The Subprime Mortgage Crisis. Do We Need a New Economic Paradigm?

I refer to an article by Gerard Wright in the Sydney Morning Herald April 7, 08 which discusses the subprime mortgage crisis and implications for the banks.

In the US, in 2006, there were 5.6 million households with mortgages with negative equity (that is, a mortgage higher than the value of the house). It is estimated that this will increase to 10.76 million by the end of the year and may even reach 20 million. Many families will be forced to leave their homes to banks and simply walk away. The social costs will be enormous.

What are the reasons?

According to Dean Baker of the Center for Economic and Policy Research, in the US culture of the last 20 years the norm has been to rip off everything you can. He further says that the banking landscape will change. “You are talking about a large amount of defaults, way beyond any historical pattern”. Gerald Cassidy, a senior researcher with RBC Capital Markets, predicts 150 bank failures over the next three years.

Does all this require only minor adjustments, or is a complete change in our philosophical attitudes and in the economic paradigm (largely uncontrolled free market economy) underlying economic policy necessary? Not long ago the Soviet system was overthrown as a consequence of its rigid economic and political structures, which prevented any meaningful adjustments. Has the time come to throw overboard the laissez-faire economy with its emphasis on more and more growth, and, more generally, our economic greed: let’s get as much as possible, whether you need it or not? Sokrates said looking at items for sale: how many things there are which I don’t need.

Such a change would solve many of the environmental problems, which are usually little considered when calculating the costs of things.

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22 Replies to “The Subprime Mortgage Crisis. Do We Need a New Economic Paradigm?”

  1. I think the mortgage crisis can be modelled as a sophisticated Pyramid scheme, where house prices can keep going up by getting new mortgage entrants any way possible, enabling other new entrants to think that the increase in house price will cover the future shortfall in repayment ability. Like with any pyramid scheme, when it breaks down, loads of people who entered late will lose their shirts. Those who borrowed heavily and sold well befor the crunch made a killing. Same with mortgage brokers who quickly sold on the risks at no discount. I’m not sure what regulation you’ve got in mind that will prevent the sort of greed that propagates these crises?

  2. I am not an economist and raised the possibility of a paradigm change as a stimulus for thought. It seems to me that things cannot continue as they are. The whole business stinks. Look at the world-wide corruption leading, for example, to large-scale (often illegal) deforestation in the Amazon and Borneo, based on greed. What is some of the timber used for? For making coffins for the rich. Or look at the disgracefully high salaries and bonuses for some executives, which makes the wider populace wanting more as well. But they can’t get enough, they deposit their cash in tax-free havens, more often than not illegally. Etc.etc. As a first step, in a global economy, we need global laws stopping these abuses. – Concerning the general economic paradigm, the holy grail of free market economy is not as sound as it seems. Look for example at the work of the Nobel Prize winner Stiglitz, who is highly critical of aspects of globalization and free market economy.

    I do not advocate a return to a strictly regulated socialist economy, but we need a way out of the mess.

  3. In a capitalist system at least, some of the greed can be channeled to some positive outcomes, such that the net effect is positive and opportunities to be successful are shared around. I don’t like the way you are throwing blame around willy nilly for a complex problem with many facets. Part of the problem is that most countries’ leaders shift the blame to what other countries are doing. A situation in which everybody blames everybody else is the worst of all, and blaming “Globalisation” is terrible because no-one is in charge of globalisation, and it is an unfair criticism anyway. A global government would help if only because the buck would stop with that Government for the Global commons of the environment which is becoming somewhat tragic.

  4. Global regulations imply a global “government” which I really think is right *within* the spectrum of Globalisation in idea space. Being against globalisation implies countries being more insulated than they are; restricting trade and immigration somewhat, as well as limiting interference from other countries to the laws and customs in their own country, even if they could be deemed inhuman by others’ standards. It is true that greed is a big factor in the mortgage crisis in America, and that lax laws related to “freedoms” exacerbated it, but greed in the US is not followed by mass starvation, revolution or other forms of chaos. However, greed in an insular, restrictive regime like Zimbabwe does result predictively with those forms of chaos. Conflating greed, capitalism and Globalisation is dangerously simplistic. They are three separable details, and capitalism together with globalisation coupled with strong property laws go a long way to reducing and spreading thin the ill-effects of greed.

  5. “capitalism together with globalisation coupled with strong property laws go a long way to reducing and spreading thin the ill-effects of greed.”

    ???Perhaps, perhaps not. I have my doubts that strong property laws alone will suffice.

  6. No matter – I didn’t quite say it would suffice, but by enforcing and punishing illegal ways of obtaining wealth changes the dynamics such that people sell rather than steal, compete rather than fight, go to court rather than taking the law into their own hands, and impose sanctions rather than declaring war. These dynamic changes tend to be enhanced with a greater connectedness between people (ie. more trade, more migration) and with great freedoms to spend (or invest) money on whatever they like to within the law. No matter what the laws are there are loopholes and moral hazard. Property still is nine tenths of the law, and property still is theft. I suspect most of the other 10% of the law is moral laws.

  7. Sorry to have been absent! I am afraid my German is not good enough to follow the discussion on Islam below… I will have to resort to Altavista babelfish, I think.

    Only intellectual property is theft. What we earn by the sweat of our brow belongs to us, but our thoughts are only sparks falling from eternity, tiny imperfect glimpses of the mind of God. 🙂

    The magazine of the Royal Australian Chemical Institute, Chemistry in Australia, just reprinted this article from Chemical and Engineering News, which also calls for a new economic paradigm. My response will appear in the July issue of Chemistry in Australia. I think blogs are much better for a quick turnaround of discussion!

  8. Chris, nice to hear that you are back. I was wondering what happened.

    I read the article you referred to in your comments and I agree with:

    “I have written this before, but an economic system that is based on an ever-increasing number of consumers is, by definition, not sustainable. At some point, the carrying capacity of Earth for any species will be exceeded. And while we are still a long way from reaching that carrying capacity for humans, the cost of even coming close—in environmental degradation and species loss—would be catastrophic. We must, at the very least, at some point in the near future stop world population growth.
    And we must develop a new economic paradigm that provides Earth’s stable population with goods and services that make life worth living. That is one of the most fundamental challenges we face in the coming century.”

    The only way to get around the problem pointed out without making fundamental changes to the present system is space travel on a large scale, but this – of course – will not happen very soon and we may all be gone by then. And it would cost a lot of energy, more than we probably can ever afford (in spite of science fiction that claims the contrary).

  9. I am sorry but I will protest! Most economists don’t agree with the premise of the current paradigm being based on ever-increasing number of consumers. There is no defined natural carrying capacity, and populations can reduce quite suddenly if required. (joke) All it would take if our population was the problem is a few well-placed nuclear warheads (/joke) Economic paradigms are a wishy-washy thing anyway, and all over the internet the economically illiterate are criticizing this or that about economic rationalism. I don’t see how economic irrationalism really helps anything. It is fine to attack formal analysis on what does and doesn’t work to obtain particular objectives through the economy. It is hugely irrational and counterproductive to attack formal analysis of economy of itself as a way to understand how to make things better for the world.

  10. “It is hugely irrational and counterproductive to attack formal analysis of economy of itself as a way to understand how to make things better for the world.”

    Stiglitz (Nobel Prize in economics, Chief Economist of the World Bank, etc.) is a very rational analyst, he disagrees with much of prevailing analysis, and he wants to make the world better.

  11. I have not yet read the book ( , but it seems to me that what Joseph Stiglitz is saying about Free Trade is similar to that famous quote about about Christianity:

    It is not that it has been tried and found wanting;
    it is that it has not been tried.

    Protectionist policies in the developed world distort markets to make life more difficult for the Third World. This is the great scandal of our time. The main reason I fear any legally binding global agreement on greenhouse gas emissions is that this is likely to be the latest and greatest of these schemes for protectionism by stealth.

  12. My main objection is of those italicised paragraphs(Dean Baker?) in your original entry is that it conflates many separate issues and generalises so much about them that his logic becomes meaningless and is only useful as a dogma. I suspect I would have completely different criticisms about the rational analysis of Stigliz. Economic paradigms have uses in particular defined spheres. They are not generally applicable, and should not be attacked outside the spheres from which they are applicable. Regulation and deregulation cannot be applied equally to everything. It is an academic matter as to what sort of things show successful deregulation and unsuccessful deregulation. There is no universal paradigm that always favours deregulation. It is a rule of thumb that most policy-makers err on the side of too much regulation. I agree that this rule of thumb is still applicable even given the runaway subPrime crisis.

  13. Chris, I again read the article you refer to in your comment. Perfectly reasonable as far as it goes, but what is not considered is the inbalance of population growth in some and the population collapse in other countries. How can we address this?

    Also, can a market economy be expected to cope with the increasing problems related to climate change? Here is the latest information on this:

    Here is a brief extract of the article

    Sea levels could rise by up to one-and-a-half metres by the end of this century, according to a new scientific analysis.
    This is substantially more than the Intergovernmental Panel on Climate Change (IPCC) forecast in last year’s landmark assessment of climate science.

    The new analysis comes from a UK/Finnish team which has built a computer model linking temperatures to sea levels for the last two millennia.

    Last year, German researcher Stefan Rahmstorf used different methodology but reached a similar conclusion to Dr Jevrejeva’s group, projecting a sea level rise of between 0.5m and 1.4m by 2100.

    A full melting of Greenland and West Antarctica would raise sea levels by many metres; but the process, if it happened, would take centuries.
    If you live in the Ganges delta you’re in a lot of trouble; and that’s an awful lot of people.”

  14. Chris, I again read the article you refer to in your comment. Perfectly reasonable as far as it goes, but what is not considered is the inbalance of population growth in some and the population collapse in other countries. How can we address this?

    This is the easy question – Obviously, freer movement of labour between countries will address the imbalances of population growth.

    Similarly with (predicted) sea level rises, the gradual abandonment of low lying areas, ideally in advance of them occuring. An efficient deregulated property market will make those properties a poorer investment.

    Climate change will make some parts of the economy boom while others will suffer greatly. How is that different from any other financial, war-related, or natural disaster that we are likely to have to deal with in the future even without having some clue as we do with climate change, what is around the corner.

  15. Didn’t you read my delta T post? 🙂 The Ganges delta can cope with rapid sea level rise if:

    (a) The coastal fringe mangroves are protected (Western NGOs could buy up these lands and repatriate their inhabitants to Sheffield etc.)
    (b) China does not follow up its Three Gorges Dam madness with megadams on the Brahmaputra
    (c) Any moves to canalise the Ganges/Brahmaputra and minimise natural flooding in the Delta are resisted.

    In general you are aware of my considered opinion that most talk about Climate Change is irresponsible and unscientific scaremongering…

    Free trade to me means free movement of labour, not just free movement of capital, goods, and services, and this removes a multitude of evils. In large countries in North America and Russia, people have readily abandoned uneconomic regions, and the Pacific Islands have almost already emptied out into New Zealand: but in Europe, national borders have prevented Albania from emptying out into Paris. The advent of the EU seems to be fixing this.

    I do not think there will be serious political fallout from the demographic collapse in Japan, as its neighbourhood is on a similar track. Nor do I think ‘Eurabia’ is a serious prospect, despite what we read in the papers. I heard on the radio the other day that although most Italians think of immigrants as predominantly Muslim, most are actually from historically Christian Eastern Europe. Eastern Europe will empty out into Western Europe, which will continue to remain relatively economically and culturally attractive, and the only new Muslim majority areas are likely to be on the fringes, in the Balkans and Caucasus.

    Australia, Canada, and the United States, which are defined by more inclusive ideologies, have nothing to fear from continuing high levels of immigration.

  16. Chris: nice to hear an optimistic opinion about the future of Europe. Of course there are much more pesimistic ones. I have forgotten the name (although the report appeared in some news yesterday), somebody has predicted that Europe will be overrun by Muslims and there will either be civil war there or a complete takeover by Muslims.

  17. Marco, nice to hear another optimistic opinion. However, Japan is a deeply conservative country and it will resist large-scale immigration to keep its culture “intact”. I suspect that some other countries are not too different.

  18. Thanks! I am glad to provide an optimistic opinion. 🙂 I was a little surprised by the neutral tone of the coverage of Daniel Pipes (if he is the one you are thinking of) in the SMH, because I had the impression he was thought of as a ‘neocon’ and hence anathema to their general editorial policy. I had a letter in the SMH back in 2005 responding to a fear-mongering piece by Paul Sheehan (another ‘nay’ in that debate on the compatibility of Islam and democracy), saying that in three years of living in strongly Arab neighbourhoods in Western Sydney the only threatening behaviour I had ever witnessed was by Anglo-Celtic yobs.

    I thought of another optimistic addendum on my home:

    We do not worry about the future of the towns in the Rhine delta.
    So even if the coastal wetlands are not protected, and China dams the Brahmaputra, and the worst sea-level predictions come to pass, I think there is a good chance that Bengal will be fine, *providing* that its people are given a level playing field to sell their goods and services. Bengalis are not less intelligent or industrious than the Dutch, and at a reasonable extrapolation of the present rate of development in South Asia will be as well placed as the Dutch to protect themselves from the sea by the end of the century.

  19. Marco, nice to hear another optimistic opinion. However, Japan is a deeply conservative country and it will resist large-scale immigration to keep its culture “intact”. I suspect that some other countries are not too different.

    It wasn’t quite meant to be optimistic in that I’m confident freer movement of labour between countries will address the imbalances of population growth *Where it is allowed to be freer*. I am not confident that repressive or insular regimes will ever allow large scale emigration/immigration. That will be worse for their citizens unfortunately. Japan appears to be banking on robotics and other technologies to offset their imbalances, but it will never be as efficient as freer immigration rules.

    As far as climate change goes, almost the complete ball-game is humanity’s ability to cope with various disasters which may include ones caused/exacerbated by climate change. We will have a distinct advantage if we can predict the disasters in advance. I contend that “surprise” disasters will be a lot more dangerous, and trying in vain to reduce a predictable one is *way* less effective than flexible and freer societies keeping and extending their tools to adjust to any disaster that may happen. That necessarily requires almost complete freedom of movement.

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