How an Economy Crashes

There's an interesting piece at The McKinsey Quarterly online right now about howthe economic forces of "creative destruction" are working in the current business environment. It's relatively short and worth a read.

It takes place in the context of an interview with Richard Foster, coauthor of the 2001 book Creative Destruction. In essence, he describes how there is a basic business cycle that has been repeating itself in American for many decades. It is one where, as he sees it, honest entrepreneurs and businesses find themselves in a marketplace collapse.

That collapse results in government placing blame and setting up a new institution or agency to deal with the perceived problem. Then honest entrepreneurs realize they can't do that business that way again so they come up with a new model for their business effort. It succeeds because it gets around current regulations.

"Eventually," he says, "all the truly good guys who are going to get into that business have done so. The opportunity starts drawing less savory figures—charlatans who overmarket, cut corners, establish usurious contracts, and do other clever things to generate profit for themselves. They end up bringing the system down." Then government steps in again, fixes blame, and sets up another agency to prevent it from occurring and the whole thing starts all over again.

He points to all the regulatory agencies whose birth occurred as a direct result of marketplace failures during the 20th century as evidence and he seems quite accurate.

So, what does that mean today? Well, it may just mean that there is more to this "car czar" idea than pundits will admit. Certainly taxpayers don't like any of this "bailout" talk when no one is bailing them out of their own problems and sooner or later taxpayers make known to politicians what they think and why and politicians, in turn, realize they need to deal with it or they could end up out on the street, like many of their unemployed constituents.

More to the point, perhaps, is how all this works at the retail level in the car business. Honest businesses can't compete with the predatory buy here pay here lots, so a few of them gloss up the operation and call it sub prime financing. That generates so much profit that sub prime goes "legit" and gets into the mortgage business. That generates so much profit that legit mortgage companies get into the business too, just like legit car dealers expanded their share of the subprime car sales business by pushing credit-borderline customers into subprime where the profit margin for the dealer was greater.

It all begins to look like it's feeding on itself and snowballing into a bigger and bigger mess.

We aren't "Ph.D" economists or anything like that, so maybe we're wrong on this. On the other hand, it doesn't take a genuis (or an economist) to realize that $700 billion dollars ought to be able to fix darn near anything if you use it right. So how come the marketplace is not much better now than it was a month or two ago? Could it be that the "entrepreneurs" figured out that the best way to get around the current regulations was to just dive straight into a federal no-strings-attached bailout that was driven by panic-stricken politicians who might have been crying wolf? When all the while the wolf was wearing a suit and tie and working on Wall Street?

A lot of people think something smells rotten in Denmark, or in Washington DC. That smell may be coming from Wall Street. Problem is, Detroit saw that it can work so why not make it work for them too?

You might want to watch your wallet. The smell seems to be getting stronger.