Bair understands something that most taxpayers could have told Paulson a long time ago. While the Treasury busily attempts to avoid what Paulson describes as ’systemic crash-and-burn’, force lenders to lend, and calm investor panic, Sheila knows that troubled taxpayers can neither borrow, nor spend more.

FDIC Chairwoman Bair is an advocate for mortgage modification. She supports steering the helm of mortgages in serious payment delinquency. She proposes modifying them to a 38% cap on income, daring all the way down to 31% of earned income if necessary. In addition, she proposes lowering interest rates on mortgages, and increasing payment time.

Bair emphasizes that in calculating new mortgages, FICO scores will not be considered. It is a beacon of light for all those worry-deep in credit debt. Any modifications will be based solely on the earned, actual income of households.

The bad news is that it is currently too late for many already in the foreclosure line. The good news, however, is that her proposal can save so many more from heading down the same path. Healthy family finances, means greater consumer spending. Isn’t this what Paulson also hoped for? Go figure.

Far from everyone is headed for foreclosure, however, the numbers are not only disturbing, they are an important indicator. We can only imagine the unknown number of subprime households teetering on the edge of one or two delinquent payments.

Sheila Bair provides a necessary solution to the core problem. The second part of the solution needs to come from an Obama investment in immediate job creation, minimizing longterm effects of a lengthy unemployment line. These two solutions would allow the grassroots to once more grow, and the corporate world could restructure their way back to health and viability.

Thumbs up for Sheila Bair.
Tamera Daun©

Pentad. Simplifying Your World.

They tinker with taxes, government payments, regulations, price controls, market manipulations, etc, even though they fly in the face of the fundamental laws of economics and have been proven wrong in precisely every instance. You cannot artificially set maximum prices below the market price without causing shortages. You cannot artificially set minimum prices above the market without causing surplus. You cannot regulate supply, demand or anything else in the market without paying the price of a grossly distorted market and misery for at least some people, not in even one instance.

In the free market, both parties gain from a transaction. If it was not so, the transaction would not take place.

That is the very nature of a truly free market. Every member is free to enter or not enter into a transaction, whether it is buying a house, a loaf of bread or a tank of gas. The very fact that the transaction is consummated is absolute proof the buyer valued the good or service more than the money and the seller valued the money more than the good or service. The buyer or seller might not be happy that the price was not lower or higher, depending on perspective, but it was obviously the best use of resources, given existing conditions and knowledge.

When government interferes, with taxes, incentives, subsidies, stipends, payments, regulations, services or any other intervention, it picks the winner, the person who will benefit from it’s beneficence. But the only way to pick the winner is by also picking the loser, directly or indirectly. Government is a less than zero sum game, a negative sum game. Something, usually a lot, gets lost in the translation in every government action.

The big difference between the perpetual motion “engineer” of yesteryear and the social “engineer” of today is that the former was playing with toys, things that didn’t have much effect on others. The latter is very dangerous because his or her irresponsible and ill fated experiments affect millions, even billions of people.

The laws of economics are known and are just as immutable as the laws of physics. You can choose to ignore them, or hide them in a mountain of numbers and reports and public relations fluff, but you cannot choose the consequences of ignoring them, any more than you can ignore gravity when you drive off a cliff. History is full of lessons about political leaders who chose to ignore the simple, fundamental laws of economics. The reason that history repeats itself is because people in power, and their economic advisors, like to tinker, even though the punishment is predictable and inevitable. It often becomes obvious that they do know the consequences all too well, but they also know that they will be on the winning side and not be the ones to bear the punishment.

Guess who is always on the losing side.

This is not an academic journal, so it would be off the mark to argue about all those „scientific“ claims made by most economists. One of my former co-workers, a Scotsmen, once told me the phrase that “common sense is not very common.” I have to agree. So, this article is based on common sense and how it helps to understand economy.

Since most of us have too much to do to get the daily chores done and to make a living, we have little time to spend understanding fancy phrases and economic babble. And if I had the choice to watch, say Jon Stewart, or read John Maynard Keynes, in my spare time, I would sure switch on the TV and throw the “General Theory” into the bin. Guessing that most of my fellow citizens would do the same, it is no wonder, that economic science rests in an ivory tower guarded by a huge army consisting of terms and phrases that the “common” man does not even know how to spell let alone knows what they really mean. You remember the story of the emperors clothes?

Mind, I am not saying that economy is useless. In fact is is much to important to leave it to the scholars in the ivory towers. Economics is about the essence of our lives and therefor “essential” to all of us. I promise I will try to keep fancy words at a minimum, and where I use them I will explain them.

Well than, let me start with some explanations. Economics as a term is derived from ancient Greek oikonomia – which basically means the rules of the household as oikos is the house and nomos means law. Because we all live in households, and all have, at least some, rules how to run it, we all are engaged in economics. In short, economics is your and my everyday struggle to survive. No need for fancy phrases here so far.

The first question that comes to my mind when I consider this would be, why do I have to struggle to survive anyway? I mean, wouldn’t it be cool to survive without any effort? Indeed, that would be cool. Yet, we as humans have a lot of empirical (another fancy word meaning “by collecting historical data”) evidence that we can not survive by doing nothing. Men has always dreamed about such an environment and we call it paradise. Alas, reality looks different. Question is, what keeps us from being in paradise? Ok, I don’t mean the angel with the sword. There are two things that keep us from the kind of paradise described above. First, scarcity and second uncertainty about the future. Think of all the basic ingredients a human being needs to survive. Air to breath, food to eat, water(well that would be very basic) to drink and, given the absence of a natural fur, shelter.

If you are still with me (which means probably that Jon Stewart is not on the program yet) I ask my next question. Which things of the list above are scarce? Well air is not, unless you are a scuba diver trapped in a wreck 30 feet below the surface of the Atlantic with a half empty bottle of air. Food is sure scarce, even if you have a well equipped fridge with bulks of your favorite Alfredo style Lasagna. The same goes for beverages. While there is no need to search for ways to get air, you can just breath, you need to find ways to get food and drink, and shelter. You have to spend time to get those vital things (unless you still live with your parents that is).

Good, we now know that some stuff we need is scarce and we have to do something to get it. But, why do we have to do something at all? Because, we do not know the future. If we would know everything that will happen in the future, we would not act at all. If I was hungry, and knew that in 2 minutes a roasted chicken would fly into my mouth, why bother to think about going out to hunt? Yet, I am pretty uncertain this would happen ever. Omniscience (well, remember my promise about fancy words), which means to know everything of the past and the future, would prevent us from doing things. Or, to say it in another way, we only act because we are uncertain about the future.

Now, what is action? Action is what we do to achieve our goals. What we do is using means we have at hand, or think we have at hand, to get us closer to the goal we desire to achieve. Wew, starts getting complicated, doesn’t it?

Let me give you an example. If you are hungry, and you are not a masochist, you probably have the desire to feel full, as hunger is a painful feeling. Now, we know that probably not much roasted chicken fly through your kitchen within the next minutes. But, you know there is some bread, tuna, salad and mayonnaise there of which you could produce (hey you are a producer) a tuna sandwich, eat it and fight that painful hunger. So homo economicus, that is you, starts acting. You take your means – bread, tuna, salad, mayonnaise and your skills in preparing those yummy sandwiches of yours- and employ them to make that great product which will be consumed by you and, hopefully, brings you the desired satisfaction -feeling full.

You just encountered one of the economic rules (remember economics means rules of the household) “Humans act, that is they purposefully employ means, to achieve what they desire”.

We have already scratched the surface of another rule when we talked about the difference between air and the other vital things. It is the rule of subjective value. Subjective means, that it is always you, or more accurate, the individual, that gives value to an item. Air has no value to you, as you do not have to act (that is purposeful employing means to achieve ends) to get it. It is abundant in a normal environment. Remember the scuba diver (he is still trapped in that wreck)? To him air is pretty valuable, don’t you think? He probably would put a lot of effort into getting more. To him air is a good.

Another important rule we have here. Goods are things that have a value to individual humans. For something to be a good, it must be a means that an individual can use to achieve what he/she desires and it must be scarce. Bottom line, whether something is a good or not, depends on its usability for individual men. Another word for usability is utility.

Before I close this first short excursion to “common sense” economics another example tho show that something is a good only, if it has a utility for individuals.

Oil was the pest of every piece of land until only a hundred years ago. Whenever a farmer encountered those black, ugly, stinking springs on his land he was probably going to curse, even if he was a puritan(not meant offensive). Oil was not only worth nothing, yes it has been used in ancient warfare to ignite enemy ships, but this was long forgotten, oil was seen as bad luck if you had it on your property. Why? Because no one had any use for it until a guy named Rockefeller showed up and invented a way to make stuff called kerosene out of it. Now Kerosene was pretty useful. You could use it in lamps (can you imagine to have only daylight, how boring nights, especially in winter, must have been…uhm), and some people even experimented with it to build engines that might one day drive coaches without the need for horses which would be called cars or automobiles(which is a bad name because they do not drive by themselves as the name suggests).

All of a sudden, a good rose out of a totally useless thing like oil. And today, we tend to believe, with good reason, that our civilization might fall, if oil vanished.

Economics is not about complex equations in an ivory tower, but about human ingenuity to transfer the natural resources man finds into something useful.

]]> http://citizeneconomists.com/blogs/2008/12/03/forget-about-the-economists-economics-101/feed/ http://citizeneconomists.com/blogs/2008/12/02/missing-the-obvious/ http://citizeneconomists.com/blogs/2008/12/02/missing-the-obvious/#comments Tue, 02 Dec 2008 11:51:50 +0000 Dan McLaughlin http://citizeneconomists.com/blogs/?p=396 I recently heard a very knowledgeable, influential person talking about the future. He had many insights that were helpful and valid. His economic views, however were quite disturbing. He made a comment to the effect that capitalism is immoral. He pointed to the fact that many people have been hurt by capitalism and that it is morally bankrupt. You can’t count on people doing the right thing.

This is an intelligent man, someone who is aware, who’s job it is to look behind the façade to see what is really happening. This is also a man who is a consultant, a businessman, an entrepreneur, a profiteer and , in leftist radical terms, a capitalist pig. It is difficult to imagine that he is unaware of that fact. He is, in essence, an example of what is good and moral and right about capitalism.

He offered his service and he was paid very handsomely. The participants went away with something of value. He has clients all over the world that also pay him a lot of money, and I would expect that he is very busy because he gives something worth paying for. That is the essence of free markets, another name for capitalism, people trading freely with others who are willing to deal with them.

He is a small scale capitalist, but size doesn’t matter. Whether the market is for a gallon of milk or a billion dollar manufacturing plant, as long as the parties to the transaction are free to make their own decisions and use their own resources, economic freedom gives the best result. Consistently good judges of value and of the future are the most profitable and contribute the most to society. The only exceptions are those businesses that use government coercion for their profits, rather than market competition. They are the source of injustice in the markets.

Our consultant friend was committing the error that so many people commit these days. They assume that the markets are actually free because that’s what they have been told. They assume that economic freedom is the source of the problems. The natural inclination with that frame of reference is to look for government to save the day. He refuses to see that there isn’t a single market in this country that is truly free. Further, the markets that are experiencing the most disastrous problems are the ones that are most seriously impaired by government manipulation.

When our futurist cited his sources of economic understanding, it became clear as to why he was so far from the economic truth. Economist Joseph Stiglitz was a key reference in the economic analysis. He is one of a breed of influential economists who have been trained in the discipline of central planning. As intellectual superiors, they know how things should work. For this group, the stated aim of economics is to guide government intervention to bring economic nirvana to the people. Lowly peasants don’t know what is good for themselves, so they need the experts to cram it down their throats.

These economists lead intelligent but unwitting people to believe that banking deregulation caused the credit crisis. They say that the boom-bust cycle is an inherent evil of capitalism and that free markets lead to exploitation of the masses. What they don’t say is that the entire banking system is built on a foundation of government manipulation of banks, prices and markets. The Federal Reserve Bank directly and indirectly controls interest rates and monetary policy, the sources of economic instability. Artificially low interest rates initiate and expand credit and asset bubbles. We are living through the latest Fed induced bubble and crash as I write this. The Fed is, at this moment, laying the groundwork for the next big bubble and crash in 5 or 8 or 10 years, which may be worse than what we are experiencing now.

Our world traveling consultant seems to be a brilliant man. He has the answers to many questions and has a good grasp of technological and demographic trends. When it comes to economic understanding, however, it seems that he is missing the obvious. He imputes injustice on capitalism when it is, in fact, the only road to true justice and prosperity. “Capitalist pigs” like him are the reason that all people, rich and poor, are better off in free economies. His comments only empower the enemies of freedom. Moreover, his indictment of capitalism is an indictment of himself. Neither he nor capitalism deserve such treatment.

Occasionally, in order to clearly see the mechanisms of a process, it is necessary to isolate the elements involved and view them without extraneous factors. This leads to the “Thought Experiment” or gedanken in German. The Gedanken is a frequent tool in theoretical physics, and here I intend to use one in economics. I am going to imagine a particular scenario that is not theoretically impossible and examine the workings of that scenario to better understand the forces that we are interested in. An earlier example was my article on the Cost of youth. So here goes.

Image Credit: ocean.flynn

Imagine that we have an Island with a hundred people living on it. This island has only fifty houses however. The law of supply and demand has raised the prices of the houses to a particular level that allows only fifty people out of hundred to afford it. The rest will live in shacks, make shifts or find another alternatives. The important thing is that there are fifty houses, and all fifty of them are occupied by the richer half of the population. The fifty people are paying ready cash. No mortgages.

Under the circumstances, this is a fair arrangement. After all, everyone can’t have everything. Sad as it may be for the fifty people who are left out, it can’t get any better than this. Since space on the island is limited, more houses of the same sort cannot be built.

Now, imagine a twist in the scenario where people no longer need to have ready cash at hand, but can spread out their payments over a period of time. Perhaps over a period of 30 years. Suddenly a lot more people can afford the houses at the price level that was earlier set since they need not pay everything at once. Therefore, the demand for the houses goes up. Unfortunately, the suppy being constrained cannot keep up with the demand. So what happens? The prices of houses go up. What initially cost a 100 units one time payment, now costs over 15,000 (say) units spread out over a period of 30 years. Again, the exact price will depend on how much the fifty richest people can afford to pay.

The end result is that the same fifty people now occupy the same fifty houses (since they are still the richest) but at a much higher price than they would have paid without the whole mortgage system. This is one side effect of the mortgage structure, in that it artificially raises prices to the level that you have to spread out payments over several years. But this by itself (ridiculous as it may be), is not really unfair. The real catch arises during an economic crisis.

Say now that the economy slows down and over 80% of the people lose their jobs. This means that out of the fifty richest people who were living in the houses and were paying monthly payments, forty of them can no longer do so. As a result, they get kicked out.

End Result: 100 people on island, and 50 houses. However, only ten houses are occupied! Forty houses are too expensive for anyone to afford. Is this possible? Is it logical? Is this not grotesque? The banks that foreclose the forty houses are reluctant to drop the prices since they incur a loss on their balance sheets if they do so.

What went wrong? Two things. First, the fifty houses artificially boomed the prices of the houses to unimaginable levels. Second, it lead to a situation where hardly anyone could afford anything.

Doubtless in the real world, there are many other factors that can either mitigate or aggravate this scenario. But that doesn’t mean that the forces at work in our imaginary island are non existent. The purpose of this article was to isolate and view in undiluted glare, the tendencies that arise due to mortgages. In my opinion, the idea that you can pay for something over a period of time is counterproductive and ultimately makes everyone’s life miserable because in the long run, prices increase because of it and the same people get the same goods that they would have got if the mortgage system wasn’t there.

I rest my case m’lud.

The Treasury decided to increase the spending stakes. Paulson sang a familiar tune today, humming $600 billion for mortgage backed securities, and $200 billion meant to thaw credit for consumers. He aims at greater credit availability for student loans, car loans, and healthy new mortgage loans.

For average Jack and Jill citizens like me, the complex jargon of Paulson’s plan may sound good and well. We hear that the availability and affordability of credit will once more flow our way. For those of us that dare to ask the question of ‘why?’ underlying the decision to spend additional borrowed money in this manner, Paulson’s answer is clear. The answer is that financial institutions are still not performing as expected. Trend turned risk-averse, the lending industry is still shaking from their own mistakes, and non-existent viable risk policies. Go figure.

Here’s the deal. The fact that lending institutions are not performing as expected is the argument put forth at the bailout turn around each, and every corner. Paulson was forced to act again as the GDP fell 0,5% in the third quarter. However, the focus of average citizens is once more diverted from their own everyday realities.

Let’s bring the subject home.

Despite Citi’s rescue plan, the public was informed that they still plan to lay off 50,000 employees, and that interest and fee rates will increase. Yes, this includes credit card debt, as if those rates were not already sky-high. Considering the size of this giant conglomeration, the potential number of Americans affected is unsettling.

Furthermore. The plan that Paulson outlined in his press conference today will take a few months to implement, so any potential consumer effects cannot be evaluated until after he has left Treasury. The plan aims to solve the availability problem of new credit eventually applied for. That is, if the plan proves to work. It does nothing with the existing credit troubles of taxpayers, and we have to remember where the first bubble burst.

Although consumers are accountable for living beyond their means, forgotten is the predator lending that has taken place. Meanwhile, foreclosures continue, the unemployment rate of 6.5% is rising, and more jobs will be lost in the meantime. Although a credit thaw may save a few jobs in the future, most taxpayers with maxed-out credit lines and increased fees, may not necessarily increase their spending. They will most likely exist in survival mode, and be less concerned with ’stimulating the general economy’.

They say that certain entities are too large to not be saved. Yet, the ‘meanwhile’ effects are grossly underestimated, and these ripples may prove to be catastrophic. Will Paulson’s plan prove to work in the future? Don’t hold your breath, because the roller coaster ride is far from over.

Tamera Daun, Pentad©.

However, these appointments are a key tell in what should be a key strategy for economic recovery- monetary expansion.  While the Federal Reserve has already implemented major rate cuts and recently undertaken quantitative easing, the effects of these policies will not be felt for 6-9 months, as is the general case with monetary stimulus.  The greater risk could be that, just as a brief monetary expansion was put on hold in 1932 (not a good decision, it turned out), renewed concerns about inflation could create pressure on the Fed to cut short an effective monetary response.   But these appointments indicate that will not be Obama-led pressure.

All three- Geithner, Summers, and Romer- have indicated an understanding of monetary stimulus to provide short term benefits for economic growth.  Geithner, for example, was one of the leading proponents of keeping rates lower back in 2006 and has historically been dovish on monetary expansion.  Summers, while touting the benefits of fiscal stimulus last year, has also supported monetary expansion.  The most interesting pick here could be Mrs. Romer, as she has has expressly written that nearly all the positive economic shifts during the Great Depression were attributable to monetary expansion rather than some Austrian school view of natural economic recovery.

While President Obama has indicated a desire for redistribution of wealth in the US economy, and based on the election results, will oversee it, there are different ways to effect this redistribution.  Taxation and welfare is one way, but monetary expansion is another, because it ultimately creates higher levels of inflation.  As long as capacity and technology can come to the rescue (and there is plent of both available) so that core inflation can be moderated, this monetary expansion can be expected to continue.

Just as money has time value, it should also have a half life.  Without inflation, the wealthy can all too easily hoard their capital.  With inflation, they must either spend, or invest- or their wealth is, in fact, redistributed.  And redistribution to money earners- those who labor and invest- is not a bad idea for growing an economy.  And make no mistake, Mr. Obama and his team are focused on growing this economy.

In many respects, it seems vastly less developed than my own country - India. In this article, I will focus on just one aspect of it. Namely how consumers are happy to let big corporations walk all over them. I realize that coming from another country gives me a unique perspective on what I see is very wrong with the economic structure here.

Image Credit: MSH*

Let me take the first concrete example of what I mean. In India, a consumer has complete freedom as to which telecom company they want to stay with. Say I have a handset. Based on whose service I like, I can choose to use that handset with any telecom provider I choose. And next month if I want to change over to another one, I can do so immediately. I can just replace the SIM card with that of another company. This is perfectly legal and is very much the norm.

Imagine my surprise when I found out that in America you have to buy a phone attached to a particular firm (Either AT&T or T-Mobile or whatever)! Not only that, you are obligated to pay them every month, or else your credit history is tarnished. It’s amazing. How do customers put up with such shabby treatment? It seems as if the big telecom firms are holding customers to ransom. I say shabby, because compared to India where the consumer dictates terms, in America the big corporations call the shots. You can’t switch schemes without paying a contract breaking fee etc. In other words, the corporations have you locked in.

In addition, people here are forced to pay for incoming calls. Regular Americans seem to be okay with this. In India, if a telecom company started to charge incoming calls they would be laughed out of business. As I said, you can switch over anytime you want. In fact (and this is hilarious), a particular telecom provider (Virgin actually) pays consumers for incoming calls! Yet American consumers are unaware that they’re being fleeced. And in fact, what choice do they have? All telcos are the same. Even if they were willing to switch after paying the “Contract breaking fees”, it would be like jumping from the frying pan into the fire.

Moving on, I will now proceed to demonstrate that Internet companies also take advantage of their consumers and force their whims and fancies down their throats. As of now, what is to prevent say AT&T from imposing a cap of 50 GB download per month on their consumers? In fact, proposals to limit and even monitor traffic are in the pipeline. If Americans are outraged by such activities, who cares right? What choice do they have? Shifting to Comcast is no better! Once more, honest Americans seem unaware of the fact that service providers can do whatever they want by just imposing their policies down people’s throats.

This could never happen in India. And I know why. In India, most of the infrastructure for telephone lines and the Internet (Over 95%) is owned by the government and private companies lease it from the government. The government has it’s own telephone and Internet service (Called BSNL). If at any time the major Indian telcos decide to collaborate and shove a policy down the throats of the consumers (including raising the prices to any level they want), we will just shift en masse to the government service! For the government to change it’s policies is a different issue altogether. If the government suddenly decides to charge incoming calls, they will be voted out of power in a heartbeat. Thus it will never happen.

Before coming to America, I thought that complete privatisation was a good thing. Now after coming here I see that it leads to exploitation of consumers through cartels. Having certain infrastructure in the hands of the government is a saving grace for Indian consumers who love their freedom and hate restrictions. And the first opportunity I get, I am going back. America isn’t the land of the free that I thought it was. Enslavement by corporations, and being held to ransom by having your credit history checked at every point is the norm. And I never want someone to be looking over my shoulder like that.

The short answer is yes, it can. The longer, more complicated answer is that the looming (potential) failures of Ford, GM, and Chrysler present long term sustainability problems for a middle class that is already clamoring for short term, emergency solutions.

Ford recently announced third quarter losses of $129 million but admitted to having burned through $7.7 billion in operating costs during the same period. GM announced a staggering loss of $2.5 billion. Chrysler, by all accounts, will be belly up by the start of 2009 if the government is unable to broker a merger with GM, and all three are begging Washington for a second $25 billion in low-interest loans to keep them all afloat until the current economic crisis passes.

The announcement of these stunning losses and the request of additional federal money came alongside industry announcements of even more lay-offs and possible suspension of the plans for research and development of new, more fuel-efficient American cars. Without a more competitive product than the big trucks and SUVs of the past 15 years, it’s hard to see how and when things will get much better for the U.S. auto industry, but unfortunately the problems go much deeper than that.

Retail sales fell of a cliff in October across the board, with the exception of Wal-Mart, which saw a 2% increase in sales. Even sales of luxury items fell; items which in the past have been fairly recession-proof. Stores like Saks and Bloomingdales posted some of the worst figures of all. Job losses for October came to just under a quarter of a million, bringing the unemployment rate to a 14-year high of 6.5%, and this, by general agreement, is only the beginning of the labor effects of the recent credit crunch.

All of this bad news is hitting right before Christmas, a time when retail stores generally expect to be ramping up for the November and December sales that will carry them through the rest of the year. This year, those sales may not materialize at all. Circuit City is shutting down 120 stores for good, right before Christmas, just to stay solvent, and other big box stores that usually hire extra help for the holidays are actually terminating permanent workers to reduce costs.

The fact is that people are not buying anything right now. Even if the Big Three could produce a car that runs on air and then start shipping it to car lots tomorrow, most Americans would be unable to qualify for loans to buy these magical air cars, even if they had jobs or money to put down on them, which fewer and fewer people do with each passing day. The recession is looking like it will be long and hard, with many analysts seeing a turn-around no sooner than 2010.

When Henry Ford first started to build automobiles in the U.S., he made the radical decision to pay his assembly line workers incredibly well. He did this not out of a sense of altruism or social justice, but rather to expand his business plan so he could market his cars to everybody, thereby making more money for himself. In making this decision, he not only enabled his workers to buy the cars they were building, he also ended up creating a thriving American middle class.

Over the course of the past 30 years several developments have increased profits for U.S. corporations and their stockholders, while at the same time putting downward pressure on the mostly industrial middle class. Changes in U.S. trade agreements allowed industry to flee the U.S. rapidly and dramatically, forcing formerly middle class workers into low-wage jobs in the service sector.

As the good industrial jobs disappeared, corporations also began to eliminate middle-management white color jobs with middle class salaries. Most of the corporate jobs left in the U.S. today are entry level service sector jobs, often in call centers or tech support, with little opportunity for advancement or career development. Not much remains between the bottom of the corporate pyramid and the CEO, and what does remain is under constant pressure to produce more profit for less reward.

In fact, in most of these workplaces (the classic cubicle farms of the ‘Dilbert’ comic strip) a management style designed to turn over employees in one to two years remains firmly in place. While this rapid turnover keeps labor costs low, it also creates a very unstable, low-paid workforce with no special loyalty to any one job and not enough annual income to commit to a four-year auto loan.

In other words, the middle class jobs that created the ‘consumer economy’ are largely gone with the decline of the Big Three and the loss of myriad other U.S. industrial jobs, both related and unrelated. Steel, textiles, electronics, computer chips—all of these items are made overseas now. When people don’t have good jobs and can’t get credit, they can’t spend money. When people can’t spend money, more people lose jobs.

Short term, the U.S. will have to find a way to keep people in their homes, keep them warm and fed, and stabilize housing and financial markets. Those challenges would be daunting in and of themselves for even an economic Mozart. Deficit spending seems unavoidable at a time when the national debt is already completely out of control.

But long term, the U.S. will have to find a stable job base that can support a middle class and do whatever is necessary to keep those jobs here. If that doesn’t happen, if we don’t see something on the horizon to replace the dead industrial base, then all the stimulus packages Congress can dream up won’t prevent a long and painful period of poverty and contraction in America.

Gas prices are finally coming down.

Unfortunately we’re running on fumes and our credit cards are being declined.

What happens next will have long and lasting effects, not just on the economy, but on the health and security of the nation.

]]> http://citizeneconomists.com/blogs/2008/11/10/ford-gm-chrysler-announce-losses-can-the-american-middle-class-survive-a-big-three-meltdown/feed/ http://citizeneconomists.com/blogs/2008/11/07/adverse-selection-when-is-it-ok-to-lie-to-insurance-companies/ http://citizeneconomists.com/blogs/2008/11/07/adverse-selection-when-is-it-ok-to-lie-to-insurance-companies/#comments Fri, 07 Nov 2008 09:00:27 +0000 Bhagwad Jal Park http://citizeneconomists.com/blogs/?p=374 Today, we are going to discuss an interesting phenomenon in the world of game theory: namely, adverse selection. Frequently, game theory attempts to isolate and analyze curious phenomena and detect the essential elements that make it work. We can then try and manipulate these element to steer the game in a chosen direction.

The phenomenon of adverse selection occurs when several people are trying to obtain a particular goal, and the criteria which make the person either suitable or unsuitable to obtain that goal from the point of view of the entity and from the person trying to obtain it are diametrically opposite.

Let us take the example of a company who is trying to project to the world that only the most stylish and fashionable people wear their watches. To accomplish this, it decides to selectively sell their watches only to the most fashionable people in the world. From the point of view of the watch company, the people who must wear it must be really stylish and fashionable. However, the people who will most want to wear the watch will be wannabes. The wannabes will benefit most from the watch since, if they have the watch, they will be projected as stylish and fashionable. Hence, the watch company must be very suspicious of anyone who desperately wants to wear the watch.

Those who are really stylish and fashionable will not want to wear the watch so badly since their reputation is already made and they gain little from wearing it.

Adverse selection is characterized by the fact that people who most want to obtain something are typically the least worthy to have it.

Image Credit: stark23x

This manifests itself beautifully in the case of insurance companies. Regardless of what anyone says, insurance is essentially gambling. Insurance students will cut my throat out for saying this, but when all the smoke clears, it’s pretty obvious that when you take out an insurance, you’re hedging your bets.

Since insurance companies want to maximize their profits, they will want to have the odds stacked on their side. This means that they will want to give insurance to people who are least likely to demand a payout from them. On the other hand, those who most badly want insurance will be the people who are most likely to demand a payout.

A person who is old and has several ailments would love to have cheap insurance, whereas a young man in perfect health will have less to gain. However, insurance companies want the young man to sign up for insurance and not the old person. This is adverse selection in its most characteristic form.

It’s actually somewhat tragic. Giving insurance only to those who don’t want it completely defeats the purpose of insurance from the customer’s point of view. What’s the big idea of refusing insurance to those who need it most? That’s like selling pizza to a person who isn’t hungry! However, adverse selection doesn’t apply in the case of pizza.

Since insurance companies don’t play fair by testing people and even excluding some people from insurance based on their riskiness, the people who want insurance are perfectly justified in trying to fool the insurance companies by hiding their ailments. It’s a dance, and the outcome all depends on whether the insurance company can discover the hidden ailments of the person or not.

There is no stable solution to this. In other words, no Nash equilibrium exists. One of the parties will always wish that they had - or didn’t have - insurance, or the insurance company will always wish that they had - or didn’t have - a certain person’s business. A zero sum game. In the end, both parties can be happy only if they assess the situation differently. That is, each thinks that they have outwitted the other.