The Market Can Stay Irrational Longer Than You Can Stay Solvent
Via Tim Fernholtz, an interesting Wall Street Journal article summarizing Richard Posner’s views on the economic crisis. I think much of what Posner says here is smart, but this is somewhere between misleading and wrong:
The conventional wisdom is that very smart bankers misunderstood their own interests. In a capitalist system, if you can’t trust self-interest, what can you trust? Judge Posner instead reminds us that shareholders would have punished individual banks that failed to take advantage of low interest rates and seemingly safe, mortgage-backed securities. Likewise, consumers acted rationally over the years to accept offers of mortgages they couldn’t afford, given the low risk of a burst bubble.
“At no stage need irrationality be posited to explain what happened,” Judge Posner writes. Instead, this was a case of “intelligent businessmen rationally responding to their environment yet by doing so creating the preconditions for a terrible crash.” He chiefly blames the Federal Reserve, for “cheap credit.”
I’ll just note as a starting point that the whole idea that one might “posit” irrationality is a powerful glimpse at the tight grasp neoclassical economics has over the public discourse. Many economic models work by positing rationality in a world that appears to be full of irrational behavior. But the models now have such a hold on our thinking, that people who suggest that sometimes things are exactly as they seem—full of irrationality—are positing something.
Beyond that, though, it’s important to make the point that for the market to exhibit irrational behavior doesn’t require individuals to be hugely loopy or anything. Keynes addressed this in Chapter 12 of the General Theory. The conventional thing for professional investors to do is to focus on trying to make money off fairly short-term market fluctuations rather than to assess the long-term prospects of investments. Of course you could try to make money by bucking that trend but:
If the reader interjects that there must surely be large profits to be gained from the other players in the long run by a skilled individual who, unperturbed by the prevailing pastime, continues to purchase investments on the best genuine long-term expectations he can frame, he must be answered, first of all, that there are, indeed, such serious-minded individuals and that it makes a vast difference to an investment market whether or not they predominate in their influence over the game-players. But we must also add that there are several factors which jeopardise the predominance of such individuals in modern investment markets. Investment based on genuine long-term expectation is so difficult to-day as to be scarcely practicable. He who attempts it must surely lead much more laborious days and run greater risks than he who tries to guess better than the crowd how the crowd will behave; and, given equal intelligence, he may make more disastrous mistakes. There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun. Moreover, life is not long enough; — human nature desires quick results, there is a peculiar zest in making money quickly, and remoter gains are discounted by the average man at a very high rate. The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll. Furthermore, an investor who proposes to ignore near-term market fluctuations needs greater resources for safety and must not operate on so large a scale, if at all, with borrowed money — a further reason for the higher return from the pastime to a given stock of intelligence and resources. Finally it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.
The big point here is that to make a long-term play, you may need a huge amount of capital at your disposal. And it’s going to be very hard to raise that kind of capital, because conventional wisdom will hold that you’re a crazy person. If you happen to have a vast fortune at your disposal, you can play this game. And a few people do. But there simply aren’t enough people in possession of sufficiently vast fortunes for this to work as an adequate corrective mechanism. The saying is that “the market can stay irrational longer than you can stay solvent”. Even worse, the problem gets recursive. Since everyone knows that the market can stay irrational longer than you can stay solvent, nobody can count on investors making the rational play which means the market may stay irrational a very long time.
Consequently, the market won’t act as a self-correcting mechanism and things can get badly out of control. I think the fan of free markets can fairly reply that it’s not obvious what the solution to this problem is, but I don’t think it’s tenable to deny that the problem exists.
40 Responses to “The Market Can Stay Irrational Longer Than You Can Stay Solvent”
Register
RSSLogin
Topic Cloud
ArchivesBlog RollAbout Matt YglesiasContact Me
Donate
May 5th, 2009 at 10:56 am
The only sane thing to do is to jettison the word “rational” as it applies to markets. It’s merely a reflex to do it and an echo of ancient propaganda. We don’t apply the word to any other human endeavor or interest. We’ve at least as much at stake with sex and reproduction, and it’s obvious that marriage and mating is an irrational crap shoot for every single one of us.
May 5th, 2009 at 11:02 am
As an aside, I once had the honor of being decribed by Judge Posner as “hyperrational”.
Anyhoo, the nature of this dispute actually has more to do with the limits of our ability to predict the future than anything else. People like Posner think it is sufficient to note that predicting the future is really hard in many material ways, and therefore we don’t need to include any irrationality into the model to explain why sometimes things go really wrong in markets. Others think predicting the future isn’t quite that hard, so you need to add some irrational elements into the mix to supplement the model.
But either way, everyone is agreeing that “things can get badly out of control” in markets, even if they aren’t agreeing on exactly why. Which should be enough of a takeaway when it comes to the issue of whether or not we can rely on markets to solve all our problems.
May 5th, 2009 at 11:04 am
“…and it’s obvious that marriage and mating is an irrational crap shoot for every single one of us.”
I don’t think the data back this up. In cultures where people choose their marriage partners, you find high correlations in attractiveness and other relevant attributes between partners. I’m not sure of the exact term, but I think there is something called “rational exchange theory” that tries to explain how people try to maximize the desirable attributes in their mate given what is obtainable for them based on what they have to offer. I think you’ll also find that most people are pretty rational in terms of how they adjust their standards in what they are looking for based on their own attractiveness, social status, personality attributes, etc.
May 5th, 2009 at 11:06 am
An important point that Posner is making is that, if one can explain what happened without assuming irrationality, then it is probably a more parsimonious explanation than one assuming irrationality, especially since there probably aren’t any good predictive models that use irrationality.
May 5th, 2009 at 11:07 am
@3, I think that’s substituting “reasons” for “rational”.
May 5th, 2009 at 11:08 am
I am having a bit of difficulty seeing Keynes’ point here. There are many people who invest in stocks or mutual funds for retirement or other long term gains. They do boring things like invest in index funds, stay with them for decades, and invest the same sum every month regardless of what the market does. This isn’t such a difficult thing to do, nor does it tend to come under lots of criticism. It’s the leveraged financial institutions that today are getting the scorn, not the people investing for retirement.
May 5th, 2009 at 11:09 am
there probably aren’t any good predictive models that use rationality.
IFTFY
May 5th, 2009 at 11:14 am
“The conventional thing for professional investors to do is to focus on trying to make money off fairly short-term market fluctuations…”
Marx called that “stock jobbing.”
A way to legally transfer money from prudent savers to corrupt bankers.
May 5th, 2009 at 11:18 am
Something that has always bugged me about making Posner out to be an economics guru:Number of degrees that Posner has that have the word “economics” in it: zero. Of course, the same could be said about McArdle, Yglesias, etc.
May 5th, 2009 at 11:20 am
Posner is right. Those people weren’t irrational; they were greedy, manipulative, egocentric, elitist and autocratic – but not irrational.
After all, who has all the money?
May 5th, 2009 at 11:21 am
Many economic models work by positing rationality in a world that appears to be full of irrational behavior. But the models now have such a hold on our thinking, that people who suggest that sometimes things are exactly as they seem—full of irrationality—are positing something.
Beyond that, though, it’s important to make the point that for the market to exhibit irrational behavior doesn’t require individuals to be hugely loopy or anything.
You’re mixing up individual rationality with market rationality here. Individually rational decisions can lead to “irrational” collective behavior. This has been known at least since Ken Arrow’s work on social choice.
May 5th, 2009 at 11:26 am
Oh dear. Matt read one chapter of Keynes and now we have to deal with long-ass half-baked economics posts.
May 5th, 2009 at 11:38 am
I think the fan of free markets can fairly reply that it’s not obvious what the solution to this problem is, but I don’t think it’s tenable to deny that the problem exists.
Isn’t the obvious solution a transaction tax? Fans of free markets may not think it’s a desirable solution, but that doesn’t make it any less obvious.
May 5th, 2009 at 11:42 am
By the way, Matt ignores this point made by Posner:
But that is really rather a crucial point, regardless of what one feels about the rationality/irrationality debate: history has shown that capital will (rationally or irrationally) flock to the financial firms where the managers are providing the greatest returns. Accordingly, getting all worked up about the managers and their risk-taking behavior is missing the main issue, because the root problem is the decision being made by the people with the capital to reward risk-taking managers with more capital to play with. Similarly, contra to Matt’s pet theory, it won’t do much good to favor lots of small firms, because then capital will just flock to the small firms offering the greatest return, which will be the small firms taking the most risk, and we will simply get a different version of the same sort of problem.
May 5th, 2009 at 11:45 am
Great post, Matt. You really should have been an economist!
May 5th, 2009 at 11:48 am
Interesting tie in to the last post. Smart Austrians don’t deny that they problem exists – they just say that the “least bad” solution is to leave the market (warts and all) alone. In this way of looking at things, recessions, despite their obvious negative effects, have the salubrious effect of washing out a lot of the irationality (irrational market evalautions of a specific company can last only until the point where the company becomes insolvent).
Again, I have problems with this approach for a whole host of reasons, but this is one of the reasons why the Austrians are seeing a resurgence.
May 5th, 2009 at 11:49 am
Marx called that “stock jobbing.”
A way to legally transfer money from prudent savers to corrupt bankers.
The current crisis remind me of Marx’s theories of overproduction and the falling rate of profit, where the system is doomed to failure, but I don’t know if they really apply.
May 5th, 2009 at 11:51 am
I think this is brenton’s point, but Yglesias doesn’t seem to be objecting to what Posner is actually arguing for. Yglesias seems to be using Keynes to show that free market capitalism can preduce irrational, in the sense of self-defeating, results. But Posner’s argument seems to agree with that. Posner’s point seems to be that one gets those irrational results through individual rational behavior. But then that seems to be Keynes point as well.
It is true that the assumption of rationality at the individual level is obviously at best an approximation. But the problems with that assumption do not enter into the argument as presented above.
But Posner seems to be giving the Keynes argument not giving an argument that is being refuted by Keynes.
May 5th, 2009 at 12:01 pm
Poptarts,
I think what applies is Marx’s opinion that there’s a big difference between a capitalist who uses his own savings to start a business and the folks who just use borrowed money to buy and sell stocks.
Capitalism without the sacrifice, as it were.
These days we refer to it as “skin in the game.”
May 5th, 2009 at 12:07 pm
From what I can discern, there is a bit of confusion between the technical term ‘rationality’ and the vernacular meaning of the term. From a technical perspective rationality means subject models that ultimately derive behavior as motivated from perceived self interest, while rationality means behaviour that cannot be modeled.
So, as simplified example, altruism may be perceived as irrational, but can be modeled as rational if one injects expected immortality in paradise or divine retribution and/or utility of emotional responses to behaving in ways that are sanctioned by ones social peers, as part of the decision making process.
Irrationality, then, doesn’t exist by definition, unexplained behaviors are simply the product of rational processes that are not understood, insufficient information, or processes which while understood on an individual level are too complex to model at at a collective level.
May 5th, 2009 at 12:07 pm
LarryM,
I guess I don’t really see the argument on behalf of the Austrians you are suggesting. Sure, many of them were right to point out the dangers of the Fed keeping interest rates too low for too long, and many of them were right to identify the housing bubble as a dangerous credit-driven asset bubble. But the thing is, you didn’t need to be a devoted Austrian to think all that.
And fast-forwarding, the actual nature of this recession is a handy reminder of how at root the non-interventionist/liquidationist Austrians are just wrong about what happens next: the popping of the credit and housing bubbles did in fact lead to a general deflationary crisis which threatened to cause not just a brief and useful reallocation of resources, but rather a prolonged and avoidable widespread destruction of resources. Indeed, the massive increase in unemployment alone is a simple and compelling demonstration of this fact.
So in truth I don’t see much reason to reevaluate the Austrians. In a nutshell, there are some good reasons to listen to their warnings when interest rates are low and asset prices are booming. But once a serious deflationary recession takes off, you need to tune them out because they are simply wrong about that part of the cycle.
May 5th, 2009 at 12:18 pm
DMT,
I agree with your ultimate conclusion. I disagree in this sense: the current crisis doesn’t prove the truth what you are saying. You’re assuming that without the various government interventions we would have had a “prolonged and avoidable widespread destruction of resources.” An Austrian would argue that (correctly, I think) that said proposition was not tested by the current crisis. We don’t know what would have happened absent the financial bailout. The fact that the financial services industry didn’t crater doesn’t prove that it would have cratered but for the intervention.
May 5th, 2009 at 12:23 pm
And the flip side is this – one can make a convincing argument (convincing to me, anyway) that many of the current interventions are preventing the “useful reallocation of resources.”
Ideally we strike the sweat spot of a “brief and useful reallocation of resources” without the “prolonged and avoidable widespread destruction of resources.” Personally, I think hitting that sweet spot is damned difficult, whether we relay upon the market or upon the government. Where that leaves us I’m not sure. I’m a pessimist by nature, and the current unpleasantness is just reinforcing that pessimism.
May 5th, 2009 at 12:29 pm
If there’s irrationality, some of it occurred when multiple market participants, all of them skilled and knowledgeable, took seriously the judgments of ratings agencies when the compensation structure for those agencies was pretty clearly backwards. Once you have made that blunder (which may represent a cynical calculation that you’ll be able to unload your overrated crap before everyone else can smell it), all the other “it’s so rational” stuff follows pretty tidily.
May 5th, 2009 at 12:32 pm
Posner’s first mistake is to conflate bankers self interest with the self interest of banking corporations. Banks have been reliably going under since they were invented. A case can be made that every bank ever created has failed. Bankers however have done quite well for themselves.
Then too the Fed and the major banks, especially the giants, cannot be separated. The banks wanted too cheap credit. So too did politicians and citizens. However the banks interests came first. Sadly this theory cannot be tested because never in history has any bank lobbied for tighter credit, ie. higher interest rates. No anyone else but the occasional crazy and most post Depression pre Greenspan Fed leaders who routinely tightened credit as responsible central bankers are supposed to when too much risk and leverage entered the system.
The incentives for low rates and easy credit are universally understandable and absurdly simple. So too the problems that inevitably ensue. That being too much lending to borrowers who will not pay off their debt. Both are perfectly rational. So Posner is right in a technical sense that at no time was irrationality involved. What he fails to say is that the crash was rational, predictable and inevitable. (admittedly the crash was not inevitable in the sense that the Fed and Treasury could have pledged the $10 trillion to the banks before the crash. You might not want to go down the road of where unlimited government borrowing and central bank printing logically lead)
May 5th, 2009 at 12:41 pm
You’re assuming that without the various government interventions we would have had a “prolonged and avoidable widespread destruction of resources.” An Austrian would argue that (correctly, I think) that said proposition was not tested by the current crisis.
How is that correct? To take my simple example, we have actually observed a massive and widespread surge in unemployment. This massive and widespread surge in unemployment represents a prolonged and large-scale destruction, not reallocation, of resources.
Now one can reasonably wonder at this point whether or not our intervention efforts will work, since many of them are just getting started, and indeed even in hindsight it will always be hard to know for sure how well they worked. So to that extent, the one word in that phrase I can’t prove belongs is “avoidable”. But the mere fact that this is happening at all is to me a clear refutation of the premises behind the liquidationist approach.
The fact that the financial services industry didn’t crater doesn’t prove that it would have cratered but for the intervention.
It would have to be an awful coincidence that all our measures of the health of the credit industry (the various spreads and the like) were dropping off a cliff until we intervened. Again, to admittedly oversimplify, the liquidation of Lehman clearly produced a shock in the credit markets which threatened to cause a great deal more harm if it was followed by more such shocks. I just don’t see how someone not dogmatically wedded to liquidationism would possibly want to risk going much further down that path.
And the flip side is this – one can make a convincing argument (convincing to me, anyway) that many of the current interventions are preventing the “useful reallocation of resources.”
Here is where I would turn the logic you offered in favor of the Austrians on its head. Let us concede that government intervention can cause all sorts of problems. But we just got a good look at the abyss again, and it turns out the liquidationist approach is even worse. Again, modern Austrians basically deny things ever get that bad without intervention, but both pre-WWII history and now this latest crisis confirm that the Austrians are simply wrong about that.
May 5th, 2009 at 12:49 pm
“How is that correct? To take my simple example, we have actually observed a massive and widespread surge in unemployment. This massive and widespread surge in unemployment represents a prolonged and large-scale destruction, not reallocation, of resources.”
Hmm, I guess I just don’t see that as a destruction of resources. A bad thing, to be sure, for the people unemployed, and obviously destructive to the economy if prolonged (prolonged = years not months), but a short term increase in unemployment to levels which are not historically THAT high, not a “destruction of resources.” Or, stated another way, if that’s a destruction of resources, I don’t think that you can have a “useful reallocation of resources” without a destruction of resources. I mean, to the extent that one of the resources we are talking about is labor, just how to you reallocate that resource efficiently without a period of unemployment?
May 5th, 2009 at 12:56 pm
“I just don’t see how someone not dogmatically wedded to liquidationism would possibly want to risk going much further down that path.”
Well, personally, I wouldn’t take the risk, maybe because I’m not “dogmatically wedded to liquidationism.” My point was that RECENT events haven’t proven your point – mostly, I guess, because we haven’t tested Austrian solutions. For some very good historica reasons. But because of that, nothing that the Austrians say has been falsified by recent events. Whereas (partly because we have been applying conventional economic policies) a lot of mainstream economic thought has been (at least partiall) falsified.
And lets not forget that there ARE some undoubted downsides to the financial intervention – both in terms of social justice and in terms of moral hazard. And as you yourself say, it still might work. So there is room for someone to say that, given two unpalatable alternatives, doing nothing would have been the right call. That’s not ultimately where I come down, but that argument has not been falsified by events.
May 5th, 2009 at 12:58 pm
Sigh, my proof reading is worse than Matt’s. Of the several errors in my last reply, the most substantive:
“it still might work” should read “it still might not work.”
May 5th, 2009 at 1:03 pm
“Again, modern Austrians basically deny things ever get that bad without intervention, but both pre-WWII history and now this latest crisis confirm that the Austrians are simply wrong about that.”
How is this true? Again, since we have been intervening, non-intevevention hasn’t been tested.
Much more convincing (and why, all this nitpicking aside, I reluctantly support the bailout) would be a reference to earlier history, where non-interventionism was tested and arguably found wanting.
I suppose you could argue – and maybe you are arguing – that contrasting post war recessions to earlier recessions and depressions proves the merits of governmental intervention – and I would tend to agree with you. But you can’t say that about the current crisis, since we still don’t know the ultimate outcome.
May 5th, 2009 at 1:08 pm
DTM,
Oops, misread your last paragraph – yes, pre-war WWII history (misread by me as post-war), absolutely, that’s why I agree with your ultimate conclusions, but for the reasons stated, your argument about the current crisis is unconvincing to say the least.
May 5th, 2009 at 1:16 pm
LarryM,
On unemployment: first, time spent unwillingly idle is a unrecoverable destruction of an economic resource (Austrians don’t like to acknowledge this point, but it is true: you can’t get back what that person could have produced in that idle time). Second, we already allow for some unemployment attendant to people changing jobs and taking some time to do it, but the current levels of unemployment have shot way above that level, and again that represents a quite large and unrecoverable wasting of economic resources. Third, these conditions have lasted a long time already (recall the recession started in December 2007), and are still getting worse. I really think all that is a clear refutation of the necessary liquidationist premises with respect to how quickly an economy should reallocate.
On the financial industry: why wasn’t Lehman a mini-test of the liquidationist approach (scoring it a clear failure)? Do we actually have to liquidate ourselves all the way to Mad Max territory before we can consider this approach to be falsified?
In general, I know the Austrian arguments for liquidation, and I know how they try to deal with the fact that recessions really sucked in our pre-interventionist days. My point is that I don’t see how recent events have actually made those arguments look any stronger, which I took to be your thesis, and instead I think we have just gotten a reminder of why we decided in the past that doing nothing was in fact a poor policy.
May 5th, 2009 at 1:34 pm
And as you yourself say, it still might work. So there is room for someone to say that, given two unpalatable alternatives, doing nothing would have been the right call.
Not really. The downside is too great. The IMF is saying there would have been a global depression had the major governments of the world not taken unprecendented countervailing actions. The bad data recorded so far would have been much much worse and a vicious cycle would have taken hold, if history is any guide.
The world economy came out of the Great Depression only because of the creative destruction and massive governmental intervention of war. Is this what the liquidationists are advocating? It seems kind of callous.
May 5th, 2009 at 1:34 pm
DTM,
We are to some extent picking at nits here, but:
“Second, we already allow for some unemployment attendant to people changing jobs and taking some time to do it, but the current levels of unemployment have shot way above that level, and again that represents a quite large and unrecoverable wasting of economic resources.”
Well here we have our only serious substantive disagreement. Reallocation of labor often requires retraining, education, etc. If, say, you need to reallocate labor from, say, the financial or automotive sectors, to some different sector (I don’t know – health care? information technology?) some people are going to necessarily be unemployed for a while. Efficient reallocation of resources REQUIRES what you are calling a “wasting of economic resources.”
And is, say, keeping a person employed (by government interventions) making cars that no one is buying any more of an efficient use of resources than having that person go through a period of unemployment? I’d say less so. I mean, I’m all for cushioning “reallocation of resources” when those resources are real people who are unemployed through no fault of their own, but you seem to be living in an unrealistic utopia where we can reallocate people from a failing sector of the economy to a growing sector of the economy by waving our hands.
Or to put it another way, you argument makes some sense if we are merely talking about a company that fails in an otherwise stable industry. You argument doesn’t account for a dynamic economy where some sectors are growing and others shrinking.
“I don’t see how recent events have actually made those arguments look any stronger, which I took to be your thesis,”
To clarify, my thesis is that recent events have made most other economic theries look weaker. It hasn’t made Austrian arguments look stronger (aside perhaps for some of the descriptive arguments regarding the causes of a downturn). They emerge “unscathed,” not “vindicated.”
May 5th, 2009 at 1:34 pm
“Posner’s first mistake is to conflate bankers self interest with the self interest of banking corporations. ”
Wasn’t that the mistake Greenspan admitted to?
May 5th, 2009 at 1:53 pm
Reallocation of labor often requires retraining, education, etc.
Right, which is part of why we treat something above 0% as full employment. So is that what all the extra unemployed are doing right now? Is there a massive surge in training and education? Or are they just idle?
you seem to be living in an unrealistic utopia where we can reallocate people from a failing sector of the economy to a growing sector of the economy by waving our hands.
Where did I say that? Everything I have said is consistent with the view that reorganizing the economy could take a while and be painful. But the point of intervention is not to eliminate the pain, but to make it not as bad as it could be.
So let us suppose that all that happens is that the extra unemployed people build public bridges for a while before the economy starts recovery, and then they switch into something else as opportunities in the reorganized private sector start to come back up. Now if you were taking these people away from their education and training, that might be a problem. But that isn’t what is happening–they are just idle. So at least we get the bridges.
And of course there really are multiplier effects: the bridge-builder’s wages become another waitress hired at the diner, and again unless you really believe that waitress would have been doing something else, we are better off. And so with the guy at the concrete plant.
But seriously, we are just rehashing the eternal debate. I thought your thesis was that the recent crisis somehow has brought something new in favor of Austrian liquidationism to the table, at least relatively speaking. And I just don’t see it.
To clarify, my thesis is that recent events have made most other economic theries look weaker.
If by that you mean weaker in comparison to Austrian liquidationism . . . how so? Again, I get that maybe some Austrians have a right to claim foresight on the credit crisis, although they have some company. But as far as the recovery is concerned, how, for example, have the Keynesians been weakened relative to the Austrians as yet? What is their equivalent to the disaster that followed Lehman? Indeed, not just an equivalent, but something even worse?
Anyway, we are going in circles. This is the same old debate, and I thought you were claiming to have something new to offer.
May 5th, 2009 at 2:02 pm
You argument doesn’t account for a dynamic economy where some sectors are growing and others shrinking.
The Austrians’ theory was tested on Lehmann Brothers, which was creatively destroyed. The credit markets froze and much madness ensued. I don’t agree on how the Bush administration went about enacting TARP, but if nothing had been done things would have gotten worse and worse and a vicious cycle would have taken hold. To deny this is to be ideological especially after witnessing what happened to the markets after the government allowed Lehmann Brothers to fail.
May 5th, 2009 at 4:02 pm
The only rational decision is to become friends with the government. The UAW, for example, is good friends with it and they’re getting amazing concessions all the way around. The hedge fund managers who bought Chrysler debt that placed them first in line if a bankruptcy went down are watching Obama villify them and try to cheat them out of their money. Chrysler is a huge failure and should be liquidated, but because of political pressure, that’s being slowed.
So if you make the right business decision but you don’t account for the government’s willingness to negate your contracts (or inflate the bubble still more) then… you didn’t make the right business decision. The people who are making out the best are the ones with a direct connection to the seat of power or who look suitably cute to the voters (UAW).
May 5th, 2009 at 9:25 pm
Poptarts Says: The current crisis remind me of Marx’s theories of overproduction and the falling rate of profit, where the system is doomed to failure, but I don’t know if they really apply.
alphie Says: I think what applies is Marx’s opinion that there’s a big difference between a capitalist who uses his own savings to start a business and the folks who just use borrowed money to buy and sell stocks.
Capitalism without the sacrifice, as it were.
These days we refer to it as “skin in the game.”
Let me tell you a little about Lowell. Lowell isn’t where the first textile mill in the US was built; it’s famous for being at the forefront of the industrial revolution in another manner.
Prior to Lowell, mills were built by industrialists, so they could own and operate a profitable business processing or manufacturing a good. Slater’s mill in Pawtucket, RI was built this way. So were the old grist (grain-grinding) mills in New England towns going all the way back to the early 1600s. The owner was a miller.
The mills in Lowell were built by a company of professional investors, using their own money and that of people who bought stock in the company. They took this money, built a mill at a site, and initially operated and expanded the site for a profit, just like the old mill owners, but then they did something that was never part of the old millers’ business model: they sold off that mill complex to somebody. They used this money to pay off investors, and build another mill site. And another, and another.
Eventually, the capacity of textile mills met and exceeded the demand for their goods – but the Massachusetts Manufacturing Company kept building mill sites, because their business model didn’t depend on the mills being profitable over the long term. Profit margins vanished in the textile industry, wages went down in the mills, corners were cut – the workers were the ones who really suffered.
You know who uses this business model today? Mall developers. That’s why there are so many dead malls, yet the keep building them.
May 6th, 2009 at 12:48 am
[...] irrational longer than you can stay solvent” – and it is a very important conceptual point. Matthew Ygelsias was onto this point today, and I think it should become a normal way we think of [...]