The Cultural Costs of Bailout Nation

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.

Posted by James Kwak

79 responses to “The Cultural Costs of Bailout Nation

  1. Excellent job in telling everyone to shut up, and sit in their designated “nice person” bough Carson!

    You must think that the bough we sit on is one that requires decisions to be made that rob a country blind is the way to go!—It was a “moral hazard” to give Lehman, the most hated competitor to Goldman and Morgan a 6billion dollar loan, even though not giving them their loan sealed their fate, but set the seeds for taking out this direct competitor for Goldman and Morgan enhancing their marketshare. Also, it enables a bigger scam to unfold, to get counterparty money flowing through the backdoor of AIG, suddenly we have “too big to fail” even though Freddie/Fannie wasn’t too big to take into receivership…and it is the bough we sit on when we have secret no transcript meetings to pass out 125billion to the monopoly crowd, but we are all supposed to believe that we are pencil pushing technocrats who couldn’t possibly understand how sacred and holy the actions of the bank bailout have been and so we need to be nice, and hope our bough wont fall, and be still to keep it in place!

    Your concerns offer the implications about the broad culture costs of the bailout are as clear as can be… you have no patience for anyone using rational understanding and critical thinking because this gets in the way of your beloved constructs that must motivate you to advire the ingenious makers of this scam–you are a cheerleader for the rotten bough keepers, but at the same time, you are right—if robbing the future of our country is the example that our country has about how to behave this kind of corruption certainly is part of the shameless culture you discuss.

    I would rather get off the bough and find medicine to cure the diseased tree that I have as a home. I don’t think the rotten bough crowd live on the tree, I think they live under something else.

  2. If you don’t mind me saying so, I have no idea what Sophie is trying to say. Would someone like to translate it for me?

  3. Sorry…..no idea but seems like a misunderstanding of your post….I think

  4. Carson,

    With the usual expertise, to your three points, sort of:

    If a helicopter flies over the square at noon on Sunday and dollar bills fall out, people will scramble to pick them up. If it happens next week, more will do the same. Next week, there will be a crowd waiting. If the helicopter flies over without dropping dollars, people will hang around. After several weeks of no dollars, people will give up.

    Your friends and colleagues must be well off. With millions in net worth, it is easy to go off in a huff. If they are doing it for the money, they are probably not that good. Compensation is relative to ones peers. Self worth does not come from absolute dollars, just relative ones. I am not worried about a lack of talented people.

    The sub-prime business model was, these people have less chance to pay off a mortgage with a normal interest rate, so lets charge them more to make up for the risk. When the tide went out, the stupidity became apparent. It is also of course insane to pay 20% or more interest on credit cards to by stuff today rather than tomorrow. A national usury law would fix this. Hopefully, we can get back to a regime where qualified borrowers pay semi-rational interest and all others pay cash.

  5. Young Economist

    Geithner’s plan is siphoning plan

    Geithner’s plan is worse than Pualson’s plan because the plan will definitely cause over-pricing assets purchase and also cause the siphoning from taxpayers’ money into banks and Wall street investors, definitely worse than Madoff ponzi scheme. Why? We are allowed the assets sellers-Wall street investors (Banks, Hedge funds and all kinds of funds) can join in the program to buy assets. They can be both buyers and sellers and they can set up groups of buyers to bid the assets at the over-price and the loss will come to taxpayers’ money. For example, the intrinsic value of asset at 100 dollars but the sellers and buyers are the same Wall Street investors such as CITIGROUP, JP Morgan of BofA. They definitely want to buy like 150 dollars meaning they will gain 43 dollars (gain from assets sales at 50 dollars but loss from private capital investment at 7 dollars) but the tax payers’ money will lose 43 dollars from the public capital at 7 dollars and the FDIC guaranteed bonds at 36 dollars. Therefore, Geithner’s plan is siphoning plan from taxpayers’ money into the banks and Wall Street investors. If the total plan is 1 trillion dollars, we could expect the loss up to 300-400 billion dollars if they allow Wall street investors to join buying at 40-50 % over intrinsic value. Therefore, we should reduce conflict of interest by not allowing the sellers or the investors who are holding the assets to join buying assets in the program.

    Why depression occur from government’s reckless intervention

    Another point I would like to explain why the economic situation is getting worse to depression if the policy makers transfer the loss from the private investors to taxpayers or we call it as the severe cost of intervention. We have to understand that the private investors/speculators hold the risky assets under risk management plan that they can get loss from investing; however, the taxpayers do not have the plan or risk management for the loss on investment. Therefore, when the government intervene the market and get loss (we are definitely facing the increasing loss of FED and FDIC and we could expect to see more under reckless Geithner’s plan), it is like money transfer from private investors into taxpayers and taxpayers will have to compensate the loss by higher taxes and higher cost of living such as the higher inflation or higher cost of fund such as the higher long-term government bond yield. I think the worst case scenario is not recession with deflated price but the depression with hyperinflation because there will be the wealth destruction to consumers and taxpayers not free lunch private investors or producers. I think every country face the same problem; all the loss going to taxpayers but all the gain going to investors and producers and this is the real crisis of economic sustainability and the huge burden to the next generation.

  6. Basically, the banks defaulted on their mortgages before laypeople did on theirs.

    Laypeople are being told the banks are managed by the brightest and smartest.

    Why would anyone complain that, for once, laypeople follow the lead of the brightest and smartest? ;-)

    —–

    In the past, it has been proposed that unpayable debt could be cancelled for developing countries — UK Parliament document: http://is.gd/oGL9- — no rickrolling, I promise! ;-)

    Since it now seems everyone is owing everyone else much more “money” than one can imagine to pay back, can’t a global toxic debt cancellation be envisioned?

  7. Carson, thanks for unpacking the Santelli line in non-rant form. All these productivity losses you predict depend, I gather, on the assumption that the wealthy in non-financial industries will nolens volens withdraw in disgust at being forced to pay for the excesses of their banking brethren. This strikes is little more than Rand-inspired preening. I ask: where they gonna go?

    With that said, I agree with your central observation, namely that: “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.”

    Another possibility that you should consider is that the cultural turn will be in a much Bolshier direction. Specifically: that there will be demands that the finance sector will be re-regulated into a low margin, utility-providing business; that “corporate excess” will become culturally unacceptable; and that, in general, the cult of executive authority will draw to a close.

  8. Dear Carson,

    Please forgive me for misunderstanding to whom you directed your “Step One: stop cutting the bough” advice.

    I am one of those people making a moral arguments. So, please, nevermind what i previously said, and thank you for your advice.

    Sophie

  9. I just don’t buy the tired old line that high taxes will make the stars of the economy lose interest in working and the loss of their talents will bring the whole economy to ruin.

    First of all, there is the myth of the small circle of stars who can’t be replaced. Sure some people are more talented than others, but there are lots of talented people out there waiting for their break. If the current batch of high earners pack up their toys in a huff because high tax rates make them mad, there will be no problem finding equally talented replacements out of the large pool of equally talented people yearning for a chance to show their stuff.

    Second, I have no empirical evidence for this, but as far as I can tell, most of the truly talented do what they do for the simple glory of exercising their abilities. Sure they like the money, but I really doubt a real star is going to sit home and watch soaps all day because his marginal tax rate is 70%.

    Third, the marginal hedonic utility of an additional dollar of income past a certain point is vanishingly tiny, and so taxing those dollars at a high rate will do little to change behavior.

    Finally, would it be the end of the world if a large portion of our titans of industry walked away? Our current corporate leadership pretty much ruined the global economy with their decisions. Some made a direct contribution by making shortsighted and reckless decisions. Others stood by and did nothing to try and stop the reckless and dangerous decisions of others. Others supported excessive deregulation. If that whole generation of leadership walks away and is replaced by a new generation who is less motivated by naked greed then I think that would be a good thing.

  10. Carson, I agree with the points you raise. I am foruntate enough to have cash in the mattress, and if I lose my job, I’m not sure how quickly I will seek another. Why should I put my sweat into paying for the excesses of bankers and mortgage dead-beats?

    I’d much rather spend my days clipping coupons on the beach.

  11. The places where housing prices have fallen far enough to justify walking away from mortgages is pretty limited. 35 counties account for 50 percent of the foreclosures.
    I lived in Texas in the 80s when falling oil prices cause a real estate crash at least as severe as the one seen now in the those 35 counties. One of my good friends walked away from a house and a mortgage. Seven years later he had no problem getting a loan, owns a 3000 sq ft house on a golf course in Austin now. He’s not walking away from this one.
    Walking away from mortgages has a lot less to do with culture and more to with the sign and magnitude of the owners equity. You want committed homeowners out in the hinterlands? Get a 20% down payment, does not take an MBA to figure this out.
    If you are worried about cultural changes for the worse, I’d be more worried about a culture in DC and New York City that allows finance companies to create a billions of dollars of zero money down mortgages and not go through bankruptcy when they blow up, courtesy of the tax payers.

  12. Guest contributer, Carson Gross wrote (March 24, “The Cultural Costs of Bailout Nation”):

    “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.”

    James Kwak wrote (March 23, “Economics, Politics, Outrage, and the Media”):

    “Outrage is an emotion, not a rational choice. Blaming outrage is like blaming greed: it’s an unavoidable part of the human condition. The question is whether we can do anything about it.”

    I’d like to comment on these remarks from a non-financial perspective. The proposed “technical solutions” of which Carson speaks will not further damage the cultural framework: that framework is the problem and must be replaced. James frames the right question, “can we do anything?” but has overlooked his vital premis.

    James’s statement above illustrates the almost universal assumption that greed and anger are “unavoidable”, that they are inherent characteristics of our species. This is not true. Unfortunately, the widespread belief that it is true undermines every attempt to reform or remake our political and financial systems.

    People are taught to be greedy and angry: these are learned responses. Even in those societies supposedly organized around the “pursuit of happiness” or the “greatest good” we socialize our children with such values and behaviour as material desire (far in excess of material need), competition, aggression, self-aggrandizement and self-righteousness. We teach them to justify, even glorify violence toward other human beings and the rest of the natural world.

    But then we are suddenly brought face to face with some extreme consequences of this upbringing. We are surpirised and shocked. We imagine the problems are caused by bad economic policies fomented by inherently greedy people who must be better “regulated” or “punished” to satisfy our sense of self-righteousness. Brilliant minds, including many who compose and comment on these blogs, endlessly debate the technical issues of what “should be done” to put the financial/economic system “right.” But no system can be made to work in the long run for the benefit of all human beings if we have not first eliminated the origin of greed and anger.

    I doubt many readers will have read this far in my comment. The suggestion that greed and anger are not “unavoidable” smacks of religious idealism (“a nutter”). Others will have already noted I have nothing to contribute to the debate on banking, balance sheets, bailouts and so on. These things are not the real problem. Many people on this and other blogs have realized the debate over AIG bonuses is a magician’s trick to divert attention away from larger acts of the unjust, if not illegal funneling of public funds into private hands. But when will the audience realize the whole technical debate regarding the best way to “fix” the economic/political/financial system is itself a conjuring trick? The trick may be self-imposed, highly thought-provoking, and hence pleasurable, but it only serves to deflect attention from the real challenge: overcoming greed and anger. If this were achieved, the “system” would sort itself without much effort. But if we continue to believe anger and greed are intractable flaws in “human nature,” then human suffering will continue to afflict everyone, even those of us who, for a moment, benefit materially from our economy.

    Rather than the works of great economists and economic historians, I recommend Eckhart Tolle’s “The New Earth”. Initially, it will seem like a work of popular religious mysticism. But even if you are temperamentally put off by such things, please persevere: Tolle points directly at the origin and potential cure of the current “financial crisis.”

  13. I mostly agree with what Carson is saying here, though I am not so worried about people on the upper end of the spectrum giving up (i.e. point 2). It seems that an important potential way to counter some of the destructive dynamics would be to use taxes to help rebalance things. First, I think that Dean Baker’s proposal for a small transaction tax on stock trades should be enacted. Second, I think there should be some sort of surtax on income earned in the financial sector, possibly with the explicit purpose of “paying back” the bailout (i.e. tax would end when some level of revenue had been earned). Not Bonusgate levels at all, but something on the order of an additional 5% on earnings over some level (100K? 250K? 500K?) Maybe with several brackets so that people earning multi-millions per year are taking a pretty big hit on their marginal dollar.

  14. ManOnTheStreet

    Thank you for your post. My wife and I are two professionals in fly-over country who do fairly well, especially considering the cost of living versus the coasts. I can honestly say that I’ve never met anyone who works for Goldmann Sachs or AIG, but I hate them with every bone in my body. I don’t know if it’s their greed or my, perhaps perceived, belief that they added little true economic value to begin with.

    When someone can actually explain to me the value we are getting in the bailouts, I might change my tune. Until then, f’em all.

  15. “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.”

    To quote Sinclair Lewis, it is difficult to get someone to understand something if their salary depends on them not understanding it.

  16. I have to agree with Nils’s last paragraph, or at least hope that possibility comes to pass.

    There are (extremely broadly) two possible cultural outcomes to this whole mess.

    The one that Wall Street and the administration seem to favor is that post-bailouts the old culture returns unscathed. Worst of all, the US (and UK) economy will continue to be oriented towards the largely non-productive finance sector (is this really the only area we have a national competitive advantage, or are we just too lazy to look for others? A question for another time). All of the other components of the “cult of executive authority” and the “maximize shareholder value” mantra would remain in place as well. The crisis will have been a costly hiccup, but in general western capitalism will remain on the course it has taken for the last 30 years. In this case, I think Carson’s points, at least 1 and 3, are valid (on point 2, if you keep the culture of corporate excess intact, the higher taxes are a red herring and “going Galt” means giving up a huge amount of wealth and status in protest of a small inconvenience). In this case, workers and taxpayers will, I would hope, stop playing the game. However, this won’t be because of the unfairness of the bailouts, it will be because of the unfairness of the culture pre-crisis and the dawning realization that the ways the little guy was supposed to make out OK in all of this (rising 401k, magical HELOC ATMs that come with everyone’s house, so-cheap-as-to-be-practically-free flat screen TVs from China) aren’t actually working out so well.

    The other “much Bolshier” option is more uncertain. I won’t push my own vision of a more equitable and sustainable economy in this already too-long comment, but obviously it would greatly reduce the power and wealth of the elite and therefore will be extremely hard to bring about. However, given Carson’s diagnosis of the impact of the bailouts on the old culture, it may be our only option. This will be extremely challenging and at times scary, but ultimately good for the American people… we just have to keep cutting.

  17. “The banking industry doesn’t produce wealth: it is there to efficiently allocate capital between alternative uses in the broader economy.”

    nice platitude

    not the capitalist song of the past 30 years

    this idea died when 401ks were created

    it died again when the credit expanded and became a commodity

    it died again when bankruptcy laws were changed to protect the banks

    where have you been?

    the financial industry expanded its footprint

    huge fortunes have been accumulated by many –

    including ceo’s in profit and non-profit sphere

    to wit

    the growth in inequality of income and other aspects of wealth

    think about “who has been gaining economically and who has been losing”

  18. As you treat people, so will you be treated. Not too complicated.

    Everybody knows a big banker would default in an eyeblink on a loan if it was to his advantage… so why should you not similarly default on a mortgage?

    The fundamental goal of a democracy is simple: voting provides an alternative to violence. You can make a change without chopping heads off. If you fiddle with democracy so that people realize they really cannot make choices, the alternative will reappear.

  19. Pingback: Readings 24/3/09 « Managing Uncertainty by Nicholas Davis

  20. Corporal Agarn

    True story, and why they should have let the banks go into reeivership.

    I have a friend who had a thriving restuant in Bethesda Md., just outside of the DC beltway for 15 years. His lease was expiring due to a giant building project and for the last three years he has been in search of a new location. Rents are close to 40k a month and his SUCCESSFUL business plan requires a rent of 28k a month or less. There are numerous locations available BUT no one will lower the rents because they PAID TOO MUCH or REFINANCED out the equity and REQUIRE the 40k to meet their obligations.

    The landlords are sure that a bailout will come their way so they are holding out.

    In a proper world, the landlords would default, new owners would buy the properties at the real price (which is determined by the abilities of a viable tenant) and the rents would come back into line.

    So because of these bailouts we now have 25 people unemployed, a great restuanteur going into early retirement, and a bucnh of vacant buildings which will remain vacant until the rents come down through another bailout.

    This is no way to run a country.

  21. I confess I’m at a loss as to what “productivity” Carson is referring to. Is this another term like “talent” or “innovation” with a secret Orwellian definition?

    So far as I can see there has been no real productivity in America for a long time, just rent-seeking, bubbles, and going into debt to buy useless gigantist junk (SUVs, McMansions, plasma TVs…).

    As for the lack of shame among the people in simply acting like the rich always have, unfortunately by now to act any differently would not only be irrational, but even on a moral and aesthetic level to act otherwise no longer makes you “honorable”, but a sap.

  22. Carson Gross

    Nils,

    I’m not much for Rand. I find her unreadable and I’d rather read Chesterton.

    I do think the dispiriting aspect of paying higher taxes in order to bailout the wealthiest segment of our society will have a detrimental effect on productivity, even if that puts in in the somewhat uncomfortable position of sounding Randian. My only evidence for this is anecdotal, as I admit in the post. It’s a sensitive claim, apparently, but one that I find common-sensical.

    In any event, focusing in on this admittedly speculative aspect of the post risks missing the larger points, and, particularly, the change in attitudes towards defaulting. That has happened, we can see it, and it is a shocking change.

    My point is that there is going to be a moral to this story, and we should be careful what that moral is.

    Cheers,
    Carson

  23. Carson Gross

    Finally, would it be the end of the world if a large portion of our titans of industry walked away?

    If they walked away from finance? No. From the real economy? Yes.

    IMO, of course,
    Carson

  24. It’s worth remembering that the top 5% of income earners pay 60% of individual income tax collected, and that the bottom 50% of earners pay 3% of the individual income taxes. So, it seems to me, the wealth redistribution will be among the wealthy.
    I am relying on http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=534 for the data, most recent 2006, for these figures.

  25. Carson Gross

    Russ,

    I sympathize with your view, but I think you overstate it. There are plenty of non-rent seeking activities going on in the U.S. and, if we are going to “grow” ourselves out of this crisis (I’m somewhat skeptical) then we’ll need to encourage rather than discourage those activities.

    My point was that there will be large, unintended cultural costs to becoming “Bailout Nation” that will kill precisely the cultural norms and rewards that would, eventually, solve this crisis. This is certainly not an argument in favor of preserving the “productivity” of Wall Street over the last few decades!

    I must not be a very good writer, since everyone seems to think I’m siding with the establishment here. Ah, well.

    Cheers,
    Carson

  26. Carson Gross

    Buck,

    What portion of the population live in those 35 counties? How culturally important are they?

    I am in violent agreement with your last point.

    Cheers,
    Carson

  27. Marty, Brentwood NH

    There’s a cynical assumption that people only do things for money underlying so much of the discussion. Other motives are certainly Power and Influence, equally cynical. Could there not be an appeal to the Common Good, Patriotism, sometimes?

    I think Tom Friedman’s recent column,

    http://www.nytimes.com/2009/03/22/opinion/22friedman.html?_r=1

    especially the fifth paragraph and on, argued similarly. More may be found in the work of David C. Korten (http://www.davidkorten.org/).

    Our Economy is way out of human scale: unless this vast complicated machine works perfectly, one cannot buy bread.

  28. Valerie Gagnon

    Carson,
    I don’t believe that Sophie realizes that you are warning that public bailouts may come at the cost of eroding the social fabric of this country. And that the ‘bought’ is a representation for social cohesion.

    You do not demand that people to shut up. On the contrary, you extol the academy and Wall Street to engage in the current moral conversation regarding bailouts at the risk of breaching the reigning socio/political consensus…. which is still very much in favor of the ruling class.

    I am afraid that Sophie suffers from a high dosage of literary deconstructivism…..

    Personally Carson, I agree with you that there could be very negative and serious political consequences from failed bailouts. That is, if these numerous bailouts fail restore the banking industry health and continue to misallocate capital thus gradually draining the country from it’s wealth. Such a chain of event could exacerbate the political landscape to a point of near break up. i.e we could indeed see the resurgence of political extremism.

    I disagree with the examples that you presented though. First when you mention the possible negative influence that these bailouts could have on the entrepreneurial class, you are just perpetuating “The Myth”. Would they really throw in the towel and abandon the system to the detriment of us all? Fernand Braudel teaches us that capitalism is the product of a culture of entrepreneurship and the natural development of the gradual concentration of capital. Not to worry capitalist culture would stay unblemished. I also find dubious your argument about the so called new culture of defaulting on mortgages. The culture of homeownership is well embedded in America. It will not vaporize because it’s members at the present time find it financially impossible keep their homes. Remember what America looked like 20 years after the Great Depression and it’s massive foreclosure rate?

    Valerie

  29. Carson, thanks for your clarification.

    I think the most corrosive factors regarding these cultural norms are that:

    1. even if we granted the premise that these massive institutions can and must be bailed out, no one has ever given an even remotely coherent explanation for why it has to be done with the same criminal cadre; why the personnel are not in prison, their stolen wealth confiscated;

    2. in the same way, the adherents of Too Big To Fail, even those who seem to only grudgingly accept it, have almost never included in their prescriptions a clear plan to dismantle these structures so that never again for all time will there exist such a structural gun at society’s head.

    On the contrary, most bailout adherents implicitly promise we’ll be subjected to such a protection racket in perpetuity, a kind of futuristic feudalism.

    (Actually, lately, belatedly the question is finally coming up. But a Peak Oiler like me was asking it from the start.)

    I think people look at these two circumstances, they fail to understand them (I know I sure can’t except in terms of corporatism), and what rational person wouldn’t respond with cynicism and the emotions of rage or apathy?

    I agree with you, it’s not a promising situation for collective, constructive action. But there’s no clear leadership in existence at this point, pointing in such a direction. So the people are left to their own devices…

    (BTW, for anybody who’s not sick of reading about AIG and could stand another piece by an obscure blogger, I’ve tried to sum up my thoughts on the issue at my new blog. Any feedback would be welcome. Thanks.)

    http://attempter.wordpress.com/2009/03/24/the-bailout-war-part-i-aig/

  30. Eric Dewey, Portland, Oregon

    Good post. As a student of history I’m not optimistic that there is sufficient a) insight and will to change among the ruling classess, or b) self-control among the proletariat, to avoid a major conflagration of some sort.

    As a simple case in point, check out the full page ad from a group called “Leap/E2020″ in today’s FT. These people are essentially posing ultimatums to the G20 leaders.

    Of course, they may just be marketing a product, or crazies, and nothing may come of it – but they have the scratch to place full-page ads, so they have the means to have some effect on culture.

    Although I remain hopeful that Obama retains credibility with the masses, the fact is that he’s having to work thru people who have created an incredible vacuum of credibility, which has sucked much of the confidence out of the economy.

    It will take time for technical solutions to help develop new confidence. There’s no quick fix.

    Ours is an atavistic species which, on occasion, requires blood rather than pleasing music to soothe it’s savage breast.

  31. While the biggest individual wealth transfers went to CEOs, etc., the bulk of the wealth transferred went to the middle class. If you sold your house for an inflated price during the bubble, or earned a higher salary because of the bubble, or borrowed against your inflated stock portfolio to buy an SUV or big screen TV, then you were one of the bubble’s beneficiaries, at least at the time. Sure, you didn’t make off with $100M, but there are a lot more of you than there are evil CEOs or financiers.

  32. Mark Stevens

    There is another cultural aspect to this. I think that many people have not yet accepted the fact that our “bubble economy”, and its associated culture, is doomed. They are still thinking it will come back, but in the long run it can’t. That means there is a huge change required in how they think about their lives and our material “culture”. That will have a major impact on the economy.

  33. Aside from the many assertions-without-data, Carson’s arguments appear (at first read) contradictory and hypocritical.

    1) When a consumer defaults on a mortgage, Carson alleges this is immoral. Yet when a business defaults on a payment to a consumer (for example, a business goes bankrupt and wipes out gift cards), this is just a business decision?

    Why are consumers held to a moral standard, but businesses are only required to do what’s in their financial self interest?

    Frankly, if you want to restore consumer ethics, begin by restoring business ethics. If you think ethics are important to the economy, then perhaps the laws governing how business operate should reflect those ethics. The massively harsh incentives in the raw free market do not respect ethics – only the legality of the contract. The larger and more impersonal the market, the more regulation it requires to preserve trust – consider, for example, the evolution of Ebay over time.

    2) At some point, the tax burden on our most creative and talented individuals will cause substantial harm – obviously. (Whether we are there yet, or when we will get there, we do not know.)

    Unfortunately, the public looks at high earners and sees many many many MANY examples of people with high incomes who are actively causing harm to society through rent seeking behavior. Its logical conclusion: the “strong incentives” argument for high pay is hogwash. It’s propaganda – so we might as well tax them.

    The solution – and it’s one that won’t sit well with free market advocates – is for govt. to begin to choose winners and losers. That is, which types of activities generate socially desirable externalities (e.g. science, health care, education, green construction…) and which generate negative externalities (finance seems high on that list right now).

    Then, as with tobacco, tax the heck out of the negative externality activities to provide greater incentives to the high externality activities.

    Frankly, the entire “we need high salaries to retain smart people” argument just doesn’t smell right (if it ever did). The salary gap wasn’t even close to this high throughout the 50s, 60s, 70s, even 80s… yet productivity growth was high. So where is the link? We know incentives matter up to 100K, 200K income… but what about 5 million in bonuses? Are these kind of incentives necessary? Are they socially productive? Are you _seriously_ arguing that if the US just imposed a 70% tax rate on salaries in excess of 500K (as existed in the 1950s-60s), this would really really harm social productivity in the US? Because the historical data suggest otherwise.

    http://www.epi.org/economic_snapshots/entry/webfeatures_snapshots_20060627/

    If you ran a correlation between this ratio and the ratio of debt-to-GDP, you’d see a high number. Does’t prove anything, but highly suggestive.

    Even leaving aside the data (which Carson has done throughout his opinions), the proverbial “man on the street” looks at the rich salaries paid to those making abominably stupid decisions, and observes there is no link between value and pay.

    AND THIS WAS HAPPENING LONG BEFORE THE BAILOUT. The bailout was just the visible proof.

    If you want to know what the proverbial “man on the street” _really_ thinks about managers and highly paid execs,

    read Dilbert.

  34. ”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.”

    Stupid, stupid, stupid, stupid. This is one of the stupidest ideas I have ever heard and completely ignores human nature. Will greedy people stop being greedy if they have a marginally higher tax rate? Will people stop working because they don’t want to pay taxes? This is absurd. People are not willing to work less to make less; people work more to make more. A prime example of this is the overtime rules and taxes that hourly employee’s work under, which you obviously don’t understand, most likely because you work in a salaried position. My employees will readily work overtime even though they are getting taxed at a higher rate to earn more money over all. Human greed trumps all.

  35. I don’t think he’s saying that defaulting on a mortgage is immoral, at least explicitly. I think what he’s saying is this: if defaulting becomes a smart financial decision, whether because it’s more socially acceptable or just because it’s the best of all possible unacceptable scenarios, that could be very destructive to the economy.

    Mortgages, before the housing bubble, were historically a safe investment for banks because they guaranteed a predictable, long-term rate of return. If default continues to be widespread, that knocks another leg out from under an already precarious industry.

  36. Carson Gross

    I don’t know how stupid it is. Work, like everything else, involves making a tradeoff: there are other things that one can do with ones time. Drink coffee, compose epic poems, or even write up ignorant blog posts. By reducing the marginal value of work, you make it less attractive given other alternative uses of your time.

    But I’d like to focus on the *moral* aspect of the higher taxation that will be borne by future earners: they will know, or at least believe, that this taxation is being done to support the past failures of the wealthiest of the wealthy. I assert that this will create a drag on the motivation to work by fostering what is, at root, a sense of helplessness.

    I admit: I’m neither a sociologist, nor an economist. Just a lowly engineer with an opinion and some circumstantial evidence to back it up.

    Cheers,
    Carson

  37. Carson,

    Addressing your second item in the list, which seems to be creating most of the heat, I have a couple points:

    1) It’s worth recalling that taxation at the highest levels of income, right now, is not terribly progressive by historical standards.

    1a) In other words, rich people have paid more in taxes in the past, particularly during times of crisis, and the country has not only survived but thrived. While the financial industry is a less sexy cause than war, I don’t think there’s any doubt that the country is in very serious trouble. Perhaps – and I’m speculating just as much as you are – reasonable people will acknowledge the necessity of investing a little now to avert a true catastrophe.

    In short: People may realize it’s better to pay more in taxes now than to let the economy worsen to a point where their incomes are partially or completely at risk. If they have confidence in the plan – and that’s a huge if – they may be more willing than you think.

    2) I think what’s throwing people is your use of “throwing in the towel,” which implies that talented, high-earners will quit in droves. I doubt this for a couple reasons.

    First, people tend to live up to their means, so while they may threaten to throw in the towel in anger, it’s difficult to do. This might even make it more likely that with stagnant wages people will work more, not less, even the wealthy.

    Second, I know very few people who are in their jobs for the money alone – especially among truly talented and innovative people – another reason I don’t see “throwing in the towel” as a potential crisis. Unless by that you mean that their productivity may decline as they work their current or similar jobs, which seems more plausible but less problematic.

    Basically I don’t see many people throwing it in, since I don’t know that many people who have budgeted so that they can, and have less productive things they would want to do. But I’m also just working from personal observation – not that there’s something inherently wrong with that, it’s just only true as far as it goes, which is why we discuss these things.

    Anyhow, thanks for the post – I think it clarifies some of the things people should be considering without recrimination.

  38. According to your link, income disparity has increased drastically during that time. The bottom 50% of earners received 20% of the income and paid 6% of the tax in 1986. In 2006 they paid only 3% of the tax but they only received 12% of the income! Maybe they would have paid more during that time if Forbes’ flat tax had been imposed.

    Meanwhile, the top 5% of earners earned 5 times the income in 2006 that they earned in 1986 while paying only 4 times the tax dollars. Their proportion of taxes paid has risen less than their proportion of income earned.

    I suppose you feel that if the top 5% made 100% of the income they should pay less than 100% of the taxes?

  39. Brief follow-up:

    1) Is individual productivity that much of a problem? America seems to be moving towards both greater income inequality and unusually high levels of individual production, and perhaps both are at excessive levels.

    If people stepped back on individual productivity – started working less for less money – wouldn’t industry fill in the gap with more people working less for less money? Would that be bad?

    (Forgive me if that’s ignorant and crazy, I’m an English major turned editor.)

    2) Kind of off-topic: I’ve heard conflicting things about the tax benefits of the financial industry’s more-or-less-guaranteed bonus structure. Is it actually a way of minimizing income taxes for individuals? Any clarification anyone could offer would be greatly appreciated.

  40. Carson Gross

    StatsGuy,

    Let me start by saying that I very much enjoy your posts.

    I think we agree much more than you suppose. I’m arguing explicitly that the bailout culture arising from rescuing an irresponsible financial sector has damaged and may continue to damage the cultural foundations that make a wealthy society possible. This is not to say that corporate america is off the hook, but the proles need to soldier on with their sturdy work ethic. Rather it is to say that the bailout of corporate america saps that ethic if it does not address and speak to the moral sensibilities of broader society. I believe it is a reflexive relationship.

    I further agree with you that much of the problem occurred before the bailout. As I said in the original post:

    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.

    But what we are doing currently is setting up a morality tale where those abominably stupid actions are not punished. My concern is that the long run effects of this on our culture will be ugly both morally, which I care about, and economically, which I think pretty much everyone cares about.

    I’ll admit a weakness of my argument is the qualitative aspect of it. At the same time, my final point is that in the discussion of solutions to the current crises, qualitative measures like the justice of various approaches are largely left on the side as irrelevant. I don’t agree with that, even simply in economic terms.

    Cheers,
    Carson

  41. The human condition is not curable. Read the Blank Slate by Steven Pinker.

  42. Well, I did admit that was at first read…

    On second read, I could not tell whether you were arguing that the social reaction is the problem, or the activities prompting the social reaction are the problem.

    I continue struggling with events – on the one hand, Team Obama’s handling of the financial crisis has been abominable. Doesn’t mean the latest plan won’t “succeed” (I don’t pretend to know either way). You are right to call attention to some difficult-to-measure costs that might be incurred (social/moral). My only contention, I suppose, is that these costs resulted more from the system/beliefs which created the crisis (unrepentant free market), rather than recent actions in response to the crisis. But this is inherent in the system, and the dominant paradigm (mathematical Friedmanomics). How many economic model-builders do you know who have read Weber’s Protestant Ethic & Spirit of Capitalism?

    On the other hand, Team Obama has some very good, very pragmatic infrastructure based initiatives – recognizing that environment/energy/education are for all intents and purposes part of our economic infrastructure now. Possibly health care too. Most are based on sound empirical research.

    I simply hope that this latest bit of financial realpolitik does not cripple the long term investments and political cleanup that needs to be made – either by a) coopting the new administration or by b) destroying Team Obama’s credibility.

    This third threat you raise – cultural – may be valid. More oft than not, however, the argument is raised and misused by wingers (on the right and left) since it allows them to avoid hard data.

  43. Hmm, fair point. I think I misread.

  44. Carson,
    Not sure about what %age of the population live in the 35 counties. here is a link to source data on 35 counties:

    http://www.motherjones.com/mojo/2009/03/35-counties-account-50-foreclosures

    I first saw this at instapundit

  45. Nice comments whetsone! I also don’t buy into the higher taxes argument. Rich people don’t spend as much period. But even if you do buy into that argument then couldn’t we build incentives into the tax code to encourage more investing, etc? Trickle-down economics is just that — a *small* amount of the wealth trickles down to the rest of us.

  46. Over the years I have acted as a private lender to individuals, with the loans secured by residential real estate. It has in the past provided a fair return for my risk. I decided to discontinue the activity once the markets got too frothy a few years ago and property evaluations exceeded my own opinion of value. Without any promising evidence to the contrary, I have chosen to discontinue my lending due to the uncertainties introduced by the government. I based my risk/reward analysis partly on the knowledge that contracts were sacred, and in fact more powerful than statute law in enforcing expectations and promises made. But now that an investor can not count on consistent (and fair rules), one is no longer certain of how to play the game. In my view, my borrowers will suffer, as they no longer have this investor to call when in need of a viable loan. This reluctance/refusal/ to lend will surely drive up lending rates for all borrowers. It’s simply common sense.

  47. “Here are three changes that I see”

    Welfare Kings, Going Galt, and Jingle Mail.

    BiaS.

    I am afraid I do not share the author’s concern for a loss of productivity due to higher taxation of the privileged. Doing what you are good at, enjoying your mastery, is a reward in itself. If reduction in payment – whether through taxation, inflation or otherwise – has a drastic impact on your “productivity”, if money is that much more important to you, if you have a choice to be less productive, then maybe you choose to prostitute yourself.

    The reality for most of us is that we do not have that choice to be “less productive”. The r5eality for most of us is serfdom, having to do menial labor that is eating your life an hour at a time, so that we can stay fed and sheltered to continue to serve.

    Consequently, I find offensive postulating a similarity between those that depend on food stamps (even if by choice) and those that play government bailouts as another opportunity for insider trading and Ponzi schemes at taxpayer expense. It is a shock-and-awe inspiring Newspeak accomplishment to rebrand social insurance as “bailout”.

    Finally, as a lower end middle class person unable to prosecute my “first time home purchase” anytime soon, I propose that propping up elevated housing prices ultiamtely did, does, and will do more damage to your ability to preditably and with manageable risk exploit my labor than rational abandonment of a home that has become a debtor’s prison ever could.

    “Wealth transfers” have indeed occurred, and are indeed more, not less relevant to “change”, cultural or otherwise, and wealth transfers are implemented at an accelerating, almost exponential rate in a display of “disaster capitalism” proactively architecting the disaster to better take advantage of it.

    To worry about a “cultural impact” on a society that is being undone by an existing, entrenched culture of sociopathic greed and recklessness is, shall we say, “rich”.

    Income equality has to be reduced, and the profits resulting from increased productivity have to returned to the many who delivered it, if necessary by taking the illicit gains back from the few who managed to manage an increasing share of the wealth into increasingly fewer pockets. It might be unpalatable, but if you want the unwashed to toil as the sinks of your markets, you will have to let them have some resources to consume. Even if it is little more than “Let Them Eat Food Stamps”.

  48. Zvi, Thanks very much for the reference. To discuss Tolle vs Pinker further on this blog would be considered “off-topic.” But I must continue to hope you are wrong, or I’d become even gloomier than I already am! Cheers.

  49. I think you’re right about the resentment in point #2, but wrong about the fallout. I don’t think many people will work less, but I do think that moderate-to-upper-income non-financial-sector workers will be extremely unhappy about having to shoulder the burden of bailing out their neighbours in the finance sector, and that this will have political effects. And while I think in general inequality is too high, I don’t put much of the blame on people earning, say, $250k a year; the real problem is the crowd who have hijacked public companies to pay themselves millions of dollars a year, and those in the financial sector who have essentially concocted a gigantic and unsustainable pile of funny-money whose supposed existence justified their fees and bonuses.

    What the political effects will actually be is anyone’s guess; both parties are closely tied to the finance industry, but that could change if they see an opportunity to grab a big slice of the middle class by opposing the banks.

    I do think the cultural changes are going to be large. I don’t know that DC understands just how much the rest of America hates banks at this point. We’ve all experienced or know someone who has experienced unfair, undeclared fees, usurious interest rate jumps, deliberately obstructive customer service, changes in loan terms, and so on. For some people those things will mark financial apocalypse, for instance increasing the rate on a credit card with a large balance to 30% for a missed payment. In a world of free-for-all capitalism that kind of behavior can be justified by their need to generate returns, and appeals to “shareholder value”. But when the banks have just taken a $1T or $2T bite out of the public purse, because of their irreplaceable role in the modern economy, their sharp practices seem a lot less defensible. After all, if they’re really a quasi-public institution – as it would appear given their involvement with government – then they should be serving a public purpose, not purely the bottom line.

    So, if they don’t manage to buy off all of Congress between now and the next election, that anger at banks is going to be driving a lot of the campaigning, and I think you’ll find a Congress in 2011 that is much less sympathetic to the banks (from either side of the aisle). If the banks are still needing bailouts at that point, they could be in real trouble.

    On the other hand buying off Congress has worked pretty well so far, so I’d expect them to ramp it up over the next couple of years.

  50. Carson Gross

    BiaS

    Perhaps.

    I’m surprised, once again, to see someone write a lot of stuff I basically agree with call me out as a Randian. I don’t particularly like Rand’s stuff and, as I’ve said, I would say I’m a Chestertonian, if anything. “Too much capitalism does not mean too many capitalists, but too few capitalists,” and all that.

    I’m in violent agreement with you that housing prices are still too high. I’m also in violent agreement with you that our culture has already been careening down a very dangerous path, although we may disagree on particulars.

    My post is directed at the technocrats who are designing solutions to the banking crisis without considering the cultural implications of those solutions. This isn’t a rubik’s cube to be solved and then set aside. There will be a moral to this story, and we should be careful when picking which one it is.

    Cheers,
    Carson

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  53. Carson Gross

    Ha! Maybe I need to get out more. I live right in the heart of it in California.

    OTOH, there are a lot of Californians.

    Cheers,
    Carson

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  57. Phil McClelland

    Carson,

    I seem to agree with your article, at least after an initial read. However, your article seems to be extremely limited in scope. I’d argue that the cultural cost of bailouts will be seen most dramatically in changing international attitudes towards globalization, in the decline in popularity of the ‘liberal democracy’ meme, etc.

  58. Well, from where I’m sitting on the lowest bough of the tree–no scratch that–from the weeds growing around the tree, I don’t see the high earners who are paying the high taxes as the brightest bulbs in the room. In fact, I’m eager for them to take their “ingenuity” and get the hell out of the way. There are plenty of us weeds who are just as bright and productive and are NOT attatched to an unrealistic and unsustainable standard of living, we, whose sense of accomplishment and quality of life doesn’t hinge on the amount of money we make or the car we drive or the school our kids attend.

    Cultural costs, my ass. It is the culture of every man for himself that the “smart dynamic” folks have given us.

    It has failed. Now get the hell out of the way and let the commoners have at it. Guarantee we won’t f*** it up any worse than you. Only difference will be we that we will remember where we came from and will be well equipped to adjust if there’s a downturn.

  59. Cultural outcomes? Il faut cultiver notre jardin. I mean, we all gotta eat, right?

    Maybe local currencies, too; the computing power we have today will make them much easier to bootstrap. Probably the banksters will try to make that illegal, along with cash, but crypto will take care of everything.

    Ha ha — only serious….

  60. Valerie Gagnon

    donailin;

    If we can only remember where we’ll have been coming from…

  61. sunsetbeachguy

    Science blogs had the best explanation of the “distasteful” populist outrage.

    http://scienceblogs.com/cortex/2009/03/aig_and_inequality.php

  62. Ok to make things fair, Carson do have so valid points but I think that many of his points overstate or misunderstand the problems created by the bail outs, taxes and so on.

    Let’s star with the taxes to the “brightest” part of our society. Well yeah, theoretically you’re right, more taxes could harm the incentives to innovate.

    First, let’s be honest, I think Ross do has a point: bubbles were an important part of the growth that we experienced on the last few years. Remember how bitterly Paul Krugman and other economist cried about the stagnation of median household income while the gap with the top 1% increased at a rapid pace. In a way that could be interpreted like part of the bubble in the financial sector, since most of the people that were increasing their income were in that sector. The fact that the median household income did not increase do hint that the growth we have witnessed in the last few years is in an important way a by product of the financial bubble.

    Second, once upon a time when America was the only center of innovation in the world, in this world high taxes in America’s “brightest” people produced a heavy burden on innovation. However, now with the effects of globalization, innovation is a much more widespread (this has been one of the main factors behind the strong economic growth we have witnessed in the last 20 years). So a fair ammount of the “innovation” that is taking place in any given country is actually just a copycat from an innovation produced elsewhere.

    Third, since the marginal cost of coping an idea is close to zero, the effect of taxes on this kind of innovation is nil. Of course, there are ffects in the “other” kind of innovation (American made innovation); however, the effects in the productivity growth in america is arguably small, even perhaps insignificant. That is, the technological progress achieved in America at any given time will be composed of the innovation brought from abroad and the innovation produced within america. Taxes would have a signifficant eefect on the later, not the former.

    On the “cultural foundation” of capitalism. I am not a beliver of cultural effects. I think that the most important thing that the recent development of economic theory has shown us is that economic behaviour is not about some obscure “culture” concept. Economic behaviour it’s all about incentives.

    So on this line I beg to differ that the current bailout on homes is destroying our “cultural foundation” of capitalism. Behavior will depend on how the bail out is conducted. The tricky part is not to produce moral hazard problems with the bail out. Moral Hazard is what truly damages the foundations of capitalism, and the lemon socialism (to use Krugman’s expression) that we’re seeing on the bank bail outs are a greater cause of concern than what we’re seeing in the mortage market.

    After all if you set the historical standard of a Geither put in the financial sector it will always be more damaging in the longer term that setting the same precedent in the mortage market. The reason is that the financial sector by it’s very nature will tend to be a concentrated sector always, while the mortage sector will always be conformed by millions of unorganized individuals. It will be more difficult for the goverment to take distance from the historical standard put on the financial sector bail-outs than on the mortage sector due to political reasons.

    That’s why the resistance of the Bush administration (and now of the Obama administration) to walk the obvious path of nationalization (aka. the standard solution to bank insolvency problems) is indeed creating the seed of our next financial crisis. The US may eventually get to the “too big to save” problem unless it reins the financial sector too much via heavy regulation, crippling in this way the long term growth prospects of the economy, which is IMO the most likely outcome nowdays. Punishing the banks by wiping out the shareholders and unsecured creditors via nationalization would have been the first best solution.

    Whatever the case, it will always be easier for the goverment to distance itself from the historical standard brought forward by the Geither put in the case of the mortage sector than in the case of the financial sector due to political reasons, not cultural.

  63. the first sign of cultural problems were when people started giving / getting loans on a large scale without any plan of paying them back.

    this is when the money was printed.

    this is when the bailouts and eventual inflation really happened.

    everything downstream is just a corollary.

  64. I don’t see our economy rebounding from this crisis, in fact, I predict that it will worsen even to the point of a possible major conflict with China. The reason I say this is that China owns 600+billion of our national debt and they have expressed doubt about recovery and the value of the dollar. Also added to this is the spying incidents. I hate to say it but I fear that this global recession will lead to war.

  65. Interesting post….

    This has nothing to do with Rand. It has a lot more to do with Polanyi (Karl). In his view, the market economy generally relies on a cultural context that springs mostly from other sources, is eroded by the market and so those sources have to fight back through measures involving the “self-protection” of society (old-age security, etc.).

    Of course, he didn’t anticipate how extreme this might get. For a long time now, market logic has been undermining legal logic (and the culture of promising) itself: this is what a big part of the law and economics movement in law schools has been doing, for example. The irony here, of course, is that this can attack contract itself.

    In philosophical terms, this is runaway utilitarianism (and of a sort that would make classical utilitarians, who cared about people, very upset). When consequentialism, instrumentalism, expediency–whatever you want to call it–reaches a certain point, we get to where we are now: when you have people continually saying “We have to do *this* now, or everything is going to hell!” where *this* amounts to something (transfer payments to screw-ups and extorters) that regularly, seriously, offends our senses of justice and fairness.

    But those senses of justice and fairness are, as you point out, what make the world–including this crazy, runaway, fictitious-capital-accumulating world, go ’round. The thing is, nobody knows just quite how depraved it can all get before it stops working–how many systems can work on fear and greed alone, with no other supports (no glory, no loyalty, much less reciprocity, etc.)? (This is not about “egoism” v. “altruism” or other silly modern reductions that Chesterton, for one, saw through, but that e.g. Steven Pinker is totally beholden to.) Who knows….

    But don’t forget about the power of forgetting. If there’s any culture that forgets, it’s this one!

  66. How could we be surprised at homeowners cynically walking away from their mortgages, when these homeowners see that financial leaders on Wall Street are allowed to walk away from their obligations? Not only walk away, but take a handsome ransom with them, backed up by the U.S. government.

  67. It is interesting to consider the transition from one perspective to another, particularly in reference to ‘defaulting’.

    It now seems common-place for people to refer the economy in their conversations, whereas in the previous ‘boom’ period, people thought nothing of it.

    As far as they were concerned, so long as the world went round, it didn’t really matter.

    We are now heading into a long and dark tunnel which is unfamiliar territory, to all nations. Mention of the ‘global economy’ strikes fear into the hearts of bankers and politicians.

    Mention of interest rates makes savers shudder.

    In fact, there’s likely a financial term for every type of person in the world.

    What we have to ask ourselves is not ‘how do we get ourselves out of this mess?’

    It’s ‘what do we see at the other end of the tunnel?’

  68. @Carson – This is the best post I’ve read on the subject to date. Your three bullet points are very real possibilities and I’m concerned most for the first two.

    Like you I don’t have a crystal ball and my worries about what may happen are enhanced by anecdotal evidence. I know of people already who are deadly serious that they simply won’t make above $250,000 even though they have in the past. They’d rather quit working above that level than give more money to the government.

    I’m even more concerned about our continuing spiral (this has been going on for decades) into becoming an entitlement society. Increasingly we as individuals do not accept our lots and expect help as a right.

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  70. > 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.

    I don’t think there has been a huge cultural shift here. What has changed is that a lot of people have hugely negative equity coupled with cash flow problems coupled with uncertainty about the future coupled with real signs of deflation.

    Companies and individuals have always been willing to default on debt when they are in this situation.

  71. Reflecting on the events of the last three or four months, I get the feeling that the U.S. is closer to being Argentina than at any time in the past 60 years.

  72. I agree with JoEllen. The ‘shocking change’ of the last 18 months which finds people deciding to walk away from mortgages is simply Main Street catching up with Wall Street. If the last 18 months have taught Main Street anything, it is that there is no shame involved in any ‘business’ decision. Why is this so shocking? This is amoral B-School culture gone populist.

  73. Paul Stubblebine

    Perhaps you didn’t notice, but the hi-earners voted for Obama by a higher margin than the electorate at large. He was crystal clear during his campaign that he would allow marginal tax rates on the upper bracket to rise again, and I am willing to assume that the people in the upper income brackets who voted for him took him at his word. So a lot of these people have already indicated their willingness to pay a little more in exchange for a financial system that isn’t going over the cliff (among other reasons they may have had.)

  74. Sure, sether–but Carson’s question is what happens when B-school behavior gets generalized, as opposed to remaining a practice that relies on its exceptionality (like buying low and selling high does!).
    When my wife and I saw a financial advisor several months ago, the first thing he said to us is that our biggest expense is taxes, and we should look to reduce those first. Even though I’ve always been appalled by any number of uses of my tax dollars, I was surprised–it had never occurred to me that I was supposed to take an attitude towards taxes of “don’t pay them if at all possible.” Taxes are a civic duty, not a penalty or a user fee–and from what I know about the regressive character of our tax code, I usually feel like I don’t pay enough as is.
    There are a lot of people like me out here. How many will there be after this crisis? I don’t think Carson’s right that this will affect productivity–but it is likely to affect the level of legal and illegal cheating that people do on their taxes, and perhaps in other areas. That’s especially the case if we don’t translate our understandable moral outrage into political argument and political action that gets results.

  75. I would like to color the cultural question the insightful Mr. Gross poses with an example in the category of views on mortgage-default.

    I have just recently returned to my Law/Economics Student life from a deployment to Afghanistan with an Army Military Intelligence unit. Prior to the deployment, several of the other officers had been stationed at the height of the housing bubble at facilities located near D.C. in Northern Virginia – where even their very modest homes removed from their workplace by substantial driving distances were particularly pricey for someone with a family and on a military salary.

    Nevertheless when they had arrived they found the local branches of the nation’s largest bank chains exceedingly eager to loan them up to 100% of the asking price plus costs with a minimum of fuss, delay, paperwork, or any other prudent diligence. I had a similar, “Really, is that it? That can’t be right. Are you sure that’s all you need?” experience when I received my mortgage in 2005 from Countrywide. The officers were also heavily encouraged to dabble in those now infamous Option-ARMs and other financial “innovations”, but despite the temptation and being skeptical-conservative types they opted for traditional fixed-rate mortgages.

    As soon as the market started to tank while we were away, their small equity positions were wiped out and they started going negative. By the time they were close to returning they were all badly underwater over $100K and, worse, the Army had reassigned them and they were required to move promptly. They were simply not in a position to hold out, wait for prices to go back up in the long term, and continue making monthly payments. Unfortunate professional timing had compelled them to buy at the top and sell at the “bottom”.

    So, as the depth of the murky trouble in which they were finding themselves became increasingly clear they all found themselves perplexed as to what to do. Their uncertainty had two dimensions – (1) technical and (2) moral. They asked for my assistance and I tried to explain the basic information I knew about short-sales, negotiated settlements, and other ways of dealing with their banks to offload their properties and what the various consequences, for example to their credit scores, would likely be.

    But even when presented with these various options, with one course-of-action usually standing out as being clearly the winner when measured purely in terms of their financial self-interest, they still wondered which fork in the road was the right one ethically. They had each accumulated a small life’s savings and could decide to hand it over the entire family education and retirement fund to the bank or choose one of the legal options that would let them try and keep it. What was the right thing to do? With these men, and with many others I would estimate, they sense a moral dimension that should be addressed in their decision-making but don’t know how to conduct the ethical analysis. They look for guidance and advice in the words of their acquaintances and the acts of their community and national leaders.

    Their instinct was that if they had borrowed $1,000 from a friend or a neighbor they would feel a deep, almost sacred, obligation to make good on their debt and pay it off in full plus interest as soon as they could manage it. It would be wrong to stiff the guy next door even if you were in trouble and the law would let you get away with it.

    And their first impulse was the extend the principle to all debts, including the one on their house.

    But then the bailouts with taxpayer money started, and the “too big to fail” talk, and the wave of foreclosures and layoffs and emerging scandals of the the unjust excesses of the financial industry, and so on. And these men began to feel that from the personal scale of their little world, their family was also perhaps “too big to fail” and forfeit their life’s savings.

    They also started to question how could the bailouts make sense without some of the benefits flowing to innocent and responsible men such as themselves while the reckless nut who lied on his applications and bought six houses to “flip”, each of which more than double what he could conceivably afford, can just abandon ship and mail the keys to the banks – or even has his multiple foreclosures delayed for months by the state legislature. All of sudden, what had seemed moral now appeared foolish, even stupid.

    And then it never seemed to end – bailouts for the big-3 car makers, countless earmarks, a thousand inexplicable giveaways in the “stimulus”. And these gentlemen are not economists or political scientists and must distill the message of these actions through our hysterical press which tells these stories in a way, it seems, increasingly so as to make us terrified and irate.

    And the point of all of this is that there is indeed an effect on culture, intended or now. The whole moral universe, in regards to debt, has been overthrown for these good and righteous men with whom I went to war. They started out with an inclination as to what the right thing to do was, and then were unsure, and then questioned whether they were just being “suckers” and if there should be a moral question at all given what was happening in the world around them.

    I think the observation of Mr. Gross makes it both mysterious and tragic that neither party at the level of our national leadership has sought to address the unintended, but nevertheless real, cultural and moral implications of our economic rescue efforts.

  76. Stephen,

    Taxes can be saved if you invest at the right place. It is more like you tuck away the money in some sort of bonds or the like where the Government benefits. If you take a closer look, its a win-win situation for the Government. You pay them taxes, its fine with them, you invest in some FDIC insured instrument, its great for them. In the end, they get what they want. The thing about reducing the toxicity of the assests that are primarily responsible for freezing up the credit markets is that nobody is willing to buy those. Old wine in new bottle? Sorry, still not good marketing enough. So, maybe a bailout and a good propaganda campaign would do some good to promote this.
    While I found the comment about defaulting a rather amusing one, I do have good belief that people still prefer to keep that as a last resort. It would rather be prudent to consider that such defaulters were actually classified as ‘sub-prime’ in the first place.
    In the end, I do have good faith in Geithner’s plan. If it works or not is a different story, but he sure is making the righ moves in the right direction.

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  78. Einstein stated to make things as simple as possible, but not simpler.

    I don’t understand how the financial markets can make up “products” out of thin air. MBS are understandable: Basically they are different types of debt instruments packaged neatly and offered for sale.. CDS are understandable: Basically insurance of the MBS. However, were these products tested? How do we know they will work? Will they kill the patient?

    Now, let me ask you, if I said that I came up with a new way of harnessing the wind using tethered, floating (using helium) windmills, what do you think the Government would say?

    1. It will need to be tested using the best engineering principles (basically on paper).
    2. A protype must be built and then it will need to be tested, in a place that will not impact humans
    3. It must meet all safety regulations
    4. We need to add new regulations to safeguard the public
    5. It will need a permit and can’t be higher than X number of feet
    6. You must have a study completed to determine the impact on wildlife, people, watersupply, future generations, etc.
    7. You will need to have a way to tie it into the current grid
    8. Etc, etc.

    Second example, what about a new medication? Same result right? It will need to be tested, it must show efficacy, long term studies must be done, it can’t be duplicative, etc.

    My point in this example is that in non scientific pursuits, such as law, government, finance, etc. we as humans “wing it” all the time. If we injected the scientific method into this practice, we would all be better off in the long run. We should make it mandatory that any new “financial” instrument is completely vetted prior to allowing it to be unleashed. We have unleashed a plague due to our lack of forethought.

    And we continue to play with fire. What evidence do we have the Tim’s plan will work? What are the second and third order effects of the Fed buying up debt? The answer is NO ONE KNOWS…

    I agree with Carson, there will be cultural fallout and I fear we may pass beyond the event horizon and get sucked into the debt black hole from which there is no returning. They didn’t call it the dark ages for nothing.

    Believe it or not there are TEN, count em, TEN members of Congress with any scientific background (and that is counting Brian Baird, which for me, is a stretch). For all you scientists out there, that is 1.8% of Congress.

    Here is a current list of Congressman who has degrees in the scientific area:

    Vernon Ehlers received his undergraduate degree in physics and his Ph.D. in nuclear physics from the University of California at Berkeley in 1960. After six years teaching and research at Berkeley, he moved back to Grand Rapids to Calvin College in 1966 where he taught physics for 16 years and later served as chairman of the Physics Department. During his tenure at Calvin, Ehlers also served as a volunteer science advisor to then-Congressman Gerald R. Ford.

    Russ Holt earned his B.A. in Physics from Carleton College in Minnesota and completed his Master’s and Ph.D. at NYU. He has held positions as a teacher, Congressional Science Fellow, and arms control expert at the U.S. State Department where he monitored the nuclear programs of countries such as Iraq, Iran, North Korea, and the former Soviet Union. From 1989 until he launched his 1998 congressional campaign, Holt was Assistant Director of the Princeton Plasma Physics Laboratory, the largest research facility of Princeton University and the largest center for research in alternative energy in New Jersey. He has conducted extensive research on alternative energy and has his own patent for a solar energy device. Holt was also a five-time winner of the game show “Jeopardy.”

    Jerry McNerney has his PhD in mathematics, served several years at Sandia National Laboratories in New Mexico as a national security contractor. Then McNerney moved to California, accepting a senior engineering position with US Windpower, Kenetech, and in 1994 began working as an energy consultant for PG&E, FloWind, the Electric Power Research Institute, and other utility companies. Prior to his election to Congress, he served as the CEO of a start-up company that manufactures wind turbines.

    John W. Olver was a chemistry professor at the University of Massachusetts at Amherst. Olver earned his B.A. from Rensselaer Polytechnic Institute, his M.A. from Tufts University, and his Ph.D. in chemistry from the Massachusetts Institute of Technology.

    Brian Baird received his B.S. from the University of Utah, graduating Phi Beta Kappa in 1977. He continued on to the University of Wyoming, receiving his M.S. and PhD in clinical psychology.

    Ron Paul graduated from Gettysburg College and the Duke University School of Medicine, before proudly serving as a flight surgeon in the U.S. Air Force during the 1960s

    Dan Lipinski earned a Bachelor’s Degree in Mechanical Engineering from Northwestern University, a Master’s Degree in Engineering-Economic Systems from Stanford University, and a PhD in Political Science from Duke University.

    Nancy Boyda graduated with honors from William Jewell College in Liberty, Missouri, where she received dual degrees in chemistry and education. She began her career in 1978 working as an analytical chemist and field inspector for the Environmental Protection Agency. Over the next two decades, she held management positions in several pharmaceutical companies, including Marion Laboratories.”

    Cliff Stearns graduated with a degree in electrical engineering [from George Washington University] and then started his four years of service in the Air Force. Serving during the Vietnam War, Stearns worked as an aerospace engineer in satellite reconnaissance. He left the service with the rank of Captain.”

    Joe L. Barton earned a four-year Gifford-Hill Opportunity Award scholarship to Texas A&M University, where he was the outstanding industrial engineering student for the Class of 1972. After earning a Master’s of Science degree in Industrial Administration from Purdue University, he joined Ennis Business Forms, where he rose to the position of Assistant to the Vice President. In 1981, he was selected for the prestigious White House Fellows Program, and served as an aide to then-Energy Secretary James B. Edwards. He returned to Texas in 1982 as a natural gas decontrol consultant for Atlantic Richfield Oil and Gas Company before being elected to Congress.”

  79. Stephen, I have worked for three different companies in the past 12 years. I would have to disagree to the extent that it has become exceptional. I think it has been happening for some time. In every one of these companies there have been decisions made which in my view are immoral. None of these companies have been in Finance. Decisions mainly based on what the downside is of illegal activity or simply defying the intent of the law by doing just enough to create an argument if actions are questioned. As for contracts, there perceived as a point of negotiation, not a settlement of negotiations.
    Why should Carson be shocked at what people are doing? The only problem I see is what a number of other people see, is that the bigger you are the less repercussions for your actions. But I guess that is what he is trying to say, that because the big guys get away with it the little guys are also doing it.
    Well I don’t think that is going to happen. These are extreme circumstances where the pendulum has swung so far out of whack that it make sense to walk away from the contract and to heck with the repercussions. Falling credit score, bankruptcy, just don’t seem to be a deterrent to staying in a bad financial position.
    Some of the issues have really started occurring in the last 6 to 7 months way after the first people start walking away from upside down positions. Credit scores are getting rocked by manipulations by banks. I’m beginning to wonder if anyone will even care what a credit score is in a few months. People with good credit have seen there scores plummet because of accounts being closed or limits changed. So if this keeps occurring then there won’t be a concern about CC debt, people will just walk away from it. I mean why not, if credit ratings mean nothing, then why wouldn’t they.
    If banks keep upping the antie on how far they can increase interest rates, then they are just going to need more bailout money. What do they care, if more people walk away from debt, that just means more money for them.
    And as far as paying taxes, until they have a flat tax, only people that think like you are going to pay their fair share ( And even then they’ll scheme for loopholes around it). So follow your financial advisors advice, don’t pay anymore than you have to. I assure you that a lot of people and companies are doing things that would literally make your head spin.
    I have a friend who was a Finance Officer at a medium sized company, who literally just got up one day and walked out. Mainly because the pressure on him to skirt the law, well actually break the law was to great. How did he do it, he finally got enough evidence that he could tell the CEO that between the two of them, one of them could wind up in jail and it wasn’t going to be him.
    So you take people out of non B-schools, put them in an environment where this B-school mentality is taught every day and expect what?