Plain Money ideas

“Conservative economic theory” sillies

The Wall Street Journal columnist Thomas Frank has come up with something he calls “conservative economic theory,” apparently placing the term in the mouth of a source on the subprime mortgage fiasco.

Like many people outside the field he assumes there’s a conservative economic theory and a liberal economic theory — overlooking the large analytical core shared by all economists. What does that core say about the role of mortgage originators in the subprime affair?

Simply this: that self-interested private firms disregard the costs they place on others. (See “externalities.”)

Therefore, if you want firms to be careful about costs, you make sure they pay the relevant costs. In the subprime mortgage affair, mortgage originators faced simple incentives to write as many mortgages as possible, short of outright fraud. They received origination fees for doing that while being relieved of liability if the owners later defaulted. Naturally, the law is complicated, but mortgage originators who simply reflected the overall market’s bad judgment — as opposed to committing fraud or misrepresentation — aren’t in much trouble.

Put yourself in the position of a mortgage officer. The housing market is hot and a ready market exists to buy up the loans you write. Are you going to inquire deeply into whether the borrower will pay it back? I didn’t think so.

It’s not a failure of economic theory, “conservative” or “liberal” or otherwise, when people respond rationally to perverse incentives. The task for reform is simple in concept: correct the incentives (as opposed to lamenting greed or making broad pronouncements about non-existent schools of thought).

Plain Money ideas

How will it affect me?

How do Wall Street’s troubles affect ordinary people? Here are some possible outcomes:

1. A rescue plan is passed and is effective. Then we get a minor increase in overall unemployment, two quarters of economic recession, and we’re done. Maximum unemployment is about 7 percent or so.

2. A rescue plan is passed and doesn’t work. Then we get an extended recession, possibly taking years to recover, with unemployment maxing out at about 10 percent.

3. No plan is passed. Here we get into uncertain territory. It all depends on how adaptable our economy is in getting savings converted through to make funds available for economic activity — something our system has been very good at, but that now seems shut down by the events of September 2008.

How bad is a recession in general? It’s terrible for those who lose their jobs, but in the U.S. it doesn’t mean people starve in the streets. Remember, even if unemployment hits 10 percent, 90 percent of the labor force is still working. As for making drastic changes in plans because a “recession is coming,” that’s a losing game. Example: Should someone drop out of college to save money because “a recession is coming”? Answer: No. The average recession lasts about 11 months. It’ll be over by the time you graduate.

Examples could go on and on, but you get the idea. Anything that’s a smart idea now — such as working hard and saving — will be an especially good idea is there’s a recession. Dumb ideas — such as buying a fast car you can’t afford — become even dumber if there’s a recession.

Plain Money ideas

What will happen with the bailout?

I have gotten this question a lot. Here’s an answer, step by step:

  1. Nobody knows what will happen, including me. So be skeptical about anyone making predictions, including me.
  2. If there really is going to be a collapse of financial institutions in the absence of government intervention, then we will have a long period of economic distress. It would have all the usual hallmarks of tough economic times: stagnant income growth and high unemployment. People would not starve in the streets, however, and it would not be another Great Depression.
  3. But there’s reason for skepticism about collapse. One alleged example of collapse was that McDonald’s was having trouble getting working capital. That proved to be overblown, and beyond that: Do you really think that a business model as sound as McDonald’s couldn’t somehow get funded in its day-to-day operations, even with ready investors holding trillions of dollars of cash and looking for a return? My own opinion is that awkward makeshift institutions would begin to fill in the gaps and McDonald’s would find a way to run. It wouldn’t be as good as our current system but I think we would muddle through.
  4. Politically, both sides have been guilty of brinksmanship in the proposed bailout. The Democrats have been trying to get goodies for political allies in the bailout, while the House Republicans have been trying to put in some long-hoped-for tax changes. This is not the time for any of that.
  5. So, my favored solution: Do a clean, technical bailout that allows the government to buy up distressed mortgage-backed assets and establish an orderly market for their disposal. If there are eventually profits from this, apply them to reducing the national debt.
  6. And when all this is done, get the government out of the business of holding mortgage debt.
  7. And for the future, try to draw a sharp line between assets the government will guarantee (such as bank deposits) and those it won’t (such as hedge fund holdings). Then try to structure things so that anyone who places a bet on non-guaranteed assets is on their own. Too often we have allowed people to take giant risks, reap the giant returns, and then put the losses on the taxpayers if the gamble goes bad.
Plain Money ideas

Don’t hold a bunch of your employer’s stock!

In my book, I recommend not holding onto the stock of your own employer. Instead, the best strategy is “buy and hold index funds.” Those are diversified funds that have a little bit of each of wide variety of companies.

If you hold the stock of your employer, you’re taking a double chance. First, you’re taking the risk that a single stock will decline. But second, you’re taking the risk that when your company’s fortunes decline, you lose big in the stock market and lose from job-related effects.

Some employers will match your purchases of their stock. Fine. Find out the time limits and, as soon as you’re permitted, diversify out of your own employer’s stock.

There are many tales of woe from people at Enron, Merrill Lynch, Lehman Brothers and AIG that all made the same mistake — holding their own employer’s stock in large amounts. Don’t make the same mistake.

Plain Money ideas

Sensible advice about bank runs

The best advice about standing in line to get your money out of a shaky bank is:


There’s very little to be gained by spending a day standing in line. Remember, we have federal deposit insurance that will guarantee your deposit up to $100,000. So, just keep that deposit where it is, in the shaky bank, and continue to write checks on it as usual.

But what if you just absolutely have to get that money out? Consider the fact that if you take the money out in cash, it will then be vulnerable to loss and theft — both far bigger dangers than bank collapse.

Plain Money ideas

The “Rodney Dangerfield” economy

Comedian Rodney Dangerfield used to lament, “I get no respect.” The U.S. economy, which now appears finally headed for a recession after years of growth, also gets little respect. This article from Social Education provides some reasons why. Of primary interest to this site’s visitors: The article explains how the “hedonic treadmill” can keep people from feeling good even as their material standard of living increases:

The image [of the hedonic treadmill] is that of someone who must run faster just to stay in the same place. The reasoning is that people seem to judge their well-being not by their own standard of living, but by how it compares with some reference level. The reference level could be set by neighbors’ standard of living or an economy-wide average. In either case, evenly distributed growth would leave everyone in the same place relative to the reference group, having a higher standard of living but no greater happiness.

The news isn’t all bad. We have the ability to get off the hedonic treadmill by setting our own standards for what we’ll consider prosperous. What better time than now to get off the hedonic treadmill?

Plain Money ideas

Intentional community and simple living

Plain Money ideas

“Recession” advice: simple living

The mainstream media seem almost gleeful that there is a recession in the offing. Wow, there’s something bad to write about. And — make no mistake about it — those who lose their jobs in a recession face serious choices and difficult times. With fixed obligations such as house payments and debt service, people can quickly find themselves facing bankruptcy.

The conventional response from the politicans is to try to stave off the recession. That’s their duty. If they succeed, then “hard-work-to-buy-stuff-and-use-it-and-throw-it-away” can resume quickly.

But a recession also offers the opportunity to think about whether there’s a better way. There is. This better way is so much superior that it deserves consideration whether there’s a recession coming or not. “Simple living” is its name.

To many people, “simple living” calls up visions of living alone on a mountain peak while contemplating deep thoughts. They quickly dismiss it as an alternative because they can’t see themselves making such a radical break.

I would modestly suggest, then, don’t make a radical break. Just try these three baby steps toward simple living and see how they work:

  1. Buy less fast food and processed food. Buy more ingredients that require genuine cooking, call everyone to the kitchen, and cook and talk at the same time. Here’s an article to help you get started.
  2. Call the cable guy or the satellite tech to unplug your TV and replace your service with the free alternative — over-the-air TV. New technology makes this a better alternative than ever before. Here’s how to use an antenna to get that free TV. You’ll still have all the channels you need and if there’s nothing you really want to watch, get a friend and take a walk.
  3. Resolve not to talk on the phone while you’re driving. You know you shouldn’t — you’re endangering yourself and others. After you’ve made that resolution, replace your expensive wireless phone contract with a prepaid wireless plan. Now when you’re driving, enjoy the road and tune in some good music or conversation on the radio.

Notice the common theme in all three suggestions? It’s “simple living,” and the idea is to enjoy life more — not to mope around because you’re going with a cheap alternative. These ideas can easily save people a hundred dollars a month or more. That’s good budgeting if you’re afraid of a recession. Still, you may find yourself spending less and enjoying it more.

Most people are drowning in stuff and starving for community. So cut back on the stuff and develop community!