How to Build a Sustainable Economy; Not Another Bubble

I know this may not be popular, but the housing bubble is not an isolated incident, foisted on the unsuspecting public by a group of law-breaking criminals who took down our economy based on their own greed and avarice.

It is, however, the latest example (albeit a massive one) of asset bubbles -- wild, uncontrolled speculation of prices upward -- that are a systematic flaw of capitalism. We all understand that when demand outstrips supply, prices are supposed to rise in response. But when that demand becomes unreasoned -- when the crowd mentality takes hold -- prices rapidly spiral upward. In those cases, when sanity is restored, prices "correct" (crash) down even faster. Examples from history include the tulip mania in the 1620s; 'The Roaring 20s' Wall Street boom and subsequent market crash in 1929; "junk bonds" in the 1980s; dot.coms and telecom in the 1990s and the sub-prime mortgage/collateralized debt obligations that were the cause of the most recent economic collapse.

We make a very big mistake if we see these things as isolated incidents, and are content to blame a few nefarious people -- or groups of people -- for the systemic problem. Bringing people like this to justice is important, of course, but we must be careful that we don't simplify the problem and avoid the other factors that cause 'irrational exuberance' and lead us into these situations which are becoming more frequent and more severe.

I know it is hard to see that this example is 'just another' example of irrational exuberance because these are our homes, where we live. They're solid and 'real' (unlike dot.coms or junk bonds or even the tulips as the deer remind me every spring when they start snacking on my garden). And yet, this time is not that different and, here comes the bad news, it won't be the last, unless we learn the true lessons. Rather than asking "why does this keep happening to us?" we need to ask ourselves "what is it what we keep doing that makes us susceptible?"

  • Capitalism is an economic, and not a political model.
  • Capitalism is not inherently 'good' or 'evil' but individual wealth creation -- the ability to earn and retain capital -- is a tremendously powerful force for change, as millions have been lifted out of poverty -- and those who have seen their fortunes reverse -- can attest.
  • Periodic financial meltdowns are a systemic dysfunction of a capitalist economy.
  • Short-term thinking is inconsistent with long-term best interests and can fuel the size, scope and frequency of 'bubbles' the lead to economic collapse.
  • We must understand that culture (nationality, faith, value systems etc.) define how capitalism is implemented. Capitalism in Japan is not the same as it is in the United States -- although the U.S. model has been the predominant model throughout the 20th century. Capitalism therefore reflects our own culture and societal values.

Buying things we cannot afford on credit flies in the face of the famous adage; 'neither a borrower or lender be.' Obviously for some things, like homes, most of us cannot afford to buy outright, so we are forced to either forego ownership or take out a loan. In that case, it is in our best interests to ensure that the value of the item is close to -- ideally below -- the amount borrowed. And wild speculation of home prices upwards was, in part, driven by the fact that people were not looking at them as (just) places to live, but also for investments to replace their lost savings in the burst.

The very acquisitive nature of our modern society -- I want it now -- is an example of short term thinking that helps fuel larger bubbles. This aspect of our culture is causing large numbers of people to charge with abandon from one investment to the next. Homes have traditionally been reasonable investments, providing shelter for us and our families while growing in value. But it is important to note that our parents bought 30-year homes and most of the money they got out of them when they did sell for higher prices was a reasonable rate of return over the life of the loan, and also reflected that they paid off (or mostly down) the principle of the loan.

The bottom line is our super-consumerism culture is partly responsible for fueling the artificial demand that causes price escalation, and our 'keep up with the Joneses' mentality makes people fear missing out more than they fear the consequences of being caught when the bubble bursts.
The phenomenon of the crowd, and the momentum that is created by groups has been well summed up by Charles MacKay: "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." Alan Greenspan called it "irrational exuberance" and people shrugged off his warning, preferring to continue to stampede down an unsustainable path.

As a society we are the more than willing victims who love the adrenalin rush that comes with watching the Dow rise, or our home assessments go up, or our portfolios expand but then turn around and blame our predators when we get caught.

Perhaps until now.

While 'this time is going to be different' is often the last gasp of the truly desperate, it is possible that the larger lesson about ourselves can be learned. Rather than things we can retrospectively look back on as foolish to begin with (plant bulbs, tea, or something labeled 'junk bonds') this time we can see that our foolishness resulted in wagering our homes. And this time the bubble was big enough that far more people were impacted when people sought to keep this bubble growing. Can this result in a cultural change toward a bit more rational optimism rather than irrational exuberance? After all, as our economy oh so slowly recovers, wouldn't it be great to build it on something even more solid than our homes - our sensibility?