Robert Shiller, the Yale economics professor who has co-authored the forthcoming Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism, has an important op-ed in The Wall Street Journal.
Shiller’s op-ed itself is an argument that the Obama Administration’s proposed stimulus package isn’t big enough, and while I’ll preview that here as a minor exercise in public service (I personally won’t vouchsafe a view on this, since I don’t have one, believing it’s still too soon to tell), this is really a column about "animal spirits:" Where the phrase came from, what they mean, and what you can do about them.
But first, Shiller’s argument, condensed:
President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits that is underway and may continue to worsen.
The term "animal spirits," popularized by John Maynard Keynes in his 1936 book "The General Theory of Employment, Interest and Money," is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people.
…But lost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place — for why the economy fluctuates as it does. It also gives some hints regarding what we need to do now to get out of the current crisis.
A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust and associated feelings that contribute to an environment of confidence. They make decisions spontaneously. They believe instinctively that they will be successful, and they suspend their suspicions. As long as large groups of people remain trusting, people’s somewhat rash, impulsive decision-making is not discovered.
Unfortunately, we have just passed through a period in which confidence was blind. It was not based on rational evidence. The trust in our mortgage and housing markets that drove real-estate prices to unsustainable heights is one of the most dramatic examples of unbridled animal spirits we have ever seen.
"Animal spirits" appears on pp. 161 et. seq of Keynes’ seminal book (as noted above). It’s important to step back a moment and put it in its original context (emphasis supplied):
"…a large proportion of our positive activities depend on spontaneous optimistm rather than on a mathematical expectation, whether moral or hedonistic or eonomic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits–of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
[…]It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimat eloss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.
This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man."
The economy, in other words, is not a system of hydraulic pipes and valves, governed robotically by the laws of financial thermodynamics. It depends on confidence, trust, reciprocity, and the expectation of future rewards and growth. In other words, to some extent it’s an exercise in faith.
(Small digression: A few years ago I was asked to speak to an elementary school class about "money"–clearly the result of an over-exercised grade school teacher’s brain–and I decided to do show and tell. I took out a $20 bill and a blank sheet of paper and threw them both on the floor to open the presentation. After the predictable flurry of excitement surrounding the $20 and the curious looks surrounding the blank paper [accusing me perhaps of littering], I asked the students to explain their reactions. This was all an exercise in reminding them that "cash" is worth what it’s worth because we all believe in it, and for no other reason. Intrinsically, it’s merely paper. And yes, I did get my $20 back; they were well-behaved kids and had push come to shove I was bigger than they were. But I would like to believe they learned a small lesson about the role of trust in the modern economy.)
Now, what does "animal spirits" mean for you?
Three things.
First, many of you, as I, are surely asking yourselves what went wrong? How could the economy have fallen off a cliff so fast? After all, housing was overvalued for years, subprime mortgages were being issued for years, securitization and structured finance had been on a tear for years, and easy money had been around since the dawn of Greenspan for years.
The answer is not that economic fundamentals changed overnight; it’s that psychology changed overnight. It has a way of doing this, particularly at the end of bubbles. (You do remember, of course, when the dot-com bubble was at its peak and no business model was too stupid to get funding, and no law firm was too smart not to get into Northern California?)
Shiller (and Keynes) rightly talk about confidence and trust, and I have my own pedestrian analogy: In normal times, you buy a 24-bottle case of Poland Spring water and trust without questioning that it’s OK, just as you’d buy a triple A bond with no doubts. But in today’s environment, buying a triple A securitized asset (if they even exist any more) is like buying that case of water worried that while 23 bottles are surely fine, one might be rotten. The upshot is you don’t buy the case.
When there’s no trust, there are no transactions.
Second, the good news about "animal spirits" is that they can and will reverse. Seemingly on a dime. As they recently did around Q3 2008. And, as hard as it might be to imagine right around now, the day will dawn when M&A will be back–not financially engineered M&A, but strategically driven corporate M&A. At some point clients will start looking around and realizing that that company they always coveted is now really really cheap.
Third, look to your own firm, internally.
Who in your firm is rolling with this punch we’ve all taken? Who seems to be paralyzed?
Who, in other words, is prepared and eager to re-invent themselves? ("We’re all restructuring lawyers now.") Who is a deer in the headlights?
Who are you counting on to constitute the core of the firm going forward? Who’s on the periphery, perhaps a recent lateral or someone who’s a summer soldier and a sunshine patriot?
These are the times to segregate those truly on board with your firm for the long run from those who may have come for a brief guarantee or a short expectation of self-interested gain.
You have, I devoutly hope, a vision for your firm going into the future and for how it will look on the other side of this brutal interregnum. This is the time to assemble, or reassemble, the team you want for that other side. I would ask you one key question about who’s on which side.
Whose animal spirits are still in the ascendancy?
