Catastrophe or Cleansing?

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Catastrophe or Cleansing?

By: John A. Baden, Ph.D.
Posted on October 24, 2007 FREE Insights Topics:

I recently met with an intelligent and highly successful young man deeply involved with our community. Most of those with whom he deals are part of young families, many having arrived here in the past few years, just as Bozeman was booming. He began our conversation with this statement, “I’m no economist, but I think we’re facing a local and national catastrophe.”

When asked why, he responded as though from a well-crafted script produced by the American Home Builders Lobby. The housing market is crashing. Folks will lose jobs and some their houses. Some businesses and even banks may fail. “This is a disaster,” he said. Of course he’s right—and also wrong. It depends on the scale.

You know the litany; too many people have bought houses with low “teaser rates,” some with no money down and no credit or income checks. Others up-sized to 4,000 plus square foot homes and assumed a far larger mortgage, one they can’t afford as interest rates rise. They now find their homes financially “underwater” with the amount owed greater than the market value.

Concurrently, general contractors, having tooled up during the boom, now must contract. Subs can’t find work as easily as before—or perhaps not at all. While a short time ago any person showing up with a good pulse and clear eyes could find work at $18 per hour, now marginal and even average workers risk layoffs.

While the good hands will always have work, housing supply exceeds demand and adjustments will and must occur. This is the “local and national catastrophe” that so concerns my young friend. And no doubt lots of good folks will suffer. I join other tender hearts and empathize with their individual plight.

Despite our sympathy for individuals, and in the spirit of tough love for them and for the nation, we should cherish, though not celebrate, these failures at the national level. Here’s why failure is important.

Observers interested in the overlap of economics and public policy celebrate success stories. Accounts of winners are easy and pleasing; there’s little obvious pain and loss when visions lead to triumph. But not all businesses and families succeed. Some failure is inevitable—and ironically is also valuable as a powerful purging force.

Every successful society has devised ways of separating incompetent or systematically unlucky people from the control of valuable resources. (That’s why civilized nations provide children and legally incompetent individuals with guardians and trustees.) This is an essential process for all but the most wealthy of nations, e.g., those cursed by great oil wealth. (This windfall wealth situation is the national analogue of individuals winning the lottery; a harbinger of bad things that follow the lack of a need to husband resources.)

A society’s economic success is increased if it has sure and quick ways to accomplish this separation, however painful to those who suffer losses. While there will be political pressures to buffer folks from the consequences of economic folly or bad luck, it is socially dangerous to do so. Reality checks should have force, so that those who fail to prudently manage resources will not keep control over them.

My banker friend and FREE board member Leon Royer recently wrote: “Too many people (borrowers, bankers, investors and investment bankers) have done too many dumb things for this situation to be resolved without substantial pain disbursed over many folks. No optimistic happy talk will change the curing time; it’s likely measured in years.”

Economist Peter Linneman nailed it more harshly in “Making Sense of the Current Capital Markets Disarray.” He observed: “As for the idiots who lent (often without down payments or documents) to the idiots who bought speculative homes, they deserve to lose. People must understand this simple fact.”

Our pressing danger is not that many folks will go broke, but rather that opportunistic politicians will bail them out and insulate them from past and future folly. We need to find and support those who instead recognize the ecological question: “If correction is not swift, then what will follow?” The longer we wait for a correction, the more massive and painful their suffering—and ours—ultimately must be. That’s the way the world works.

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