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The need for reliable information
I very much agree with this sentiment of Mark Thoma's:
There has been much debate about whether the financial crisis is driven by lack of liquidity or from fears about lack of adequate capital and solvency, but I'm starting to think a third component is important as well, the complete breakdown of traditional information flows, and a loss of confidence in the models used to evaluate that information. Markets need information to work properly, and the information financial markets need is not available.
Here is more. I do not wish to suggest that we abolish currency and T-Bills, but the deeper (and less stable) the private demand for these assets the harder it is to generate socially useful information from the trade in other assets. Maybe today we're in a world where the 1980 Grossman-Stiglitz paradox of information partly holds. It's not that the status quo price is already efficient, but rather no one gathering information feels they could benefit from swapping with the noise traders and so in turn not enough information is gathered.
Posted by Tyler Cowen on November 29, 2008 at 04:20 PM in Economics | Permalink
Comments
In the crisis of 1907, J.P. Morgan demanded that the heads of the major companies bring their books to his house, where Morgan's smart young men pored over them and determined what each company was really worth.
We need something like that now for all these "securitized" (actually, "secretized") mortgage-backed securities and the more complex instruments based upon them.
Posted by: Steve Sailer at Nov 29, 2008 4:42:37 PM
"How do we distinguish between healthy banks and "lemons"? Before doing something we should invite banks, particularly those in favor of which any intervention is made, to publicly disclose their positions and make their balance sheets fully transparent. There is no point in recapitalizing and restarting inter-banks lending, forcing or guaranteeing confidence, if no disclosure is made of mutual positions and off balance sheets operations which are causing money market failure"
This was Already Posted by: Massimo GIANNINI at Oct 13, 2008 3:10:50 PM on Marginal Revolution
Read also these Comments by M.G.
Posted by: Massimo GIANNINI at Nov 29, 2008 5:00:43 PM
I'm not sure what he means.
This financial crisis is different from any other in that we have a truly enormous amount of free high-quality information on the Internet, particularly from the blogosphere. The only shortage is time and human attention span. The ordinary retail investor is better informed today in many ways than the bigshot plutocrat of yesterday.
Posted by: at Nov 29, 2008 5:22:00 PM
The I ask: if free markets are the best information gathering devices on the allocation of goods and services and now we are saying markets need proper information flow to work more efficiently. Is it not the same than saying that we have got not enough free market?.
Posted by: Pedro J. at Nov 29, 2008 5:28:33 PM
Pedro - I don't think that is quite it. The problem is we have been too willing to give money to corporations we don't understand. This is a problem beyond the bailout and the reason banks share prices seemed to have fallen so fast.
Posted by: Jason at Nov 29, 2008 5:39:30 PM
@no name
"The only shortage is time and human attention span"
Which is exactly the point. It's a problem calling for pure Hansonism: clearly we need a prediction market to aggregate all this info and solve the TMI problem. I'm remembering Bill Cassano's previous Economic Derivatives at the CME. Earlier this summer I heard rumors that there was an effort underway to revive this, and I spoke to Cassano himself briefly about it. Since the beginning of the crisis I often wondered how things might have been different if Cassano hadn't had to close up shop. Could it have all been avoided, or at least more broadly highlighted in advance?
Posted by: StreetWalker at Nov 29, 2008 5:41:40 PM
You're way over theorizing this, as you often do.
[Keynesians avert your eyes here.] When the Fed jimmies interest rates, the single most important signal in the economy is distorted, with all sorts of bad consequences, which have been coming home to roost since August 2007.
When the government taxes profits earned by successful firms, subsidizes weak banks and other businesses, and otherwise distorts price signals, information flows, particularly those embodied in profits and losses, are impeded and distorted; and resources are directed to unprofitable ventures and away from profitable ones.
This is happening in every sector that is being bailed out or continuing to be subsidized (e.g., ethanol producers and "green" manufacturers).
I think most economists, including the latest Nobel laureate, know this; but for some reason a lot of them are in denial about how markets actually work, and think that we need Big Daddy Diddly Gub'ment to come to the rescue, even though Big Daddy (1) caused the problem; and (2) can't even get its own books straight, never mind about the socialist calc problem of, oh, is $500 bill. the right number of Other People's money to spend (you can't call it investment), and is 2.5 mill. jobs the right number for Big Daddy Diddly to "create" when Team Obama takes power?
Btw, the current (Dec. 8) issue of Business Week has a scary series of articles on what's going on. "Can Obama Keep New Jobs at Home" points out that Hoover's last act as prexy--his last shot at the American economy, his last criminal act--was to sign a "buy America" act, which is still wreaking havoc.
And a small point about information flows.
The rating agencies had models of mortgage-backed securities, which assumed that housing prices would never fall. If private firms get this wrong (admittedly, the rating agences are a government-protected oligopoly and their issuers pay-business model doesn't make much sense), don't expect Big Daddy Diddly to get it right, expecially having prevented competition in the industry to begin with.
The article on Green Jobs also has to be read to be believed.
Posted by: Bill Stepp at Nov 29, 2008 6:05:35 PM
Bill Stepp, let me tell a story.
I knew a man who owned a small lake that he kept stocked with fish. Every now and then he went fishing, but what he really wanted was once a year or so he wanted a whole lot of fish for a fish fry.
So he had a sort of deep ditch in the side of the pond, and twice a week he'd throw in a loaf of cheap bread and he'd watch the fish rip it apart. It got so they'd get real good at knowing when he'd do that and they'd be waiting for him on those days.
And when he wanted a fish fry, he'd throw them some bread and then he'd close off the ditch so they couldn't get out. Then he'd scoop them up with a net and throw back the ones that were too small. It was a lot less work than fishing.
It cost him bread. It bought him fish.
Imagine that the government wasn't distorting market signals. Could rich businesses do that? It costs to distort a market signal, but maybe it can pay off bigtime. Maybe it costs you product and it buys you companies?
A whole lot of microeconomics focuses on competition and ignores predator-prey models. I think before we assume that any market signal would be undistorted in the absence of government, we need to look at:
1. Who can distort it and at what cost?
2. Is there any way for them to make a profit by doing so?
3. Who benefits by preventing others from distorting market signals to third parties, and at what cost?
4. Can they make a larger profit by preventing distortion than they can by sharing in the scam?
5. How can signal consumers tell whether their signals have been distorted or not? It's risky to pay someone to prevent distortion when you can't tell how successful they are.
Until you have definitive answers to these questions about some particular market signal, you might as well keep the default assumption that it is distorted to an unknown extent in an unknown direction.
Posted by: J Thomas at Nov 29, 2008 7:01:10 PM
Every investor needs a reliable financial information. Though rewards are always associated with risk, it is necessary that we always have the choices and alternatives in investing our money, depending on the current economic situation. A particular investor will make a choice depending on his stock of financial knowledge and understanding...and ultimately depending on the risk he can take for that aimed reward.
Posted by: Vic at Nov 29, 2008 9:43:24 PM
Well, it's certainly nice to see others coming around to this way of thinking!
Perhaps Al Roth will be able to contribute some practical advice for designing that new kind of information market. This is not an area where I have experience, so much as a sense of what might be possible.
Posted by: Ironman at Nov 29, 2008 10:03:25 PM
The ratings agencies failed. People were taking more
risk than they thought because they trusted the ratings
agencies.
From what God's eye perspective can we say that they are
no not taking enough risk? Is it because we think they
would take more risk if they trusted good ratings agencies
now?
Getting rid of currency sounds like a good idea.
Maybe a currency suspension for the duration is appropriate.
T-bills aren't a problem as long as their yields can
go as negative as necessary. (And insured deposits, etc.)
Let the spread for risky financial instruemtns rise. Just
keep the level of interest rates low enough to maintain
aggregate expenditure growing at an appropriate rate.
Some parts of the economy will expand and others shrink.
Macroeconomic policy should never try to do more than to
keep the shortages and surpluses roughly matched. Trying
to make sure that the proper of amount of risky projects are
financed amounts to efforts at central planning.
Posted by: Bill Woolsey at Nov 30, 2008 9:48:06 AM
T-bills aren't a problem as long as their yields can go as negative as necessary.
How do you do that? "Give me $100,000 dollars today, and I will gladly give you $94,000 next Tuesday."
You could tax the alternatives. Better to lose 6% on a T-bill than 28% on a commercial bond.
Posted by: J Thomas at Nov 30, 2008 12:17:23 PM
Someone or other -- I've misplaced the name -- coined a law that measurements lose informational content over time as the assumptions they are based on cease to apply to actual practice. The speed with which they lose informational content is proportional to the amount of money (or time or prestige or utility generally) that people have riding on them, as this creates incentives to find new and exciting ways to game them.
One interpretation of a crisis caused by an informational breakdown is that important measurements (bond ratings, sarbox accounting disclosures, econometric aggregates, whatever) have decayed more quickly than one would have expected. The obvious reason for this is that they have become more important, that people have more money or whatnot riding on them. This would be consistent with the view that several people have expressed (Tyler here and Arnold Kling over at econlog spring to mind) that accounting standards, ratings requirements, and other such bookkeeping institutions have played a big role in getting us here.
Posted by: Grant Gould at Nov 30, 2008 6:51:55 PM
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Posted by: ajanslar at Jun 29, 2009 12:06:52 PM
How do you do that? "Give me $100,000 dollars today, and I will gladly give you $94,000 next Tuesday."
You could tax the alternatives. Better to lose 6% on a T-bill than 28% on a commercial bond
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