Forget Confidence — Fix What’s Broken First

Imagine you discover you have a termite problem in your home. The main beams show serious signs of infestation, to the point that their load bearing capabilities have been compromised.

You call in an expert, a professional exterminator. He reviews the homes structure, and gives you the following 3 step advice:

1. Paint the outside of the house white with black shutters
2. Curtains. Pretty ones.
3. Fresh flowers in the entrance way

As ridiculous as this sounds, it is essentially what many economists are prescribing as a cure for the financial crisis. It is ridiculous in so many ways, we can barely begin to count them. Even worse, it points out that the field of economics can be dangerously into absurdity at time. If you want to understand how 95% of economists missed the warning signs about the recession, housing crisis, derivatives threat, and credit crunch, look no further than the misguided obsession with Confidence, and the misunderstanding it reveals of Human nature.

Now, confidence is an important factor in influencing consumer and corporate behavior. When companies are confident about the future, they hire people, give raises, and invest in CapEx. When consumers are confident, they buy homes, durable goods, invest in the stock market, spend discretionary money.

But understand that confidence does not occur in a vacuum. It takes place within the context of a economic environment. People are not so stupid that painting the outside of the house that is rotting from within will solve those problems.You need to fix the fundamentals problems first, and improving confidence will come along naturally.

In this Sunday New York Times, Princeton Economist Alan Blinder wrote: “Because nationalization runs counter to deeply ingrained American traditions and attitudes, there is a danger that it might undermine rather than bolster confidence.”

Let me make sure I understand this: We have lost 4 million jobs in about a year, the S&P500 had its first quarter ever where profits were zero, the government has given away trillions of dollars in ill advised corporate bailouts, credit remains frozen, the housing market is still in the crapper, and the stock market is down by more than 50%, with the Bear market losses now about $11 trillion dollars — and nationalizing the banks is whats going to undermine confidence?

Man, do you even read your columns before you submit them?

Confidence is a symptom, not the cause of what ails us. It is ironic that so many economists make what is essentially a classic causation/correlation error. Healthy economies have confident consumers and businesses; if we shore up confidence, goes this misguided thinking, things will improve. But healthy economies also have expanding economic activity, gaining jobs, wage improvements, active home sales, free credit activity. Confidence flows from the improvements in these basic economic activities; it is not an isolated state of mind independent from the rest of the universe.

In today’s WSJ, Bank of America CEO Ken Lewis makes a similar fallacious argument, claiming that “Nationalization would undermine confidence in the financial system.” And I guess the $45 billion in capital rescues you received from the taxpayer, and the $300 billion in bad paper we guaranteed — that’s bully for confidence, right? Gee, somehow your Op-Ed omitted mentioning THAT. (He must really think people are idiots).

Classical economics made a fundamental error in its key conception of Human Beings, treating them as perfectly rational. It now compounds that error by utterly misunderstanding Confidence.

Fix whats broken, namely the financial system. When that’s repaired, confidence will improve.

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Sources:
Nationalize? Hey, Not So Fast
ALAN S. BLINDER
NYT, March 7, 2009
http://www.nytimes.com/2009/03/08/business/08view.html

Some Myths About Banks
Nationalization would undermine confidence in the financial system.
KENNETH D. LEWIS
WSJ, MARCH 8, 2009
http://online.wsj.com/article/SB123655575807665985.html

An Amazingly Disingenuous Piece by Alan Blinder on Bank Nationalization
Yves Smith
naked capitalism, March 8, 2009

An Amazingly Disingenuous Piece by Alan Blinder on Bank Nationalization

The Mood Always Matters, So Restore Confidence First
TYLER COWEN
NYT, November 8, 2008
http://www.nytimes.com/2008/11/09/business/09cowen.html