Prices as virtuous
Yves Smith, excerpted from her post Boston Fed’s New Excuse for Missing the Housing Bubble: NoneOfUscouddanode. This part caught my eye in addition to the critique:
The problem is that mainstream economics sees prices as a virtuous. Everything can 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).
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!”
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.
WSJ article is here
If one is unfamliar with the rivalry between mainstream economics on the one hand, Austrian and Marxist views on the other, it’s easy to think this statement –
“Second, some very unfashionable schools of economics, namely the Austrians and the Marxists, both recognized the imbalances in the economy prior to the bust.”
– is more helpful that it really is. You know – even blind squirrels…? Austrians and Marxists are ever finding imbalances. The Marxist critique is all about imbalances, tensions and the like. Knowing at the time that Austrians and Marxists saw imbalances would not have helped an unbiased observer, because an unbiased observer would not have had reason to trust either Austrians or Marxists. There were lots of reasons to think we had a housing problem. I’m not sure why Smith thinks there is mileage in noting Austrian and Marxist views.
“The problem is that mainstream economics sees prices as a virtuous.”
This is not the problem. Prices are virtuous.
“Everything can be solved by price.”
This is the problem. Prices are not perfectly virtuous. Assuming that they are will make a fool of you.
“Mainstream economists also believe that price mechanisms lead to optimal outcomes from a social welfare standpoint.”
Not the honest ones. In fact, I don’t believe that statement actually stands up to scrutiny. Mainstream economists are prone to say things like “we cannot compare utility between individuals” and “gains from trade generate sufficient benefits to allow us to compensate losers – everyone can be made better off”. These sorts of statements are tacit admissions that social welfare is problematic. We can Pareto all we want, but being Pareto optimimal is not the same as being social welfare optimal, and many of the standard dodges offered by economists are tacit admissions that price mechanisms cannot be said to produce socially optimal outcomes because economics doesn’t tell us what is socially optimal. Economics only tells us what is efficient.
On top of agreeing with KHArris’s two comments what grabbed me was the last line of the post:
“It isn’t yet clear we have the political will to take on the people who win short term from borrowing binges.”
I think its perfectly clear. There is zero political will to take on these people. It would have been closing the bar in the middle of the party and turning the lights on. Not only did most not see it the few who did were politically powerless to takle away the punch bowl. The howling would have been overwelming…heck it still is today as people do not want to face the fact that there 2006 top-of-the-bubble house is now $400,000 underwater and will NEVER recover…they want the Gov to do something, ANYTHING to save them from their folly.
Islam will change
Economics only tells us what is efficient.
No it doesn’t. It only tells what maximises allocative efficiency given the current distribution of wealth. Real efficiency is something completely different.
Markets are self correcting, but that does not mean the correction is pleasant – people get hurt economically when this happens.
I wonder what the economists would make of the health insurance market when median household income is $55,000 and the average group premium is $13,000?
Would they say, offer subsidies to make it affordable?
The usual “consevative” response, is “the premium is what it is, livew with it!”
and that is what is wrong with people who think they are economic realists. the premium is arguably too high because medical care costs are too high. the question is whther they are too high because we don’t want to pay what it costs to keep us as healthy as we want to be, or alive as long as we want to be, or if there is some aspect of “the market” that drives prices up beyond some level where they “could” be if there were not “unfair” constraints… not “on” the market, but that “determine” the market.
and that’s where the whole “prices are efficient” reveals itself as a religious issue. “god is in his heaven and this is the best of all possible worlds.” the fact is that political actions can and do change the conditions under which the market operates… always. the market is efficient by definition. but that doesn’t mean that the people who profit under the existing rules should be allowed to determine what the rules are or continue to be.
maybe to make it a little clearer: it is obvious that in the very short run getting rid of taxes would make selling more profitable, and end one constraint on the “efficiency of the market.” it is a little less obvious that the chickens would soon come home to roost and impose new conditions on the market, which the market would adjust to, efficiently, but which likely would leave everyone worse off than they would have been just paying their taxes. this does not mean that the taxes were always fair, or even “efficient.” they are just part of the world, like gravity and friction, and the markets deal with that world as it is. it is only politicians and their idiot “economists” who run around claiming that the effiiciency of markets means that no one should ever change the conditions under which markets operate.
Does it make any sense to focus on theoretical prognostications concerning economic events when there are, or were in the case of the financial destruction caused by mortgage derivative pkroducts, plenty of ealy signs that certain real world parameters of the destructive probability of such products trading were available? That’s a loong and complex sentences, but it gets to the heart of an issue related to our concerns regarding how to come to terms with financial debacles. First, it wasn’t the bubble that came first. It was the heated trading in newly invented derivatives on the mortgage debt that was potentially available if such mortgages could be made more readily available to the general public that brought about the housing bubble. Such derivatives made mortgage resale bundling the new means by which funds for yet new mortgages could be made available. That is, those derivatives made the mortgage market more fluid. That fluidity of capital had the secondary, and more important, consequence of generating financial handling fees. The profits on the sales and trading of the derivatives were enormous. The issuance of derivatives on mortgages increased with the knowledge of the enormous fees and profits to be made by such products. Those derivatives required that there be an ever increasing mortgage market so to provide the basic parts of the goods to be sold. Lacks reguirements for the new mortgage borrowers became essential to that increase in the mortgage debt market. That produced a housing bubble. Every sector of the financial system and the government, where it over laps the financial system, had a role in the process.
The rating agencies that evaluated the quality of those derivative products was one real world place to look for the underlying problems that were developing. The derivative products themselves were apparently note too closely scrutinized by the buyers of the product. The buyers were also sellers, as such derivatives were sold to end users through a banking and finance system that has both a retail and wholesale structure. How did no one in that system not see the absurdity of grade Z debt product being up-graded when combined with grade A product rather than vice versa?
Too much money was being made by too many players in the system. Don’t blame the failure to prognosticate a bubble in some sector of the economy. Blame the failure of the system to be adequately policed for its more tawdry products. Focusing now on why this theoretical school iof thought should have, or could have seen a cloud on the horizon is not the issue, and it obscures the appropriate focus. Financial products were invented and marketed as something they were not and fortunes of fees and profits were generated by those products. The housing bubble was only an unforeseen, but necessary, consequence of those products.
In my opinion, these products were developed to attract buyers who “normally” would not be in the market. It’s as if people ran out of viable ideas, so they started to promote smoke and mirrors.
In the 40s and 50s, I believe homes used to cost one’s annual salary – for one wage earner.
Now, they are 3 times the median household income – for 2 wage earners and fewer kids.
Is that a viable market?
Well, maybe with no money down, and very low teaser rates – at least viable for a while.
Actually, economic realists are religious – their God is money.
And, the more money one has, the more realistic and religious he becomes.
Don, but maybe that is the price? If you subsidize it, then isn’t it possible the price stays artificially high with no incentives to find ways to deliver it more cheaply? What happens if people simply did not pay it, demand drops, and health care prices might decline to afford-ability? Health care is a tough one because we demand the latest and greatest treatments, many of which are expensive. We also demand that insurance cover costs that are guaranteed to occur. My drug costs for colitis exceed my premiums substantially each year, and I have to budget for my co-pay.
Yes, I agree that subsidies artificially inflate the premiums.
People are going to have to say no, as you suggested, enough is enough.
We are going to have to adjust our desire with our demand, our ability to pay for our desires.
Health care premiums are crowding out retirement and savings, as well as salaries.
I am willing to grant that even the claim for allocative efficiency depends on a number of assumptions, some of which are pretty fragile. I am aware of no evidence that wealth distribution is among the necessary assumptions. If you have some evidence, I’d love to see it. Otherwise, I’m gonna assume you made that up.
Yes, in deedy. The Boston Fed’s focus is on the failure of models to reveal bubbles. If models don’t do what we need done, then the reasonable thing to do is look to some other tool. Complaining that the tool we have isn’t working is kinda dumb, when there are trillions of dollars and millions of homes and jobs and the welfare of the entire nation at stake.
Even economists know that models are not all there is. Now, the fancy-pants kind of economist does tend to sneer at the up-and-down economist (as Krugman did when he used the term years ago), but up-and-down economists use leading indicators heavily, models less. Are we not aware of leading indicators of financial trouble? Rapid growth in credit. Persistent change in the flow of money between sectors or countries. Changes in finance to accommodate changes in the real economy. (I know, I know, that’s “innovation”. Last time I checked, financial innovation IS a leading indicator of financial turmoil.)
I wasn’t addressing what it is that economists should be doing concerning the ups and downs, or ins or outs of any market or sector of the economy. What the prognosticators have to say, or should have said, is immaterial to the issue of the financial mismanagement that occured and that caused a housing bubble to expand. I’m suggesting that we should be more concerned about the mismanagement of financial markets because such mismanagement has both intended and unintended consequences, none of which are likely to be good.
jack… look for “The Big Short”. sorry I don’t remember the author’s name. some people saw the idiocy of the game and bet against it and made lots of money.
fancy models are a way to avoid thinking.
I think you are agreeing with me. But I won’t tell anyone. But smoke and mirrors has been the way finance has been conducted in this country since the beginning.
No, not really. Fancy models are one way of thinking. Any of us, when we think only one way, are begging to be wrong. Fixation on fancy models may prevent us from thinking in other ways, but it surely doesn’t avoid thinking. Modeling is a form of discipline – disciplined thinking is something we need more of. Narrow thinking is not. There is a tension between the two that needs to be overcome. Good thinkers can do it. Others cannot.
Face it, it’s no longer a rent-seeking economy, it’s a scam-seeking economy.
Here is a good website for tracking expected prices of commodities and financial indexes: