Financial Responsibility

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The recent recession, which some call the Great Recession, has been around for years, yet it simply refuses to go away. I believe that American business is strong enough that not even Obama’s socialist agenda can permanently destroy our prosperity. But even if a Republican is elected in 2012 and this recession ends, what is to prevent another one?

The question of what causes recessions is perhaps the single most important and most highly political question that the science of economics seeks to answer. The Keynesians and socialists have one answer, the Austrians have quite another. Perhaps the Federal Reserve’s manipulation of interest rates has caused or exacerbated the recession. However, I think that from an empirical, factual standpoint the linchpin of the Great Recession was the American public's financial irresponsibility, as manifested in the collapse of the real estate bubble. Many thousands of Americans irrationally believed that home prices could only go up, and they incurred real estate mortgage indebtedness far in excess of what a financially responsible person would incur. When real estate prices collapsed, very many mortgages went into default, which led to foreclosure sales, which further reduced home values, which triggered a downward spiral. It is probably true that government efforts to encourage low-income home ownership and government home mortgage guarantees contributed to inflating the real estate bubble. But the disaster would not have been so widespread if more home buyers had been committed to living within their means or had been more risk-averse.

This is the most dangerous matter, and also the easiest to correct. If the American public, especially the lower middle class, learned to understand the concept of “financial responsibility” then this syndrome would never happen again.

What precisely is financial responsibility? I think that the main point that people should understand is that money does not grow on trees, and there is no such thing as a free lunch or easy money, and that money is not magical and cannot be created by waving a magic wand. The great Randian contribution to economic theory is the idea that in a free market people trade value for value, and to “make money” is to create value. (Yes, Ayn Rand did not invent this idea, but she perfected it.) In order to make money you have to do work to produce the value; in other words, you need to make the money that you trade with others when you buy things from them. If you don’t produce value, then you have nothing to trade.

This not only means that people earn and deserve their salary by working at their job; it also means that people do not deserve to consume more value than what the other traders in the free market are willing to purchase in exchange for money. From each as he chooses, to each as he is chosen, to quote a Robert Nozick saying that captures this concept.

Financial responsibility is the understanding that you cannot spend more money than the amount you earned because of the work you did, unless someone gives you charity or you steal wealth from others, and that you cannot consume a value that has not been produced by someone. To use Rand’s old-fashioned phrasing, you can’t have your cake and eat it too, or as I would prefer to say, you can’t eat your cake before you bake it. Understand this, and you will probably not spend money that you don’t have or use borrowed money to buy stuff when you can’t repay your loans. If you want to buy something, then you will be more likely to do the work necessary to earn the money before trying to get what you want.

This understanding that money is finite and must be created before it can be spent is the essence of financial responsibility. Implicit in the concept, however, is the notion that charity and theft are exceptions, and the general rule is that you, and only you, must do what is necessary to make your own money and control your individual financial destiny.

But if you understand this principle then you will be very careful about economic risk, because you will understand that you will be required to assume responsibility if you make a mistake.  You will be on the hook for your losses and no government will bail you out. Financial responsibility means being held responsible, which means that you are held accountable and you will accept the rewards and punishments that result from your economic choices. Thus, you will not assume risks in excess of the amount of sweat or skill you are willing to put in to compensate for your mistakes. A person who is financially responsible would not assume a gigantic mortgage on real estate he had an annual income in the lower-middle class range, because he would understand that the debt would actually need to be repaid.

If the public were financially responsible, it would not put up with a government that steals money from others or borrows excessively and spends money that it does not have.

It seems to me that the solution to the problem is for high schools or colleges to incorporate personal finance management training into their liberal arts educations. Simply teaching people how to write up a personal budget that matches income and expenditures, sort of like a balance sheet, would go far toward creating the practical skills of financial responsibility. Some high schools have such classes, but they are treated like trivial afterthoughts compared to the more important subjects. Also, merely teaching students how to spend money is not enough; the financial responsibility class would somehow have to simulate earning income in proportion to productivity, possibly by tying fake money to GPA or class performance, to give students a feel for the fact that you cannot spend what you have not earned. The ideal personal finance class would teach career ambition, how to budget to spend within your means, and the crucial importance of saving money and not borrowing beyond your ability to repay.

One would expect the poor to appreciate the crucial importance of saving money. But it is precisely the low-income families that are most vulnerable to financial irresponsibility. The poor face a dark temptation to borrow beyond their ability to repay and not worry about repayment until it is too late, so that for a short time they can live a more affluent lifestyle before their debts catch up with them. The temptation to take shortcuts to one’s desires is deeply seductive even to rational, honest people. But people with no money to spare can least afford to make mistakes. Good finance classes in high school would help poor families budget properly, save for retirement, and avoid predatory lenders. This would help the poor much more than all the modern-liberal nonsense of entitlement spending, welfare, food stamps, etc.

Middle- and upper-income people could also benefit. A study cited on Yahoo claims that the average New Yorker is $200,000 in debt and the average Californian is $300,000 in debt. The American economic system encourages credit card debt, home mortgage debt, and student loan debt. I personally have struggled with handling my finances, which were recently made worse by roughly $90,000 in law school student loans that I needed to incur; and I wish that there had been a serious class in this subject that I could have taken, particularly in college where young people are supposed to learn how to live like adults.

If such classes were commonly available, the average American would actually be exposed to the concept of financial responsibility, and the odds of another recession happening would be greatly reduced. If it were customary for every American student to take a class in financial responsibility, it would be more likely for voters to vote for financially responsible fiscal policy. And if American politicians had taken such classes, they might have better training in the art of living within a budget and be more appreciative of a balanced budget and the dangers of excessive debt.

Of course, if the public were financially responsible, it would not put up with a government that steals money from others or borrows excessively and spends money that it does not have. So the leftists who control most colleges and the teachers' unions who control the high schools would fight to keep people from understanding the truth about financial responsibility and how to prevent another recession.  But while government is the primary source of economic problems, even in a libertarian anarchy they would still exist, if the majority of individuals were financially irresponsible.

Financial responsibility is the understanding that you cannot spend more money than the amount you earned because of the work you did, unless someone gives you charity or you steal wealth from others, and that you cannot consume a value that has not been produced by someone. To use Rand




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Comments

Jon Harrison

This is very sound and sensible as far as it goes. I have a couple of caveats. First, I'm sure you're right that many poor people don't see the value of saving. On the other hand, if you've spent much time around poor people (and I've spent some), you quickly realize that saving is virtually impossible for many of them. Rent, food, heat, and transportation consume virtually all of the poor's income. It's true that many poor people smoke, drink, go to the movies, etc., but we really can't expect them to do without the little pleasures that make a poor person's life bearable. The biggest issue as I see it is poor people's reproductive habits. Why couples who have no business raising one child produce two, three, and more is perhaps understandable from an evolutionary point of view, but socially it's an unmitigated disaster. Some combination of education and incentives should be devised to keep the poor from overbreeding. Politically of course that's a nonstarter, so I fear the poor and their brats will always be with us.

Second caveat: You are right that the current economic malaise is the result of financial irresponsibility on the part of millions of Americans. I published something about that in Liberty three or four years ago. However, we make a great mistake if we fail to recognize that institutional greed enabled that financial irresponsibility. The mortgage companies and banks (not to mention Fannie and Freddie) had to play their part, and they did so with gusto. Of course, the institutions were in turn enabled by the politicians of both parties. Democrats and Republicans alike sought, on the one hand, to make homeowners out of people who should have been lifelong renters, while on the other they responded like whores (no surprise there) to the money held under their noses by the lobbyists for the housing, mortgage, and banking industries. So three actors were needed to create the disaster. Of the three I blame the financiers most. Why? Because they truly should have known better. Most people are stupid or greedy. Most politicians are stupid whores. The bankers should have understood the mess they were creating (many did); should have been more sensible and less greedy. Most of them allowed greed to overwhelm their better judgement. That means, of course, that they need to be regulated. Except -- the regulators were asleep at the switch, right up to Sept. 2008! Perhaps you think the works of Ayn Rand or Hayek provide a solution to this terrible conundrum. But I have to tell you that no one, not even the best libertarian thinkers, has got a roadmap to utopia.

Suggestion on another topic: You mentioned your outstanding college loans. I'd love to see someone publish a piece about the deleterious effects of the college loan program (or I guess I should say programs). By guaranteeing virtually everyone a college education (itself an inane proposition), it has allowed colleges and universities to raise prices again and again, until the education consumer is burdened with enormous debt when he graduates. In my opinion subsidies should be provided only to the most brilliant students who are also poor (actually, I would just give them a free education)). Under the current system higher education is a racket. Take away the subsidies (and therefore the guaranteed customer base) and prices will have to come down. I've been talking about doing a piece on this subject for years, but my natural laziness has prevented me.

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