Bubbles

Apparently, we live in the era of the endless bubble. 1996-2000 – a stock market bubble, primarily stemming from “tech stocks”. Any company with “.com” in its name was accorded astronomical value, far beyond what it might reasonably provide in the foreseeable future. 2004-2007 – a housing bubble, with prices rising 15-25% a year, based on nothing of increased value being created. There is talk of a “higher education bubble”. And I will argue that, for over 40 years, we have been living inside of a health care bubble.

But just what is a bubble, from an economic perspective. Classically, a bubble exists when people are buying something with plans, not to use it, but to resell it soon at a higher price. With easy money being made, more and more people want a piece of the action, and prices rise faster than any true economic value is created. Eventually, there are no more new buyers, and the price crashes back to, or below where things started. Bubbles have existed for hundreds of years: tulips in Holland in the 17th century, south sea islands in the 18th, Florida land in the 1920s.

But the bubbles now seem to be happening more and more frequently, and affecting not just a small segment of the populace, but many or most of us. After all, over half of American families own stock, and about 2/3rds own houses. More than half go to college, and all of us use health care. If only a small group is buying tulips or land, the damage is generally confined to them and those who lent them money for the purchase. But when more than half of us see our paper wealth diminish over a very short span, it can disrupt the entire economy, and cause a downward spiral very hard to recover from.

So are health care and higher education truly bubbles? College costs are clearly rising faster than inflation, and the value of the product does not seem to be increasing to any significant degree. But do people, once they purchase an education, sell it as-is to someone else for a higher price? Well, to some extent they do. Education is a form of investment; persons with a college degree are more likely to be employed, and to get a higher income, than those without.  But those differences are starting to diminish, which is what makes higher education seem to be a bubble.

True, the education can’t be endlessly resold to an unlimited number of marks. But that just means to bubble moves in slower motion – prices can’t rise overnight, if the thing can only be re-sold once, But prices can rise faster than expected, simply because of that one hopeful resale. The counter example would be – it’s hard to have a bubble in Big Macs, which are consumed and not re-sold.

What about health care? The classic bubble definition seems even less applicable here. But satisfactory health is a very real prerequisite to being able to work and earn a living, with the most obvious example being, you can’t work and make money if you’re dead (unless you’re Elvis Presley). So during my professional lifetime, I’ve seem health care rise from 10% of our economy to nearly 20%. And I don‘t think people are twice as healthy, nor do they live twice as long. Price rising faster than value, but people keep selling and buying, ergo, bubble.

The basic concept, it seems, is anything which can be viewed as an investment – stocks, tulips, land, houses, fine art, gold, health, education – can lead to a bubble, wherein prices rise faster than the perceived in value.

Since inflation has been going in only one direction, shouldn’t all prices naturally rise over time, even if the value remains the same? Wrong. Take televisions, as an example. Fifty years ago, a good color television would cost $500. Several things to note about that price. First, $500 then is equal to maybe $6,000 of today’s dollars. Second, if you tried to watch TV on that contraption, you’d quickly throw it out the window: no place for the cable to hook-up, no HD, muddy, mushy colors, big bulky box, not a flat screen. If prices had been rising as fast for TVs as for health care or college, we might be paying $15,000, and still be watching on cathode ray tubes. More value, lower price, almost a reverse bubble. There are lots of other examples of prices which have dropped relative to inflation, and the value of the product is better.

I’ll give just one more, which might not be so obvious on first blush: domestic air travel. Forty years ago, when the airline industry was regulated by the federal government, all prices for each route were set by the government. Compare those prices to today’s costs, even including baggage fees and meals, and we’re spending a lot less to get from Seattle to Denver now than in 1977. And, I would argue the value is higher. Flights are more frequent, they are more likely to be on time, and, most important, they are much less likely to crash and kill passengers. There has not been a fatal airline crash on a major route (the kind requiring a 737 or bigger plane) since November of 2001. More value, lower price, and a lot healthier.

If bubbles are bad, is there any way to avoid them? Some folks feel bubbles are just an inevitable result of the free market in action, the invisible hand getting palsy, or something, I guess.

But a closer look into price behavior shows the more visible the hand is, the more likely the price will rise out of proportion to either economic value created, or inflation.

Televisions are an example of a broad swath of consumer goods which share one thing in common: the federal government does not provide subsidies to either make or purchase the product. This should be obvious on the purchase side: no TVs are made in America now; fifty years ago, almost all were. And, the government does not give people money, or underwrite loans, for the purchase of televisions. The government stopped controlling prices in air travel in 1977; since then, value has remained the same (or gone up, I would argue), and the price relative to inflation has gone down significantly.

Now, look at three big segments of our economy today: military hardware, health care, and higher education. Prices in those industries have risen faster than inflation for decades. In each case, the federal government is either the major purchaser or subsidizes many purchases (student loans).

In defense, the issue is obvious – the federal government is the ONLY purchaser. And, just as President Eisenhower predicted in his farewell address, the military industrial complex has grown in power and size since 1940.

For health care, not only does the federal government directly pay for more than 1/3rd of all costs through Medicare and Medicaid, but it also stimulates behind the scene by subsidizing medical education (both school and residency), funding basic and applied research into new drugs an other treatments. And, the tax code subsidizes the purchase of health insurance.

Likewise in higher education: guaranteed student loans have paralleled the rapid rise of tuition. As states become less able to cover the cost of “public” colleges and universities, the costs are being shifted to those enrolled (or their families), and subsidized easily available loans.

A bubble has the risk of popping, if people can’t repay the borrowed money for the good or service purchased. For health care, that means people are increasingly unable to borrow the money to begin with (they can’t afford insurance, which for some is a form of borrowing), or can’t repay it (in the case of defaulted student loans.) Then, those who loaned the money (“creditors”) risk going bankrupt. For student loans, it’s a direct problem. In health care, it means the person himself goes bankrupt if he can’t afford the care he purchases to stay alive, or the rest of us lose money as our costs go up by subsidizing those who can’t pay.

This mimics, in slow motion, what happened with the housing bubble. First, the government subsidized loans through the income tax code. Then it became the implied lender for some through the VA Home Loan program. That concept was extended to the majority of home loans through “Fannie Mae”. Finally, prices dropped, loans became worthless, and creditors went bankrupt. In some cases, the federal government saved the creditors by covering their losses; in other cases, the money just disappeared.

Of course, the reason the federal government can do this – can create and try to salvage bubbles – is because it can create money by borrowing against the future with no collateral. It pains me to say this, but I look around and see that almost anytime the federal government gets involved in pricing, or paying for goods and services, there is a big risk of bubble economics eventually appearing in that industry. And the outcome is generally not good.

So if we are facing potential bubbles in health care and higher education, and the government seems more and more entwined in those industries, is there a solution? So far, neither the Republican, the Democrats, nor the Libertarians have an answer, in my opinion.

Since I’ve come to my self-imposed 1500 word limit, I’ll have to pick this up in my next entry.