The Downfall of the American Economic and Authority Model

Economic theory states that effective capitalistic markets exist only when every individual and organization acts in their own best interests and are left unhindered and empowered enough to allow for each market to balance supply and demand.  To translate that into plainer English: Capitalism only works when everyone is able to create enough and purchase enough products to ensure that there is an ideal number of products on the market to avoid a surplus or shortage.

As the video above shows, whenever suppliers set prices of products too high then consumers are no longer able to purchase these products and they remain in excess or "surplus."  Conversely, whenever suppliers do not set prices high enough then there's increased consumer demand in getting the great deal and there's a shortage in supply to meet that demand.  Ideally, each of these would level themselves out in a free market.  Either the supplier would lower their price and increase demand, or raise their price and decrease demand until a happy balance was struck known as market equilibrium.

However, this method has been poisoned over the last thirty years in the American capitalistic model, starting immediately after the "dot-com" bubble burst in the 1990s.  A combination of factors led to some incredibly risky financing maneuvers by venture capitalists seeking to make a quick buck on the internet craze that ultimately led to unsustantial business models that fell apart in the late 1990s. Unfortunately the largest effect that the dot-com bubble had on the American economic climate was not the collapse of the bubble itself, but in the way in which the Clinton Administration softened the blow.

Immediately following the dot-com bubble, the Clinton Administration artificially propped up the buying power of the middle class by loosening the regulations surrounding mortgages and by keeping mortgage interest rates artificially low.  As you might imagine the increased buying power of the American middle class would raise demand (more houses wanted) which would increase supply (more houses being built) and increase prices (houses are more valuable).

Remember: the middle class has seen its buying power decrease, substantially, over the last few decades due to wealth distribution inequality, so this sudden increase in buying power was abnormal and contributed to the over borrowing frenzy that followed.

If this artificial lowering of the interest rates had only happened once or twice, then the market would have eventually slowed as less consumers received loans, and the housing prices would have plateaued. Unfortunately, this happened several times and consumer buying power continued to increase and housing prices continued to rise in something known as a positive feedback loop. To make matters worse, given that housing prices were continuously on the rise, they were no longer seen as homes, but investments and led to the same risky financing methods of the "dot-com" bubble where lenders and borrowers both signed mortgages against the perceived future value of their homes and earnings instead of the current value and wages of the borrower.

This process of over lending to underqualified borrowers was a process known as subprime lending and these subprime mortgages were propped up by a rather complex set of shady principles known as securitizations.  Andreas Schou describes how using the housing market to cover up income inequality without addressing it seemed like an appropriate stop-gap solution.

And for a while they were correct: The middle class started seeing an increased quality of life through their new purchasing power; but then the house of cards started to fall apart.

Once the housing bubble burst, the economic house of cards started to fall apart rapidly and the first attempt to stabilize the ship was to pass a stimulus package to infuse a small amount of cash directly into the hands of the American consumer, but unfortunately another economic crisis occurred during this time:The 2008 Oil Price Shock.

The steep ascent in the price of oil between 2004 and 2008 coincided with the first significant decrease in non-OPEC supply since 1973 and an unprecedented surge in global demand. Although OPEC members responded by increasing their production, they lacked sufficient capacity after years of restrained field investments to bridge the growing gap between global demand and non-OPEC supply.

The oil management methods that led to the defeat of the Soviet economy during the Cold War had led to a market in which fluctuations were frequent and susceptible to speculators and one such spike occurred in 2008. Unfortunately, while the stimulus package released at this time helped ease the increase of gasoline prices it did little to help the housing problem. As a result, home owners continued to struggle to meet their mortgages and investors continued to pull out of risky investments and Hank Paulson, the Secretary of the Treasury, was forced to take more drastic measures to ensure that investment gridlock did not occur.

To understand these measures, we must first understand how the housing market operated during this time. Prospective home owners borrowed money from banks, who sell the mortgages to entities known as a "Federal Home Loan Mortgage Corporation" who bundle multiple mortgages together in something known as a mortgage-backed security, kind of like a mutual fund that is based on a tangible asset (a home) rather than a stock.  These securities are then sold to private investors (other banks, companies, or individuals) like any other security or investment.

(Click for Larger Image)  This shows the convoluted "Secondary Mortgage Market" process.

 

This is a convoluted process known as the "Secondary Mortgage Market." Delving into this deeply is outside the scope of this article, but it's important to know of its existence and to recognize the fact that when the government kept incentivizing over-lending through relaxing regulations the number of underqualified borrowers went up, increasing the risk the banks and private investors were taking on.  By keeping the interest rates low, the housing prices soared and the risk of the investors rose while the returns (payments made on these mortgages) stagnated.  This ultimately led to the bubble "pop" and the largest victims were not the banks, but two of the Federal Home Loan Mortgage Corporations, Freddie Mac and Fannie Mae.

This may seem counter-intuitive at first blush, how could more mortgages be bad? The entire profit of home ownership for the lender is in the interest that homeowners pay the banks; so when interest rates are kept low, the pay out for the lender is low. Couple this with high housing prices and the risk taken on by the lender is high; and big risk with small dividends is never a sound investment strategy.

Without these two FHLMCs, banks would not be able to issue new mortgages and the entire American mortgage and lending system would come to a complete stop. Given the reliance that the middle class had on debt, and the reliance of the American economy on a spendy middle class, any disturbance in the mortgage and lending system would have been catastrophic to the American economy; and that was ultimately the argument used by the federal government when we bailed out Freddie Mac and Fannie Mae. It wasn't that these institutions were too big to fail due to lost jobs, but that the failure of these businesses would have completely destroyed the lending market in the United States and, by proxy, the entire global economy.

 

While these bailouts have been paid back to the United States government, these corporations continued to issue seven figure bonuses to their top executives, during and after the financial crisis that nearly brought the American economy to a halt and severely shook international confidence in American markets. As a result of this extremely brazen move by these executives, coupled with a feeling of despair in the uncertain economic times, a grass-roots protesting movement was born: Occupy Wall Street.

What many Americans don't take into consideration is that this movement was actually a mirror of a similar movement in SpainIsraelGreece, and Britain. And while the financial crisis in America certainly hurt the global economy, not all of these protests occurred during their country's recession (specifically Israel); so what the hell happened between 2010 and 2013 on the global political table? Martin Gurri, author of The Revolt of the Public and the Crisis of Authority in the New Millennium puts it plainly:

"It's hard to avoid the suspicion that the zeal for patricide among these groups was directly proportional to its loss of earning power."

While not every country was experiencing a recession or economic fall-out from the financial crisis in the United States, every protesting group around the world was protesting against inequality of some form. These groups were not exactly known for having cohesive strategies or a well thought out list of demands, but they were unified in the fact that they were pissed at what they considered the ruling class: the rich.

But we've had recessions and bubbles burst dozens of times in our new global economy, so what made this bubble so ripe for catalyzing a seemingly global protest? The Internet.  More specifically, the decentralization of information flow that the internet provided the people. This subtle change in information flow signaled a paradigm shift in which the asymmetrical relationship between the government's authority and the authority of the people had been lessened. The economic uncertainty of the 2010 - 2013 time frame in the global economy coupled with the increased transparency and information flow that the Internet provided gave the middle class far more insight into how and why they should be angry.

So who are "The People?"

The protesters weren't The People, but rather The Public. The People are a purely political entity meant to legitimize governments, whereas The Public are a persuasive entity meant to influence the political entities (The People, The Government) to enact positive change. This can be a slightly confusing concept to grasp, so consider it from a mathematical point of view:

When you perform an experiment or collect data on something, you refer to the entire collection of data as "The Population." However, whenever you analyze this data you do not typically have the resources available to look at each data entry, so instead you take a "Sample" which is used to influence your decisions on the authenticity and message of the data.

In an analogous way, The Public are the people who are interested in a certain political or social event, but can only affect its outcome through influencing others with their voice, whereas The People are the population as a whole that are allegedly represented by The Public in the same way that The Sample represents The Population.

This distinction was never very important until the turn of the century as the number of people who were interested in affairs were very limited given that the number of people educated enough to be interested were also extremely limited; so governments tended to operate only with respect to The People. However, with the rise in social media penetration across the globe, this is no longer the case; governments no longer have unilateral control over the information that is being presented to The People. As a result, a schism occurred between the active minority of The Public and the passive majority of The People.

This schism and the preceding shift in information control catalyzed more than just global protesting, but a shift where The Public went from a passive acceptance of its fate to one that is actively trying to control it, though with very limited success.

Aside from the rise in hashtag activism and the occasional protest in the streets, why is this shift so important? It's not because these protests of the early 2010's had in tangible effect, in fact the decentralization that made them so popular also made it difficult for governments or The People to take them seriously.

It's important because it signals a cataclysmic shift in how we, both The Public and The People, view authority. Whenever information is scarce (such as it was in a pre-Internet world), its source becomes authoritative. Take, for instance, Walter "Most Trusted Man In America" Cronkite; he was not voted most trustworthy entirely because of his stellar journalism, but also because he had a defacto monopoly on the information that the American People were digesting.

On the opposite end of the spectrum, dictatorships often balance the need to limit information against the need to provide for economic prosperiety. Why do they limit information flow within their country? To legitimize their authority by decreasing the number of dissident opinions. See also: Egypt shutting down the Internet or Great Firewall of China.

So with more decentralization, there are fewer avenues in which governments can control and limit the access to information - that's a huge plus, even if we have to endure a few protests (some futile, others - as was the case with Mubarak in Egypt - noteably more effective) as a result. So is there a downside?

Last year I wrote about a psychological concept known as the Halo Effect in which an object, person, or ideology that you generally view as positive is assumed to have no negatives, and an object, person, or ideology that you generally view as negative is assumed to have no positives. This is a pretty great concept for centralized sources of information, like Walter Cronkite. If you trust Walter on most issues, then you're likely to trust him on all issues; even if he is outside of his expertise.

For decentralized sources of information, like the Internet, the Halo Effect doesn't carry nearly as much weight. Instead, we tend to parse information more sequentially, where we first accept our foundational information from strong personal bonds (friends, church groups, family members) and then accept mediated information from weaker and often centralized bonds (newspapers, news agencies, Cronkite). While, on the surface, this may seem like a fantastic way to prevent information monopolies, it completely destroys the authority and authenticity of the information that we're receiving.

For example, if your family, friends, and peers implicitly or explicitly teach you that vaccines are linked to autism, then no amount of science from legitimate authorities (doctors, for instance), are going to convince you otherwise. So The People stop listening to the centralized authorities that conflict with their new Google-Fu acquired medical degrees and eventually, driven by the need to chase ratings, the new agency's stop fighting.

It's easy to blame FOX (or CNN - seriously, black holes?) for giving very stupid 'scientific' theories credence on the air, but these theories are aired because the viewers not only watch them, but demand them. This practice runs so rampant that the British Broadcasting Company has had to reevaluate its coverage of scientific theories to reign in some of the insanity.

Now, we already know the effect that our strong personal bonds can have over moderates when it comes to dragging them towards extremist views (such as this vaccine nonsense) thanks to something known as the Deffuant-Weisbuch (DW) model. We also know that education can help prevent a lot of that, but education is difficult to fund with a weak middle class because of "The Vicious Cycle," but self-paced education through free programs or self-study can help off-set these problems.

So it's easy for us to become discouraged when we step back and realize that increasing wealth inequality begets more inequality and less education, and less education increases the legitimacy of extremist views, and extremist views help delegitimize central authority figures without offering any tangible alternatives. However, I think it's also important to realize that this is all still early hypothesis that are not yet tested.

History is written decades after the occurrence, and we do not yet know the significance that the first two decades of the 2000's will have on human history. Until then, I say: Embrace the digital culture; but don't expect it to change the world just yet.