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The best caption I read this morning
Nine-party coalitions are fragile, and Italy's 61st postwar cabinet was no exception.
Here are related articles, I cannot find this caption on-line but it is in the print NYT.
Elsewhere in the Times today, David Brooks has an excellent column on Wall Street and the recent financial mess. Scream it from the rooftops, as they say.
Posted by Tyler Cowen on January 25, 2008 at 08:00 AM in Political Science | Permalink
Comments
In his article, Brooks writes that "The U.S. has enjoyed 25 years of strong economic growth". Assuming that he is talking about the period 1983-2008, what is the evidence for this statement, with particular reference to the words "strong" [comparative to what?] and "growth"? Taking both inflation and population growth into account, surely an argument can be made that there certainly hasn't been 25 years of economic growth and what growth there has been has not been strong relative to other periods of growth. Certainly Brooks is entitled to his opinions but not to his version of the facts. I guess he is still on his "learning curve".
Posted by: derek at Jan 25, 2008 11:32:49 AM
Should any MR readers care to delve deeper into some of the debate between the proponents of the Greed Narrative and the Ecology Narrative, in Brooks coinage, they could do worse than by starting at the following post on my blog and following the links until either revelation or exhaustion sets in.
http://epicureandealmaker.blogspot.com/2008/01/pressure-room.html
Fair disclosure: I am both a proponent of the Ecology Narrative and an investment banker. You have been warned.
Posted by: The Epicurean Dealmaker at Jan 25, 2008 11:45:41 AM
Derek, well, real GDP per capita, by definition, takes both inflation and population growth into account. That statistic has been much stronger than the big drop in Real GDP during the hyperinflationary 70s. Granted, there are problems with the statistics, but most macroeconomic indicators have increased a good bit since 1983.
Posted by: Matt Waters at Jan 25, 2008 12:20:41 PM
IMHO, this "crisis" is a failure of risk management. Rating companies manipulated the securities to make them more attractive. I mean, really, if one set of paper gives you X% return and another set of paper gives you X+Y return (assume Y>0), do you really think the second set has the same risk as the first? If that were true, then those who took out the loans for the second set are either stupid or have been duped (and do you really want to gamble your money on that?).
From reports, Goldman Sachs had this one figured out (and they were the only ones). All things being equal (that is, investment banks are fungible), I would not be suprised to see some high level executives from Goldman Sachs taking jobs as CEOs of other investment banks. And good for them.
Posted by: Allan at Jan 25, 2008 1:37:57 PM
I think the problem goes well beyond a failure of risk management at the rating companies. A huge portion of the population was duped into believing ridiculous things about real estate and practically NO ONE stepped up to do anything to educate them.
For instance, a few years ago it was common to hear people with little financial knowledge say with certainty that real estate "CANNOT" go down, it can only level off. Arguing with these people was futile, because this is the only message they heard consistently from people who they thought were authorities in the real estate industry (i.e. scummy lying mortgage brokers and real estate brokers, and even some "experts" in the mainstream media), and no one in the press, and none of the financial pundits out there did anything to correct them.
Now obviously the notion that real estate can only go up is absurd, but if it were TRUE, it would make sense to get a crazy interest-only ARM, and lie through your teeth about your income to do it, because when the payments went through the roof you would be able to re-finance, and take out some of the equity you earned through appreciation to help with the payments. If "worse came to worse," and the real estate market "leveled off,' you could sell your home at a wash.
So where were all the experts who have the ability to look at the growth in incomes, population growth, and rental prices and say the growth in housing prices is unsustainable, and heading for a crash? Where were all the stories in the mainstream media warning people? If the average home buyer knew that a real estate crash was probable, or even possibile, I think the mortgage crisis would never have happened.
I remember thinking how crazy this all was as it was happening; looking at the prices skyrocketing for no apparant reason, and the insane loans people were getting, and wondering why no one was talking about how crazy it was. The only person I ever saw do reasonable rational analysis of the situation was the guy at piggington.com, and nobody in the mainstream media would listen to him. Why didn't any of the so-called experts ever bother to do the same kind of analysis and warn people?
I think this was a failure not only of risk management at the ratings companies, it was a failure of the media and of the financial pundits, and it was created by positive fraud on the part of fly by night mortgage companies and real estate brokers who sold people on the absurd notion that their homes could only rise in value.
Posted by: Doug at Jan 25, 2008 2:10:58 PM
Doug,
I do not disagree that educating consumers would have been nice. But the fact is that the problem is mostly with those with capital losing their capital. Most of those who entered into the arena on a personal level started with nothing and now they have nothing. There are those who got screwed had their equity locked up in their house and frittered away their money. I don't have so much sympathy for them. And there are those who had equity in their house and took out unconsciably high interest rate loans to use the money for a good purpose (pay health care costs...). I have sympathy for them.
But, it was those with the capital (the lenders) who decided to take risk. A risk that was not related to the return, i.e., for much of the notes, the risk was higher than than was put on paper.
And, if the capital holders wanted more education for the masses (because it would have enhanced their return), they could have taken it upon themselves to provide it.
All said, I believe the capitalists are responsible for this mess. And government should not bail them out.
Don't take this as an anti-capitalist screed. Markets work or don't work based upon the sophistication of those with the capital. Although I think what happened is stupid, don't look to me for a government based solution (except that those who made obscene salaries based upon profits were not their should somehow be taken to task).
Posted by: Allan at Jan 25, 2008 2:31:27 PM
Re: Doug
I'll quote you (that just happens to be really convenient) from the comments on the bargaining theory a couple of posts ago.
"Even when the other side reveals some potentially enlightening information about their perspective, we typically use that information to attack the perspective, and prove that our own perspective is superior, instead of taking the opportunity to use the information to search for a compromise that might satisfy both sides."
If people really do believe that housing prices (or real estate) can only level off or go up (which makes no sense to me but I remember someone, maybe a friend of mine, being in disbelief when I told him housing prices in our hometown in FL had shot up and then DROPPED off a cliff - he just couldn't believe they didn't level off), and someone states that this is probably not true, then doesn't your statement apply here as well? If someone wrote/said that "real estate prices can fall" could not the "real estate prices can only level off or go up" group somehow turn this into information to attack the prices can fall perspective?
As for me, I lived through the (relatively) inexpensive baseball card boom and bust as a kid, and know a little better than to believe anyone who tells me "prices of good Z can only go up or level off" ...
Posted by: AZ at Jan 25, 2008 2:38:18 PM
Doug,
If Hayek was right, and markets are one of the only tools (if not the only?) which efficiently aggregate the dispersed information of society, what use are those pundits? I'm not saying they can't be of some help, but I don't think its at all likely they'll ever reach any sort of consensus on the state of the market. In fact, I'd bet such a thing is impossible, because then their information would be priced into the market... I can't see how non-market actors could possibly correct a bubble for this reason.
If you reject the belief that extremely low interest rates fueled the housing bubble, then I'd think you'd want to turn to other financial tools to prevent such bubbles in the future (i.e., markets fail... use markets). Maybe prediction markets, or the ability to short mortgage securities?
Posted by: Grant at Jan 25, 2008 2:47:41 PM
Brooks is only right if financiers were "innovating" for the right reasons, i.e., to manage/reduce risk. However, anyone familiar with the incentive structure on Wall Street knows that this is extremely unlikely. Year-end bonuses, for example, give traders and bankers an incentive to pursue short-sighted strategies that may reduce the risk of short-term losses, but dramatically increase the risk of losses in the long run.
Packaging some subprime ARMs into mortgage bonds with traditional prime-rate mortgages looks like a great way to spread risk for the first few years (that is, before the interest rates reset), but when the subprime borrowers predictably start to default a few years later, then holding mortgage bonds becomes a game of blindfolded hot-potato. That's when everyone realizes that the "innovation" of a few years ago wasn't designed to reduce risk at all, it was designed to shift the timing of the risk.
I don't buy the "Greed" narrative either, but Brooks' "Ecology" narrative is as naive as it gets ("It's all just innovation! Innovation is always great!"). Any half-competent market proponent knows that outcomes depend on how the incentives are aligned. When the incentive structure in a particular market produces bad outcomes, calling for a reform of that market's incentive structure isn't "anti-capitalism." On the contrary, calling for reform of a bad incentive structure shows a much greater understanding of and appreciation for capitalism than blindly tut-tutting that anyone who criticizes the current system doesn't understand how markets work.
Give me a break. Brooks has been living in a make-believe world of Black and White for years.
Posted by: TV at Jan 25, 2008 4:18:13 PM
Allen,
"Most of those who entered into the arena on a personal level started with nothing and now they have nothing. There are those who got screwed had their equity locked up in their house and frittered away their money. I don't have so much sympathy for them."
1. A lot have less than nothing because they now owe more than their house is worth.
2. Its not about sympathy. If the home buyers had not bought houses they could not afford with loans that made no sense, the people whose capital funded those loans would not have lost their capital. I'm not saying its ALL on the consumer side, or that a lack of risk management is not also a problem, I am saying that "it takes two to tango," and the problem is more than just a lending problem, its a borrowing problem too.
AZ, I'm not following. Yes people tend to defend their positions, as the "real estate can't go down crowd" did, even in the face of argument to the contrary, but people are still at least somewhat open minded, and experts are able to influence their beliefs.
Grant, "If Hayek was right, and markets are one of the only tools (if not the only?) which efficiently aggregate the dispersed information of society,"
I don't necessarily agree with that proposition.
"what use are those pundits? I'm not saying they can't be of some help, but I don't think its at all likely they'll ever reach any sort of consensus on the state of the market."
I'm not talking about agreeing on the state of the market. I am talking about cold, hard facts that consumers were being misinformed about. Not everyone will agree when real estate is in fact over-priced. The "experts" SHOULD have been able to agree that in the short term real estate can go down, has gone down in the past, and almost certainly will go down again at some point in the future. They SHOULD have been able to agree that adjustable rate loans with interest-only payments that were being taken out, by people overstating their income, were excessively RISKY propositions. But no one was out there warning people that their loans were risky, and that there was at least the possibility of a crash.
Again, I don't think the lack of helpful information from the media and fraud by the mortgage crowd were the only problem, but they were a big problem, and without them I don't think we would be in nearly as much trouble as we are.
Posted by: Doug at Jan 25, 2008 5:42:27 PM
By the way Allen, I am not advocating a "bail out." All I am saying is that along with the scorn that is being heaped on the banks and ratings companies, a large helping should be dished out to the mortgage brokers and on the media and their cadre of experts that did nothing to prevent this.
Posted by: Doug at Jan 25, 2008 5:50:50 PM
Doug,
I'm not talking about agreeing on the state of the market. I am talking about cold, hard facts that consumers were being misinformed about. Not everyone will agree when real estate is in fact over-priced. The "experts" SHOULD have been able to agree that in the short term real estate can go down, has gone down in the past, and almost certainly will go down again at some point in the future. They SHOULD have been able to agree that adjustable rate loans with interest-only payments that were being taken out, by people overstating their income, were excessively RISKY propositions. But no one was out there warning people that their loans were risky, and that there was at least the possibility of a crash.
I hear what you are saying, but consider: If there were a lot of experts who did what you said, how could there have been a bubble in the first place? The experts are, in most all cases, professional investors. The media doesn't really have many incentives to employ real experts. Investors are the ones with "on the spot" knowledge, and they are the ones who bet against a bubble they believe is going to burst (lessening its damage in the process). Any expert who believes he has spotted a pricing error in a market will generally try to profit off of it.
I don't think the experts knew what was coming.
If they had of known, it probably wouldn't have happened (or would have been significantly lessened).
Posted by: Grant at Jan 25, 2008 6:46:38 PM
Alternatively, if the experts did know what was coming and were still driving up prices anyway (to profit from the bubble before it blew up), then they wouldn't have any incentive to tell others what was ahead.
Posted by: Grant at Jan 25, 2008 6:55:34 PM
GS shorted the subprime mess right before it blew up. They made big money during the housing bubble and made some more when it tanked--well timed. The other big banks, on the other hand, failed to follow GS position; they believed that the housing market would stabilize. Unfortunately, all of the "experts" worked for GS.
Posted by: dhans at Jan 26, 2008 12:39:25 AM
"I hear what you are saying, but consider: If there were a lot of experts who did what you said, how could there have been a bubble in the first place?"
There wouldn't have been (or at least it wouldn't have gotten as big). That's the whole point. While the experts that could predict the timing of the bubble with sufficient accuracy to make a boatload of money may have all been at golman sachs and may have had no incentive to warn anybody, I still think someone in the mainstream media should have been able to do enough homework to realize that the mortgages people were taking on were extremely risky, and that the popular conception that housing prices could not crash was patently false. I believe that the reason this didn't happen is that people were sleeping on the job.
Posted by: Doug at Jan 26, 2008 3:01:44 PM
So is the ecology narrative a more simple telling of Austrian business cycles?
I am a loyal MR reader and I a recent econ convert (from philosophy).
Posted by: eric at Jan 27, 2008 10:48:37 AM
Doug,
I believe you'll find people in the mainstream media are very often sleeping at the job ;) They just don't have the incentives to appoint real experts. No layman wants to look at real experts on television, not when they could look at attractive people with charisma instead.
As the Internet takes over media, at least the truth will be out there for people willing to look for it.
Posted by: Grant at Jan 27, 2008 11:45:50 AM
The ecology metaphor isn't a bad one, provided that we think of the economy as an island where the rats will eat everything if we let them.
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