Psychology Behind the Package, Obama Inspiring Fear, and Markets Are the Answer

Was at a faculty lecture this morning and one of the professors had mentioned an article by David Brooks who writes about the Worst-Case Scenario for the stimulus package in the New York Times last week. What's really cool about the article is that it talks about how these economic policies fail because oftentimes they do not take into account the social psychology that drives people to behave in the ways that they do.

Economics is wildly unpredictable, not because you can't identify trends or patterns, but because economics is part of a larger system that is mostly chaotic. So much of the theory is based on rational thinking, but people for the most part are not rational. We act contrary to our better instincts all the time. So in this case with trying to apply a theory of economics that was developed in the 1930s under circumstances that in some ways are similar, but in probably more ways are dissimilar, it's impossible to determine if the solutions would work in today's society. It's even still debatable that these theories worked even when they were first developed.

From the article:

President Obama defended spending initiatives in broad terms. He had enormous faith in the power of highly trained experts and based his arguments on models and projections. The actual legislation was cobbled together by Democratic committee chairmen, often acting beyond the administration’s control.

During 2010, the economic decline abated, but the recovery did not arrive. There were a few false dawns, and stagnation. The problem was this: The policy makers knew how to pull economic levers, but they did not know how to use those levers to affect social psychology.

The crisis was labeled an economic crisis, but it was really a psychological crisis. It was caused by a mood of fear and uncertainty, which led consumers to not spend, bankers to not lend and entrepreneurs to not risk. No amount of federal spending could change this psychology because uncertainty about the future remained acute.

Essentially, Americans had migrated from one society to another — from a society of high trust to a society of low trust, from a society of optimism to a society of foreboding, from a society in which certain financial habits applied to a society in which they did not. In the new world, investors had no basis from which to calculate risk. Families slowly deleveraged. Bankers had no way to measure the future value of assets.

I think the biggest problem I have right now with President Obama is that he is doing very little to inspire optimism. I'm not old enough to remember what Reagan was like, but everything I read about him indicates that the man was an eternal optimist. And the crises that he faced were much more difficult than they are now. Here's an illustration if you don't believe it:
Obama, however, seems to lead by inciting fear and dread. It's a far-cry from his campaign rhetoric of hope and change. I saw an exchange with him the other night while he was talking about what to do with the housing sector and he probably used the word "crisis" about 20-30 times in the short segment in which he was on. I understand that times are tough, but what is inspiring about having a leader of the most powerful nation on the planet always broadcasting doom? If you ever get a chance, look at the fear-related words that he uses, their frequency and variety. It's startling.

Another thing I don't like is that people are pointing at the current troubles and trying to assert that this is why the market system doesn't work. The truth is, nobody is allowing the market to correct itself and readjust. The housing crisis began because the government felt that minorities should be able to own homes, so they forced lenders into relaxing their requirements for loan qualifications. Not that minorities shouldn't be able to own homes, but the problem wasn't that people weren't lending to minorities because they're black/hispanic/etc., but because they were low-income people who couldn't afford houses in the first place. With the sudden availability of credit to everyone, regardless of their ability to actually fulfill the terms of the loans, demand increased. Increased demand drove up prices, so supply increased to meet the new availability of profit. Now people are defaulting on their loans, and it's leading to the most recent wind of new bailout packages going to the housing market.

The always sharp, always-on Thomas Sowell writes in more depth about the market system and housing market here. Here are some relevant paragraphs:

From television specials to newspaper editorials, the media are pushing the idea that current economic problems were caused by the market and that only the government can rescue us.

What was lacking in the housing market, they say, was government regulation of the market's "greed." That makes great moral melodrama, but it turns the facts upside down.

It was precisely government intervention which turned a thriving industry into a basket case.

...

The Community Reinvestment Act of 1977 directed federal regulatory agencies to "encourage" banks and other lending institutions "to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions."

That sounds pretty innocent and, in fact, it had little effect for more than a decade. However, its premise was that bureaucrats and politicians know where loans should go, better than people who are in the business of making loans.

The real potential of that premise became apparent in the 1990s, when the Department of Housing and Urban Development (HUD) imposed a requirement that mortgage lenders demonstrate with hard data that they were meeting their responsibilities under the Community Reinvestment Act.

What HUD wanted were numbers showing that mortgage loans were being made to low-income and moderate-income people on a scale that HUD expected, even if this required "innovative or flexible" mortgage eligibility standards.

In other words, quotas were imposed-- and if some people didn't meet the standards, then the standards need to be changed.

How did the auto people do? So far, so bad that GM and Chrysler are looking for more bailout money. Now they're considering bankruptcy. So why couldn't this happen 6 months ago before all the bailout money? Oh. Government intervention. Right. The markets are what's going wrong.

This is just my feeling, but we just need to get past the mentality that it's always going to be a feast. There are bound to be some famines along the way, but ultimately, the market system is what allows for the most opportunities for feasts to prevail. There will be some corrections where things will tighten, but recessions go away, unemployment rates will drop, and people will be able to live in relative comfort, that is, if we can resist the urge to do things that prolong the downturns.

UPDATE: Here is an article by the editors at NRO talking more about additional bailouts for Chrysler and GM.
As we predicted,

General Motors and Chrysler need more money. One of the Bush administration’s last acts was to tap the Troubled Asset Relief Program (TARP) for loans in the amount of $13.4 billion for GM and $4 billion for Chrysler. The administration instructed the automakers to return in February with restructuring plans to ensure their long-term viability. The companies have now submitted those plans, admitting that they haven’t solved their problems and asking the government for more cash.