I Have Decided that I Believe in the "New Economy"

I have been thinking for a while about the so-called "new economy." Of course, my knowledge of economics is quite limited, just what I've picked up from reading the Wall Street Journal of the years. Nonetheless, I have come to form an opinion on the "new economy," and I have decided I'm for it.

The "new economy," from the perspective of my limited understanding, consists of hedge funds, new ways of packaging debt and investment, and many more leveraged buyouts (LBO's) than in the past. On hedge funds, my understanding is still pretty cloudy. However, I've come to accept the idea that they sometimes serve as a sort of "shock absorber" in the economy.

The new ways of packaging debt and investment have, in large part, led to our current meltdown in the sub-prime housing loan market. This is that of course but it is a probably inevitable result of being in the early part of the learning curve in understanding these new ways of packaging debt and investment.

What is positive is that this sub-prime market meltdown has not resulted in a recession---at least not yet. Apparently, this is because, unlike in the past, banks are not holding the bulk of loans. Therefore, the meltdown in the sub-prime market is not resulting in overall withdrawal of credit from banks. This is a good thing.

Of course, banks are tightening their credit in certain ways this time. Most specifically, they are rapidly and extremely tightening the credit they extend to hedge funds. In part, this is related to the sub-prime market but to be honest, I cannot remember how. But mainly, it is related to the fact that hedge funds have gotten in trouble and banks are more reluctant to lend them money.

At the same time, it must be pointed out that banks are already very committed and vulnerable on large number of loans known as "bridge loans." These are short-term loans that banks give hedge funds and LBO companies. They allow hedge funds and LBO companies to close deals without actually having adequate cash on hand. The deals are closed using the banks money, than the hedge fund and/or LBO company arranges financing.

What is going on now is a bit like musical chairs when the music stops. Unfortunately for the banks, in some cases they are the ones without a chair. The banks are going to be losing some money here and it is making them more cautious in a general way. This is obviously bad news for the economy, reflected in the current stock market. However, it still seems more positive than the previous type of situation where the banks would have been carrying all of the subprime loans and when the sub-prime market fell apart, money would dry up all over the economy, causing a recession.

Because of new ways of packaging loans and investments, businesses are less dependent on banks for financing. This is a good thing. It helps stabilize the economy and allows it to keep a positive track for a longer period of time. On the other hand, the current meltdown in the subprime one market probably would not have occurred without these new ways of packaging loans and investments. Sorry that this is somewhat repetitive, but I was developing another point at the same time I was repeating myself. I lack the time and energy during this period my life to straighten this blog entry out into a well-written piece.

LBO companies are possibly the most positive part of the "new economy." Of course, they are quite negative for many individuals, causing large numbers of layoffs. Nonetheless, I feel that the overall positive for the economy is quite definite. In my mind, LBO's are converting the large-scale economy, which tends to consist of somewhat ossified corporations, into something more resembling the small-scale economy, which tends to consist of aggressive, pennypinching small businesses.

This conversion is uncomfortable to many people who lose their jobs. I was reading the Friday Wall Street Journal about the layoffs that resulted when Blackstone took over a company that was involved in airplane flight reservations. It seemed like they laid off many people in their 50s and 60s with very high paying jobs. Though the article didn't explicitly state this, I drew the implication that they were replacing some of them with younger employees. What the article said was that they were firing some people and then hiring others to adapt to "new technologies."

Yes, this is pretty brutal stuff. However, it is also the nature of capitalism. Our economy already has numerous features to try to help people in transitional job situations and we will probably need to develop more of these features. In regard to the Blackstone example cited above, I imagine some of the people in their 50s and 60s would be able to retire with reasonable comfort, but some would not. In addition, many younger people were also laid off.

In reading about waves of layoffs in the telecommunications industry in the 90s, I found that most of the people laid off got new jobs pretty quickly. This depends on two things: highly trained people and a healthy economy. This is not to discount the pain and suffering involved in being laid off, even if you find a new job fairly quickly. In addition, some do not get new jobs. Another unpleasant fact is that some of the people who were laid off do not perform as well. However, the article seemed to imply that this reality does not exist. They only referred to people who were laid off who had "good performance records." These records are often nonsense, in my opinion.

On the negative side of LBO companies, they are accelerating the process of turnaround. Laying off people faster, cutting expenses faster... This part seems like a scam. You can cut expenses past the desirable point and not affect profits for a while. Then if you sell it fast enough, you can make a big profit yourself. After it is sold however, the company crashes, goes into a hangover, and money needs to be spent to rebuild it. So part of the phenomenon is just a scam, in my view. However, is really impossible to separate this sort of thing from truly adding value, or a should say it is impossible in a general sense. For some people, it is possible to separate scams from adding value. These are the real investors.

Capitalism is pretty painful, but so is life. The alternative is a European-type system based on "job protection." However, it seems to me that the European system is inevitably sliding and spiraling downward. I will admit that I'm not sure about this last point.

I will close with a statement made by a person from England who had moved to America. This person said that most of all, they were struck by the optimism of this country. I think optimism springs from opportunity, and we still have it.