Generations rise, economies fall

42 years ago when I arrived at Harvard, the Economics Department was probably the most impressive intellectual aggregation in Humanities and Social Sciences, and I took Ec 1 (as it then was) during my freshman year. The GI generation lacked the imagination and sense of its own feelings to excel at literature or history, but they had everything they needed--both academically and as policy-makers--to handle the dismal science. They liked data, and they knew, from their own young adulthood during the Depression, how important economics were. Keeping unemployment at or below 5% mattered critically. So did a strong dollar and fiscal discipline (the deficits which Republicans and Democrats argued about in those days were trivial by today's standards.) They also understood how the crash of 1929 had become a catastrophic 12-year Depression and were keeping in place the restraints that the older generations had established in the 1930s. I particularly remember one class that year about the stock market and margin. One could, we learned, buy stock at 90% margin in 1929--in other words, $1000 of one's own money could buy $10,000 worth of stock, and if the value increased the $12,000 nearly all the increase was yours. If however the value fell to $5000, you owed $4000 which you did not have, and that, in a nutshell, is why so many well-to-do lives were ruined, along with those of others, during the Depression.

The Boom generation has never believed much in restraint, least of all in the economic field. We have cut marginal tax rates from 91% in 1963 and 50% in the late 1970s to 35% now, vastly increasing the incentive for managers to increase profits as much as possible--partly by cutting the labor force--because they can keep so much more of the proceeds. We have chpped away at the Depression-era restraints, allowing commercial and investment banks to combine during the late 1990s. (The Clinton Adminstration did impose fiscal discipline--probably its one real domestic achievement--but it paved the way for the coming crash in many ways as well.) We have developed new financial instruments like bonds backed by sub-prime mortgages that have been every bit as seductive as the Mississippi bubble in the early 18th century or prime Florida land in the 1920s. And by creating new institutions not subject to regulation, such as hedge funds, we have allowed clever Boomers and Xers to avoid the regulations that their parents and grandparents so wisely put in place. Last Friday almost became the Black Friday of a new generation when Bear, Stearns melted down. Bear Stearns, the New York Times informed me, works on 96.66 margin--of every $1 million it invests, $966,000 is borrowed. Much of those investments have now collapsed along with the subprime market, undoubtedly threatning a whole range of banks, hedge funds, non-profits and pension funds as well as Bear Stearns itself (since they are presumably the ones whose money Bear Stearns was playing with.) The Federal Reserve stepped in to ward off the catastrophe, but it will not be able to continue to rescue failing firms that way without implicating the whole nation in the potential crash. A sound banker, wrote John Maynard Keynes, is not a banker who is never ruined; he is one who is ruined along with all the others. Wall Street hasn't been so full of sound bankers since 1929.

I do not mean to be too holier than thou about all this, even if my own financial strategies have been consistently conservative over the years. This is, as I have been saying for nearly four years here now, the rhythm of history, and thanks to various historians from Thucydides to Strauss and Howe, I can recognize it as further proof that events, human nature being what it is, occur in much the same ways again and again. In addition, regretfully, human greatness is only born of adversity, and the younger generations will have the satisfaction of putting things back together again. (Alas, in my own field of academia, there is no self-correcting mechanism to expose bankruptcy and put things right.) Economically, the weeds that have been growing apace for thirty years are now threatening the crops upon which we depend, and we shall have to try to uproot them. Those who planted them--the financiers themselves--should rightly feel more pain than the rest of us. But as everyone from Martin Feldstein, the economist who on Friday predicted the worst recession since 1941, to Paul Krugman, is warning us, the economic collapse is likely to dwarf every other issue, including Iraq, by the time of the election. If that focuses us more on domestic affairs, that will be all to the good.

On another front, this weekend I taped a one-hour interview with Christopher Lydon, the former host of The Connection, about The Road to Dallas. It went very well and should be available for podcast within a few days at radioopensource.org. Please spread the word!