The Four Scariest Words Of Markets: “It’s Different This Time”

The Economist Free Exchange blog points me to Steve Waldman and an interesting question:

Suppose the good guys win. Better yet, suppose they had never lost. Suppose banks had never ventured beyond conservatively prudent lending; that there had been no housing, internet, or credit bubble. Forlorn cul-de-sacs surrounded by mouldering homes were never cut from the Arizona desert. Webvan and were rejected straight off by investors rather than soaring against all reason then dying in an unreasonably sudden collapse.

In a world without bubbles and, let’s not mince words, in a world without fraud in substance if not in law, would we, or how could we, have enjoyed two decades of near “full employment” and apparent growth? Without all the internet companies that were forseeably destined to fail, without all the housing construction, without all the spending by employees whom we know now and should have known then were not actually participating in economic production, without all the spending by people feeling rich on stock or housing gains that would eventually collapse in their or someone else’s arms, what kind of economy would we have built?

He goes on to defend FDR in the wake of the Great Depression and suggest that the reforms FDR built into the economy set the stage for a more stable and long-lasting postwar boom. There’s a lot of “what if?” to be played there, and I’m not going to wade into that one.

What I am going to argue against is the attempt to lump the internet bubble and the housing/credit bubble as if all bubbles are equal. Of course, there are parallels. The biggest one that I always — as a contrarian — harp on is the belief during bubbles that “it’s different this time!” During the internet bubble, people seemed willing to throw money at companies that had no business model, no revenue or expected revenue stream, just because they ended in .com. During the housing/credit bubble, people were willing to stretch farther than ever historically prudent because they believed that the complex financial instruments spread the risk as far away from them as possible — and besides, “housing has never had a nationwide crash!”

But I personally believe that during the internet bubble, it indeed was “different this time”. Not from the standpoint of a bubble, as people were willing to invest in an industry they didn’t understand with no history or easy way to determine who would be the winners and the losers. It was a true measure of “irrational exuberance”, where stock investors got WAY ahead of the fundamentals and valuations soared so quickly that normally prudent investors got sucked in.

But it was different. The world of today shows just how different it was. How many existing business models has the internet broken? Ask the travel agency business. Or the book/DVD sales business. Music sales are replaced by the internet. Newspapers are dying. TV is being transformed (enabled later than “the internet” by the growth of high-speed connectivity and computing power). The 24-hour cable news world has now been replaced by the instant news feed called “twitter”. And of course one of the oldest business models in the world — mail service — has been replaced by a worldwide instant network.

Outside of business models that were destroyed, many have simply been enabled. My boss lives in Virginia; I live in California. I’ve met him in person once. Yet that’s not an impediment to business. Near-ubiquitous connectivity ensures that I can travel to a city to visit customers and be reachable by cell phone, email, and wherever I have wifi my laptop can hook me into any resource I need in my company. These things were in their infancy in the early 90’s — now they’ve changed the way we do business.

The instant communication and vast repository of information the web puts at ones fingertips creates new social networks and niches for all sorts of interests. As a homebrewer, the trials and tribulations of learning to brew in a pre-internet period would have led to a lot more poor-quality, infected, or generally crappy brews. Instead, I have a ready-made resource of “tribal knowledge” willing to answer questions, help someone out, etc. Even here at the blog I’m linked to an entire community of libertarians. Pre-internet, most libertarians thought they were the only one in their community. Now it’s obvious that there are a lot more out here than one would think. Pre-internet, back in my BBS days, to meet people in person from the online world was “weird” and/or “creepy”. Now people meet their spouses through the ‘net.

The internet bubble was a stock bubble — that much is certain. But the internet is a revolutionary transformative technology that is dramatically changing the way society lives and communicates. Much of the internet bubble occurred because people could sense that something big was happening, and they wanted to be a part of it. And they were right.

As far as I can tell, the housing/credit bubble had none of this. The financial innovation of the last decade never really seemed transformative or revolutionary. Houses didn’t suddenly sprout money trees in their backyards, although the HELOC/ReFi ATM may have made it seem like it. House prices started skyrocketing, but the fundamentals (i.e. income, rental parity, etc) never came close to keeping up. Instead of transforming housing, the only transformation was that affordability went out the window, to be only replaced by crushing debt loads and the hopes that appreciation will keep you solvent.

Steve asks in lieu of the bubbles, what kind of economy we would have created. At least with respect to the internet bubble, I’m not sure we’d have done much differently.

  • AndyC

    You make a lot of good points but I think the question is still valid

    What would the economy have been like without the tremendous amount of malinvestment that went on during the dot com and housing booms?

    All of that money was spent on everything from computer mice to warehouses to everything in between and created loads of jobs

    In 1998 we added over 250k jobs a month which was not even eclipsed in 2005 during the peak of the housing boom.

    We shall see what the answer is to these questions shortly because a simple analysis of the unemployment numbers show that we would have to add 200+ jobs a month for years on end just to bring the jobless rate down and without a dot com boom or a housing bubble or the necessary credit expansion to facilitate such an expansion it wont happen…

    This is just simple but hard factual mathematics and cannot be disputed.

    There will be no recovery and the answer to the guys question will be forthcoming over the next decade.

    It wont be pretty


  • Joshua Holmes

    He goes on to defend FDR in the wake of the Great Depression and suggest that the reforms FDR built into the economy set the stage for a more stable and long-lasting postwar boom.

    Uh no, being the only industrial nation of any consequence to survive WW2 unscathed, and making our currency the de facto world currency, set that stage. Once the rest of the world caught back up in the early 1970s, the boom was over. The rest has been, more or less, either stagflation or a huge debt bubble.

    Steve asks in lieu of the bubbles, what kind of economy we would have created. At least with respect to the internet bubble, I’m not sure we’d have done much differently.

    It’s hard to say. The massive amount of funds flowing into the stock market have been partially caused by low interest rates. Not only does more money flow out in debt, but less money flows into savings accounts, since the returns turned so pitiful. Trying to stay ahead, and boosted by favorable tax policies, we turned into a nation of speculators instead of savers.

    In a large sense, though, nothing can stop the death of America’s middle class. Technology continues to make workers obsolete. Many Americans, myself included, no longer do anything useful but shuffle papers to follow this or that directive. Globalization means you can replace an American worker for someone costing a tenth, even lower. Bad government policies haven’t helped, to be sure, but the brute force of technology and 6 billion more workers calls the tune.