One step in deciding where you stand as an entrepreneur is to make sense of the financial environment in which you will be competing and in which you choose to compete. This post shows how individuals in the free market can make completely rational decisions that lead them astray. In other words, once you choose certain paths, even smart decisions lead to disaster.
The recent financial crash started with the subprime mortgage crisis, but this was not the cause. In House of Cards, CNBC reporter David Faber breaks down the components that led to the housing crisis. It is fascinating how the banks, mortgage companies, rating agencies, investment banks, consumers, and even sovereigns came together to create what is described in the show to be massive Ponzi scheme. In my view, what Faber presents below is an exaggerated depiction of what happens in every business. Individuals act rationally (from their point of view) and the free market takes you on a ride-- either up or down.
In July 2009, a writer for The Federal Reserve Bank of New York magazine presented an entirely different angle on the housing crisis here. He says that a decline in labor productivity growth (not increasing as fast as it was) which began in 2004 was really a major underlying cause of the financial crisis. There is no doubt that over-leveraged banks and poor regulation caused serious issues, but if James Kahn is correct, then productivity growth decline was probably an equal or larger factor.
In July 2009, a writer for The Federal Reserve Bank of New York magazine presented an entirely different angle on the housing crisis here. He says that a decline in labor productivity growth (not increasing as fast as it was) which began in 2004 was really a major underlying cause of the financial crisis. There is no doubt that over-leveraged banks and poor regulation caused serious issues, but if James Kahn is correct, then productivity growth decline was probably an equal or larger factor.
In 2003, I read the book The Coming Crash In The Housing Market (John R. Talbott, 2003) which I found so convincing that I eventually sold my house in 2005. There were other pessimists back then, of course, but most argued that the bubbles were location-specific. I tried for a number of years (2003-2006) to convince numerous colleagues, many of whom were in commercial and residential real estate, that the end may be near. Not one person-- not even one among dozens-- agreed with me (well, effectively with Talbott). The best I got was that the market would slow some. Such is the nature of bubbles.
Incidentally, I read Talbott's 2003 book because he had written a book in 1999 called Slave Wages in which predicted the Dot Com Crash of 2000. He later wrote a book (in 2006) called Sell Now! The End of The Housing Bubble. He has a habit of being right. His latest book, Contagion (2009), is pretty insightful as well but was not as persuasive to me as his past books.
Talbott and many others have targetted Alan Greenspan as one ingredient in the crisis for encouraging self-regulation among market participants. Greenspan has also taken some heat for admittedly not understanding or properly regulating Collateralized Debt Obligations (CDOs), the rating agency system, and Credit Default Swaps, and for overly aggressive monetary policy. But irrespective of who is to blame for the crisis, the result is that the nation's populace is polarized between the types of solutions that we should implement to fix our apparently broken system. The sanctity of Adam Smith's 'free market', which lifted a billion people out of subsistence poverty since the fall of the Berlin Wall, is under attack.
"The superior man understands what is right; the inferior man understands what will sell." - Confucius (ref)
