The Un-Bankrupt and the Lending Crisis

Tightening consumer bankruptcy laws was supposed to be good for lenders. Banks pushed hard for the legislation, which made it virtually impossible for a consumer with a salary to file for bankruptcy. Borrowers could no longer go bankrupt, so they would have to repay their loans — right? Unfortunately, it seems that this is what lenders were thinking, and their overconfidence brought us to the lending liquidity crisis everyone is talking about now.

When the bankruptcy law changes were being considered, there were voices saying that the changes would actually benefit consumers. Bankruptcy is a stain on your reputation, they said. Instead, a penniless consumer could simply stop making payments, and that would be the end of the matter. In practice, there would be nothing a lender could do about it. Bankrupt or not, if a person does not have any money, you can’t get any money from them.

For all its faults, bankruptcy is at least an orderly process. The court finds out who all the lenders are and decides who gets what. By contrast, the new un-bankrupt consumers, financially bankrupt but not allowed to file for bankruptcy, are about as easy to sue as the “un-dead” of zombie movies. The situation can turn into a free-for-all among the lenders involved, fighting it out against each other in court with legal ground rules that are as clear as mud. Lenders who want to take advantage of the tighter bankruptcy laws can spend enormous sums of money on lawyers.

Even worse from the lender’s point of view, the un-bankrupt are not subject to any of the restrictions that bind a person who is legally bankrupt. An un-bankrupt consumer can hide their money, give it to friends and family members, spend it, pay their lawyer anything they want without having to wait for a judge’s approval. The chances of a lender who sues an un-bankrupt person of getting any money before the defense lawyer gets it? Not particularly good.

Others can debate exactly what the standards for consumer bankruptcy should be. The point here is simply that lenders who thought the tighter bankruptcy laws would benefit them were sadly deluding themselves. And it seems many of the largest consumer lenders brashly went out and lent money to just about anyone.

The problem was kept under wraps for a short time by the low initial interest rates of many loans. Sometimes called “teaser” rates, these initial fixed interest rates gave way to market rates at some point, resulting in monthly payments that everyone knew all along the borrowers would not be able to pay.

The problem came to the surface last year in states with job market problems, such as Georgia and Michigan. It is clear now that it has gone national. All across the United States, consumers are defaulting on loans in unprecedented numbers. This is not, as some have suggested, the result of the current economic slowdown. The lending crisis and record high oil prices appear to be the two important causes of the slowdown.

The lending liquidity crisis is affecting banks in various countries, but it is important to note that it is limited to loans made in the United States. It was the United States that changed its personal bankruptcy laws, and the bad loans at the center of the crisis are all located in the United States.

In the short term, the most important thing that needs to be done is to prop up the banking system. Without strategic intervention to prop up troubled banks, the banking system worldwide could collapse, with all the major banks going bust. Governments, central banks, and even money center banks have stepped in in recent months with unprecedented amounts of cash to prop up troubled banks in the United States, Germany, and the United Kingdom, and this will have to continue as new trouble spots emerge.

In the long run, the problems caused by lender overconfidence can be cured with some very simple reforms in lending laws. Lenders need to stop lending money to consumers who do not have the income to repay the loans. It is not necessary to make it illegal for lenders to make these loans, as some have suggested. But when lenders choose to lend money to a consumer who is patently unqualified to borrow it, the lender should be prevented from going to court to collect the money from the consumer. The courts do not exist to prop up incompetent and unscrupulous lenders, and that particular abuse of the legal system could be stopped with a relatively simple piece of legislation.

Of course, most lenders would be very careful not to make any loans that were not legally enforceable, so that change in the law would also ensure that the overconfidence of lenders that led to the current crisis would not come back to create another crisis in the future.

Squeezing the Low End of the Labor Market

I have been hearing stories for the past two months of employers having trouble hiring workers for low-paying jobs, especially in sectors like retail and food that traditionally have high turnover. The fact that this squeeze is occurring during the summer, when the labor market is largest, is a troubling sign for retailers who may end up more than a few workers short later on in the year. There shouldn’t be too much sympathy for the employers, though; there are, in fact, plenty of workers available. But it takes the larger employers a period of time to adjust their pay scales, and until they realize their pay is now too low, and take steps to bump up their wages by around 75 cents an hour, workers could be hard to find.

It is easy to imagine reasons for this change in the U.S. labor market. There are more retail locations open than ever. Some foreign workers have been deported (even pop star Lily Allen was booted out last month — sorry, Lily, I don’t know what our government was thinking) and others have been discouraged from entering the country. In a country that has hundreds of new millionaires every day, more young workers than ever are entering the labor market already wealthy and with little incentive to work at jobs that pay slightly less than a living wage.

Employers can adjust to a smaller labor pool by taking other steps to boost productivity so that all the work can get done with fewer workers. In retail, new, easier-to-use cash registers shorten the lines that form when there aren’t enough cashiers working, and employers may look for similar investments in labor-saving equipment elsewhere. Employers may also look for ways to streamline jobs so they can be done by workers with less training, such as shortening the menus in restaurants — and employers who never took training very seriously may have to start doing so.

One especially encouraging sign is that employers seem more willing than ever to hire high-school age workers, a group that for decades has been mostly frozen out of the job market. It is a sign of the declining influence of labor unions — they were behind the move a century ago to prevent young people from working — that adolescents are entering the job market in large numbers now with relatively little resistance.

It is this last effect that is likely to have the greatest long-term benefit for the economy. It’s a matter of economic development. A 17-year-old with an income has a better chance to buy a vehicle, get a career-oriented education, and have a smooth, productive entrance into the broader labor market. This is a huge step forward compared to those who are forced to start out their adult working lives looking for unskilled jobs within walking distance of home. College is the biggest expenditure that teenagers make, so it stands to reason that more income for teenagers means more of them can go to college.

And this last effect is the reason I think you’ll see more of the corporate conservatives in Washington insist that the United States must let in more foreign workers. Corporations maintain their power in part by keeping workers off balance, and that is hard to do if an ordinary 17-year-old can gain the economic power that comes with a car and a college education. By letting workers get off to a quick start in life, a high level of teenage employment undermines the big corporations’ grip on power. But while corporations can expect to get a small measure of relief from Washington, it will surely not be enough to bring back the depressed labor market of the past.

Those who imagine that teenage workers will blow all their newfound money on handbags and music CDs are sadly behind the times. Teenagers actually spend less on clothing, accessories, and entertainment than the 20–59 crowd, and they save a higher fraction of their income than any other age group. And so even though they face new economic disadvantages, such as the high cost of insurance and college, we can expect most of them to enter the job market ready to get things done. The economy will never be the same.

A Million Dollars in Debt

An AP story this morning laments the recent hesitation by banks to issue new million-dollar mortgages to home buyers. Specifically, the issue has to do with “jumbo” mortgages, those over $417,000. Home mortgages over this limit cannot easily be resold by banks, which are stuck with them if anything goes wrong. Home buyers, according to the lending and real estate specialists interviewed for the story, have picked up on that hesitation and in many cases are not even shopping for a home unless they really need one.

The situation is frustrating to real estate agents, who now find it hard to sell homes that, from the agents’ perspective, the buyers can easily afford. Yet in the bigger picture, this may be a good thing.

Because when you look at what it means to “easily afford” something, it is not really a question of qualifying for a loan and being able to make the biweekly payments. Taking the buyer’s point of view, unless you want the banks to end up owning most of your money, you cannot “easily afford” to buy a home if you have to borrow a million dollars, or half a million, to do it.

This kind of high-stakes borrowing adds to the volatility across the economy because of the economic inefficiencies and losses involved in the occasional bankruptcies and defaults that follow. An economic downturn can trigger millions of bankruptcies, which in turn magnify the economic downturn. The economy, then, is on a more solid footing if these high-stakes loans are kept to a minimum.

Of course, some people need to borrow money to buy a home or other building, but it works out better in the bigger picture if people don’t borrow much more than they really need, and don’t borrow at all if they don’t need to. There are even people who need to borrow money to buy million-dollar homes. But for most people who find themselves in that situation, it makes good sense to put off that purchase for a few months or a year or two so they can save their money and borrow less, or perhaps not borrow at all. Apparently this is what many high-end home buyers are thinking now. They’ll save a small fortune in interest charges and fees and eliminate some personal risk, and as a bonus, it makes the economy more stable too. And even if it took a small economic crisis to get people to look at this approach, the fact that they are doing so seems like a good thing.

Why Food Still Matters

Several readers have asked me why, if I am the “shamanic economist,” I write so much about food. This would have seemed a peculiar question just a century ago. Then, economics was all about food, which along with clothing and shelter was considered one of the three necessities of life. Economics acquired its nickname, “the dismal science,” around that time as a result of a theory put forth by a few American economists that purported to explain why there would always be masses of people starving to death. It almost seems a cruel thing to suggest now, yet up until that time it was all that history had ever known — when times were tough, people went hungry and often died because of it. And, in case anyone needs to be reminded, hunger remains a problem for half of the world’s population, and mass starvation is still a threat when disasters strike the most politically troubled areas of the world — reasons enough for food to continue to be a subject of interest for economists.

And food is important even beyond the question of hunger. Food is more than just the fuel that keeps the human body going. It is also fuel for the human brain. One of the most potent economic resources you can bring to bear in your own life — mental focus — depends to a great extent on how you eat.

It can be tricky. The ultimate brain food is sugar, but eat too much of it and you get a buzz that can keep you from thinking coherently for a few minutes. Eat a little sugar (ideally as part of a complex food) and it gives your brain a boost for an hour or two, but that might be followed by a decline, over the next two hours, to a level of mental functioning below what you would have if you had not eaten. Going hungry can make some people mentally sharp, but unfortunately, the only thing they can think about consistently is food. Eat lots of sugar over a long period of time and it can cause metabolic diseases. So it is not easy to say how you can make the most of your brainpower in connection with sugar. More complex foods can provide similar results without the specific dangers of concentrated sugar, and of course, with those, there are even more scenarios to consider.

Another important issue with food is its long-term effect on health. This is especially a concern with junk food, a broad category that includes everything from cheeseburgers to donuts. Some of the components of junk food are specifically known to be harmful — harmful enough that the quality of food people eat has significant economic impact.

It has been calculated, for example, that a fast food meal is so bad for your health that it can be expected to shorten your life by more than the time you theoretically save by selecting fast food. Add this up across the whole labor force, and we can say that fast food depresses economic activity by killing off workers prematurely.

The best current example is trans fats. These are heavy artificial oils made in factories by chemically combining natural plant oils with acids and other chemicals. Trans fats are known to cause long-term damage to cell walls and are specifically linked to heart disease, so they have been banned in a few places, and giant restaurant chains — Dunkin’ Donuts is the latest example — are removing trans fats from all their recipes. Fried food will still have some trans fats because they also form in cooking oil, especially as it is repeatedly heated and cooled — this the main reason restaurants are supposed to replace all their cooking oil every day (some, though, still reuse the same cooking oil for a week or more at considerable risk to their customers’ health). Trans fats also occur in meat when animals are fed junk food. Still, taking trans fats out of the recipes will probably take away more than 90 percent of the trans fats, making a huge difference in the health effects.

Removing trans fats from junk food is especially important because the health consequences from food are the greatest for the people who will eat just anything. It is hard to estimate how many heart attacks may be avoided by the change in Dunkin’ Donuts’ recipes, but the number is surely at least in the thousands. The cost savings to the economy as a whole are enormous. Even if you just look at the medical care that won’t be needed, it’s enough to dwarf the incremental cost of the natural cooking oil.

In ancient times, everyone took it for granted that food was the most important thing in life. And food is still important, more important than we modern people want to give it credit for. If economics includes the question of how people working together can get the things they desire, and if you look at the central role of food in people’s lives, then you can’t have a proper study of economics without taking a look at food.

The CD Alarm Clock, and How Countervailing Power Is Undoing the Planning System

Yesterday, I bought myself a CD alarm clock. Looking at this transaction in economic terms, it might seem to be nothing more than a simple consumer purchase of a durable good. Yet something more is going on. This purchase also leads to a change in lifestyle — and it is part of a trend that is changing the way the economy is organized.

A CD alarm clock in itself is the unremarkable combination of an alarm clock and a CD player. Instead of waking up in the morning to the sound of a radio, I can now wake up to the sound of a music CD. The CD clock takes on more significance, though, when you look at the reason why a consumer would buy a CD clock ($30) instead of the less expensive clock radio ($20): to wake up in the morning without having to listen to those annoying commercials on the radio. Other people are getting the same result in other ways: satellite radio subscriptions, public radio stations, Internet radio stations, and MP3 music players. It is not hard to arrange to wake up with commercial-free audio programming, and more and more people are doing it.

This trend is an example of countervailing power. If you look at the two parties at the endpoints of radio advertising, the advertisers and the consumers, each has ways of exerting influence on the other, and this influence should help keep the exchange in balance. Consumers long ago stopped devoting attention to radio advertisements. Yet advertisers had a way to respond, by producing their audio content in a way that makes it more insistent, although this is also what makes it annoying. Consumers are now responding by limiting their exposure to radio advertising. Consumers listen to the radio just half as much as they did a few years ago and are more likely to listen to commercial-free radio when they do tune in. One response from advertisers has been the recent legislative initiative to silence Internet music radio by requiring exorbitant per-listener music royalty payments from the Internet music radio stations, yet this is only a small step, as Internet radio is just one of dozens of ways for consumers to get audio programming.

In theory, the potential for this kind of response and counter-response is supposed to keep an economic relationship relatively in balance. Yet in some cases, as in the example of radio advertising, it seems to have the opposite effect. Each party stakes out more and more extreme positions until there is scarcely any relationship left. Some advertising messages today, in their attempts to cut through the clutter of commercial radio, are so jarring that just hearing them can ruin a listener’s whole day. And some listeners are so annoyed at the intrusion of radio advertising that they are determined to shut it out completely, even if that means no longer going into restaurants where commercial radio is playing.

Perhaps this result, where the parties go to extremes instead of finding a workable compromise, is more likely when there is little economic validity in the relationship to begin with. Consumers, it must be conceded, get very little benefit from radio advertising, so why wouldn’t they eventually find a way to block it out completely? And advertisers, for their part, have only the slightest interest in the long-term effects of their messages. If an advertising campaign brings people into a store this week, then the thought that it might help drive listeners away from the commercial radio medium over a period of years is of little concern.

Of course, the flight from advertising is not just affecting radio. Television viewing hours have been falling for years, and when people watch television shows, they are more likely than ever to purchase the shows online so they can see them without commercials. Newspaper circulation is falling rapidly, and while magazine circulation is holding up, people are less likely than in the past to read the magazines they get.

Advertisers look at their advertising opportunities as windows into a consumer’s day. Most of the day, consumers are out of reach — asleep, at work, reading books, exercising, and so on. The decline in commercial radio is taking away two points in the course of the day when advertisers could get into consumers’ heads: waking up and driving.

The declining reach of advertising is not just a case of advertisers worrying about nothing. The effectiveness of advertising can be measured in many ways, and it all points to the same conclusion: advertising is having less impact. One of the best ways to measure the effectiveness of advertising in general is by measuring brand awareness, and brand awareness is declining. For example, people often cannot tell you the brand name of the camera, refrigerator, or blue jeans they own. Asked to identify the top brands of televisions in the United States, consumers are more likely to pick Zenith and RCA, brands from decades past, than Vizio, Samsung, and Polaroid, some of the current market leaders.

Technology is letting consumers steer clear of advertising. So what does this mean for the economy? It is troublesome news for the planning system, the large-scale half of the economy that traditionally has depended on long-term planning. In order to sell to consumers the products they are gearing up to promote and distribute, large companies depend on a degree of control over popular culture to create the level of consumer demand they have planned on — and this mainly means advertising. If advertising no longer reaches consumers, and the consumer response can no longer be guaranteed, then the planning process becomes an empty exercise. The plan to sell 10 million units of the New Hot Product is useless if consumers aren’t even aware that the New Hot Product is something they are supposed to be buying.

In this context, the ability to advertise on the Internet is little consolation. Internet advertising is largely self-selected. It reaches consumers only after they are interested in a subject. This is a real boon to some advertisers, but it is useless as a way to drum up demand for a new product that consumers don’t yet know or care about.

If consumers cannot be controlled, companies are having to rely more on predictions of consumer behavior, preferences, and trends. Focus groups, which assemble a random group of consumers for a short meeting to gauge the reaction to product concepts, are part of this research, but these results can be misleading. A focus group is naturally curious about the subject of their work, and this is a curiosity that consumers at large do not share. Lots of products that succeed brilliantly at the focus-group level fail to capture consumers’ attention out in the real world.

One way to make predictions more accurate is not to try to predict so far into the future. Half a century ago, it was common for a large company to plan initiatives that could take five years. Now, planning does not extend more than 16 months into the future unless it’s absolutely necessary. The shorter planning horizon may seem surreal sometimes, as corporate committees prepare to launch products that will be designed and named at a later date. Yet this is what it takes for a big company to avoid unnecessary risks when consumers are hard to predict and control.

And so, as the reach of advertising declines, the planning system is losing its central position in the economy. It no longer seems to be half of the economy, but something less than that. It is no longer so clearly distinct from the so-called market system that makes up the rest of the economy, but is forced to work within the constraints of market forces much of the time. Venture capitalists have become more important as there are projects to be financed that involve real risk that cannot be planned away.

And all this is happening as a result of lifestyle changes as simple as waking up to a music CD. As technology gives consumers more control over their lives and surroundings, it can only get harder for the big corporations to include those consumers in their long-term plans.