Saturday, January 17, 2009
World Views Clash at Economics Meeting
Liberal Professor Lectures to Largely Socialist Group
by MARK GABRISH CONLAN
Copyright © 2009 by Mark Gabrish Conlan for Zenger’s Newsmagazine • All rights reserved
Two world views unexpectedly clashed at the June 12 meeting of Activist San Diego. The group invited Grossmont College economics professor Shahrokh Shahrokhi to speak on “Understanding the Economic Meltdown,” but Shahrokhi’s understanding of it as a crisis of “market fundamentalism” and call for more and better regulation of the capitalist economy clearly disappointed some of the people in the audience. Many organizers from Activist San Diego are also key players in the Socialist Unity Network (SUN), and some were clearly disappointed they weren’t hearing a call to replace, not reform, the capitalist system.
“Market economies are inherently unstable,” Shahrokhi conceded at the start of his talk. After acknowledging Karl Marx for having coined the term “capitalism” and begun the modern analysis of “ups and downs” in a market-based economy, Shahrokhi said that the current crisis really began with the fall of the Soviet Union, which so-called “market fundamentalists” seized on as evidence of the failure of socialism and the triumph of the unregulated lassiez-faire market. As a result, he said, the regulatory brakes that had governed the U.S. financial markets since the 1930’s depression were lifted — and the way was cleared for market bubbles, first in Internet stocks and then, after that one collapsed in 2000, in real estate.
Much of Shahrokhi’s analysis was based on the contradiction between what sort of economic behavior is good for the individual and what’s good for the society as a whole. In an economy like the current one — in which employers are closing outlets and laying off workers, credit is incredibly difficult to obtain and many people rightly fear becoming unemployed — his advice to an individual would be to spend less and save more. But if everyone follows that advice, he added, “businesspeople receive less revenue, there’s less production, more unemployment and a smaller economy,” deepening the crisis.
“Pure economists pay much attention to ‘rational behavior,’” Shahrokhi said. “The idea is that people look at the costs and benefits of their own actions. If you are fearful of the future, your income and your job, it is prudent to lower spending and increase savings. People behave economically conservatively under stress, and that’s good. That’s rational. The problem is that what is good and rational for individuals is not necessarily good for the entire group. … If all people reduce spending, income and productivity will fall and it will become a self-fulfilling prophecy” of economic collapse.
Shahrokhi analyzed the recent collapse in the U.S. housing market as the classic bursting of an unsustainable economic bubble, in which housing prices went above the “normal rate” the market would ordinarily sustain. “The price of homes increased quickly and unsustainably due to overeager owners and investors,” Shahrokhi said. “They had different motives. Owners wanted to stay in their homes, and investors wanted to make a profit. In economics, nothing goes on forever.”
According to Shahrokhi, blame for the bubble and its eventual collapse lay equally with the people who bought overpriced homes on shaky adjustable-rate mortgages and the bankers and other investors who financed them. “Why did buyers want homes they couldn’t afford?” he said. “One, they thought the price of homes would keep rising — i.e., other people would keep increasing the demand for homes. Two, especially pervasive in recent years, conspicuous consumption” — a concept Shahrokhi borrowed from late-19th century economist Thorstein Veblen.
What Veblen meant by “conspicuous consumption” was the extravagant lifestyles led by the new super-rich at the end of the 19th century. His theory was that the rich were determined to avoid a crisis of overproduction — a depression caused by the inability of low-wage workers to buy the products they produced — by spending wildly and extravagantly themselves. But Shahrokhi argued that in today’s economy, it’s not only the wealthy but also the middle class that are overextending themselves in the pursuit of conspicuous consumption. “People wanted to consume, just to show off that they had large homes and oversized cars as signs of success,” Shahrokhi explained.
As for the investors, Shahrokhi said, they took “speculative risks” — ones in which they had little or no information about the true risk of their investments. “They knew the houses could be overpriced,” he explained, “but they still undertook the investments. They underestimated the actual risk.” He noted that behaviorist economists have spoken of a “herding theory,” in which investors buy when others are buying and sell when others are selling.
Shahrokhi also invoked the “greater-fool theory,” the idea that investors will sometimes deliberately make an investment they know is risky in the belief that they can quickly unload it again, at a profit, on a “greater fool,” a person with less awareness of the risk level and a willingness to buy in at a higher price. “Later, when no fools are left, people wonder, ‘Why did we buy all this?’” Shahrokhi said.
Answering his own question, Shahrokhi quoted the famous “Greed is good” line from the movie Wall Street and added that when financial assets are “securitized” — when they’re bundled together, as many of the subprime home loans were, and sold to investors as packages — “market fluctuations will change the value, and the value could become zero. In a financial economy, all shares ultimately have to be redeemed in money, and when everyone wants to sell and no one wants to buy, prices will fall.” Greed was also the reason home lenders made the bad loans in the first place, Shahrokhi said.
“Did they know many buyers weren’t qualified?” he noted. “Yes, but to make more commissions, they overlooked the qualifications. So all the normal criteria [for home lending] were ignored. People bought homes without down payments or any history of payment.” The product of these three groups — would-be homeowners taking out loans they couldn’t afford and counting on being able to refinance when the loans “adjusted” to higher (sometimes three times higher!) monthly payments; investors eager to make money from mortgage-backed securities; and lenders making loans to people who couldn’t afford to repay them and trusting that “greater fools” in the securities market would buy them — was the current housing crisis and the general collapse of the entire economy that has derived from it.
And why didn’t the federal government and the Federal Reserve — the quasi-public, quasi-private entity to which Congress has delegated the power to regulate our money supply — regulate the process and slow it down before it reached a crisis point? Because, Shahrokhi explained, the “market fundamentalists” had gained control of governments worldwide and convinced them that the only alternatives were lassiez-faire capitalism and state communism — and communism had clearly failed.
“Since the 1980’s,” he said, “it was held that markets could regulate themselves. So when these mortgage-backed securities started defaulting, the financial insurance institutions started to default too.” Shahrokhi cited AIG, the world’s largest insurance company, which was brought to the brink of ruin by marketing so-called “credit-default swaps,” essentially insurance policies against the failure of mortgage-backed securities. When the value of these securities collapsed in the wave of housing-loan defaults and foreclosures, many of their holders filed claims with AIG — and the avalanche so totally collapsed AIG that the federal government has spent $120 billion just to bail out this one company.
“A basic rule of Finance 101 is diversification,” Shahrokhi explained. “You don’t put all your eggs in one basket. After they lost a lot of money in Internet stocks, investors put their money in the housing market, betting that prices would always increase. After 9/11 the Federal Reserve lowered interest rates, so there was more money available. If all your eggs are in one basket and it goes wrong, there’s nowhere else to go. Unregulated markets and market fundamentalism helped start the crisis, and the housing crisis led to a crisis in the real economy.”
So what is to be done? “This is very complicated,” Shahrokhi said. “There is no simple answer.” But his emphasis was basically on reversing the trend towards deregulation and massive government intervention in the economy. He cited John Maynard Keynes’ recommendations for deficit spending and, speaking eight days before President Barack Obama was scheduled to take office, said that investment in infrastructure would be a more effective economic stimulus than tax cuts. “Governments should spend more,” Shahrokhi said. “Obama’s program will be close to $1 trillion.”
Shahrokhi also called on the next administration to be more aggressive in holding the major financial companies to account than the previous one has been. “I don’t think we should nationalize the debt of the financial companies,” he said. “Instead, we should buy their shares and not let them do things the way they used to. Right now, corporations are undemocratic and workers aren’t represented in their decision-making. In Europe, [governments] buy shares, so people own parts of these companies and governments demand that they restructure [when they need to]. If [U.S. financial institutions] continue to run the way they did before the crisis, you’ll have another one in six or seven years.”
Asked by an audience member why a drop in the annual growth rate of the gross domestic product (GDP) from 2.5 percent to zero precipitates an economic collapse, Shahrokhi said, “The confluence of people moves the economy. Because people lose their confidence, they reduce their spending and the GDP falls. When you’re talking about a labor force of 160 million people, a drop of 1 percent in employment is a lot. Economists say 5 percent unemployment is ‘natural,’ but now that unemployment has increased to 7.2 percent, that is a large number. Last year alone we lost 26 million jobs, and that’s a large number. People look at that and think, ‘Maybe I’ll be next.’ That’s why I expect GDP to fall further.”
Despite Shahrokhi’s criticisms of market fundamentalism and his praise for European nations and their more active interventions in their countries’ economies, much of his presentation rankled many members of his audience. They bristled at his suggestion that an economy is simply the sum total of the individuals in it, and were even more upset at his suggestion that would-be homeowners taking out mortgages they couldn’t afford were partly responsible for the collapse of the housing market. Many audience members suggested that they were actually victims, tricked by deceptive marketing strategies lenders were able to engage in once they were deregulated.
Shahrokhi refused to budge on the point. “People were encouraged” to take out loans they couldn’t afford, he admitted, “but they could also compare situations and find out whether the loans were good or not. Of course, there is always fine print, but the borrowers were told that the loans would double based on interest rates. We’re not dealing with fraudulent transactions. Fraud will be with us all the time, but fraud didn’t cause the meltdown.”
Veteran local activist Lace Watkins said that one problem is that before mortgages were securitized, borrowers could contact the company that lent them the money and have at least the possibility of renegotiating the loan to a payment schedule they could handle. Now, she said, loans change hands so often that “when they try to renegotiate, no one knows who owns the loan.” Watkins also argued that in a city like San Diego, with its notorious combination of high housing prices and relatively low wages — “the average income is $40,000 per year and the average home price, even now, is $400,000” — almost all housing purchases needed to be “creatively financed.”
Another woman in the audience said, “The working class should not be held responsible. They are the victims. The decisions [about the U.S. economy] are all top-down. There’s no democratic process to determine how loans were made.” Noting that the Service Employees International Union (SEIU), one of America’s largest, is expecting layoffs of hundreds of thousands of their members, she added, “People in much higher positions of power need to be held accountable.”
“I’m just trying to explain a process,” Shahrokhi replied. “I’m not blaming anyone. But if a working-class person in a three-bedroom home wants a four-bedroom home they can’t afford, are they blameless? You cannot just say that the decision you made is not your fault. One basic economic lesson for everyone is don’t spend beyond your income capacity. If they were not given the right information [about the terms of the loans], that’s one thing. But if they bought something they couldn’t afford, they’re responsible.”
One man who identified himself as a 64-year-old socialist said, “We don’t have power. It’s not like Karl Marx didn’t understand a depression. The Communist Manifesto called for progressive taxes. The people with money still have it, and they’re backed by the system to keep their money and power.” He added that in Cuba, contrary to popular belief, “you can still own property and use it to produce. You just can’t use it to speculate.” And he predicted that the next bubble to burst will be in the Midwest, where farmers have been steadily losing the land to agribusiness and commercial development.
Activist San Diego founder Martin Eder said, “I do think generally we are an enlightened audience. Most of us have a class perspective of the United States.” He asked Shahrokhi to “discuss the redistribution of income between the rich and poor, especially with a bailout that’s probably more like a $1-2 trillion burden being shifted to another group of working people” — i.e., the younger and as-yet unborn generations that will have the burden of paying back the money the U.S. is borrowing for bailouts and economic stimulus. “Is the bailout really an extension of class war?” Eder asked.
“The question is whether government is really representative,” Shahrokhi replied. “If not, they’re only going to help themselves.”