Pinball

"Stuff Happens" t-shirts are easy to find. Less popular are "Cycles Happen", "Price Swings Happen, "Bubbles Happen" or any such.

Robert Shiller writes "Challening the Crowd In Whispers, Not Shouts" in today's NY Times.

Yes, many smart people, (including of course Shiller) were alarmed by real estate price trajectories. And many used the B-word. In today's piece, the writer asks why economists do so less than others.

Why do professional economists always seem to find that concerns with bubbles are overblown or unsubstantiated? I have wondered about this for years, and still do not quite have an answer. It must have something to do with the tool kit given to economists (as opposed to psychologists) and perhaps even with the self-selection of those attracted to the technical, mathematical field of economics. Economists aren’t generally trained in psychology, and so want to divert the subject of discussion to things they understand well. They pride themselves on being rational. The notion that people are making huge errors in judgment is not appealing.

In addition, it seems that concerns about professional stature may blind us to the possibility that we are witnessing a market bubble. We all want to associate ourselves with dignified people and dignified ideas. Speculative bubbles, and those who study them, have been deemed undignified.

In short, [psychologist] Mr. Janis’s insights seem right on the mark. People compete for stature, and the ideas often just tag along. Presidential campaigns are no different. Candidates cannot try interesting and controversial new ideas during a campaign whose main purpose is to establish that the candidate has the stature to be president. Unless Mr. Greenspan was exceptionally insightful about social psychology, he may not have perceived that experts around him could have been subject to the same traps.

True enough. But the well known fact that cycles can (and often will) overshoot and undershoot does not equip anyone to know when enough is enough -- or what to do about it. Banning short-sales illustrates what not to do. Once we get into the fix-it mode, we can easily do more harm than good.

While it is easy to recount past warnings about price bubbles, it is much more difficult to identify early warnings about how housing price swings would interact with mortgage and credit markets. That is the much more interesting discussion. How the ball bounces in pinball is also tough to predict.

Know-Nothings Gone Wild

I used to chafe at the know-nothing sermonettes offered up at restaurants, hotels, Starbucks, Ben & Jerry's, Whole Foods and many others about how do the right thing with respect to "the environment". But it is no longer a charming eccentricity that goes with eating at Chez Panisse; it sprouts almost everywhere. Just about everyone seems to "know" which trade-offs are best. If, indeed, they even fathom that there is scarcity and myriad trade-offs to consider.

So it's refreshing to see that Pierre Desrochers and Hiroko Shimizu have just published Yes, We Have No Bananas: A Critique of the 'Food Miles' Perspective. There is much to critique and they do it very well.

How do we know that green fervor is part of a religious revival? It's easy. For one thing, I see more and more young people tear up when their themes are challenged.

Distribution and redistribution

The economics and measurement of who gets what and who has what (distribiution) is difficult and easily distorted. In election years, it is trampled on.

But Martin Feldstein's NBER WP 13953 ("Did Wages Reflect Growth in Productivity"?) is helpful. Productivity has been growing, as has labor's share. Labor's share is best (and most honestly) measured when the whole compensation package, including all perks, is considered. Much of the rhetoric about declining real wages is misleading. Is anyone surprised?

Greg Mankiw calculates how he would fare under the McCain and Obama income tax proposals.

No reason that the algorithm could not be placed in interactive format in each ballot booth next Tuesday. Just a thought.

UPDATE

Ironman points us to this. As he says: Why wait?

Mystery of the perfect storm

Michael Boskin describes the "perfect storm".

The current situation was created by a perfect storm of mutually reinforcing trends and policy mistakes: loose monetary policy (years of negative real interest rates in a growing economy); socially engineered housing policy (the Community Reinvestment Act, Fannie Mae and Freddie Mac, HUD's no-money-down mortgages); the rapid growth of leverage, opaque and technically deficient derivatives, and the shadow banking system; fragmented regulation, lax diligence, poor governance, fraud; and an oil price shock. The result: a housing bubble bursting into recession.

John Quigley suggests ways to better align inventives in mortgage lending. He also notes that how we got to where we are makes quite a mystery.

How, you may wonder, could contracts with
such poor incentives have evolved? To some
extent, that remains a mystery.

Perfect storms and mysteries command the attention of smart people. So fight the lows brought by financial losses and politicians' posturing with the high that there are huge and auspicious puzzles before us. How do you unscramble the mystery of a perfect storm?

Fairness

Differential tax rates (it was once feared) would set class against class. How could they not?

There are the additional problems that state-run efforts to fight poverty morph into efforts against inequality -- and that evidence of their success is spotty -- and that they can even be counter-productive.

And vote-buying is introduced, implicitly or explictly. Professor Adam Lerrick does the math in this morning's WSJ ("Obama and The Tax Tipping Point ... What happens when the majority of voters are net beneficiaries of government?").

What was so revealing about the Joe-the-plumber episode was Joe-the-Senator Biden's scoffing about a plumber worrying about a tax on those making over $250k. What business does he have dreaming? (And he did not even have the state's permission to be a plumber!)

Baptists and Bootleggers Gone Wild

Robert Barro famously said that once you start thinking about economic growth, you cannot think about anything else. A corollary must be that once you start thinking about institutions (and how they succeed or fail with respect to growth), you can think of little else. The fascinating question is addressed by Martin Ricketts, Oliver Williamson, Erik Furubotn, Rudolf Richter, Elinor Ostrom and Stephen Litlechild in the Sept 2008 Economic Affairs.

Listening to all of the policy fixes that are wheeled out day and night by politicians and many others makes one wonder. Have they never heard of public choice economics? Have they never heard of Baptists and Bootleggers?

The various "fixes" generated by the political process are, by definition, politicized.

UPDATE: I should have cited Robert Lucas instead of Robert Barro. HT to Gabriel Mihalache.

Hell to pay

The financial crunch is especially hard on all those who are overextended. Transit agencies too are subject to margin calls. This morning's LA Times includes "MTA may have to cut commuter service". Lease-back arrangements with AIG are beginning to bite.

Just two days ago, the Times reported how average daily September 2008 ridership compared to the year before. Applying LA County population numbers for the 2 years and the 3.9 trips per person per day that we found in the NPTS data the LAMTA's various fixed guideway lines served just over 0.8% of daily travel demand, up from just over 0.7% the year before. But less than 1% in either year. Much bigger, however, on the cost and debt side.

Appealing idea

In the Oct 27 Forbes, there is Prof. Luigi Zingales' "Cramdown ... How to fix the credit mess with a government bailout: quickie bankruptcy ...Banks would be allowed to convert debt to equity."

The idea is to create a special Chapter 11 process to allow banks to reorganize quickly. Read it. I like it a lot. Before we dive into unlimited ad hoccery, let's adapt something that we have a lot of experience with, the Chapter 11 process. We have a good bit of the learning already accomplished.

Adding to the wish list

In yesterday's WSJ, Judy Shelton ("A Capitalist Manifesto") dreams of a world of better post-election-post-crisis policy. Her thoughts are all sensible. Fewer real estate asset bubbles from fewer central bank errors is always a good idea. But missing from Shelton's wish list is fewer development bottlenecks from fewer local government regulations. Ed Glaeser's "The Economic Impact of Restricting Housing Supply" makes the point. Wendell Cox elaborates the local effects.

Interesting times

Arnold Kling notes the politicization of Fannie and Freddie.

Becker and Posner disagree somewhat in this week's post on the financial crisis. Becker notes that:

The second relevant development has been advances in financial instruments, such as derivatives, securitization, credit-backed swaps, and other even more esoteric instruments. These instruments seemed to work quite well in managing, spreading and even reducing the risk of the assets held by banks and other institutions. However, in the process they encouraged greater risk-taking ventures, as reflected by the large increase in the leverage-that is, in the ratio of assets to capital- of banks and financial institutions like Fannie Mae and Freddie Mac. What has been insufficiently understood is that the growing use of these instruments, and the growing leverage of financial institutions, created considerable aggregate risk for the system as a whole that could not be diversified away.

Some will call this a "market failuure".

The WSJ's Mark Gongloff writes how "Policy Blunders Have Created Crisis of Faith".

It all suggests back-to-the-drawing-boards when it comes to a broad range of policies. But is there any theory available to guide this project? Public choice economics is available, but unlikely to be considered. That theory suggests that there are no panels of wise men and women available to make new and improved policy. It does suggest that the next round of policy making will be as politicized and inept as the last. Even Nobel laureates who are recognized for their skills in economic theory ignore this economic theory when placing their faith in new and improved politicians.

And the beat goes on

In today's LA Times, colleague Jim Moore argues that LA's Metrolink should die. It has killed enough people and the economic justification for its existence has never been made. But the Governor wants a "yes" vote on another high-speed rail boondoggle. Shikha Dalmia elaborates in today's WSJ ("California is Headed for a Real Fiscal Train Wreck").

In today's WSJ, Peggy Noonan writes that both Presidential candidates are clueless on the market meltdown. Surprise!. Jonathan Macey writes that, "Letting markets work is messy and costly. Nevertheless, the only sensible way to deal with the current crisis is to force the companies who created the mess to bear at least some of the costs of their mistakes. Most of all, if the markets are to get back on track our regulators must an immediate stop of publicly demonizing the markets and work to restore confidence in the system."

Panic

There is all the talk of panic on Wall Street and panic on Main Street, but Lee Ohanian, writing in today's WSJ, reminds us of the problems caused by panic in Washington DC ("Good Policies Can Save the Economy ... Why we need lower tax rates and more skilled immigrants").

Amity Shlaes (The Forgotten Man: A New History of the Great Depression) and Bob Higgs ("Regime Uncertainty ... Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War") document how the hysterics in Washington turned a panic (of which we have had many) into the Great Depression.

This is a profound lesson for today's panic, but one which very few people (or candidates) even address.

Bad time for an election

Bob Higgs' summary (and critique) of journalists' and politicians' use of metaphors to describe the current economy is priceless. It's a shorthand; it communicates effortlessly; but it ain't deep. Higgs elaborates how it's lazy and obscures more than it illustrates.

Both presidential candidates have savvy economists on their teams. But it's clear that they often ignore good economic advice. Who do they listen to last? A nearby politco? (Most of these people are lawyers.) Their own inner voice? Whoever sounds most like the inner voice? Do Obama-McCain naturally revert to Lou Dobbs-Bill O'Reilly populism? Tuesday's televised debate could be ugly if they each try to hog this road.

Sorry. Metaphors.

All the wrong lessons

Today's NY Times includes "Pressured to Take More Risk, Fannie Reached Tipping Point ... Wall St.and Congress Fueled Fateful Choice." The longish article includes: "shortly after he became chief executive, Mr. Mudd traveled to the California offices of Angelo R. Mozilo, head of Countrywide Financial, then the nation's largest mortgage lender. Fannie had a longstanding and lucrative relationship with Countrywide, which sold more loans to Fannie than anyone else."

The Times also includes "A Snarl of Regulation" along with a spaghetti diagram of who regulated what and whom. There is also "Goodbye To All That" which takes off from the sentiment of Steve Fraser, that "It's the beginning of the end of the era of infatuation with the free market."

We're going to hear a lot of this, in spite of evidence that we have anything but free markets in action. Extend the regulation and politicization that we have and extend that to trades that are currently unregulated? Why? Inept regulation and/or politicization will follow. More competition and fewer bailouts are out of vogue.

Market participants (even the specialists) in all fields are just people. They will do things right and they will make mistakes. Letting them reap rewards when right and letting them fail when wrong is the only known antidote. But that approach will surely recede as all of the wrong lessons are drawn on a daily basis.

Whopper

Today's NY Times op-ed page includes most of the standard sneers at Sarah Palin's debate performance -- and personna. I did see the whole debate on TV and (surprise) both sides got away with stuff. That is apparently the way of modern American politics.

But I thought that the true whopper of the evening was Joe Biden's story about Lebanon. In his patented style he informed the audience that when the U.S. and the French kicked Hezbollah out of Lebanon, he and Obama lobbied to put NATO forces into Lebanon to "fill the vacuum." Huh?

Neither moderator Ifill nor Palin nor the NY Times' writers (including Steven Pinker), nor any source that I had seen or heard, picked up on this one.

I now see that Michael Totten had the same reaction that I did ("Joe Biden's Alternate Universe").

But narratives are stubborn things. The wise and seasoned foreign policy "expert" vs. the unready hick from somewhere off the mental map is just too good and too comforting to let go -- even through 100 inches of NY Times op-ed column space.

Two glimpses inside the sausage factory

In light of where I live and what I do, I have followed LA Times coverage of local boondoggles for many years. There has been some movement. For many years, bad projects were strenuously made to look good. In recent years, however, some problems (like huge costs) have been acknowledged. But as true boosters, the editors still find their way to an endorsement. Today's lead editorial ("Yes on state bonds") endorses Prop 1a, to fund a "High-speed rail line". Read it to appreciate the logic.

There's something undeniably alluring about a bullet train -- the technology is so powerful, the speed so breathtaking, it makes quotidian trips seem exotic. Perhaps that's why proponents of Proposition 1a, which would authorize $9.95 billion in bonds for a high-speed rail line connecting Northern and Southern California, think it would be wildly successful. They predict the line could draw 117 million riders a year by 2030, compared with 3 million now taking the high-speed Amtrak train in the densely populated Boston-Washington corridor. And they say it will turn a billion-dollar profit by then even as it keeps ticket prices remarkably low.

The projections by the measure's opponents, led by the libertarian Reason Foundation in Los Angeles, are much less sanguine and more persuasive. If voters approve Proposition 1a, it seems close to a lead-pipe cinch that the California High-Speed Rail Authority will ask for many billions more in the coming decades, and the Legislature will have to scrape up many millions of dollars in operating subsidies.

And yet, we still think voters should give in to the measure's gleaming promise, because it's in their long-term interest. Weaning travelers from gas-powered, road-choking cars is critical to the state's health and competitiveness. A high-speed rail line would not only provide a cleaner and faster alternative to automobiles, it would encourage transit-friendly development.

The measure isn't as big a risk as it would be if the state were footing the entire bill. The "backbone" segment from Los Angeles to San Francisco is projected to cost $33 billion, with about 75% from federal and private sources. Until those funds are secured, the state won't issue most of its bonds. If the line never gets built, the state's losses will be well under $2 billion. That's not too much to wager on a visionary leap that would cement California's place as the nation's most forward-thinking state.

Speaking of pigs in pokes, Otto von Bismarck famously remarked that, "There are two things you don't want to see being made -- sausage and legislation." We now hear that the 3-page "bailout" bill has grown to a 450-page "package". Stuff happens from ingestion to egestion.

Shameless

Wilshire was once Los Angeles' main boulevard. Driving over its decrepit pavement these days is pure Third World. Try anything east of Beverly Hills, including its storied Miracle Mile. Deferred maintenance is the rule and it has long been policy to divert auto user fees to public transit.

Not content with the waste and the damage done, there will now be a vote in California to invest billions on high-speed rail. The Baptists and bootleggers (see Bruce Yandle) for this one are greens and politicians. Demographia.com elaborates the gory details.

Wall Street physics

Joseph Stiglitz contributed the "Information" entry to The Concise Encyclopedia of Economics. He wrote, "Since about 1970, an important strand of economic research, sometimes referred to as information economics, has explored the extent to which markets and other institutions process and convey information. Many of the problems of markets and other institutions result from costly information and many of their features are responses to costly information."

Later in the essay, he notes that "The standard theorems that underlie the presumption that markets are efficient are no longer valid once we take into account that information is costly and imperfect. To some, this has suggested a switch to the Austrian approach, most forcefully developed during the 1940s and later by Friedrich Hayek and his followers. They have not attempted to 'defend' the market by the use of theorems. Instead, they see markets as institutions that have evolved to solve information problems."

And (disagreeing with Hayek) "The fact that markets with imperfect information do not work perfectly provides a rationale for government actions."

Some of us would add that government actions are also imperfect. Many years ago, Harold Demsetz warned about "nirvana economics."

Last night, on 60 Minutes coverage of the bailout, former Treasury official Roger Altman mentioned AAA ratings given to novel credit instruments that no one really understood. The market vetting institutions had fallen behind the innovations.

At econtalk.org, Pete Beottke talks about the economics of disasters. He mentions that mainstream economics in the 20th century went the way of physics (theorems) when it should have gone the way of biology (evolution).

Now we hear that the credit instruments that no one adequately understood were designed by physicists that the investment banks had hired.

Wait till next time

Warren Buffett talks about how Fannie/Freddie were regulated and cannot decide whether to laugh or cry.

QUICK: If you imagine where things will go with Fannie and Freddie, and you
think about the regulators, where were the regulators for what was happening,
and can something like this be prevented from happening again?

Mr. BUFFETT: Well, it's really an incredible case study in regulation
because something called OFHEO was set up in 1992 by Congress, and the sole
job of OFHEO was to watch over Fannie and Freddie, someone to watch over them.
And they were there to evaluate the soundness and the accounting and all of
that. Two companies were all they had to regulate. OFHEO has over 200
employees now. They have a budget now that's $65 million a year, and all they
have to do is look at two companies. I mean, you know, I look at more than
two companies.

But read the whole interview because the popular wisdom these days is that we are paying the price for the orgy of deregulation that we have recently been through.

How and why will regulation be better the next time?

Peggy Noonan and Dan Klein reflect

This morning's WSJ includes an excerpt from Peggy Noonan's Patriotic Grace: What It Is and Why We Need It Now (which I have not yet read). In the excerpt she writes about the collection of people milling and waiting at "Gate 14" (at any major U.S. airport), going through the "costly and embarrassing kabuki" of getting through TSA security. She notes that "Gate 14 doesn't think any of the candidates is going to make their lives better. But Gate 14 will vote anyway, because they know they are the grown-ups of America and must play the role and do the job."

This reminded me of Dan Klein's "Resorting to Statism to Find Meaning: Conservatism and Leftism" Dan begins this way: "Man is a meaning seeking animal. Meaning is developed and sustained in beliefs, communities, customs, and institutions. It is represented by symbols and identifiers. These components work together as a subculture." In the paper, he thoughtfully explores differences and definitions. How do people find meaning in conservatism and leftism as we know it? Dan also explains why liberalism [traditional definition] appeals to him.

It is a bit simpler for me. Statism carried to the extreme, where it becomes a religion (Hitler, Stalin, Peron, Castro, Milosevic, Kim Jong-Il, etc., etc., etc.) is vicious and evil. There are no worse forms of social organization. But democracy as we know it leaves room for populism which on these shores has not quite stooped to the lows we have seen abroad. But it's practitioners sometimes look in that direction.

Unlike Noonan's Gate 14 people, many of us sniff around every four years to see if we can find any redeeming qualities among the candidates presented to us. I'll have to read Noonan's book to see what is expected of grown-ups in these circumstances.