The REAL Cause for the Economic Crisis

Much has been written about the causes for the nasty economic downturn we are living through. The popular suspect is irresponsible sub prime lending leading to a real estate bubble, but some have blamed the Fed's past interest rate policies, while others have blamed deregulation or capitalism itself, still others place the blame on "Wall Street greed". The supposed causes are legion, but while all of these may have contributed to the downturn, none of these is the true underlying cause of the crisis. The ultimate cause is much more prosaic: misaligned incentives.

Incentives are the very foundation of capitalism. Capitalism is built on the assumption that when people act in their own self economic interest, a greater public good emerges from the chaos, and generally this is true. However it is only sustainable so long as people's own economic incentives are aligned with those of society as a whole. For example, getting an education improves my chances for economic success, while also allowing me to contribute more to society by paying more taxes and enabling me to use newly acquired skills to benefit myself and the company I work for. Society benefits from my actions because our incentives are aligned. 

The trouble starts when my economic incentives are not aligned, or are even opposed to the public good. For example, I have an economic incentive to rob banks - if I do, I can get a lot of money for very little work. Of course, society will be greatly harmed by my actions, therefore our economic incentives are opposed. Government exists to resolve such economic conflict and to realign incentives - in the example I gave above, government legislates and enforces a penal code to ensure that if I decide to rob a bank, I get sent to jail. The threat of punishment realigns my interest with that of society at large - it is now no longer a winning proposition for me to turn into a masked bandit.

The example I gave above is an extreme one, but the take away is simple: as long as an individual's own economic incentives are aligned with society's interests, capitalism will generate prosperity. If economic incentives are out of whack things will turn sub-optimal, and if they are seriously misaligned, and given enough scale and time, really bad things will start to happen. Now let me show you how incentives are to blame for the current economic crisis:

Take mortgage bankers. In the past, mortgage bankers' interests were aligned with those of society as a whole: they made a loan decision and they would make or lose money based on the success of their mortgage. In recent years, however, these folks' had no economic incentives to ensure the stability of their loans - their incentives were to get as many loans as possible and sell them to a third party, perhaps to an investment bank. This meant that the banker had an economic incentive to accept loans even if he doubted their economic value. A completely different example: government regulators are poorly paid. However, there is never a shortage of folks who want to work for the SEC, the FCC, the IRS or any other three letter agency you can think of. Why? Because those folks know that their pay-day will arrive, it is simply delayed. While they are not highly compensated currently, they will be in extreme demand if they decide to go to work for the companies they once regulated or to become lobbyists. This means that while on the job as regulators, they have an incentive to cozy up to future employers rather than to ensure the economic interests of the public at large. Incentives are misaligned. In the case of bank regulators, could they have had an economic incentive to under regulate at the request of industry and at the expense of the public? 

I could continue dishing out examples all day long, but let me get to the point. Incentives in our economy were and still are severely misaligned: industry groups, unions, individual workers and business owners have a built-in economic incentive to... not cheat, that would be too strong a word. They have an economic incentive to be persuaded that practices that might not seem too smart need to be allowed to continue... it pays to look the other way. misaligned economic incentives are the dynamite which makes the economic crisis go BOOM, regardless of what specific match or event lit the actual fuse.

Economic incentives are the key and the foundation for capitalism. Laws, regulations, work rules and, indeed, culture itself, should work together to ensure that economic incentives are aligned. Your success should be my success, and your failure should lead to mine. Shared incentives lead to mutual success, while misaligned ones encourage predatory or irresponsible behavior. Don't get me wrong, economic incentives could not stop the occasional Barney Madoff from initiating the odd ponzi scheme. However, if incentives are carefully controlled, the Madoffs of the world will not be able to bring economic calamity on the rest of us. Sure, it's easy to blame Wall-Street's greed for the problems we're in, but economically minded people understand that it is that very greed on which the capitalist system is built. Greed in itself is not a bad force, it is to be encouraged, it is part of human nature. Suppressing greed is simply impossible, but channeling it in ways that benefit society as a whole is the way to guarantee economic stability and long term prosperity. 

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Signs that You May be About to Lose Your Job

Pretty much every manager has in his head a list of people in his team that he or she would release if there was a need to lay people off. To find out if you are on this black-list and to potentially do something about it, you need to watch out for telltale signs that you may be about to lose your job:

No New or Important Projects - if your boss knows that he is about to let you go, he will not want you on any new projects. After all, why would you want someone to start a job that you know they will not be allowed to finish. Similarly, if you are still getting new projects, but they seem less important than the ones you are typically assigned, or even seem like busy work, you have cause for concern.

Low Work-Load - At a time when many businesses are seeing a decline in activity, it is not unusual for many workers to see their workload diminish and that in itself is not sufficient cause for concern. Of Course, in the long run management is more likely to reduce staffing levels if employees are not working at capacity. However, you should be more concerned if you notice that your work load is diminished to a greater extent than that of your colleagues. It can be a sign that you are being "phased out".

Unusual Interest in Your Work - In many cases, your boss will make arrangements for someone else to take over your projects and duties once you are no longer with the company, and such preparations may give you an early indication that something is afoot. Anything that can be taken as preparations for a smooth transition should set-off some alarms. For example, if your boss is asking you to put him in touch with customers or vendors that normally only interface with the company through you, you should be paying close attention to developments. 

Verbal Clues - laying people off is an emotionally charged and difficult responsibility for managers, and many of them don't take it well. Such managers may try to soften the blow by giving small or large clues that should alert you that your job may be at risk. Statements like "we are going to have a tough week next week", or "be sure to be in the office early on Friday" which are not followed by more detail, may be indications that bad stuff is about to happen. If you think you spot a clue, try to follow up on it - tactfully - to get more information.

Non-Verbal Clues - some people feel so uncomfortable about laying people off that they do anything they can to avoid contact with the team members that are about to be released. I have known some managers who would leave a room when the team member in question joined a meeting. If your boss has been avoiding you, you definitely have cause for concern.

What to Do If You Think You Are on the Black List

First of all, don't panic. If a mass lay-off is under way, there may be little that you will be able to to do to change your fate, however, here are some of the actions that I would take:

Talk to the Boss - be direct, respectful and to the point. Don't whine. Don't beg. Get as much information as you can. For example: "I may be completely off base here, but I have an uneasy feeling about my position in the company. Is my job at risk?" Who knows, your boss may completely explain away your concerns, or she may confirm them. Either way, trying to find out more information is always a good idea.

Listen to the Grapevine - many people know many things. I don't suggest you become an office gossip, but listen to what people have to say. In my previous company, long before a business unit was cut, many people were discussing the possible timing and implications of such a move. If you spoke to the right people you knew that things were in motion.

Maneuver Internally - think about trying to find a safer position in the same company while there is still time. Maybe a different business unit? Maybe a different position? It's never too early to network or to search for options.

Get a Jump on the Job Search - if you think that there is a significant risk of job loss, start searching for a new job immediately. In this economy, chances are that finding a new position will take longer than it would take you otherwise. No sense in wasting time.

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Asking for a Raise? Now?

In tough economic times many companies are resorting to aggressive cost cutting measures, including pay freezes, benefit reductions and lay-offs. However, some folks still feel that they need or deserve a raise, and one such anonymous reader recently found his way to Money and Such. So here is my take on the reader's query: how should you ask for a raise in a tough market? I'll break the question down into several topics:

Should you ask for a raise when the economy is in decline?

The short answer is "probably not". The more detailed and nuanced answer is that it depends on your specific circumstances. Obviously, not all companies are cut from the same cloth. While some are struggling to survive, others are actually thriving in this kind of market. If your company is one of the ones struggling, asking for a raise is the equivalent of wandering around a firing range with a target on your back: prepare to lose your job. However, if your company is one of those who is doing well in the current conditions, asking for a raise might not be a bad idea. Even if that's the case, be aware that when unemployment is high and headed higher, companies feel that they can easily replace team members who decide to leave. They also consider it less likely that employees will quit over compensation issues. After all, it's going to be difficult to find another job. Bottom line - your negotiating power in this kind of market is pretty limited.

Consider Your Specific Situation

Before you hit the boss for an increase, you should consider your specific situation. If you are well respected in your organization and are considered a star-performer, your chances of getting a raise are obviously better. If you are a marginal player? Forget about it. Unfortunately, I find that many marginal players have an over-inflated sense of personal worth (this is one of the things that makes them marginal players to begin with) - so try to be honest with yourself.

Other cases where I would consider asking for a raise are if it was previously promised to you; if a compensation review is part of your employment contract; or if you were recently promoted.  Even so, think twice before insisting on a salary increase. This may backfire.

How to ask for a raise if you decide to do so?

If you decide to ask for a raise, remember that your chances will improve if you build your case well, and if you are tactically sophisticated in how you go about getting that increase. Here is some advice on how to ask for a raise and how not to ask for a raise. Finally, here are some suggestions about what to do if you don't get the raise you wanted.   

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iPhone: It's Worth Every Dime

Last summer I bought me a brand new and shiny iPhone 3G - and even though I paid $300 for my cool new phone - I think I am absolutely getting my money's worth. This only goes to show you that value is not so much a question of price as it is of cost effectiveness. A couple of weeks ago when we went shopping for furniture on a random Sunday, I too note of what I was using my phone for and here's the full list:

eMail - big deal. Pretty much any smart phone will do that for you.

Real Time Traffic Reports - checking google maps while on our way to San Francisco, I decided to take an alternate route when I noticed some congestion up ahead. Unlike many GPS devices that charge you a monthly fee for integrating real time traffic, traffic data comes free with the iPhone.

Finding Lunch - when we stopped for lunch at a local TGIF that we have been visiting for years, only to find out that the place was out of business, it took us all of 30 seconds to find a new family restaurant in the area, using an iPhone application called "Around Me".

Furniture Pictures - out shopping? Taking pictures of the furniture and sending it to folks for their opinion or to yourself to remind you what you've seen or what you actually purchased, is very useful.

Identify Music - sometimes when I am out or simply driving around I hear a cool song and I tell myself I have to buy it next time I go on iTunes. Of course, I always forget. No more. While shopping at Macy's two fun songs came on the store speakers. I didn't recognize them, but "Shazam", an iPhone application that identifies songs it hears, sure did. Songs purchased on the spot, while still in the store.

Keep Up on the News - standing around in the store waiting for my wife to finish browsing I can check out the NY Times or some other newspaper. No more being bored.

Free Pod Casts - there is a tremendous amount of free audio and video content available on iTunes, including many university lectures, and personal finance podcasts, including a monthly podcast from Bill Gross of Pimco, which I listen to regularly.

Did I mention that thing also works as a phone? Although I do have to admit that I still suffer from dropped calls and periodically I have to restart the device to make sure it works properly. Another downside is battery life - the phone needs to be recharged daily. My service plan costs about $80 a month, but happily, my monthly cell phone bill is covered by my employer. Can you tell I really love this machine?

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Future Concern: Run on the Dollar

The current global economic crisis is causing governments around the world to take aggressive measures to mitigate the downside risk. One of the most aggressive is the US government which has basically thrown the kitchen sink at the problem. What didn't we have? Bank bailouts; auto bailouts; reduction of interest rates to 0%; massive stimulus packages and tax rebates; you name it, we got it. AND we're not done yet. The problem is that all the money for the bail-out needs to come from somewhere, and the main sources for spending? Debt and good ol' fashioned money printers. All of this leads me to be concerned about the value of the greenback. 

What is a "run" on a currency? Much like a run on a bank, where investors all try to take their money out while the bank does not have enough liquid assets to satisfy everyone, a run on a currency is a case where investors panic and try to quickly pull their investments out of a particular currency and move to a currency that is perceived as being stronger.

How could a "run" begin? The government is raising incredible amounts of money by selling its debt to individuals, corporations and foreign governments. Essentially, our government is taking a huge mortgage on our future. But here is where it gets scary: what if people start to get scared about lending to the US government? What if folks suddenly realize that we Americans are living well beyond our means and maybe our IOUs are not worth all that much? What if they decide that the US is too risky of an investment and that all this money that's being pumped into the economy and printed up by the Fed is going to cause inflation and erode the value of their investments? If that happens, they might decide to get the hell out of the market, while their investment is still valuable. If enough investors attempt this at once and head for the exits simultaneously, all trying to sell their dollar denominated investments in favor of other currencies, we could see a sharp drop in the value of the Dollar.

What would a run on the Dollar mean for you? A dramatic weakening of the Dollar could have some alarming consequences. For one, the government would feel obliged to try to defend the currency. It may be able to do so by offering significantly higher interest rates which will encourage folks to stay in the market. Unfortunately, higher interest rates tend have a weakening effect on the economy, since consumers and businesses find it harder to borrow money at higher costs and therefore need to scale back consumption and investment. At the same time, a weakening of the dollar would make imported goods more expensive in the US. For example, if the Dollar falls compared to the Euro, and European exporters do not reduce their price in Euros, American buyers will need to pay more in Dollars to meet the same price. Our purchasing power abroad, and therefore our standard of living, will decline. 

More ominously, one of the key things about the US currency is that many governments around the globe use the Dollar as a reserve currency - i.e. they save their spare cash in Dollar denominated investments or simply hold large amounts of US currency. If the Dollar weakens, it is very possible that some countries will decide that this is no longer a good solution and that it may be better to diversify into other currencies. This would have implications that go well beyond the scope of this post, but they are not good.

The good side of a weak Dollar. As the Dollar gets weaker, American goods and services become more competitive in the international markets. This can lead to an export led recovery, and reinvigorate such sectors as manufacturing, which have been steadily losing jobs to foreign competition. So, it's not all bad, but let's try to not go there anyway...

Is this a likely scenario? God knows. I don't. However, there is increasing chatter from economists who expect that the Dollar will weaken significantly once the global economy stabilizes, unless the US government is aggressive about soaking up any superfluous liquidity and vigilantly combats inflation and deficit spending.

How you can protect yourself from a worst case scenario. Well, a relatively easy solution is to diversify your portfolio into foreign denominated investments. For example, E*Trade offers investors the opportunity to open up brokerage accounts in one of several foreign subsidiaries and these accounts are denominated in the local currency. If you are not into opening up such an account, a simpler solution may be to invest a significant chunk of your portfolio in foreign stocks, or the stocks of American companies that get much of their revenue internationally. This is our preferred solution: we try to maintain 25% to 30% of our portfolio in international funds.

I sure hope such a scenario will not come to pass, but with the dramatic global economic turmoil, nothing seems impossible these days. 

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