Macroeconomics and Market Meltdown
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Posted: 08/16/07
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Macroeconomics and Market Meltdown
By Thomas E. Brewton
Big government, abetted by Keynesian macroeconomics, fostered today's
macro meltdown in the financial markets.
Collectivism in the Federal government since the 1930s New Deal is
paralleled by the emergence in financial markets of giant, multi-
national financial institutions. Both reflect the detached, numbers
only, view of socialistic regulators who deal in large abstractions
called "the economy" and "the workers."
As Stalin is reputed to have said, one death is a tragedy; a million
deaths is just a statistic. Make it big enough, and it can be made
to seem in the best interests of society.
Stalin's detachment applies to the process of pooling thousands of
individual debts – home mortgage loans, automobile notes, etc. –
into a single large debt package. Implicit is the idea that, even
when a whole class of debt is highly risky, putting enough of them
together will somehow mitigate the riskiness of any one of the
components. Risks of default may be high in any one of the
underlying pooled obligations, but aggregating enough of them into a
single statistical vehicle presumably cancels the risk of individual
components.
Macroeconomics is the Keynesian thesis that specific prices and wage
rates don't matter, that it is sufficient to look only at averages of
prices and wages for the whole economy. And, in that picture, the
ultimate determinant of employment and economic activity is Federal
deficit spending, the perennial Democratic Party "solution" to every
economic slowdown. Closely allied is the theory that the Federal
Reserve can control inflation and the level of economic activity by
fiddling with interest rates.
In contrast, traditional economics looks to the free market to
readjust interest rates, prices and wages that have become too high
in individual companies and segments of individual industries, fully
aware that average wages and average prices are meaningless in re-
establishing economic equilibrium. History repeatedly demonstrates
that individual people and enterprises are far better at judging
prices and wages than any elite group of economists or state-planners.
The 1920-21 recession was as severe as the start of the Depression in
1929-30. With little government interference, the 1920-21 recession
was ended in less than a year via the historical processes of
lowering wage rates and materials prices until businesses could again
produce goods at a profit. It is to be noted that there were many
thousands of different adjustments of prices and wages, varying from
industry to industry and from company to company.
In baleful contrast, the macroeconomic approach of Presidents Herbert
Hoover and Franklin Roosevelt pressured businesses to keep wages up,
with the result that production costs remained too high for
businesses to resume profitable production. Unemployment remained in
excess of 15% for ten years.
The appearance in 1936 of John Maynard Keynes's "General Theory of
Employment, Interest, and Money" made macroeconomic theory orthodoxy
among the socialist intelligentsia in Franklin Roosevelt's
administrations. Since then, three generations of students have been
taught that Keynesian macroeconomics is the appropriate analytical
tool to understand the dynamics of our economy. Those students,
since the 1980s, have transformed banking and investment analysis
into a numbers-only abstraction of averages that disregards
underlying risks in the individual transactions that now are rolled
up into huge pools of securitized debt.
Bankers historically were schooled to judge first and foremost the
personal character of their borrowers, then to determine whether the
requested loans could reasonably be repaid from cash flow of the
business. Banking and investment since the 1980s has been
increasingly divorced from knowledge of the underlying assets and
increasingly focused on law-of-large-numbers abstractions in which
the underlying economic reality is out of sight.
In the commercial real estate field, for example, as recently as the
1970s, institutions financing office buildings, shopping centers,
apartments, industrial warehouses, and hotels were staffed with
people who had lived through one or more economic recessions, people
who therefore were keenly aware of potential risks in property
locations and property types. Prudential Insurance
Company, then the largest real estate lender, had more than 60
offices in every part of the country with loan officers who knew
every detail of their territories and details of every investment.
By the early 1980s, hyperinflation created by President Johnson's
Great Society deluge of welfare entitlements spending had wrecked the
balance sheets of S & Ls and insurance companies. S & L depositors
withdrew their savings from 4.5% savings deposits, and insurance
company policy holders borrowed full cash values of their policies at
the contractual 5% rates, both groups reinvesting in short term money
funds that were paying interest rates around 12% to 14% per annum.
This started the rapid agglomeration of financial institutions,
changing S & Ls from local institutions that knew their territories
into giant organizations lending nationwide. They were staffed
mostly by young people in their 20s who had never lived through down
markets. And those inexperienced lending officers were asked to lend
in much larger individual deals, at a fast pace.
The same scenario was repeated in insurance companies, investment
banks, and commercial banks.
Most of the young people taking jobs in those huge financial
organizations were schooled in computer analysis and creation of
abstract financing techniques, which meant that too many of them
never left their offices and knew little or nothing about the
underlying business or real estate projects they were financing.
The diffusion of the Keynesian macroeconomic mindset thus set the
stage for recent unraveling of complex, computer-constructed
investment vehicles in which it is impossible to determine the real
economic bases of the millions of individual transactions comprising
them.
Thomas E. Brewton is a staff writer for the New Media Alliance, Inc.
The New Media Alliance is a non-profit (501c3) national coalition of
writers, journalists and grass-roots media outlets.
His weblog is THE VIEW FROM 1776
http://www.thomasbrewton.com/
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