Gresham’s Dynamic

Almost forty years before the craptastic Wall Street meltdown of 2007-08, an economist named George Akerlof published an article titled “The Market for Lemons” in the 1970 issue of the Quarterly Journal of Economics.

In that article, Akerlof identified the problems that plague markets because of “assymetrical information”, a situation that occurs when a seller knows more about a product than a buyer. Part of Akerlof’s Nobel Prize winning article centered on a theory he called “Gresham’s Dynamic”, a corollary to Gresham’s Law – the theory that in an economy, bad money drives out good money.

Akerlof posited however that Gresham’s Law – or Gresham’s Dynamic as he called it – wasn’t just related to money. In fact, he said, it applied across markets and in particular to businesses. The core of his theory was that dishonest dealings in business tend to drive honest dealings out of the market.

The cost of dishonesty, therefore, wasn’t only the amount by which a purchaser was being cheated, but also the loss incurred from driving legitimate, honest businesses out of existence.

It’s axiomatic these days that the mortgage loan fiasco and the subsequent Wall Street meltdown were caused by a top-to-bottom infestation of scumbags.

Mortgage loan bucket shops like Countrywide Financial conjured up huge incomes that didn’t exist from home purchasers in now notorious “liars loans”; customers themselves, with the encouragement of mortgage underwriters lied through their teeth about their income; the loans were sold to Wall Street banks who sliced and diced them into unregulated derivatives that they then sold off to unsuspecting investors; ratings agencies gave the steaming shit piles AAA ratings in order to protect their business relationships with the Wall Street banks; insurers like AIG entered into credit default swaps to insure the $441 billion of securities rated garbage… And on and on and on.

If ever there were a great proof point of Akerlof’s Gresham’s Dynamic at work in the marketplace, the mortgage loan fiasco is it. From top to bottom, the process was corrupted by unfathomable fraud and abuse.

But could Gresham’s Dynamic apply in other areas as well?

I contend it does… In fact, I would argue that just as corruption in the mortgage loan industry cascaded through Wall Street, ratings agencies and the like, corruption in government cascades downward to society at large. The latest evidence is a report circulated a few days ago from the financial blog Sober Look on the topic of unemployment, or more specifically, what happens when the nation’s unemployed stop looking for work.

According to the report, once their 99 weeks of unemployment benefits run out, an increasing number of unemployed just switch to another government handout program – disability.

Sober Look projects that nearly 25% of those not actively seeking a job had applied for, and been accepted for, disability benefits. Citing a JP Morgan study, Sober Look reports that as of January this year, more than 8.5 million individuals were receiving federal disability payments. Since the onset of the recession, this figure has accelerated much faster than the overall size of the potential labor force – 5.3% of the population aged 25-64 on federal disability, up from 4.5% when the recession began. From Sober Look:

Half of the benefit recipients suffer from “mental disorders” and “musculoskeletal disorders” (such as back pain). “Mood disorders” alone account for over 10% of this group. And once someone starts receiving these benefits, it’s almost impossible to take them off the program. In 2011 only 1% of the recipients lost their benefits because they were no longer deemed disabled.

If I were out of work for 99 weeks, I’d probably have a “mood disorder” as well, but that hardly qualifies me for disability.

For the record, I don’t begrudge anyone who is truly needy and legitimately claims disability benefits, although I continue to believe that the days of ever-expanding benefit programs are numbered. But I can tell you from personal experience that disability fraud is indeed a reality. That’s because I have a distant step-relative – perfectly healthy and capable of working – who has been claiming disability… for YEARS.

To me this is morally repugnant, but for an increasing number of Americans I’m guessing, they simply look at the world around them (and particularly at the elites) – utterly corrupt politicians, Wall Street scoundrels, a centralized banking system based on legal thievery – and conclude, “well, if they’re doing it, then so am I.”

In other words, what started off as a way to describe the consequences of corruption in business, now explains much more. Gresham’s Dynamic explains a societal phenomenon that is having devastating consequences.


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4 Responses to "Gresham’s Dynamic"

  1. Brokermike says:

    really well written post. i got here from bill black’s post on the same topic.

  2. Brokermike says:

    forgot to say that i ve felt the same as your conclusion for years; before knowing about gresham’s dynamic or akerlof’s work, i used to say that when elite fraud becomes rampant and sort of the norm and unpunished, then what do you think the little guy on the street is going to do? he’s going to look around and try to get his piece of the pie under that same corrupt dynamic as well, to the point where you now have fraud throughout all levels of society.  this is what you get under a techno-fascistic market dominant ideology where everything is commoditized and stripped of its moral components for the sake of ‘efficiency’ or ‘productivity’.

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