has considerably less experience, but a fresh perspective on how to solve problems.

….

Kim offered a case study from Alcatel-Lucent – Lucent Technologies at the time – on how to inject a spirit of disruptive innovation into an existing and stagnant culture. Lucent’s optical networking division was severely underperforming and the company fired the unit’s top managers. “I was really convinced that the reason I was put in there was that nobody else would do it, and they needed somebody to blame,” says Kim.

The division was moribund: Financial results were disappointing and morale was low. Kim shook up the management team and took the survivors to an off-site retreat that featured whitewater rafting. “First thing they do is say, ‘Why are we doing this …?’ After a while, they get really bored.” The exercise, intended to foster teamwork and cooperation, was designed with the help of a psychologist. Instead of cooperating, the managers began splashing one another with their oars, “like little kids.”

But the exercise-psychology experiment wasn’t over at the end of the rafting run. “After six or seven hours of whitewater rafting like this, they were tired.” That evening over dinner, people let their “at-work” guardedness down and spent time learning about one another.

The next day included all the off-site strategizing and white board sessions one might expect, but Kim says the interaction was more genuine and productive than if they had met as they were previously, a grouping of near strangers. In the first quarter following that meeting, he says, the group posted revenues of $510 million, $560 million the next quarter, then $730 million, then $970 million. The point, he adds, is that “teamwork is so critical for the success of a company.”

….

“You have to make an investment in capital, human knowledge and networking,” says Kim. “That’s the way to get ahead.”

A key point to remember here is that there are many ways to invest in “human knowledge and networking.”  There are also many ways to “disrupt” existing norms in order to shake out a more disruptive innovation.

Workplace change could be one – having employees to sit in different places, or around different people.  Another option would be introducing new employee activities (whether rafting or something else that gets people interacting and connecting to different people and in different ways).

What efforts (if any) at “disruptive innovation” are you seeing?

This Monday, the world’s governments took a final plunge on fixing this crisis by basically assuming the debts of the world’s important banks. In the U.S., the politics of who receives the bailout and who doesn’t will be interesting. In my mind this gamble poses two questions:

1)  Will it be enough to prevent a collapse of the financial system?

This is a difficult question to answer.  I have my doubts.

If this extreme program operates as many think it might, it would guarantee that a certain set of banks would not collapse. The reasoning seems to be that these guarantees will unfreeze credit markets. For this the governments of the world will take hundreds of billions of bad bank loans, default swaps, structured investment vehicles, and all manner of so-called assets (probably worth zero or close to zero) onto their books. The sheer scale of what is being proposed can be seen by the aftermath of the Lehman Brothers bankruptcy. We now know it had worthless loans and assets of, at least, $100 billion. Some Europeans are saying that Lehman’s collapse cost them about $300 billion. We also know that almost always in such bankruptcies the true cost is greater than what is initially reported. Let us extrapolate from this and assume (because to take on all of them would be unimaginable) that when the Treasury/Fed say they will bail out banks, they only mean a few key banks and leave the rest to their own devices (there is evidence for this suspicion as the large regional banks such as Sun Trust and Zion did not participate in the huge rally on Monday). So, which banks will be bailed out? My guess is Goldman Sachs (Paulson and Robert Rubin’s ex-employer), Citi, JPMorgan Chase, Bank of America, and a few others (did Wells Fargo buy Wachovia so that it could enter this charmed circle?).  P.S. – We now have confirmation of which firms are being bailed out: JPMorgan, Goldman, Citi, BoA, Wells Fargo, Merrill Lynch, Morgan Stanley, State Street Bank [thank you Barney Frank], Bank of NY Mellon [thank you Hillary and Schumer].

Will this unfreeze credit markets? I think it is unlikely for two reasons: One, if you are an unprotected bank, then why would you lend at all? If you are one of the protected, then banks why on earth would you lend to any organization outside the circle of protected banks? The assumption appears to be that the actors in the system will now assume everything is fine and begin lending. If as everyone expects a recession is coming and most firms are highly leveraged, lending would be very risky. What type of collateral for a loan could you receive that would be worth as much in a bankruptcy tomorrow. Of course, one could have loans or investments a la Warren Buffett in Goldman Sachs or GE, which charge nearly usurious penalty interest rates of 10 percent and radically dilute the common stock holder, i.e., our pension funds and 401Ks.

The world’s governments have taken what appears to be a final step by assuming on the debt of their largest and privileged banks, they are committing future taxpayers to valorize today’s debt. They are not yet willing to admit openly that the taxpayers are buying garbage and moving it from the banks to themselves. Governments appear to hope that by moving some portion of the garbage to the taxpayer the problems will go away. This is similar to the belief among Bear Stearns, Lehman, and AIG executives that hiding garbage debt inside their firms and then lying about it to the public would make the garbage disappear.

So will this newest plan unfreeze credit markets and encourage banks to loan again? Unlikely, but no one has a crystal ball.

2) The second question is this: Is the financial system telling us something far more profound about the underlying economic situation?

Why is this the most important question? If this is a profound crisis in the core of the economic system, then these approaches are merely treating symptoms and are destined to fail (sort of like treating metastasized cancer by surgically removing parts of the body). Remember, Ben Bernanke has been called the “foremost expert on the Great Depression” by his fellow mainstream economists. Bernanke essentially lays the problems of the Great Depression on bad financial policy by the Federal Reserve and other fiscal and monetary mistakes. This belief says that government fiscal and monetary policies, if well administered, can circumvent capitalist economic crises. Marxists and Schumpeterians are not so sanguine. Particularly Marxists argue that the Great Depression was the expression of fundamental discontinuities in the underlying economy and, if this is the case, then attempts to patch the current system up are bound to fail – and probably in the process waste resources and time.

Let me play out the reasons that we may be in a more profound crisis and, if this the case, why the current ever more panicked efforts by governments to swallow private sector debts cannot provide a basis for a sustainable recovery.

a) The forces of globalization are still underway and, as many of have been saying, they are putting downward pressure on incomes in the developed nations, which, of course, are the consumers of the products of the developing nations. A small telltale of this, IBM announced dramatically increased profits on only slightly higher sales. My guess is that these profits were made by substituting low-cost developing world service providers for their high-cost developing nation employees. This dynamic will continue putting pressure on wages in the developed nations and contributing to a deflationary dynamic.

b) Real wages have stagnated in the U.S. since 2000 for all but the wealthy.

c) Income inequality has increased globally and, as a result, the vast majority find themselves less and less capable to consume.

d) The technological revolution of digitization has changed the central source of value creation from the assembly line to the designer/engineer.

e) The entire credit complex that was built up after World War II that Vance Packard decried and the cult classic The Hidden Persuaders may be at its endpoint. This would mean a deleveraging on a scale never before seen in human history. Is it possible that we can no longer borrow from the future because the future is now?

If our situation is, as I suspect, more profound, then the newest bailout will fail, and this will be clear soon.