Debt
One of the smartest things that I overheard the weekend I went back to Arizona came from my youngest brother. He pointed out that a big problem with modern economies is debt and financing when it runs amok. (To be clear, in this post I am not paraphrasing what he was saying, although he gave me some food for thought and I'm running with it.)
A good economic system is supposed to encourage efficiency. That's what communist central planning was supposed to do - put smart people in charge to decide how much wheat and tungsten were needed and ought to be produced. Unfortunately central planning was better in theory than in practice while the free market ended up being a lot better. In the free market, if we need more wheat or tungsten the price increases, more people are incentivized to produce those commodities, supply increases, and price drops again. Conversely, if you can think of something really clever to do with tungsten you'll be willing to buy more of it and pay a higher price for it than someone who just wants to use it as a doorstop. The result is that prices for commodities end up being more or less what they're worth, what they ought to cost, and what they're used for.
But some commodities and prices haven't been working that way lately. Houses, for example, became three times as expensive as they were a decade before. That wasn't because houses got three times better, it's because people were able to pay three times as much as before because they were able to borrow three times as much as before. The free market should have created efficiency by providing the best real estate to the people planning to use it most productively, but buying real estate turned into a game of chicken where buyers were competing to see who was willing to take on the biggest loan and take on the most debt. The same goes for other big ticket items like college educations. In the 50s, someone could pay their way through college by working a second job and graduate debt-free, but tuition prices have risen faster than inflation because (among other reasons) easy credit, low interest rates, and tuition deferment have allowed students to compete for huge amounts of debt. Easy credit means the person who ends up with the assets isn't necessarily the person with the greatest need or best idea, it's the person with the least misgivings about going into debt. And as we've just seen, credit exacerbates boom/bust cycles. Leverage gives investors an incentive to shoot the moon. Easy and available credit allows bubbles to inflate far larger than they normally could.
So what do we do about it? This is where heads stop nodding, things get thorny, and opinions diverge.
First, debt is an investment by the borrower. Someone who buys a house for $500,000 is not "in the hole for half a mil" because if it's a fair price their balance sheet still balances (assuming that $500k is a fair and reasonable value for a house). They can rent it for $2500 a month and resell it for $550,000 in 10 years. Someone who gets a college education acquires the valuable assets of professional skills and education. Someone who goes into $500,000 worth of debt to get an education can use those skills and that education to make $150,000 every year till retirement while enjoying side benefits like smart friends and cultural literacy. And someone who lends that person money for a house or education is making an investment in that person, just as they would invest in any other business venture. You can't limit debt without limiting both freedom and prosperity.
Second, this sort of debt is not just beneficial to the debtor and lender but beneficial to society for the same reason that capitalism is beneficial not just to capitalist and customer but to society. You want the person who graduates from medical or law school to be the most promising doctor or lawyer, not just the rich son of a doctor or laywer. Debt is an economic equalizer. It gives poor people with big ideas but no capital a chance to compete with the people who already have capital.
Third, part of the reason why money got so easy to lend is because it seemed like there was a lot of money out there to be lent. The most recent bubble of debt inflation was caused not (or not just) by Democratic social programs or Republican deregulation but by the giant global pool of money looking for assets and ventures to invest in. Investors were just as eager to lend their money as debtors were to accept it - and just as foolish.
It would be easy to just shrug and say "boom/bust is the natural order of free markets" or "foolish decisions should be painful" but that doesn't really address the issue of systemic risk or all the idiots who are willing to go into unreasonable debt inflating prices and snapping up the assets of the people who aren't. And even if we did come up with some magical measure to prevent, encourage, or incentivize people to not take on unreasonable amounts of debt what's to stop the next generation from forgetting the lesson, getting seduced by cheap credit all over again, and coming right back to where we are today? Is the problem worse than the cure? I dunno. This one's a tough nut.
A good economic system is supposed to encourage efficiency. That's what communist central planning was supposed to do - put smart people in charge to decide how much wheat and tungsten were needed and ought to be produced. Unfortunately central planning was better in theory than in practice while the free market ended up being a lot better. In the free market, if we need more wheat or tungsten the price increases, more people are incentivized to produce those commodities, supply increases, and price drops again. Conversely, if you can think of something really clever to do with tungsten you'll be willing to buy more of it and pay a higher price for it than someone who just wants to use it as a doorstop. The result is that prices for commodities end up being more or less what they're worth, what they ought to cost, and what they're used for.
But some commodities and prices haven't been working that way lately. Houses, for example, became three times as expensive as they were a decade before. That wasn't because houses got three times better, it's because people were able to pay three times as much as before because they were able to borrow three times as much as before. The free market should have created efficiency by providing the best real estate to the people planning to use it most productively, but buying real estate turned into a game of chicken where buyers were competing to see who was willing to take on the biggest loan and take on the most debt. The same goes for other big ticket items like college educations. In the 50s, someone could pay their way through college by working a second job and graduate debt-free, but tuition prices have risen faster than inflation because (among other reasons) easy credit, low interest rates, and tuition deferment have allowed students to compete for huge amounts of debt. Easy credit means the person who ends up with the assets isn't necessarily the person with the greatest need or best idea, it's the person with the least misgivings about going into debt. And as we've just seen, credit exacerbates boom/bust cycles. Leverage gives investors an incentive to shoot the moon. Easy and available credit allows bubbles to inflate far larger than they normally could.
So what do we do about it? This is where heads stop nodding, things get thorny, and opinions diverge.
First, debt is an investment by the borrower. Someone who buys a house for $500,000 is not "in the hole for half a mil" because if it's a fair price their balance sheet still balances (assuming that $500k is a fair and reasonable value for a house). They can rent it for $2500 a month and resell it for $550,000 in 10 years. Someone who gets a college education acquires the valuable assets of professional skills and education. Someone who goes into $500,000 worth of debt to get an education can use those skills and that education to make $150,000 every year till retirement while enjoying side benefits like smart friends and cultural literacy. And someone who lends that person money for a house or education is making an investment in that person, just as they would invest in any other business venture. You can't limit debt without limiting both freedom and prosperity.
Second, this sort of debt is not just beneficial to the debtor and lender but beneficial to society for the same reason that capitalism is beneficial not just to capitalist and customer but to society. You want the person who graduates from medical or law school to be the most promising doctor or lawyer, not just the rich son of a doctor or laywer. Debt is an economic equalizer. It gives poor people with big ideas but no capital a chance to compete with the people who already have capital.
Third, part of the reason why money got so easy to lend is because it seemed like there was a lot of money out there to be lent. The most recent bubble of debt inflation was caused not (or not just) by Democratic social programs or Republican deregulation but by the giant global pool of money looking for assets and ventures to invest in. Investors were just as eager to lend their money as debtors were to accept it - and just as foolish.
It would be easy to just shrug and say "boom/bust is the natural order of free markets" or "foolish decisions should be painful" but that doesn't really address the issue of systemic risk or all the idiots who are willing to go into unreasonable debt inflating prices and snapping up the assets of the people who aren't. And even if we did come up with some magical measure to prevent, encourage, or incentivize people to not take on unreasonable amounts of debt what's to stop the next generation from forgetting the lesson, getting seduced by cheap credit all over again, and coming right back to where we are today? Is the problem worse than the cure? I dunno. This one's a tough nut.