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Michael Lewis on Bankrupt California

It's Michael Lewis week here at the PolyCapitalist.

His latest in a series of financial disaster pieces he's been penning for Vanity Fair is about his home state of California. The whole article is a must-read (here's a link to the full article) but below are a some of the highlights:

But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly.

On the fiscal nightmare that is the City of San Jose...

The ex-Governator

The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt. 

By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever. 

This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them both­ered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.) 

“How on earth did this happen?” I ask him. 

“I think we’ve suffered from a series of mass delusions,” he says. 

I didn’t completely understand what he meant, and said so. 

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here—this place—is where the reality hits.” 

...and the bankrupt hell that is the City of Vallejo:

On the way back to the elevators I chat with two of Mayor Reed’s aides. He’d mentioned to me that, as bad as they might think they have it in San Jose, a lot of other American cities have it worse. “I count my blessings when I talk to the mayors of other cities,” he’d said. 

“Which city do you pity most?” I ask just before the elevator doors close.

They laugh and in unison say, “Vallejo!” 

I notice on his shelf a copy of Fortune magazine, with Meredith Whitney on the cover. And as he talked about the bankrupting of Vallejo, I realized that I had heard this story before, or a private-sector version of it. The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans. 

The evolutionary explanation underpinning society's collective behavior:

The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core. We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”

Lewis concludes on an optimistic note:

When people pile up debts they will find difficult and perhaps even impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their pres­ent wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that, when the future difficulty arrives, they’ll figure it out. They don’t always do that. But you can never rule out the possibility that they will. As idiotic as optimism can sometimes seem, it has a weird habit of paying off.

For more Michael Lewis, both past and present, simply click on the tag with his name at the bottom of this post.

Does Money Buy Happiness?

“Gross national product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts the destruction of our redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and armored cars for police who fight riots in our streets.”

"Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile.”

-Robert F. Kennedy, 1968

While interest in qualitative economic indicators, such as happiness, has grown substantially in recent years, the above quote from over four decades ago suggests a longstanding interest in holistic economic measurements which encompass more than the venerable gross product of a nation, or individual income.

Research on subjective indicators, such as happiness, has lead to new and interesting economic insights. Observing the growth in happiness related research prompts interesting questions in its own right: has the world become more complex, therefore necessitating more sophisticated heuristic techniques in heretofore underexplored economic provinces? Or has the development of modern social science methods, in fields such as statistics, psychology and micro-econometrics, made recent scholarship possible in areas previously rife with challenge?

Happiness and Income

Can money truly buy happiness? Perhaps no other question throughout history is responsible for as much debate. In recent years economists have been able to put this question to actual scientific test. Research has shown that happiness is in fact directly related to income. However, income aspirations increase alongside income growth, thereby undercutting the favourable effect of income growth on happiness. In other words, the concept of diminishing marginal returns appears to apply when measuring happiness derived from income (Easterlin 2001).

In addition, while wealthier individuals appear happier than those less well off at certain points in a life cycle (‘context specific’), over the entire life cycle (‘context free’) actual experienced happiness remains constant on average (Easterlin 2001). In short, the answer to life’s age-old debate is “yes”, but with limitations. Further, happiness derived from money is not absolute, but relative (Duesenberry 1949; Blanchower & Oswald 2001).

Further happiness research has provided a number of interesting, and perhaps surprising insights:

• A high correlation has been shown between income and happiness across countries (Deaton 2008)
• Income and happiness are positively correlated but other institutional factors, such as local autonomy may be a more important determinant than income on happiness (Frey and Stutzer 2000).
• On an individual level, well-being over a life cycle plots a U-shape curve, with the happiness trough occurring in life’s middle years and peak happiness occurring both early and later in life. This pattern suggests a release of aspirations and adaptation to one’s life circumstances (Blanchower & Oswald 2001).

Criticisms

Happiness is a direct but subjective measure, and like all subjective measures it has quantification limitations. For example, Blanchower & Oswald point out that the evolution of a word’s meaning over time may pose challenges (e.g., ‘happy’ may no longer mean exactly the same thing today as it did 40 years ago). This creates significant challenges for the measurement of happiness, particularly across time and space. 

Easterlin goes on to point out that scientists have begun to discover the effects of genetic traits on disposition, which in turn influences (and perhaps ultimately determines) happiness. Contrasting with Deaton’s comparative country findings, individual countries such as Japan have experienced rapid income growth but no material upward or downward change in happiness during the same period (Vennoven 1993).

Blanchower & Oswald studied happiness in modern Great Britain and the United States. In the case of the U.S., over the past 30 years happiness has been declining while per capita income has been rising. However, real wages over this period have largely remained stagnant (Mishel and Bernstein 2007).

There is also some criticism over whether society should invest its scarce resources in the measurement of something as nebulous as happiness? Does a sufficiently precise and agreed upon definition of what happiness is even exist? Without one there will be intractable problems with measurement. 

Finally, there is a fundamental philosophical criticism of whether or not happiness is, or should be, a shared cultural goal. In other words, should everyone adopt Taoism’s motto of “happiness is my duty”? There is no definitive global, or perhaps even national, answer to this question.

Conclusion 

Overall, while there appears to be a correlation between income and happiness, definitively determining causation may prove elusive. Also, the question of whether income is a derivative of happiness or vice versa is unclear. The subjective nature of happiness and the difficulty of measuring it across cultures, time and space places limitations on reaching strong comparative economic conclusions. 

However, while happiness research (and perhaps research into other qualitative measures) carries limitations, it is an important area of research due to the perhaps even more problematic limitations of existing objective measures, such as GDP per capita. Objective measures may also fail to take into account all economic incentives and goals. 

Perhaps the argument for the usefulness of happiness as an economic indicator is strengthened when it is not pitted solely in relation to income, but rather combined with other subjective and objective measures to form a more comprehensive picture. For example, the Prosperity Index was recently launched by the London based Legatum Institute. The index ranks countries across eight different wealth and well-being measures, including a number of subjective measures such as ‘Trust in Others’ and ‘Satisfaction with Health’. The purpose of the index is to “provide new insights into the factors that produce successful countries and fulfilling lives”.

The Legatum Prosperity Index also makes use of other qualitative data sources and indexes, including:

• Global Peace Index
• Global Competitiveness Index (World Economic Forum)
• Governance Indicators (World Bank)
• Index of Economic Freedom (Wall Street Journal/Heritage Foundation)
• Freedom in the World Report (Freedom House)

The Prosperity Index is indicative of growing interest in happiness measures by governments from around the world. For example, the U.K. recently announced that its Office of National Statistics will be surveying the British population in an attempt to measure well-being, along with sustainability measures. The decision to pursue this study follows the recommendation of Nobel Prize winning economists Joseph Stiglitz and Amartya Sen. The U.K.’s announcement follows similar moves by governments in France and Canada (Rumsey 2010). Overall, the measurement of happiness would appear to be on the rise.

The proliferation of subjective economic indicators continues unabated. Looking ahead, the emergence of new qualitative economic lenses through which social scientists may attempt to better understand the world suggests strong interest, and perhaps funding, for further research on the economics of happiness and other subjective measures.