Causes of the Meltdown

We are living through the greatest economic crisis since World War II, if not the Great Depression. It will take regulators, political scientists, economists, and historians years to sort out all of the sources of the crisis, although we can hope that concrete steps will be taken soon to right the economy, and restructure the various regulatory systems that have been poorly administered, have malfunctioned or were structured poorly at the outset. I have been reading and learning a lot about these lately, but I wanted to mention some other issues that I find worth thinking about as well. After all, the origin of the crisis was the housing market. It is amazing to think that a global financial crisis began with such a low tech and ordinary item of commerce. I am sure that there was a significant amount of fraud both by the issuers of mortgages and by the buyers of them, not to mention the creators of mortgage backed securities. But what is interesting to me is the extent to which ordinary people were prepared to take big risks in buying homes or taking out loans on them. I have not seen a lot of discussion in the press about how so many people were able to get in so far over their heads.

I will mention a few things that I have seen that I have found helpful. One was simply a letter to the New York Times by Neal Tyson, an astrophysicist, who claimed that the mathematical illiteracy of a nation can have costly effects:

http://query.nytimes.com/gst/fullpage.html?res=9E04E2DA123AF93AA2575AC0A96E9C8B63&sec=&spon=&pagewanted=2

Another helpful angle on the crisis was provided by Barbara Ehrenreich, who described in a vivid way the manic optimism that seems characteristic of Americans.

http://www.nytimes.com/2008/09/24/opinion/24ehrenreich.html?scp=2&sq=Barbara+Ehrenreich&st=nyt

If you think that a big investment in ‘the American dream’ can’t go bad, we’ve now seen, you may not only be a menace to yourself, you may be a menace to others. It’s difficult to talk about this issue intelligently, since we all believe that hope and optimism are valuable traits, but there is a kind of realism that we all need, too.

Tyson’s point about the prevalence of mathematical illiteracy complements Ehrenreich’s point about about dangerous optimism. If people can’t calculate the real costs of their own investment in their houses, and they think they can’t lose by it, they’re liable to take on too much risk.

Another point that has been emphasized by some intelligent commentators like Robert Shiller, the Yale economist, is the ‘herd mentality’ that sets in as a bubble progresses, where people see others making lots of money and feel foolish if they don’t jump in as well.

Finally, someone–whose name escapes me–questioned the whole premise that we as a society should be encouraging people to invest a lot of their wealth in their own homes. We’ve now seen that they are not a sure fire way to make money. And homes are not nearly as productive an asset as a factory, or a school. (This last point appeals to me personally, since I accept the saying, made in another context, that ” a house is a machine to live in”. I do not get at all misty-eyed about my house, and I look at it as simply a comfortable shelter near my work place.)

Patient, realistic saving and investment are things we need to have widely practiced, and for reasons that I’ve only sketched it seems that numerous Americans have not got the hang of it.

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