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Boston Fed’s New Excuse for Missing the Housing Bubble: NoneOfUscouddanode

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It is truly astonishing to watch how determined the economics orthodoxy is to defend its inexcusable, economy-wrecking performance in the runup to the financial crisis. Most people who preside over disasters, say from a boating accident or the failure of a venture, spend considerable amounts of time in review of what happened and self-recrimination. Yet policy-making economists have not only seemed constitutionally unable to recognize that their programs resulted in widespread damage, but to add insult to injury, they insist that they really didn’t do anything wrong.

Even worse, the latest excuse, from the Boston Fed, is that they are blameless because no Serious Economist could have recognized the bubble. From the Wall Street Journal Economics blog (hat tip Richard Alford):

Should economists and policy makers have identified the housing market bubble before it burst? The answer is most likely no, says the Federal Reserve Bank of Boston, because economic theory was not up to the challenge.

“Economic theory provides little guidance as to what should be the ‘correct’ level of asset prices — including housing prices,” the new paper published by the bank says. It was written by economists Kristopher Gerardi, Christopher Foote and Paul Willen.

“While optimistic forecasts held by many market participants in 2005 turned out to be inaccurate” those projections were not “unreasonable” given what was understood about the economy and housing market dynamics in the years before housing prices crashed and helped create one of the worst economic downturns in generations.

The paper notes economists were clearly not of one mind about the implications of rising housing prices. Some saw them as consistent with economic fundamentals, and driven by factors like the need for shelter to house a growing population, a favored explanation of central bankers themselves during those years. Others simply punted, offering no view.

Then there were those with negative views, many of whom have been sharply critical of the economics profession, and of policy makers.

“The pessimistic case was a distinctly minority view, especially among professional economists,” the paper observed. “The small number of economists who argued forcefully for a bubble often did so years before the housing market peak, and thus lost a fair amount of credibility” in the process. Others called a bubble with “arguments fundamentally at odds with the data” that became available after the fact, the economists write.

That paper notes that for the most part, regardless of the view economists held on housing, the science of economics wasn’t really even equipped to deal with the issue. “Academic research available in 2006 was basically inconclusive and could not convincingly support or refute any hypothesis about the future path of asset prices.” That meant anyone could argue anything.

Yves here. This recitation is truly embarrassing, in that the writers clearly see this abject failure as completely reasonable, as opposed to compelling evidence that the discipline is not qualified to provide policy advice. What could be more damning than admitting that economics was incapable of seeing the blindingly obvious?

The problem is that mainstream economics sees prices as a virtuous. Everything cal be solved by price. If there is some unbalance in the economy, it merely means prices need to rise or fall, the impediment must be stickiness or some other inefficiency that is preventing the magic price setting mechanism to do its magic work. Mainstream economists also believe that price mechanisms lead to optimal outcomes from a social welfare standpoint. There is a reason that this line of thinking. aka neoclassical economics, became dominant (and Keynsianism is merely a branch; Keynes himself believed economies were fundamentally unstable, while the neoclassical types believe that markets are always and every self correcting). It’s very favorable to the business community. (Note this is a simplification; ECONNED provides a long form treatment of this topic).

So there are quite a few reasons this “noneofuscouddanode” tale is sheer bunk. First is that economics is really really bad at fieldwork. How often do economists go and muck about in the phenomena they opine about? Nobel Prize winner Wassily Leontief, in the 1970s, did a tally of economics papers and found that a mere 0.5% had economists gathering data they then analyzed. The rest were pure theory papers or had the writers crunching data sets they had found. And on those rare occasions when economists do do their own data gathering, they are not very good at it due to the lack of interest in the profession in this activity. I’ve read surveys designed by economists to address particular issues, and it’s evident that they aren’t even remotely current with good, let alone best practices (for instance, asking people about their whether they will buy something or take an action relative to their finances is guaranteed to elicit wildly unreliable answers. No savvy marketer would use this approach).

Second, some very unfashionable schools of economics, namely the Austrians and the Marxists, both recognized the imbalances in the economy prior to the bust. It wasn’t just housing; the negative personal savings rate and the widening trade deficit with China were red flags.

Third is the through-the-looking glass logic: “Well, it took those (supposed) few who saw the bubble a long time to be proven right!” So how could you expect us to listen to them?” Huh? The bubble was hardly a secret, save maybe to central bankers (and that isn’t even true, William White of the BIS was issuing warnings as was ignored). The Economist made it a cover story in June 2005. And if the bubble had been arrested then, the damage would not have been very serious. The fact that it went on so long is perversely used as an excuse, when bubbles by nature go on absurdly long (as the recent example of the dot com mania vividly demonstrated). As we saw in this crisis, by the beginning of 2007, risk was so underpriced across all credit products that most market participants knew it was going to end badly, yet the vast majority stayed the course because exiting what might be too early had costs. Everyone acted as if they could all push through the door when the party stopped, and that of course proved false.

There is a good reason why economists may not be able to prick bubbles, but contrary to the Boston Fed’s lame excuses, it’s political. Ian Macfarlane, the former head of Australia’s Reserve Bank, did see that Australia’s housing market was overheated, and in 2004, used a combination of jawboning and a couple of interest rate increases to take some air out of it. But he was at the end of his term, and his successor did not continue with his efforts.

Macfarlane wrote in 2005:

Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it for two reasons.

First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, such as house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may not be much affected at first by the higher interest rates, but the rest of the economy may be.

Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence in inflation, but nowhere, to my knowledge, have they been delegated the task of preventing large rises in asset prices, which many people would view as rises in the community’s wealth. Thus, if they were to take on this additional role, they would face a formidable task in convincing the public of the need.

Even if the central bank was confident that a destabilising bubble was forming, and that its bursting would be extremely damaging, the community would not necessarily know that this was in prospect, and could not know until the whole episode had been allowed to play itself out. If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not. If in the most favourable case, the central bank raised interest rates by a modest amount and prevented the bubble from expanding to a dangerous level, and it did so at a relatively small cost in terms of income and employment growth forgone, would it get any thanks? Almost certainly not…In all probability, the episode would be regarded by the public as an error of monetary policy because what might have happened could never be observed….

Looking back at the evolution of monetary and financial affairs over the past century shows that policy frameworks have had to be adjusted when they failed to cope with the emergence of a significant problem. The new framework then is pushed to its limits, resulting in a new economic problem. The lightly regulated framework of the first two decades of the 20th century was discredited by the Depression and was replaced by a heavily regulated one accompanied by discretionary fiscal and monetary policy. This in turn was discredited by the great inflation of the 1970s and was replaced by a lightly regulated one with greater emphasis on medium-term anti-inflationary monetary policy….

No one has a clear mandate at the moment to deal with the threat of major financial instability, but I cannot help but feel that the threat from that source is greater than the threat from inflation, deflation, the balance of payments and the other familiar economic variables we have confronted in the past.

Yves here. Now there are other measures that regulators can use to attack bubbles, since the ones that are most damaging involve borrowed funds. They can take measures to restrict the gearing used in the markets that are superheating. But Macfarlane’s comment about the resistance to intervening rings true. Just imagine the howling you would have heard from homebuilders, realtors, bankers, home decorators, land speculators, you name it, had the authorities been able to severely restrict no-doc loans and had required a minimum downpayment, say, of 10% for non FHA loans. It isn’t yet clear we have the political will to take on the people who win short term from borrowing binges.

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54 comments

  1. petros

    The man who cannot occasionally imagine events and conditions of existence that are contrary to the causal principle as he knows it will never enrich his science by the addition of a new idea.
    – Max Planck

    1. carping demon

      That’s easy for Planck to say. It’s gibberish for most economists, except maybe Stiglitz.

  2. purple

    Maybe they let the bubble go on because that’s all they have left in the tank. The collapse of the bubble has laid bare the fundamentally weakness of the US domestic economy.

    1. Tao Jonesing

      @purple,

      That’s my thesis, too.

      Once the monetarist Volcker sowed the seeds of destruction of U.S. manufacturing, the only game in town was the FIRE sector, and the only ways they can show growth to maintain the illusion of healthy U.S. GDP growth is by churning (they get paid for each transaction in which they stand between us and our assets) and by blowing asset bubbles that increase asset prices and expand credit (the FIRE sector benefits from both in the short run).

      1. liberal

        …they get paid for each transaction in which they stand between us and our assets…

        Good description of economic rent collection.

        As for the pointlessness of the churning, it reminds me of a Bevis and Butthead episode, where they’re out selling candy bars for some school charity thing. One of them sells one bar for $1, then he uses it to buy a bar from the other, who turns around and does the same thing. Soon enough, no candy left, and one dollar in the pot.

  3. burnside

    Perhaps. But with the nation still smarting from the tech stock-driven collapse, there was a ready example showing the costs of inattention or inaction. Had they been aware and serious, they might have found the tools to be effective. I suspect they were neither.

    The late Balkan conflicts sent similarly lurid signals far in advance of the violence, and were similarly dismissed. We have a problem not limited to economists and economic ‘schools’.

  4. fiscalliberal

    Years ago, I came off a dairy farm in Wisconsin and took a Economics course in Madison where the Samulson book was used. In that book was a theory called Supply and Demand which confirmed a lot of my youthfull experience on a farm.

    So – how could Samulson gotten it so wrong? Does it not make sense that if you build to many houses, that the demand would go down and hence cost would go down? Kind of looks like some in the business community just do not know how to comprehend the fundamentals. Also – this concept of not recognizing fraud is just amazing. There was a time when Enron executives went to jail. Now days, they get meaningless fines. One might argue the bubble of insanity is still with us.

    1. David D

      Here’s the problem: when the demand is driven solely by those who need (or want) the good for themselves, then supply and demand curves work fairly well. When demand is driven by speculation on price, then a problem arises. No end users = no robust, genuine demand. Look at the market in Florida during the bubble: an astounding proportion of apartments were sold to people who bought them only because they believed the price increase would outstrip the cost of finance, and they could sell to the next guy. When the buyers in each neighborhood finally realized that there were no genuine end users at the end of the line, only more speculators, the market collapsed.

  5. DownSouth

    Yves said: “The problem is that mainstream economics sees prices as virtuous.”

    Herein lies the problem. For the simple fact is that this is not a statement of scientific convictions, but of religious convictions. The discipline of economics masquerades as science, but is in reality a value-laden endeavor that comes much closer to religious practice than scientific practice.

    I started reading Robert H. Nelson’s Economics as Religion: from Samuelson to Chicago and Beyond a couple of days ago. Although I immediately agreed with Nelson’s hypothesis that the discipline of economics is religion, my first impression was that he and I were members of different congregations, that he was a free-market fundamentalist. But as I got further along in the book, I discovered it to be much more thoughtful and nuanced than that.

    If we place Nelson within the larger framework identified by philosophers like Michael Allen Gillespie and Hannah Arendt, we find that the discipline of economics is not only religion, but it is more specifically Christian (or one Christianity’s begets, such as Islam). The governing concept here is a belief in paradise or utopia. Prior to the Renaissance, Descartes, Hobbes and the Enlightenment that paradise was other-worldly. But with the advent of modernism, the utopia is now this-worldly, or secular. The discipline of economics is the religious practice that deals with the pursuit of a worldly utopia. Classic, Marxist, neoclassic, Austrian, Keynesian, you name it—-they are just like the sects and schisms of old in that they have different visions of the utopia and how to achieve it, but they all believe this worldly paradise is achievable.

    And as is the case with any religion, veridical truth in these various economic sects falls victim to normative mandates.

    1. Tao Jonesing

      @DownSouth,

      “The discipline of economics masquerades as science, but is in reality a value-laden endeavor that comes much closer to religious practice than scientific practice.”

      Neoclassical economics as exemplified by the Chicago School is nothing more or less than the propaganda arm of the FIRE sector. Hence, the masquerade. They don’t actually believe in anything they say and they don’t have to because the ends justifies the means.

  6. But What Do I Know?

    If no Serious Economist could have recognized the Housing Bubble, what good is Serious Economics?

  7. anonymous

    Excellent, as usual, Yves. Many thanks. I’d expand the looking glass analogy far more broadly. The viewership of the networks is aging rapidly and shrinking, readership of newspapers continues to shrink, all that at a time when there is more information available than ever.

    There seems to be a real skepticism at play here. It isn’t so much that the public believes the bankers spin, quite the opposite. Folks don’t expect authorities to tell the truth on any topic, so there’s a real lack of surprise or shock when facts come to light, just a deeper sense of resentment and hostility.

    I’ve no idea where it will end, but with a collapse in support for the Afghanistan mission and Iraq unraveling, the public has real cause to feel ripped off.

  8. Jim Haygood

    ‘ “Economic theory provides little guidance as to what should be the ‘correct’ level of asset prices — including housing prices,” the new paper published by the bank says. It was written by economists Kristopher Gerardi, Christopher Foote and Paul Willen.’

    Risible, just risible. Housing prices two standard deviations above trend in 2006, at record multiples of median income? What is wrong with these eggheads?

    Economic theory provided the tools, but economists immersed in groupthink rationalized away the results. Economists are notoriously bad at dealing with sentiment (behavioral economists at least try), and accordingly get swept up in the same irrational extremes of optimism and pessimism that ordinary lay people, unburdened by PhDs, do. Mad Al Greenspan, the Pied Piper of Penury, is the retarded poster child of conventional-wisdom groupthink.

    Macfarlane: ‘There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence in inflation, but nowhere, to my knowledge, have they been delegated the task of preventing large rises in asset prices, which many people would view as rises in the community’s wealth.’

    Asset prices ARE a component of inflation, just as surely as goods prices are. As a first pass, I’d assign asset prices about a 10% weighting. Had the CPI included an asset price component in place of imputed rent, it would have been apparent that the policy rate needed to be raised sooner and higher during 2003-2006 as the housing bubble raged. (Of course, the failure of regulators to intervene against obviously unsound, opaque, misrated, conflict of interest-ridden collateralized debt instruments was also an important contributor to the ensuing catastrophe.)

    Lately I’ve been reading papers about avoiding a deflation trap. In a nutshell, most central banksters pin their hopes on expectations. Like the Wizard of Oz, they propose to announce an inflation or price target, et voila, the peasants are supposed to ‘just believe,’ and pull out their purses in anticipatory spending.

    The fecklessness of the economics ‘profession’ just beggars the imagination. They could at least entertain us by dressing up in clown suits. Popcorn! Dancing bears! This way to the egress! Bwa ha ha hahhh …

    1. greg g

      “The fecklessness of the economics ‘profession’ just beggars the imagination. They could at least entertain us by dressing up in clown suits.”

      Best. Comment. Ever.

      Eventually though, we have to realize that we, ourselves, are the problem. We do not take sufficient action to end the madness/clown-show. Until we the people demand honest, transparent reform, we’ll continue to be fed this drivel and led down primrose paths.

      http://en.wikipedia.org/wiki/Primrose_Path

      1. Vangel

        The show will not end until it is forced to end by reality. Voters love politicians who promise them a free lunch and will continue to elect them over and over again. Those politicians pass laws to ensure that they can carry on their reckless policies and they are assisted by the Fed’s inflation bias. Without the Fed’s use of newly printed money to purchase newly issued government debt the politicians could not fund most of the programs that are now in place.

  9. prostratedragon

    Regarding the housing bubble, the U.S. Federal Reserve system had additional, less crude policy tools in the form of their regulatory power over a portion of the consumer lending institutions that fed the frenzy, a topic worth more than I can give it on the run.

    1. liberal

      …their regulatory power over a portion of the consumer lending institutions that fed the frenzy…

      Yes, this bears repeating.

  10. Vangel

    “Now there are other measures that regulators can use to attack bubbles, since the ones that are most damaging involve borrowed funds.”

    Regulators can begin by not fueling bubbles in the first place. The housing bubble was created by an interplay of the CRA, injections of liquidity by the Fed, HUD policies, Fannie and Freddie activities, government protected rating agencies, and the activities of a private sector looking to take advantage of the opportunities that the regulators provided. That bubble could not have taken place in a truly free market.

    1. Tao Jonesing

      Yeah. The government made the banksters and loan originators act extremely irresponsibly and, in many cases, forced them to commit outright fraud.

      Bad government. No donut for you! Poor banskters and fraudsters, we’re sorry the bad government didn’t stop you from being bad. You can have this donut.

      The Fed is run by Wall Street. So are the rating agencies, who are both owned by Wall Street and a vendor to it (the customer/owner is always right). And Fannie and Freddie became a convenient mechanism for laundering fraudulent loans, which is not surprising given the revolving door for management between the GSEs and Wall Street.

      And what you leave out is that the housing bubble was created to fuel a much larger, completely unregulated derivatives market. That bubble is exactly what you get when you have a truly free market: corruption, greed and hubris.

      1. readerOfTeaLeaves

        Ah, the unfettered, free market makes the Ferenghis in Star Trek almost seem to be timid acolytes of Emily Post’s Etiquette.

        But Yves posted:

        But Macfarlane’s comment about the resistance to intervening rings true. Just imagine the howling you would have heard from homebuilders, realtors, bankers, home decorators, land speculators, you name it, had the authorities been able to severely restrict no-doc loans and had required a minimum downpayment, say, of 10% for non FHA loans. It isn’t yet clear we have the political will to take on the people who win short term from borrowing binges.

        May I be in the first, loudest row of the Hallelujiah Chorus on this one?

        No doubt many around here were in various degrees of UpCloseness to the Housing Bubble; I happened to see it at the land use, local government level and it was hideous to behold: the venalty, the greed, the insolence, the egoism were astonishing to behold among the developer and mortgage banker participants. As for the electeds…?

        Such cowardice, almost weirdly synchophantic accommodators of developers as to shock the eye of a reasonable soul — or anyone paying taxes in the region.

        At this point, I must note that one of my fave bits in Econned is the line about:

        “Faulty financial technology not only understated risk, but its widespread adoption created a lingua franca of sorts, namely, approaches for measuring and modeling. Those standards facilitated trading and investment, since they gave investors benchmarks for how they ‘ought’ to invest and think about pricing. But these approaches were, and still are, accepted and as valid as the theory of the four humors (black bile, yellow bile, phlegm, and blood) that was the foundation of Western medical practice through the nineteenth century.

        Oh, speaking of measurement?
        The local electeds were just woozy with delight about ‘full employment’ — because if you ‘measure’ a job framing houses as a ‘job’, right in the same category as a teaching ‘job’, or a law enforcement ‘job’, then wheeeee! You can brag about your great ‘jobs’ so-called metric.
        Nevermind about the fact that the teacher and cop ‘jobs’ provide medical, retirement, and annual employment.
        Nevermind that the house framers are working for hourly, or ‘per job’ pay with little-to-none long term employment security.
        This is the ‘job metric’ at the heart of the ‘policies’ driving subdivisions based on gas at 2002 prices. Wheeeee!

        And who was whispering in the ears of those feckless, well-intentioned, but meek and suppliant electeds? Their buddies on the boards of local home-mortgage banks, upstanding Chamber of Commerce members every one.
        And who was on the boards of those mortgage banks (and in many cases, put up significant sums to set up those mortgage banks)? The housing developers. So the circular reasoning, the HomeOwnershipSanctimonious enthusing over what is basically the economic equivalent of black bile, yellow bile, phlegm, and blood made for such an intense ideological bubble that anyone who didn’t buy into it was politically excommunicated.

        Wow, do we need new economic theories, and badly.
        And we need to make sure that electeds understand them, if only to give them a tiny bit of spine — at least enough to look at a ‘jobs’ report and ask some questions that might better insure the long-term fiscal discipline and viability of the jurisdictions on whose behalf they are supposed to be making decisions.

        1. liberal

          But AFAICT local governments are always in the pockets of real estate developers, bubble or no bubble. At least here in the US, in every locality I’ve lived in.

    2. Historian

      “That bubble could not have taken place in a truly free market.”

      Straight GOP line, and complete ignorance. Bubbles have taken place throughout history in free markets.

      http://en.wikipedia.org/wiki/Economic_bubble

      Basic reason: people are not perfectly rational. Seems obvious, but recognizing that gives some small credence to government intervention, so the right as is their fashion, refutes the basic facts that lead to conclusions against their ideology.

      1. Progressive Ed

        For a straightforward explanation of the macroeconomics of financial bubbles since the collapse of Bretton Woods, see
        “The Dollar Crisis” by Richard Duncan.
        Published in 2004, it details the economic dynamics of the monetary aspects of the Millennial Meltdown and the mess we are now in. This, in spite of the fact he mentions the insanity of the CDO and CDS “markets” and abuses only in passing.

  11. Siggy

    Yves said: “The problem is that mainstream economics sees prices as virtuous.”

    That’s idea that has always puzzeled me. I’ve always felt that prices were allocative and in that, amoral in that who got how much, more or less, was entirely a secular proposition within the framework of a transaction or set of transactions. Those with more get more. I’ve never endorsed the idea of sharing without recompense.

    The study of Economics as religion. Yes, one can reasonably assert that the acceptance of various tenets is predicated on something other than a rationale that is imbued with a veridical line of logic. As that crosses into the realm of pure faith, one can readily see that assigning economics to the religion bin is quite rational and veridcal.

    As to veridical truth. Now that made me think. Thank you for that. Lovely catchy phrase.

    As to new and probably recurring mea culpas that aver whocouldanode. Well, they certainly tell you how dumb and quite possibly malicious the inmates of the parthenon of economics happen to be.

    I tend to favor the Austrian view, but favoring is not equivalent to fully endorsing. In 2000 I noted the beginnings of an acceleration in house prices. by 2002 I was convinced that we were experiencing a house price bubble while the general level of consumption prices were increasing at a very moderate rate. This led me to conclude that we were experiencing a Gresham’s Dynamic wherein too-easy-credit-money (I’m of German descent and freight train words make perfect sense to me)was supplanting traditional credit money. Too much credit money and you get an increase in credit money funded purchases and prices.

    I pondered, how does, and when does, one short this obvious bubble. After all, the dictum: ‘what can’t go on forever, won’t', was and is very much in line with my experience over the past 50 years. Ah those lovely little RMBS and their faith companions CDS. 2005 was position time and 2007 was collection time.

    So, if the greater fools in Fed Land want to believe in efficient markets and that no fraud is worthy of prosecution, let them have at it. With a modicum of freedom I can do a work around that brings home the bacon. Now, of late, the bacon is less than a pond by the package at yesterday’s price. So, this whole affair is convoluted in the fact that we have this worthless fiat paper. Mind you, it’s a lovely printing job; nonetheless, those Federal Reserve Notes don’t buy as much as they once did in the not that distant past.

    Now dealing with that core problem is mentally difficult and mathematically rigorous. It’s a really tough slog to assemble the appropriate data, not to mention just what shall the null hypothesis be. In lieu of that tough row, we’ll just endorse whatever it is that our leader says and be on our way.

    Pity their way does not lead to the exit door. Pity it leads to a conference room were all can huddle and muddle along creating chaos in the production component of our political economy.

  12. Evoo Kermartin

    “[E]conomics is really really bad at fieldwork.”

    Yes, yes, YES! Anyone who analyzes data without considering the reliability of the data is not a scientist. Company audits have been a public scandal since Enron. For starters, huge GIGO problem, huge.

  13. jomiku

    I read the paper when the link from the Boston Fed appeared in my inbox. I think you mischaracterize the point somewhat. They looked at what economists said. They found that most waffled, even prevaricated, saying in one breath that it looks like a bubble and in the next that it might not be bad or one doesn’t know how it will end (meaning a slow down, not a pop). They found that the sentiments of actual economists were so mixed that people relying on those sentiments could easily have been misled about the bubble. I did not read the paper as saying that noonecouldaknown, but instead as a statement that look, here are what economists actually said and now we focus on the pessimists who were right but that’s not the way it looked at the time to actual economists.

    My read of the paper was that it shows well how difficult it is for people to know what they’re in the midst of. It shows the difficulties of policy making because odds are really, really good that the right views will be surrounded if not inundated with loads of junky statements, some that outright argue for the opposite of right and most that waffle so much that relative inaction becomes the most weighted course.

    1. Evoo Kermartin

      Is that you, Kartik? An analytical methodology that cannot distinguish signal from noise is unsound.

    2. liberal

      My read of the paper was that it shows well how difficult it is for people to know what they’re in the midst of.

      How can the paper show that, when it actually wasn’t hard to understand we were in a bubble?

      At best, it shows economists found it hard. That’s not surprising, given the ideological underpinnings of modern economists.

  14. Bill Wood

    Greenspan II (the sequel, aka Helicopter Ben) promises to continue to apply the same old one-size-fits-all reflexive monetary policy in his misguided attempt to revive an economy already severely damaged by this very same putative solution. This is pretty much the equivalent of a coach taking a wounded athlete and sending him back into the field of play after loading him up with steroids and pain killers.

    So far kicking the can down the road in this way has been far more successful than I would have guessed. But as a strategy, it won’t last forever. In much the same way that a bingeing drunk will sooner or later collapse, the collective refusal of our business and political leaders to acknowledge their own responsibility for our worsening economic conditions will ultimately fail as well. By then perhaps they’ll have constructed a narrative that lays the blame for all of this on some foreign enemy. Let’s hope that they don’t get away with that.

  15. Dan Myer

    To be a ‘serious’ economist, must you ignore common sense?

    When models and actresses enter the ‘house flipping’ business and countless (and I really mean, countless) TV shows are spawned around ‘Flip this House’, ‘house flippers’, etc. You HAVE to know that we are in a bubble. Frenzies do not always create bubbles, but all bubbles are accompanied by such frenzies. Not only marked by TV shows, but also common references to the housing market at the time as “hot, exploding, soaring” etc.

    What do serious economists think about the endless ‘gold’ commercials on TV now and the abundance of cnbc-mass-audience-appeal shows such as “Fast Money”, “Mad Money”, “options action”…deploying the same old terms when a company happens to beat its quarterly earnings guidance: “exploding, hitting the cover off the ball, popping, ripping”.

    I believe this is why our founding fathers had the wisdom to prescribe a congress composed of ‘common men’, rather that ‘trained’ (serious) legislators. For some reason, our eductional and political systems scorn common-sense reasoning. Yet, common sense tells you that we are in a world of trouble on many fronts…even when the ‘serious’ are blind.

    1. Wallyz

      Precisely this. I was rehabbing properties in 2000-2005, following a formula of Finished sq ft price* sq ft- amount of work needed to finish* 1.25. It worked because I did most of my work myself and I’m better and faster at hanging drywall than 98% of the population. When houses that were worth 140k finished that needed 50k worth of work were auctioning for 125k, I said “Bubble” and got out a quickly as I could unwind. the last house I sold (2006) was to an out of work woman on alimony that was about to run out.

      The only reason you would waffle about this condition is the fact that if you want to stay employed as an economist for the government, you have to be part of the “Positive Message” brigade that keeps equity prices up and everybody happy.

  16. Ishmael

    They looked at what economists said. They found that most waffled, even prevaricated, saying in one breath that it looks like a bubble and in the next that it might not be bad or one doesn’t know how it will end (meaning a slow down, not a pop).
    —————————————————
    This has been a major problem with main stream economists and news reporting. Any more if some one was blown to pieces the newspaper would report the subject appeared dead. No one in power has the cohones to say things as they are.

    I had a letter to the editor published in the Boston Globe in 2005 or 6. I can not remember. Anyway, in this letter I clearly pointed out that housing was forming a bubble and that it would be devastating to a large percentage of new home owneres.

    I started beating this drum around 2002 and people indicated I was nuts. I have been around the housing industry for 42 years and have seen numberous bubbles (Oklahoma, Texas, Australia, Boston) anyone with half a brain could have seen this would end in tears. All it would have taken to kept this bubble from happening is people in positions of power to come out and speak unhedged that housing was forming a bubble and where that would lead.

    Even Robert Shiller was always speaking in a hedged manner.

  17. Namazu

    Yves said: “The problem is that mainstream economics sees prices as virtuous.”

    Amen. From your blog to the ears of Krugman and others who can’t see the bubble in Treasuries.

  18. Bruce

    You’ve got to be kidding me!

    If only we had restricted no-doc loans and required 10% down payments?? Just why do you think banks were doing that in the first place? Because they loved throwing money around?

    No. Banks had to get creative to meet the requirements to lend to lower income borrowers. The relaxed standard/requirements (which had served them well for years and years) resulted in bad loans being made (even to higher income borrowers, as the reduced requirements applied across the board). Mortgage brokers were able to make outlandishly bad loans because lenders were hungry for loans to “low income” people to fulfill their requirements.

    If it weren’t for government interference (lending requirements and artificially low interest rates), the entire bubble would never have happened.

    1. Tao Jonesing

      @Bruce,

      Your argument, which implicitly places the blame at the feet of the CRA, has been so thoroughly debunked by so many people that it is not worth responding to again because you clearly want to blame poor people and the government.

      Just go to Barry Ritholtz’s site and search for “CRA,” or better yet check out his book “Bailout Nation.”

      1. Tao Jonesing

        Also, interest rates don’t cause asset bubbles, debt-fueled speculation does. Fractional-reserve lending should never be offered to speculators.

      2. Bruce

        The debunking depends on a juvenile 1-level analysis of the situation. Yes, most of the loan originators were not covered by the CRA. But that’s because they new that they could sell their mortgages bundled as securities to the CRA-covered banks – rule changes during the Bush Administration allowed CRA-covered banks to satisfy a large portion of their requirements by holding mortgage backed securities rather than.

        Companies like New Century were emboldened to make ever riskier loans because they new they would be able to sell them off to the banks which needed them to cover CRA requirements. What bit New Century was the “early defaults” that it started experiencing, which required it to repurchase loans it had sold off because people were defaulting within the first 6 months.

        Banks aren’t in business to lose money. They didn’t lend money to people unable to pay it back because they thought it would be fun. They did it because they were pushed to do so by the CRA and by court actions; they hoped that bundling them would spread the risk out. Were there frauds and charletons out there who took advantage of the situation? Absolutely! But they would never have been able to pull of their scams if the CRA, lawsuits and threats of lawsuits hadn’t forced banks into a corner.

  19. Ishmael

    Ed:

    Check out the interest rate on the 30 year Japanese Bond. That will give you idea how low interest rates can go and how high up bonds can go. Of course this is like a year or two horizon. After that watch out below. Japan will probably lead the way down.

  20. CingRed

    You mean the emperor aka economist has no clothes?

    “Economic theory provides little guidance…” While I agree with the whole sentence the shortened version is more correct.

    “While optimistic forecasts held by many market participants in 2005 turned out to be inaccurate” those projections were not “unreasonable” given what was understood about the economy and housing market dynamics in the years before housing prices crashed and helped create one of the worst economic downturns in generations.”

    What this says is that they still don’t understand the exponential function. You can’t sustain a growth rate in an expense that is greater than the growth rate of income.

    I once argued with a corporate VP that they could not expect to continue their 30% per year growth rate because in x years they would “be” the entire US economy. They didn’t understand it, and apparently neither does economic theory. I have sent our state legislators graphs and data showing how the rates of increase in tuition vs income will shortly make it impossible to justify the expense of going to college. We face the same exponential math in the area of health care expenses vs income.

    The matter of not being able to design policy that would have targeted and prevented the bubble is completely false, as they were systematically removing or ignoring such policies causing an acceleration of the expanding bubble. While it is easy to understand the political pressure against removing the punch bowl just when the party gets going, we have to understand that doing the right thing has never been the popular route.

    The other major blindness that economics has is their seeming lack of being able to distinguish between wealth and money. If they do understand the difference then their policies are clearly designed to decrease the wealth of the general population.

    1. readerOfTeaLeaves

      Ah, the lowly exponent, which is daily used in biology and environmental studies (as well as other fields) seems to be outside the range of thinking of the mortgage bankers, realtors, builders, developers, and local electeds of my acquaintance. Compound interest, they understand.
      The lowly exponent, not so much.

      Exponents are less apt to produce the sort of ‘equilibrium pricing’ they all seem to assume exists.
      Bah.

  21. B Con

    How many economists does it take to pop a bubble? Answer: None – because they can’t see it.

    That was a great post. The state of macroeconomics is dismal and its not clear where the revolution that overthrows the clown prince kingdom will come from.

    1. Raging Debate

      Once the plebes have been sheared they cannibalize themselves. The bankers will fund the revolutions on which political group that supports their kind of model flavor. Who funded the American revolution?

  22. Jim

    Congratulations to you, Down South, for trying to get to the bottom of things.

    Isn’t politics, finally, also political theology–meaning that all political concepts are secularized versions of theological concepts.

    And if this seems a valid hypothesis then isn’t it imperative that all of us take a careful look at the process by which our deepest desires, longings and feelings take conceptual form–especially when this process seems to necessitate the use of tradition-laden language and inherited ideas, goals and visions of the future.

    Strangely enough, it is perhaps the frank acknowledgment of these traditions and a closer examination of their contents, as embedded in both politics and economics, that may offer us a way out of our contemporary morass.

    1. psychohistorian

      Changing the American motto back to E PLURIBU UNUM would be a good start, IMO. We should have never gone down the “In God we trust” rabbit hole.

      Fuck the rich and their pawn christianists that have hijacked what was once an aspiring secular country.

  23. up over

    Clarifications re the Australian situation:
    * The boom was 2002-03 not 2004 and the rate rises you are referring to happened in late 2003.
    * Macfarlane’s extended term ended in late 2006 – he took a three-year extension
    * His successor, Glenn Stevens, expresses himself differently but did not walk away from the idea that asset and credit markets matter (see, eg, his speech to their 50th anniversary symposium earlier this year)
    * Actually, RBA kept raising rates for several years afterwards, including in the middle of an election
    * If the RBA was banging on about housing less after 2004 it is because their bubble did actually fizzle after 2004 so there was less to bang on about. Nationally, the dwelling price to income ratio has been flat since then, with a few bumps. Prices boomed in Perth (mining boom and population growth running faster than supply could meet) but the east coast was pretty flat even in nominal terms for some years.

    Suffice to say I disagree with your characterisation of the Australian episode.

  24. ChrisPacific

    “Economic theory provides little guidance as to what should be the ‘correct’ level of asset prices — including housing prices,” the new paper published by the bank says.

    Bullshit. The value of an asset is the net present value of the cash it generates over its lifespan. In the case of a house, it’s the rent you could earn from it over the time you own it (or the rent you don’t have to pay as a result of living in it, which amounts to the same thing), minus maintenance and expenses, plus the expected sale price at the time you sell it, all with an appropriate discount factor applied based on the return you need to make it worthwhile due to cost of financing, risk of drop in prices or prevailing rent, etc.

    There is one factor peculiar to residential house pricing that I haven’t factored into the above, namely the American Homeowner premium (it is the right and destiny of every American to own their own home etc.) which tends to result in people paying higher prices than might be justified economically. However, I suspect this has remained relatively constant over time. What makes a bubble is inflated expectations around the last term (expected future sale price). Normally wage growth acts as a brake on this because if house prices climb faster than wages for an extended period, it becomes impossible for average buyers to afford them. In the recent case, the MBS industry and predatory financing effectively removed this constraint, which allowed the bubble to grow.

    I’m not an economist and I can do this. It’s not hard. Property investors make these calculations regularly and to a high degree of accuracy. Are economics professors expected to ignore this stuff as a condition of entering the profession? This seems akin to a mathematics professor publicly denying the existence of the multiplication table.

    1. liberal

      Are economics professors expected to ignore this stuff as a condition of entering the profession?

      Yes. Most of the calculation involves capitalized land rent. Economists don’t want to know about that, because it points to the fact that most of the gains of the wealthy are ill-gotten, as J. S. Mill pointed out centuries ago.

  25. doc Holiday

    Kristopher Gerardi, Christopher Foote and Paul Willen

    ==> For the record, they are either total retards or totally retarded criminals.

  26. Hugh

    This is an example of the clown effect. It is amazing that these clowns have jobs, but that they do and indeed have the ones they do explains why the economy is in the mess that it is. The other point is that having missed the last bubble and meltdown we can take it as a given that they not only don’t see the next collapse coming but because they don’t they will do nothing to prevent it or mitigate its effects, until, of course, it is far too late.

  27. Weevie

    Perhaps one answer to the political problem with pricking bubbles is to grant independence to those with the responsibility, something akin to judicial independence. As is done with supreme court justices, but for a limited term, not for life. This would definitely have its own problems, but perfection is the enemy of the good.

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