Cowen: Economy Victim of Success

by Patrick McAlister '10

February 24, 2009

Dr. Tyler Cowen is not what one would normally consider a pessimist. The renowned George Mason University economist talked Monday about how economics is applied to musical innovation; he has published a dining guide to DC restaurants in the Washington Post; in the mindset of an optimist, he originally believed the effect from the burst of the housing bubble would be a nominal recession and everything would return to normal.

Cowen now freely admits he was wrong. In his talk he outlined the origin of the crisis, which he believes is much more general than the conventionally accepted starting point.   

"In my humble personal opinion," Cowen said, "the current downturn is not about the housing market. The housing market is one symptom of the downturn. It may be the biggest, strongest boldest most pernicious symptom, but I think of the housing market as literally that - a symptom."

The real catalyst, in Cowen’s opinion, was the incredible economic success the world has had over the past few decades. Cowen noted that, at least since the last major recession in the early 1980s, the world has seen incredible economic growth, greater enfranchisement, stronger political institutions and a great expansion of human rights. The World has come to expect growth as standard, and this is where problems arise.

This expectation of growth is reflected in the Phoenix Suns relationship with their elderly all Star, Shaquille O’Neal.

"Until the trading deadline expired," he said, The Phoenix Suns were trying to trade Amare Stoudemire and Shaquille O’Neal. You might wonder why a team would want to trade two all star players; the obvious answer would be they wanted to get two other all star players in return. Not so; they did not want to pay their salaries; to get that money off their books. This has nothing to do with banking per se; this has nothing to do with the real estate market. You could figure this as the Shaquille O’Neal Recession."

"Here’s the problems the Phoenix suns had; they assumed every year the economy would get stronger and they could charge individuals or companies more for season tickets. That was their basic underlying economic assumption. For a long time this was true, so they could spend millions and millions of dollars on Shaquille O’Neal and Amare Stoudemire and the money would, in some sense, come back to them. In essence we have an entire world planning under the assumption that we can afford to pay Shaquille O’Neal a lot of money. There was a fundamental error of judgment that people assumed each year the world would get bigger at a certain rate. It turns out they were wrong."

Cowen used another familiar analogy to communicate the faulty thinking in expecting growth at a standard rate.

"You ever go to a place like Indianapolis, or in my case Washington DC, and you go to a corner and you see two Starbucks on the same corner? And you think, ‘maybe this is stupid.’ Well, it turns out, it is stupid. They thought they could get away with it because demand would always be high, they were the high and mighty Starbucks, and this could in essence go on forever."                                                                                     

In the United States, this expectation of growth and retrospectively unmerited confidence pushed banks to lend to their fullest extent; this included loans for individuals who should not have qualified.  

"It turns out we behaved with such over-optimism that a lot of the large banks in the United States are now essentially insolvent; perhaps not in a legal sense, but de facto insolvent. Those banks aren’t worth anything."

Once again, Cowen had a readily accessible allusion to explain his idea of the current status of US banks.

"They are (major US Banks) what we economists call ‘zombie banks," he said. "You ever see a zombie movie? They are the living dead – the zombie is there, the zombie walks, but the zombie doesn’t live a real life; and it’s very hard to kill the zombie."

"Citicorp, the holding company of Citibank, is probably a zombie bank. The government owns a quarter of it, the government is guaranteeing a lot of its debts, and the government won’t even say in full how much it’s aided Citibank. That’s not a good sign."

Cowen believes in order to emerge from the crisis, the United States must do what anyone who knew anything about zombies would say is impossible – bring them back to live.

"To get from splat on the pavement back to growth we need a working banking system that isn’t just zombie banks. We don’t know how to do that, we know however it is done it will cost a lot of money."

Cowen is very skeptical of the effectiveness of the stimulus package Obama signed into law last week in bringing the economy back.

"There’s an old saying, never try and catch a falling knife; right now, we are that falling knife. In my opinion, the Obama stimulus won’t in total work. Some of it may have been necessary, I’m not sure. It’s not like Obama wasn’t smart enough nor had good enough advice; but when a knife is falling at a fast enough speed, can anyone catch it? The answer is no."

While many in the audience were in agreement with Cowen’s historical interpretation of the economic crisis, some were skeptical about his assessment of the Obama stimulus package.        

"I think he’s definitely spot on about the current state," said Junior Aaron Bonar. "I don’t, however, agree with letting the economy hit rock bottom. I’m in favor of a stimulus plan; I think we’ve seen it work in coming out of Great Depression, for example.

"As far as irrational exuberance and overconfidence in the economy, I think he’s right about that," said professor of Political Science Paul Vasquez. "What I’m curious to know is rather than just saying there’s a problem in the sub-prime mortgage market, what triggers a problem like that. I would have been very curious to know what was that triggering mechanism."


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