Cows caused the economic collapse. Yes, cows are the culprits. Cows may seem calm and easy-going, but in large numbers they can cause economic crashes. With the great recession we've been experiencing, however, the problem is not so much the cows themselves. Instead, we've experienced a failure to learn the lesson of the cows.
At one time, members of a community shared access to a common pasture. Families sent their dairy cows to the pasture and the cows grazed happily. At the end of each day, families retrieved their cows and the milk. A beautiful and simple shared resource. Everyone shared and benefitted.
Shared resources involve a risk, however, and this leads to the lesson of the cows. If I have a good year, I may have enough money to obtain an extra cow. With an extra cow, my family could make money by selling surplus dairy products. What harm comes if I add one more cow? Clearly the common grazing pasture can handle one extra cow.
The harm occurs when everyone keeps adding cows. Soon the members of the community will own more cows than can be supported by the common grazing pasture. The field becomes overgrazed, the cows starve, and everyone goes broke. An economic collapse caused by cows.
The lesson of the cows is known as the Tragedy, or Problem, of the Commons. Individual decisions favor self-interest: Getting an extra cow improves my personal situation. Crucially, the individual retains all the benefits of having an extra cow. In contrast, the costs and risks are shared across the entire system. As we keep adding cows, the risk is to the grazing commons - a shared resource. The shared resource will inevitably collapse - this is why Garrett Hardin called this a tragedy. In a problem of the commons, the individual retains the benefits, while the cost is transferred to the shared resource.
This is the lesson of the cows: decisions guided by individual self interest will often drain a shared resource. Hardin originally described applications to overfishing, overpopulation, and pollution. For example, if I let off a little pollution, the environment can absorb it. True, until everyone follows this approach. Eventually, the air becomes unbreathable and the water toxic.
The lesson of the cows can be seen in the mortgage crisis. Bankers make lots of loans for homes and other things. They know that although some of the loans will go bad, the system can absorb a few defaults - just like the common pasture can handle an extra cow or two. In the last decade, however, the people setting up the mortgages had a strong self interest in making more and more loans. Mortgage bankers made money for both safe and high-risk sub-prime loans. The bankers made money because the borrowers paid loan fees and because the bankers sold those loans to others (like Fannie Mae and Freddie Mac). Here's the most important feature: By selling the loans, the bankers were no longer holding the risk of bad loans. They gained the benefits, but passed the risk along to a common resource: A classic problem of the commons.
Banks used to hold home loans and make money slowly as people paid off the loan. The bankers assumed the risk for any loan that went bad. Since the bankers gained the benefits and paid the costs, they tended to be careful. When, however, those loan officers made the money but passed the risk along to someone else, suddenly self interest encouraged making as many loans as possible. We need more cows or, in this case, more loans.
The commons will always be overgrazed and overfished and over-polluted without appropriate oversight. When the risks of subprime home loans were passed along to the common grazing pasture (in essence, the US taxpayer), while the benefits accrued to the individuals, the system was inevitably headed toward a crash.
To stop a future failure of this common resource there are two general classes of solutions. One solution is for mortgage bankers and their companies to both reap the benefits and assume the risk. To do this, we return to a system in which banks continue to hold the loans they make. Bankers will be more careful.
The alternative solution is to limit the number of cows. In a grazing commons, you'd set a limit on the number of cows each family can own while maintaining a sustainable commons. In mortgage banking, strict limits on the nature and quality of loans would be needed. Otherwise, cows overgraze the commons and bankers crash the US economy.
