Self-reinforcing trends

There's a lot of talk these days about how to "fix" the problems in the economy. One of the major causes of both the initial problems, and the problems with the proposed solutions, is the concept of self-reinforcing trends (or spirals). Often these can cause problems to get much worse, and its hard to prevent them if you don't know (or choose to ignore) what's going on.

For example, the housing bubble was such a trend. As prices went up, lenders figured they could give a loan to anyone with a pulse and the ability to make a teaser rate payment, even if they were accruing negative equity, because when they sold in a few years the rise in asset valuation would cover the balance of the loan and then some. Buyers figured the same thing, which led to many people speculating on the premise of getting rich quick with virtually no effort required.

The housing correction has a similar trend, only in reverse. As house values decline, speculators default. Their foreclosed homes are resold for market value, which pushes prices further down, causing more people to be underwater. Of course, it's only the speculators and people who couldn't afford the houses they purchased who are being affected, but it turns out that's a huge portion of the people who "own" houses in the current market, enough that the government feels it needs to pay off their reckless actions with responsible people's money.

Then we come to the stock market. All the powers that be are trying to stop the market from going down, with all the powers they have. Unfortunately, we're in a spiral, and here's why: the market will go down more the more investors think the economy will be bad and governments will be manipulating the markets. As the various government organizations work to try to manipulate the market, the market reacts by going down more (correctly interpreting that more government interaction is worse for private businesses). Hence the self-reinforcing trend.

The big problem is, like all spirals in the past, and in particular like the Great Depression, it's likely to get much worse. We're likely to elect a socialist leader who will enact large-scale government interaction and manipulation to "stabilize" asset values, which will of course destroy them further. This will force the government to intervene directly, paying off bad debts and mandating benefits demanded by people hurt by the declining businesses. This will be paid for indirectly by higher costs to American businesses and of American goods, which will drive more businesses to extinction, and hinder the formation of new businesses. This will cause more people to demand more from the government directly, which the socialist government will happily provide in a series of New Deal type initiatives.

The even bigger problem is that modern societies have a pretty bad track record of pulling themselves out of self-reinforcing negative spirals; usually it takes an external impetus to force the government away from their self-destructive policies. Some successful ones in the past have been external attack, internal revolt, or similar large-scale disruption. For a counter-example, look at Japan: they have been in a self-imposed economic standstill for the last 15ish years, with interest rates basically zero the whole time and essentially no progress.

I don't know what will happen in the US, but I'm pretty sure it'll get worse before it gets better; and unless the electorate gets a lot smarter in a very short period of time, it could be very bad. Self-reinforcing trends suck.