A New Values Debate

Henry Paulson’s proposed bailout of Fannie Mae and Freddie Mac has justifiably sparked a lot of debate. I won’t attempt to add to that, but I’ll simply direct you to a few predictions and rants by frustrated economics professors: here’s one by Paul Krugman, here’s one by RGE Monitor’s Nouriel Roubani, he cites one by Willem Buiter in the FT. Then there’s another one published by the Wall Street Journal. All of these are worth reading, and they all have differing opinions about the severity of the problem and who is really to blame. However, as with most crises, there isn’t just one group at fault, but a number of different complicit wrongdoers. Certainly, the two mortgage giants and the financial industry in general were overzealous in selling and packaging mortgages that perhaps didn’t deserve to exist and the government stood by so idly that they are rightfully accused of negligence. Even American consumers are duly ridiculed for their rampant debt accumulation. But placing blame is one thing, solving the problem is another.

Part of the difficulty in addressing this problem is that it seems to require altering economic behaviors that are part of the American identity. The American economy is designed—through a number of mechanisms—to promote radical risk-taking and innovation. That general attitude is not something we will change, nor is it necessarily something we should abandon. However, we clearly crossed a line into excessive risk-taking, and we need to send a message that we should take a step back at every level. Sending a message that condemns excessive risk-taking without opposing the practice in general is a politically difficult maneuver, but one that presidential and congressional candidates will have to make.

One way of addressing this might be by making this the new debate over “values”. Previous elections were one or lost based on claims to having superior values on issues of moral import like gay marriage, gun rights and abortion. I could see the candidates addressing these economic problems with the same language of values—starting a journey back to the “culture of thrift” perhaps, as David Brooks calls it. One candidate could (should?) claim that they are the candidate of responsibility, the torch-bearers of the protestant work ethic that used to have Americans spending what they had and, as a result, having more to spend; a candidate that could reintroduce us to the values of modesty and hard work. This seems like a traditionally Republican mantra, but the Bush era of fiscal profligacy lost them that mantle. McCain could make this turn to traditional values, but his support of the Bush tax cuts loses him some credibility. Obama doesn’t exactly seem like a fiscal conservative either, but he could argue that having the government spend more on health care and education helps keep people out of the debt that is perhaps the root of this problem. Whether or not either candidate picks up this undertone, it is clear that getting out of the credit crisis will require more than a new set of regulations; it may require a more substantial change towards a new set of values and social ideals. What are those values and does either candidate have the capacity to lead us down that path towards change? I think those questions deserve some discussion.

Financial Literacy/Transparency and The Debt Burden

There’s been quite a lot of discussion recently about the crippling burden of debt faced by many Americans, and understandably so – the rippling effects of the mortgage crisis have a number of analysts suggesting that the U.S. economy is heading towards recession.

Unfortunately, it doesn’t seem that many lessons from the recent crisis are especially clear, at least as far as policy prescriptions might go. While it is true that many lenders were certainly irresponsible, many borrowers freely admit that they were, too. And while the availability of easy credit certainly contributed to the growth of debt, it’s important to recognize that, in general, access to credit is a very positive thing, provided that it is offered and taken responsibly, with rational pricing of risk all around. To put it more concretely, while access to credit and the resulting growth of debt led to many Americans losing their homes, access to credit helped put some of them in those homes in the first place, and it helped others improve aspects of their lives, if only in the short term given how events played out. Without excusing irresponsibility on the parts of the various players involved in the recent debt crisis, I think it’s essential to note that addressing the problems in these markets entails what might end up being a fairly delicate balancing act, and that the parameters governing such an act aren’t necessarily known.

I can’t help but wonder, though, if we wouldn’t be able to achieve a lot by focusing on some of the informational aspects of the decisions made by consumers. Specifically, I wonder about the role financial illiteracy and opacity played in convincing borrowers to take on risky high-interest-rate loans of various sorts. Was it the case that many borrowers didn’t understand the economic risks they faced in general (e.g. the risk of medical emergencies or layoffs), some of which might be large enough to force them to default? Did they, perhaps, fail to understand the risks associated with ARMs, or the terms underlying their credit-card debt, or the specifics of any of the myriad of other debt instruments that were purchased? It’s an empirical question, surely, though I think it’s somewhat intuitive: who hasn’t been at least somewhat confused by the terms and fees associated with a bank account or credit card? If it is indeed the case that these sorts of misunderstandings were important in the evolution of the current financial crisis, perhaps there is a role to be played by government in promoting financial education or enhanced transparency of financial contracts, independently of any regulation of the terms of those contracts.

From what I know of the literature in general, the evidence about the efficacy of financial education and transparency interventions is mixed. But I can’t help but think that it’s important to continue exploring this area. The economic world becomes more complex every day, and it seems that the importance of the effective management and transmission of information grows with it. Perhaps focusing on better financial education and transparency on the ground will prove to be a more valuable (and workable) approach than playing an outmoded blame game.

What do you guys think?