Current Thoughts on The Economy

Many I tell people that I majored in finance they immediately believe I am a skillful accountant as well. While finance and accounting are similar they are not exactly the same. Finance has to deal with risk, reward, understanding the right mix of corporate financing (example how much stock or bonds should the company sell). On the other hand accounting deals with understanding financial statements, how companies collect money from individuals, and auditing the books to make sure financial statements are correct. I would say that economics and finance are more closely related in the sense that one must understand economics before they can understand finance. My macroeconomics professor Dr. Harvey summed it up quite well. He basically said that the difference between economics and finance was policy. I agree with this statement. Economics generally look at the overall economy and how to make society better off economically while finance looks at how to make individuals and corporations well off. This distinction is important because it helps us understand the current financial crisis.

Many people have blamed greed Wall-Street executives for the current crisis. I agree somewhat with this. Yes, these executives did take excessive risks and money from shareholders to take these risks. However, companies had an incentive to take risks since history has shown that the government has a tendency to bail companies out. Examples of this can be seen in late 1980's and early 1990's, with auto companies (GM, Chrysler), and throughout history. Bailouts create the notion that companies in the future can be bailed out. An analogy to this might be the following: Let's say that you have a friend who has a little bit of an alcohol problem and constantly gets into fights and causes trouble. Every time he gets into a brawl you (the loyal good friend) are there for him and try to help in anyway. A few times your friend ended up in jail and you paid his bail money to make sure it wouldn't happen again. If your friend believes you will keep bailing him out doesn't he have every incentive to continue the same behavior? The similar logic can be applied to the current economic situation. The government is bailing out your friend and millions of his friends. Clearly, this is not a good situation. This situation is known as moral hazard. It would be important to give your friend incentives to try to limit his alcohol and try to get him to sober up. Moreover, the government could stop the "bailout" problem by simply not bailout out future companies. Companies knowing that they couldn't get money from the government or bailed out if they went bankrupt would have different incentives to make sure they didn't do anything foolish. The basic of economic is incentives and giving people the right incentives can go a long way.

I do believe that the economy will pick back up. I don't like how the media and everyone seem to compare recession to the Great Depression. Looking at historical data the recession the current economy looks most comparable to the 1990-1991 recession. In past year, businesses have fired millions of workers and millions more are trying to find jobs. However, the silver lining here is that businesses will increase their productivity (same amount of work/less workers). Although, it make take time businesses will once again reap the same profits they did before the recession. The recession can't continue forever! The business cycle shows that firms dip into recession and then bounce back over time. The $64,000 question is when. No economist really knows this answer. From the current situation I can only see the economy improving and not getting any worse.