This post was written, at my request, by Carson Gross, one of our regular readers and a multi-talented person I have worked with in the past. (We met one night when I needed help debugging a classpath error I was getting on my computer.) I don’t necessarily agree with what he says, but I think he has something valuable to say. Everything below is by Carson.
James asked me to elaborate on a comment in which I worried about the public’s reaction to the real or perceived wealth transfers occurring during this financial crisis – in particular, how that reaction would manifest itself culturally.
“Wealth transfers” is a charged term, and a lot of smart people have spent a lot of time patiently explaining that, in fact, most of the bailout thus far involves loans and that, under some models (which, apparently, don’t include housing prices regressing to roughly 3x incomes, where they have been for most of history) we, the taxpayers, may actually end up making money on this whole thing. I think that’s fanciful, but I’m not going to debate that here. Rather, I want to focus on the bailout’s cultural impact.
I assert, without proof, that the proverbial man on the street sees the words “bailout” blaring on his TV and computer screen day in and day out, and doesn’t care to look too deeply into the details. Who can blame him? He has enough of his own problems to deal with without attempting to decipher deliberately impenetrable financial jargon. Even if the government is getting reasonable compensation for the capital injections in some cases, the man on the street just sees more of his tax dollars going into banks to pay out people who make orders of magnitude more money than he’ll ever see. That’s his reality.
And, despite the tut-tuting that this is a shallow view of what is happening currently, I think his view is correct in a deeper sense: the wealth transfers have already occurred, during the boom, when no one was looking. The money has already been sucked out, we all know it, and now it comes down to who holds the multi-trillion dollar bag. The banking industry doesn’t produce wealth: it is there to efficiently allocate capital between alternative uses in the broader economy. Therefore the replacement wealth will have to come from somewhere else. People in the real economy sense, correctly, that it’s going to come from them, be it through inflation, higher interest rates, higher taxes, or some combination thereof.
How will this realization affect the culture and how will that, in turn, affect our economy? Here are three changes that I see: one that is happening, one that is imminent and one that has already occurred:
- Currently, in the broad culture, a “where’s my bailout?” meme is becoming increasingly dominant. You can see it written on the faces of auto executives as they go before Congress and you can see it in the debt-relief ads playing off the various bailout programs that have sprung up on TV. This dependent mentality has been devastating in other countries and ages, and will lead to decreases in productivity as people simply give up, muting an economic recovery.
- Imminently, in industries other than banking, high earners will increasingly resent the higher taxation they are being asked to shoulder to fund the bailout. This will cause further, and more severe, decreases in productivity. This is speculation on my part, since no one has been asked to pay higher taxes yet. However, based on the conversations I’ve had with friends and colleagues over the past few months, I believe that this will indeed happen. When smart, dynamic people start throwing in the towel, the real economy loses a huge source of productivity.
- Finally, consider the astonishing revolution in homeowners’ attitudes towards defaulting on a mortgage that has occurred in just the last 18 months. Defaulting has gone from being a mark of shame, to an understandable misfortune to, almost overnight, a smart financial move. Eric Hovde comments on this radical change in this CNBC video at the 9:30 mark. It’s a truly scary sort of cultural change. Mortgages were the most stable private financial transactions we had to build our banking system on. Can banks in good faith offer the mortgage rates that they once did, after the government has withdrawn pressure from them? We’ve fundamentally changed the risk of holding mortgages, making them more risky. Eventually the market will reflect this, whether we like it or not.
There may be technical solutions to the banking problem. However, if those solutions do enough damage to the cultural framework on which the system was based in the first place, even the most brilliant among them will be useless. The eye-rolling from both the academy and Wall Street when people make moral arguments regarding the bailout is short-sighted and, ultimately, ignorantly technocratic. Paraphrasing C.S. Lewis: we must not saw off the bough that we are sitting on.
Step one: stop cutting.
Originally published at the Baseline Scenario and reproduced here with the author’s permission.