Monday, September 14, 2009

Bubble Thoughts

I haven't posted for a long time, but it's not that I haven't made any mistakes. Indeed, I've participated to some extent in one of the biggest mistakes of my lifetime -- the market crash of 2008.

Personally, I did see the bubble as such, earlier than some...I sent a message titled "Housing bubble warning" on June 5, 2003. Was I prescient? No, I was just quoting the Economist of that time:

 This survey will conclude that the latest housing boom has inflated
 bubbles in several countries, notably America, Australia, Britain,
 Ireland, the Netherlands and Spain. Within the next year or so those
 bubbles are likely to burst, .... ... ... Significant numbers of
 owners may be left with homes worth less than their mortgages...  

After the quote, I closed that message saying
 And of course if houses are worth less than their mortgages, there
 might be bunches of trouble of various kinds. "Within the next year or so".

 Tom of-course,with-stocks-irrational-exuberance-kept-going-for-years Myers 
And I went on talking about it for the next few years, as I had talked about the original "irrational exuberance" starting around 1997, and I sold some real estate and urged people to read Shiller's second edition when it came out, and urged my son not to buy real estate (and he didn't), but I didn't foresee the crash. I didn't realize that the global financial system was betting trillions that Shiller was wrong.

It doesn't worry me that I didn't foresee the timing of the pop; I never expected to be able to do so, so I did not even think about betting against the market myself. ("The market can remain irrational longer than you can remain solvent.") It does bother me that neither I nor the experts foresaw the disaster it has become. If you'd told me in 2006 that we'd be having a banking crisis, I'd have said something like

"of course we have a real estate bubble, and when it pops we'll have a wealth-effect problem, perhaps a small recession, but people who run banks or investment firms know what Shiller has been saying and they know they've got to hedge against his being right, even if they don't believe him. I read a bunch of economists' blogs; they talk about the housing bubble, they're not talking about a crash."

In other words, I depended upon experts. There were some who kept on predicting one disaster or another, most notably Paul Krugman and Nouriel Roubini. They seem to have gained credibility from the meltdown and recession, but they both predicted a dramatic fall in the dollar as part of the meltdown they predicted. Krugman, it seems, has been predicting a dramatic fall in the dollar since the mid-1980s. Understandable, of course, but that doesn't count heavily as a prediction. As to Roubini, it doesn't really bother me that he "was one of those who predicted 10 crises out of three", but it does bother me that, like Krugman, "In 2004, he predicted that the oncoming recession would precipitate the crash of the dollar. The crisis has mainly buoyed it."

Of course the dollar still might fall -- it seems to me I put something about that in class notes (computer science, looking around for random examples of numerical stuff to model) of the late 1980s, and I may have been reading Krugman back then. For me it went along with a comparison of the savings rates of Americans vs. Japanese, as now it would go along with thoughts about our suddenly increased Federal debt, with the prospect of continuing increases. But the dollar didn't fall as part of the crash we're talking about, so the crash we're talking about is not the one Krugman and Roubini predicted. Or so it seems to me.

To a disturbing extent, I think expertise in (macro)economics has been discredited. I don't believe this is adequately answered by Greg Mankiw's

It is fair to say that this crisis caught most economists flat-footed.
In the eyes of some people, this forecasting failure is an indictment
of the profession.

But that is the wrong interpretation. In one way, the current downturn
is typical: Most economic slumps take us by surprise. Fluctuations
in economic activity are largely unpredictable....

Likewise, students should understand that a good course in economics
will not equip them with a crystal ball. Instead, it will allow them
to assess the risks and to be ready for surprises. 
Yes, but macroeconomists did not assess the risks, at least not correctly, and were not ready for surprises. We were all clueless. The academics, the legislators, the regulators, the raters, the financial moguls, investment advisors, ordinary investors... clueless. That's not good. So, do I have a theory? Sure. Lots of overlapping theories, and I think that each of them is probably somewhat true. More later.

Or then again, maybe not.

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