Sunday, May 17, 2009

Quarantined.


Souled out(!!!).

Words.

"..."We are going to be in a period of decreased risk tolerance," he said. "We'll overreact. We'll end up contracting more than we need to."

To estimate how long that will take, Lo switched metaphors -- to the five stages of grief theorized by psychiatrist Elisabeth Kübler-Ross. "Financial loss can be as traumatic as terminal illness," he said. "We're somewhere between stages three and four, between bargaining and depression -- emotional depression, not financial depression. We're not going to recover until we get to acceptance. We have to accept the fundamental reality that we can't live in a leveraged state. I think we have another six to nine months before we see a genuine recovery."

That may sound a little New Age-y compared with the supply-and-demand stuff you learned in college. But Lo is only one member of a growing caucus of respected behavioral economists who argue that psychology's impact on the economy isn't a blip, it's a real factor that can help inflate a financial bubble -- and, after the bubble bursts, delay a recovery.

Most behavioral economists don't rely on dopamine, but the underlying point is the same. Humans control the economy, and humans aren't purely rational beings. They have emotions, mood swings and hormones, and those non-rational factors affect their economic decisions, from splurging on lattes to reducing interest rates at the Federal Reserve.

During the real estate boom, consumer spending was boosted by the "wealth effect." Homeowners thought they had money to burn because their houses had risen sharply in value. Now that phenomenon has turned upside down like a bad mortgage. Instead of a wealth effect, we're embracing a "new frugality." Both rich and poor say they are cutting back. Spending at luxury stores has plunged; spending at Wal-Mart is up. If we were hoping for a recovery led by consumption, that's going to take a while.

The good news is that Americans, stung by the results of their profligacy, are saving again. Last year, the national savings rate -- the percentage of income that Americans didn't spend -- dropped below zero; as a nation, we were borrowing money to buy stuff. This year, for three months in a row, the savings rate has edged up above 4%, and economists expect baby boomers -- anxious about their depleted retirement accounts -- to push it over 6%.

More saving is good for the economy in the long run because it means more capital to invest in growing businesses. But the way people invest is likely to change too, and for the same reason spending habits have changed: Once burned, twice shy."

  • LOS ANGELES TIMES: The psychology behind boom and bust
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