Ex-FDIC Chairman Calls for Creative Destruction

We’ve been bombarded with talk of “irrational exuberance” for more than a decade. It’s time for a new catchphrase. Here to help us is a recent FDIC chairman, Skip Hove, in his article at the monthly journal Prairie Fire. During the current recession, he sees the need for “creative destruction."

In 1942, Joseph A. Schumpeter introduced the concept, now an ECON 101 staple:

Industrial mutation … incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in. [Capitalism, Socialism and Democracy (New York: Harper, 1975), pp. 82-83]

(An example of creative destruction would be the abandonment of the Silk Road in favor of a naval route to bring spices to 16^th century Europe. More efficient shipping lanes led to greater quality and quantity of goods at less cost.)

Before talking economics, Hove analyzes forest management practice according to creative destruction. A few natural fires here or there, or some small planned burns, keep forests clear and healthy. But proscribed burns have been in the Forest Service arsenal for only a few decades. Before that, Smokey the Bear stopped every fire cold in its tracks. Decades of debris accumulated, and now the monstrous infernos burn so hot that the soil itself incinerates.

Hove then applies this lesson to the economy:

The Forest Service policy failure is apropos of decades of overzealous economic policy intervention. We have been too quick to stanch recessions. When coupled with policies aimed at promoting housing and consumption, we have let the debris build up steadily over several decades. Now the great conflagration is upon us and our traditional policy responses have at best only slowed, not stopped, the destruction.

On the mortgage crisis, Hove says that for interest rates currently available to consumers, home prices are too high. One or the other must drop. Foreclosures in the meantime will multiply. But fix housing, and we’ve got our ticket back to normalcy.

That path to recovery, though, will be tough. The recession itself will kill the housing markets for a long time yet, according to Hove (emphasis mine):

The rapid worsening of the economy and rising unemployment is accelerating the rise in mortgage delinquencies. No longer are delinquencies focused only on sub-prime borrowers who were aggressively underwritten and put into extremely risky “affordability products.” The new wave of delinquencies is coming increasingly from traditional-conforming, fixed-rate mortgages. And the tsunami is coming. Lag times between unemployment, default and foreclosure cover many months.

And two points Hove does not address are (1) how the housing crisis might be an instance of creative destruction at work; and (2) how housing policy fixes might be at odds with creative destruction.

To get back to our example of the spice trade, now that the 111^th Congress is in session, how would they handle the demise of the Silk Road? Would they give people “spice vouchers” to artificially inflate demand? Would they nationalize the Silk Road to let taxpayers keep it afloat? Ah, then there's the Fed ... Would the entire banking system be riding on too many credit default swaps, so the Fed would be forced to guarantee Silk Road debt?

Creative destruction is indeed alive and well today – just witness the rise of online shopping and the fall of the shopping mall. But countless Silk Roads are still living beyond their years.

Disclosure: no positions

Comments

[keithp:]

More accurately, these are "prescribed burns" to elminiate "proscribed material". They are actually _old_ techniques (with a recent resurgence).

Jan 09 07:50 PM

[Rhett:]

An excellent contribution to the rational discourse.

Jan 10 12:58 PM

[Can'tSpotAB...:]

Ross

Thank you for a great contribution!

Jan 12 05:52 PM