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Charles Wheelan, Ph.D. The Naked Economist

Charles Wheelan, Ph.D., The Naked Economist

The Human Capital Bubble

by Charles Wheelan, Ph.D.

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Posted on Tuesday, June 2, 2009, 12:00AM

I recently had dinner with some of my students who will be graduating in the coming weeks. To make conversation, I asked what they will all be doing next year. An uncomfortable silence settled over the table. No one ever did answer the question.

I suspect there are many such conversations going on around the country, as students pick up diplomas, take stock of their student debt, and wonder what the heck comes next.

This isn't just a bad job market - it's the popping of a "human capital bubble." Wall Street and its assorted reckless offshoots didn't just squander much of our capital; the financial industry also sucked up human talent for the better part of a decade that should have gone somewhere else. It's the human equivalent of those empty subdivisions in foreclosure that never should have been built.

That's what happens with bubbles. Resources -- including people -- are allocated poorly because the market sends faulty signals.

Too Many Investment Bankers

Several years ago I looked at the list of jobs for the graduating seniors in my old fraternity. These are really bright kids at an Ivy League school. At least half were going to consulting and investment banks. I remember thinking: "That's too many," which is an odd thought for someone who believes in labor markets.

But I had a similar thought around the same time when I saw new golf courses and developments springing up like weeds across southwestern Florida. The units were priced at $700,000 or $800,000, even though the land had no inherent scarcity value. The developments weren't on the ocean, or even near the ocean in some cases, meaning that there was nearly unlimited space to build more and more identical developments across Southwest Florida.

"Those prices don't make sense," I remember thinking. The land doesn't have much value, and the construction costs for stucco condominiums around a golf course are only a fraction of what's being charged.

Believe me, I didn't predict the crash; I'd be a much richer man if I had. If anything, I talked myself out of believing that there were problems afoot because I'm such a firm believer that the most beautiful thing about markets is their ability to allocate resources efficiently.

After all, the whole point of a market, whether it is real estate or labor, is that prices send meaningful signals. Graduates take jobs with high salaries because that is where their skills will be most productive. Developers build new units where prices are high because that is where there is the most demand relative to supply.

Signals Were Wrong

Here's our problem now, particularly for the new graduates: Those signals were wrong.

In fact, if you want a snapshot of the impact of what happens when a bubble sends inaccurate market signals, ask yourself this question: How many people do you know who became real estate agents over the past five years? In hindsight, does that make much sense?

In the case of the financial industry, salaries had become rock-star huge, both for new graduates and for Wall Street veterans. (In fact, I would venture that the "stars" in finance were making a lot more than most successful rock musicians.) When we were in the midst of it, people like me assumed that those salaries reflected real value for the economy -- that we'd found more efficient ways to allocate capital and reduce risk and that the people who'd come up with those innovations were being compensated for their innovation.

Now it turns out that Wall Street hadn't really built a better mouse trap. Much of what was going on was just reckless speculation with borrowed money -- more like tearing up the old mouse trap and selling it for scrap. At best, these complex financial products offered minimal improvements over what we already had; at worst, they squandered enormous sums of capital and devastated the financial system.

When smart young graduates were lured to Wall Street (and related jobs) by staggering starting salaries, they were making the same mistake as the Florida condominium developers. The problem was NOT greed; self-interest is and always will be at the heart of market behavior. The problem was that self-interest is a disaster when the market signals are wrong. It's like giving someone a bad map and then criticizing their driving when they show up in the wrong place.

Smart People, Bad Choices

With real estate, that means we now have empty subdivisions and millions of homes in foreclosure. In the labor market, the effects were more subtle but arguably more damaging: Smart people could have and should have been doing something else. The clever men and women who made a lot of money designing and trading credit default swaps could have been conducting research on alternative energy, teaching math, practicing medicine, or doing any number of other jobs that strengthen society, rather than making bad bets with borrowed money.

The human capital bubble will take time to unwind, just like all other aspects of the larger financial crisis. People followed the money into jobs for which there is now less demand. In my world, college students flocked into economics, not necessarily because they were scintillated by its ability to predict human behavior and make the world a better place but because it was perceived as the best route to Wall Street.

But in the long run there is good news, too, though it may not be much immediate solace to the college graduates who are now moving in with their parents.

First, a tough job market will lead to a healthier job search for young people. Nothing focuses the mind like struggling to find a job rather than having one handed to you. I watch students participate in "corporate recruiting," which is the process in which firms come to campus and make it enticingly easy to take a lucrative job. It's a stunning opportunity for smart young people who know what they want to do; it can be a sad trap for those swept along by what everyone else is doing.

Twenty years ago I opted not to participate in corporate recruiting. After graduation, my friends had jobs; I was broke, unemployed, and unhappy. It was an awful stretch, but it also forced me to think hard about what I really wanted to do and then go out and find it. (I wanted to be a writer.)

Second, the post-Wall Street collapse job market will be healthier in the long run for the economy, as smart people do other things. It's the human equivalent of NOT building unneeded condominium developments.

The economic tragedy is that some of our smartest graduates took the big salaries on Wall Street (and in law firms doing Wall Street work and so on). Those folks could have made significant contributions somewhere else. That problem is now fixing itself.

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  • Yahoo! Finance User - Wednesday, June 10, 2009, 2:55PM ET  Report Abuse

    • Overall: 5/5

    Dr Wheelan, If you have ever read my past comments, you know that I am a harsh critic of yours. But this article is one of the best I have seen in a while. Many intelligent people with economic/financial backgrounds rationalized this looming crisis the same way you did: "This can't be right... but that's what the markets say and I am very hesitant to call the market a liar..." Although a capitalist like myself will admit that markets are not perfect (nor are they as efficient as the semi-strong EMH suggests), it is undispitubable that there is no better alternative than free-market capitalism. On a final note, the best thing about Obama being President is that I can read actaul ecnomic commentary now instead of constant Bush / Republican bashing. I get fed up now with people bashing Obama, but let's be honest: Bush was treated unfairly. Even an honest liberal can admit that. Remember how bad Bush was criticized in the media when the unemployment rate ticked up to 4.6% (apalling when 5.0% is considered the natural rate). Yet where is the outcry against Obama now that unemployment has climbed to near 10% when he promised that it would not exceed 8%? Let me be clear (I got that from Obama), I don't want the media to start treating Obama the way they did Bush. All I want is for the next time we have Republican, Independent, or Libertarian President, I just want them to get the same treatment as if it were a Dem. Thank you.

  • niceflyer80 - Wednesday, June 10, 2009, 8:47AM ET  Report Abuse

    • Overall: 4/5

    The person below who states that the types of people who pursued investment banking and Wall Street are "ill suited to more difficult but enduring jobs such as engineering, medicine, ..." couldn't be more correct. As an engineer I have to say that to do engineering work you must be trained as an engineer, just as to practice medicine one must be trained as a physician. The people on Wall St. and in investment banks mindlessly buying and selling securities would have no where near the academic training and ability to do engineering work.

  • RobertM - Wednesday, June 10, 2009, 6:33AM ET  Report Abuse

    • Overall: 5/5

    Very good column. Worst career strategy is to pursue current hot jobs, which can change very quickly. The folly of the US economic system has been exposed. You cannot create long-term wealth and prosperity by bidding up the prices of houses, financial products, dot com stocks, etc. As someone who lives in SW Florida, me and most of my associaties knew that we were in a huge real estate bubble that would pop and chose to just stay on the sidelines.

  • Yahoo! Finance User - Tuesday, June 9, 2009, 6:49PM ET  Report Abuse

    • Overall: 2/5

    The premise of this article is somewhat weak. The market sent "bad signals" because it was intentionally manipulated by Alan Greenspan and Co. after the tech bust. Any Ivy Leaguer with an economics degree should have been able to spot the unsustainable situation. Also, what's wrong with your former students making the big bucks on Wall Street for a few years, and then the market changing its mind? Just because a career is lucrative for a few years, doesn't mean that trend will continue forever. In fact, most jobs that earn far above the median salary without producing a valuable durable good or technology will end up being short term. Distorted or not, the free market allocated those students, and now it has deallocated them. If they are intelligent, they will transition to the next lucrative career path. And finally, the get-rich-quick crowd, no matter how bright, tends to be poorly suited to difficult but enduring jobs like medicine, engineering or high tech manufacturing. Humans aren't *that* interchangeable, even if economics models would like to presume such for the sake of simplicity.

  • Yahoo! Finance User - Tuesday, June 9, 2009, 5:27PM ET  Report Abuse

    • Overall: 4/5

    I remember trying to find a place in Florida closer to family for our aging mother. We looked at one place with a termite damaged garage that needed replacing, home made repairs that showed a lack of skill, and other assorted problems and damages. The home had been bought three years earlier by the owner for $180K. And they were asking $325 K. We had a contractor look it over and they estimated it would need $60-$80K in repairs. So from $180 to around $400 in three years. And the Real Estate agent claimed that was a GOOD deal. At that point in late 2007 I knew the market was in a big mess, and something had to give. That type of increase was beyond all reason. By late 2008, the whole house of cards collapsed. And the house we were looking at? Someone bought it for about $280K and was repairing it. It was probably a flipper, as the place now sits, unfinished, becoming an eyesore, as it was only worth maybe $120K to begin with.

  • Jim - Tuesday, June 9, 2009, 2:14PM ET  Report Abuse

    • Overall: 4/5

    "How many people do you know who became real estate agents over the past five years?" I laughed out loud when I read this, as I personally know 3 people who left great paying jobs to become real estate agents. The first gal was fortunate to enter right when the market took off, so hopefully she was smart enough to save some the big bucks she made. The last two.. I cringe when I think of what must be going on in these gal's lives as both entered at absolute worst time. One gal quit mid 2007 AND decided to have a baby..I can only imagine the stress. I too had no idea what I was witnessing.. but boy have I learned. Next time around when I get that nagging, frustrated feeling that something is just not right and my coworkers start ditching their jobs to join in whatever new mania is unfolding.... get ready to short the market. Fool me once.... that's enough for me.

  • Drew - Tuesday, June 9, 2009, 12:52PM ET  Report Abuse

    • Overall: 5/5

    This is a brilliant piece. One of the first people who had the bravery to say that the issue was NOT greed. Markets are always right, except when they aren't.

  • Bourbon - Tuesday, June 9, 2009, 12:39PM ET  Report Abuse

    • Overall: 4/5

    Pretty good column. Only thing it left out was that so many people wnet to Wall Street because there was so little growth elsewhere. No use studying engineering when all the manufacturing jobs have gone overseas and GM and Chrysler are bankrupt. No use studying computer science when you have to compete with graduates from India who will work for $20K per year. We have so little real economy left that there is little for graduates to look forward to. I guess that is why the young people are voting democrat. Instead of building the next generation of American industry, they can all become community organizers or lawyers and fight over the remaining scraps of the American economy. Or learn Chinese and work for America's new bankers.

  • Roger - Monday, June 8, 2009, 7:10PM ET  Report Abuse

    • Overall: 4/5

    This is the problem when our values are driven too much by monitary gain. Consider less, the financial aspects, and look for a career that is focused on a larger purpose. Discover your mission and use that to fullfil yourself and most of your other needs will be met.

  • Yahoo! Finance User - Monday, June 8, 2009, 4:21PM ET  Report Abuse

    • Overall: 4/5

    This is BY FAR the most useful and interesting information this man has ever written on Yahoo. Commendable and spot on. It is much easier to chase the dollar than to contribute to society.

  • JD - Monday, June 8, 2009, 4:07PM ET  Report Abuse

    • Overall: 3/5

    You make comments about the desirablity of people going into technical fields but there doesn't seem to be any jobs there either. I have many years experience in IT with skills in UNIX, Windows Server, Oracle, SQL Server, Java, etc. and I have not been able to find a job since being layed off in January. It is not just real estate and financial peoplethat are out of work. Going in to engineering is not going to solve anyone's employment problems.

  • Chay-nun - Monday, June 8, 2009, 1:39PM ET  Report Abuse

    • Overall: 3/5

    The signals were corrupted by government interference. Bailing out everyone from Long Term Capital Management forward sent a signal that no matter what stupid risks were taken or resources misallocated, the taxpayers would bail out the greedy, stupid and corrupt. Why not go to work in a place where you can only win and never lose, and be paid obscene bonuses for incompetent work?

  • Galen W - Monday, June 8, 2009, 10:50AM ET  Report Abuse

    • Overall: 3/5

    What this story misses is the big picture. Labor, across the economic spectrum will be devalued. The world is overpopulated. Advances in mechanization and technology have removed thousands of jobs. The economic collapse has removed trillions of dollars that could have been invested to produce jobs. Work will never be the same. Unemployment will remain high for decades and those lucky enough to be employed will see thier salaries slaxsheed.

  • pvk - Monday, June 8, 2009, 10:40AM ET  Report Abuse

    • Overall: 3/5

    Yes, it would have been wonderful if all those smart grads had actually created something other than a house of cards. I am totally with you on the wasted human capital issue. And, I agree that the market signals were faulty, which was a factor in the bubble(s) now bursting. But you never ask, or answer, the question: WHY were the signals wrong? What prevented the market from sending the right information?

  • asdf - Sunday, June 7, 2009, 2:54PM ET  Report Abuse

    • Overall: 5/5

    This is nothing new. Back in the 60s, the IEEE professional society yearly made dire predictions on the engineering shortage. At the same time 1/3-1/2 of the new graduates could not get jobs in engineering. A similar thing happened recently. Too many students got trained in RF only to find no jobs it that field when they graduated.

  • M - Sunday, June 7, 2009, 1:57PM ET  Report Abuse

    • Overall: 3/5

    The WSJ has a piece recently saying bonuses and salaries are soaring again on Wall Street. No wonder, given that there is no free market in finance anymore (everything is being backstopped by the government and the Fed is messing up with normal market prices in bond markets) so prices are distorted. It's scary to think we are going to do the same mistakes all over again.

  • Gene - Sunday, June 7, 2009, 2:09AM ET  Report Abuse

    • Overall: 4/5

    I totally agree with the author that the signals were wrong. They created a positive feedback loop. The question is why did it take so long for the signals to adjust? One big reason is that the Federal Reserve simply kept interest rates too low for too long. A bigger problem is that the Federal Reserve attempted to prevent every recession that even hinted of coming our way. This is ultimately what allowed misallocation of human capital, physical resources, etc... Denying the business cycle is the same as putting a price floor on a particular good. Price Caps, floors etc corrups the prices signals. Same this happens when too much money is available to be lent out. It encouraged banks to lend to everyone. If money available to lend out had been rare or valuable then interest rates would have dampened all the borrowing that lead to the housing and human capital bubble.

  • Yahoo! Finance User - Sunday, June 7, 2009, 12:04AM ET  Report Abuse

    • Overall: 5/5

    The human capital issue is a critical one in today's economy. The best book on this is the recently released book, The New Human Capital Strategy. It talks about why current management methods have not make real improvements in workforce productivity and what to do about it.

  • frankm - Saturday, June 6, 2009, 11:43PM ET  Report Abuse

    • Overall: 5/5

    Engineers in finance: Nonlinear modeling with neural networks offers a promising approach for studying the prediction of a chaotic time series. In this paper, we propose a stochastic neural net based on Extended Kalman Filter to examine the nonlinear dynamic proprieties of some financial time series in order to differentiate between low-dimensional chaos and stochastic behavior. Kalman filtering, because it can deal with varying unobservable states, provides an efficient framework to model these non-stationary exposures.A controlled simulation experiment is used to introduce the issues involved and to present the proposed approach. Measures of forecast accurency are developed. The pertinence of this model is discussed in the light of some real word examples from the Tunisian Stock Exchange database.

  • __A_YAHOO_USER__ - Saturday, June 6, 2009, 11:22PM ET  Report Abuse

    • Overall: 5/5

    I am not sure how we got here. Wall Street and government sold out manufacturing and value addiing business. The dollar became the be all and end all and not just a means to an end. The media has painted a certain view of the world that is very troubling and impossible to meet. Out government seems ultimately corrupt and our banking institutions ultimately fraudument. Things that we had grown to believe to be cornerstones of capitalism and hope are expose as mere shams designed to benefit a few. Money has taken on the appearance of the answer to all ills and thoughts of how or why it is procured seem not to matter...and those that have sold themselves to the corruption and greed now need to rationalize their lives to themselves. They cannot admit that what they do not only does not help mankind, but detracts from it.

  • Yahoo! Finance User - Saturday, June 6, 2009, 9:47PM ET  Report Abuse

    • Overall: 4/5

    Excellent article. Many of my colleagues chose Wall St. (I am from a top 5 school) when they could have used their mind to find a cure for cancer or to improve the world. Pity. Of course, to pay off student loans you need a real salary. I challenge the top schools to reduce their tuition (just like companies these days must reduce costs) so people can graduate without the heavy debt burden that drives them to high-salaried employment only. It is so ironic that these schools are politically liberal (= wall st is evil) and yet to pay for that education drives many to focus on high-paying careers rather than what serves the human good.

  • throwingstones - Saturday, June 6, 2009, 9:27PM ET  Report Abuse

    • Overall: 1/5

    This is the dumbest thing I have ever heard, "Human Capital Bubble." WTF! A human capital bubble would be folks having lots of babies because there was an abundance of jobs available. Humans DO NOT comprise a bubble, they are a resource. Jobs are created due to the booming economy and people are hired to fill those positions to keep up with service/production demands. My guess is that your students don't know what they are going to do because you didn't teach them anything useful at all and since the housing bubble has been beat to death, you thought you would come up with a new buzz word. I've got a buzz for you..."Buzzzzzzzz! Wrong Answer!"

  • george - Saturday, June 6, 2009, 10:24AM ET  Report Abuse

    • Overall: 1/5

    What a demeaning article. How were those 700k houses being sold in the middle of no where? Oh don't worry about your balloon mortgage, you can refi in a few years etc. All sold by the best and brightest you mention with immense fees. But now due to the econ. tragedy these best and brightest can venture out here to make us dumb and honest folks lives better. Have you researched beyond your ancedotal dinner parties? The financial sector has lost fewer jobs than the manufacturing and service industries. You glam over the causes and consequences of this crises with "market signals." Even a cookie company was cooking its books -archway. The fact is your smart students bought in to this corporate culture, and you did nothing to protect them or educate them. I'd rather stick with the honest peopleright now that are "teaching math, practicing medicine ..." You keep your smartest, let them write for yahoo, if they can't find a wall street job.

  • Yahoo! Finance User - Saturday, June 6, 2009, 9:22AM ET  Report Abuse

    • Overall: 2/5

    The market was pretty bad in 1991 when I was looking for a job so I applied to grad school as a backup plan. Turns out that I did find a job and did my grad school in the evenings while working on my career during the day. We don't need more idiot finance people or lawyers but we do need more doctors, nurses, engineers, scientists, etc. These are people that actually do something for a living.

  • Yahoo! Finance User - Friday, June 5, 2009, 10:55PM ET  Report Abuse

    • Overall: 1/5

    "The clever men and women who made a lot of money designing and trading credit default swaps could have been...practicing medicine, or doing any number of other jobs that strengthen society." You are kidding yourself if you think that having more doctors is a benefit to society. I work in finance for a hospital. We receive millions of dollars to train residents (recent medical school graduates). We convince politicians to provide additional money or they will be "hurting the children." We are a not-for-profit, but our CEO and other executives receive millions in salary and even more in bonuses and fringe benefits. Many doctors come from other countries to train in America and get their licenses because American doctors get paid so much more than they do elsewhere in the world. Congress complains about the ever increasing percentage that healthcare accounts for in our GDP, but they repeal or delay cost cutting measures passed during the Bush administration because the medical lobby is so powerful/generous with the money. More doctors would be a good thing if you plan to open the border so everyone can get free healthcare. Illegals already do not pay becuase they use the ER as their general practitioner, which costs people who actually pay taxes billions. Encouraging people to become doctors would only lead to excess supply of doctors and increased un/underemployment. If Congress really cared about reducing the cost of healthcare, they would reduce the payouts for malpractice and lawyers' fees. That would lead to lower insurance costs and lower doctors' fees.

  • Yahoo! Finance User - Friday, June 5, 2009, 6:01PM ET  Report Abuse

    • Overall: 1/5

    why are you back!! why did yahoo let you back!!! i thought you were running to be part of the socialist government!

  • Craig - Friday, June 5, 2009, 4:26PM ET  Report Abuse

    • Overall: 5/5

    I've been thinking about what the economic crisis has meant for allocation of human resources for awhile, but this is a very interesting perspective.

  • BobS - Friday, June 5, 2009, 2:44PM ET  Report Abuse

    • Overall: 3/5

    For those students with extra time on their hands, I have some suggested reading: The End of Work Atlas Shrugged The Long Emergency

  • Yahoo! Finance User - Friday, June 5, 2009, 1:37PM ET  Report Abuse

    • Overall: 1/5

    Jeff: Of course Wheelan thinks that he can allocate resources more efficiently than the market. He is a socialist and he loves central planning. He does not say what course he taught his students. I hope that he taught public policy, which is what his degree is in (NOT economics!). It is a good thing if would-be public policy graduates had no idea who will hire them. The less government control, central planning, and mind control, the better.

  • Yahoo! Finance User - Friday, June 5, 2009, 1:29PM ET  Report Abuse

    • Overall: 1/5

    Bubbles are caused by Bubbleheads ie Federal reserve, politicians buying votes, and special interest groups looking to get something for nothing. These Bubbleheads distort the social economic ladder normally used by honest people looking to climb this ladder to better themselves. The Bubbleheads basically throw capitalism out the window and try to control who gets ahead or not.

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