Gregory Mankiw:

Some years ago, I read on a birthday card that you know you are old when you spend more time thinking about money than sex. If so, we economists must age prematurely.

It is hard not be worried about the economy. No, I am not talking about the subprime meltdown and the possible recession that looms on the horizon.

My parents’ recession is not my problem, and our next recession will not concern our children when they reach adulthood.

What worry me are the problems that we will bequeath to our children ... an issue that no presidential candidate has taken up in earnest.

Democratic candidates like to talk about expanding the social safety net with universal health insurance. But they blithely ignore the fact that the safety net we already have was bought on credit and that the bill is almost due.

My Birthday Wish: Not Burdening Our Children

WSJ:

George W. Bush took office in 2001 with budget surpluses projected to stretch years into the future. But it's almost certain that when he returns to Texas next year, the president will leave behind a trail of deficits and debt that will sharply constrain his successor.

In the 2009 budget, the White House ants to cut about $200 billion from the government's medical programs for seniors and the poor. The longer-term picture is darker.

The next president, if he or she serves two terms, could find the U.S. government so deeply in hock that it would face losing its Triple-A credit rating, something that has never happened since Moody's Investors Service began grading U.S. securities in 1917.

As a result, the ambitions of Mr. Bush's successor to cut taxes, institute universal health care or aid troubled homeowners might have to give way to the reality of soaring costs for Social Security, the Medicare program for the elderly and the Medicaid program for the poor.

"We kicked this can down the road about as long as it can be," Senate Budget Committee Chairman Kent Conrad, a North Dakota Democrat, said at a hearing this week. "It will absolutely bedevil the next administration."

Legacy of Deficits Will Constrain Bush's Successor

The Census Bureau reports that the homeownership rate declined to 67.8% in Q4, from 68.2% in Q3 2007. This is a huge drag on the U.S. housing market.

... there are about 1.65 million excess housing units in the U.S. that need to be worked off over the next few years. These excess units will keep pressure on housing starts and prices for some time.

From the archive:

Is It Better to Buy or Rent?

By the Realtors’ way of thinking, it’s always a good time to buy. ... But in a stark reversal, it’s now clear that people who chose renting over buying in the last two years made the right move. In much of the country, including large parts of the Northeast, California, Florida and the Southwest, recent home buyers have faced higher monthly costs than renters and have lost money on their investment in the meantime. It’s almost as if they have thrown money away, an insult once reserved for renters.

Homeownership Rate: Cliff Diving

The state government is staring at a billion-dollar shortfall in its $11 billion budget. Forecasters expect a region that grew 7 percent in 2006 to contract this year. Retail sales, which rose 16 percent in 2006, are dropping. Dennis Hoffman, an economics professor at Arizona State University, said he had never seen such a sharp turnabout in 25 years studying the local economy.

To many residents of the Phoenix area, which has long been one of the nation's sunniest economies, the solutions being offered by Washington may be too little, too late.

"We're in so deep that it doesn't seem like anything will help," said Rebekah Ao, 33, a pregnant homemaker who lives in a new four-bedroom home in Avondale with her husband, Otto, a truck driver. The Aos, with $50,000 in income, owe a total of $607,000 on mortgages for two houses they bought since they moved to the Phoenix area about two years ago.

Many business people and economists here do not expect things to pick up until the area works through its inventory of about 37,000 unsold homes, which could take three or four years.

Housing Crisis Casts a Cloud Over Sun Belt

If you still haven't read The Next Bubble, you might try this article. Minsky's theory of the market seems broadly consistent with Janszen's, but his regulatory remedy sounds unfortunately similar to Mihm's, and therefore hopeless. Even more unfortunately, he is dead, and therefore unable to defend himself or revise his prescription for the bubble of the moment.

Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.

Many of Minsky’s colleagues regarded his “financial-instability hypothesis,” which he first developed in the nineteen-sixties, as radical, if not crackpot. Today, with the subprime crisis seemingly on the verge of metamorphosing into a recession, references to it have become commonplace on financial Web sites and in the reports of Wall Street analysts. Minsky’s hypothesis is well worth revisiting. In trying to revive the economy, President Bush and the House have already agreed on the outlines of a “stimulus package,” but the first stage in curing any malady is making a correct diagnosis.

...

There are basically five stages in Minsky’s model of the credit cycle: displacement, boom, euphoria, profit taking, and panic.

...

You might think that the best solution is to prevent manias from developing at all, but ... the greatest need is for intellectual reappraisal, and a good place to begin is with a statement from a paper co-authored by Minsky that “apt intervention and institutional structures are necessary for market economies to be successful.” Rather than waging old debates about tax cuts versus spending increases, policymakers ought to be discussing how to reform the financial system so that it serves the rest of the economy, instead of feeding off it and destabilizing it.

The Minsky Moment

The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis...

Main Street consumers have overspent and over-borrowed and are unable to meet their obligations...

Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.

The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand... put downward pressure on world growth.

Sustainable growth is not the consequence of an unsustain­able consumption boom but of the progress and diffusion of science, technology and innovation...

An efficient adjustment to the US over-consumption imbalance (and Chin­ese under-consumption) in a way that does not hurt longer-term growth should be based on compensating for the decline of US consumption with an increase in domestic investment and in consumption abroad. It should not be based on giving the US consumer more rope with which to hang himself... giving US households a $1,000 cheque by April, a trick that no macro­economic textbook would argue is particularly effective...

This essay is extremely clear and paints a stark picture.

Many of these points were made elsewhere earlier in the week:

The current slowdown is layered on top of deep-rooted economic problems that are not addressed by a stimulus package. If the nation’s leaders do not start showing the political will to do more than dole out popular tax breaks during an election year, short-term fixes could actually make the long-term problems worse.

For all its power, the Fed cannot change this troubling fact: trust in much of the financial system -- banks, brokerage houses, ratings agencies, bond insurers, regulators -- has been severely damaged by the subprime mortgage crisis. And that damage cannot be reversed with a quick cut in interest rates.

Stop behaving as whiner of first resort

Behind the recent bad news lurks a much deeper concern: The world economy is now being driven by a vast, secretive web of investments that might be out of anyone's control.

Lest anyone forget:

The reality is that, despite fears that our children are "pumped full of chemicals" everything is made of chemicals, down to the proteins, hormones and genetic materials in our cells.

1. This thesis seems to run counter to Ben Stein's complaint from yesterday, in which he argues that "market makers" are completely and nefariously in charge of the whole thing, swinging the pendulum at a whim for their own benefit. (To clarify: there is an important distinction between being able to make a particular stock or sector move in one direction or another, and having positive control of "the market.")

2. The author's characterization of the "prevailing assumption" runs counter to the evidence compiled by Eric Janszen, who argues that "The bubble cycle has replaced the business cycle." The author implies that before hedge funds, we understood the mechanisms of the market and were more or less in control of things. How, then, to explain the Asian financial crises of the 90's?

3. Frankly I'm surprised this article appeared in the Globe. Now, the Globe is not NYT or WSJ, or even WaPo or LAT, but this article would have been more at home in the Boston Herald, perhaps printed in Comic Sans. I'm inclined to believe the author is simply plugging his friend's new book. The chattily informal prose is off-putting: "swinging wildly", "slapping together", "booster shot", "building blocks", "sound the alarm", "huge wilderness", "chafe against the restraints", "prying eyes", and so on. I am led to believe those "small-circulation newsletters" he mentions are known elsewhere as "spam." But I have to admit I laughed at the characterization of innovative derivatives as "very sophisticated and chi-chi."

4. The author attempts to explain away Enron as a problem of "nontransparency". Hardly. I suggest he take "The Smartest Guys in the Room" and Gladwell's Open Secrets and revisit this in the morning.

5. He acts as though everything would have been alright if only everyone had been more upfront about all of the dodgy debt they were buying up. Never mind that the risks of issuing adjustable-rate interest-only jumbo loans to the marginally employed were always plainly obvious, even to the most casual observer. He pretends to ignore the fact that speculators built entirely too much new housing, flooding the market.

6. It's like, "Everything is so complicated. We ne... [ Read More (0.1k in body) ]

The black box economy

Powerful signals point to a long period of sub-par growth. The huge backlog of unsold homes suggests house prices have further to fall -- by around 20% going by housing futures. Lower house prices will force Americans to spend less and save more -- a process that has hardly started. They will also spread the mortgage mess well beyond subprime borrowers, which would lead to greater financial losses.

A new study finds that, on measures from capital inflows to asset-price rises, the build-up to America's mortgage crisis looks eerily like earlier financial crises in rich countries. The parallels are not perfect, but their message is that whether or not the economy falls into an official recession, it will probably stay weak for longer than many now expect.

America faces a long, hard slog.

A long slog | Economist

I recommended this article on Monday, but I would like to draw your attention again to one passage in particular:

Because all asset hyperinflations revert to the mean, we can expect housing prices to decline roughly 38 percent from their peak as they return to something closer to the historical rate of monetary inflation. If the rate of decline stabilizes at between 6 and 7 percent each year, the correction has about six years to go before things stabilize, leaving the FIRE economy in need of $12 trillion. Where will that money come from?

Janszen concludes that the next bubble is alternative energy.

The Next Bubble, by Eric Janszen | Harper's, February 2008

In the February 2008 issue of Harper's Magazine, Eric Janszen writes about the economy:

The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitization, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.

That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.

Pick up the February issue today at your local newsstand, or read about it at Janszen's web site.