Anyone else finding it ironic that this article directly follows one touting Bernanke saying that the recession is "likely over?"

Oops!

@katstermonster: Yeah I got a good chuckle out of that, especially since I think Bernanke has it wrong.

#2 should, in theory be correct.

Regulators are supposed to keep information flowing, preventing unreasonable pricing from occuring.

The trouble this time is that the regulators stopped doing their jobs and risk was never properly evaluated.

The trouble with economics is that it is a science where theories hold up inside a vacuum, but because there is no true way to test them it is extremely difficult to nail down any universal formula.

@katstermonster: nice catch.

Speaking of catching, catch The Daily show yet?

Krugman considers himself an economist, does he not?

Why on Earth should we be listening to him then?

@MostlyHarmless: No...I haven't slept well in a month, and I finally sucked it up and took an Ambien at 10 PM and passed out as fast as I possible could. :( And I'm working 6-9ish tonight, so I can't even catch it on the replay! Dammit! I'm gonna try and watch it online at job #2 in about an hour...maybe...

There is a whole school of economics that actually got it all so very right. Any Economist who follows the Austrian School saw this bubble coming a mile away.

@Notsewfast: They all should, in theory, be correct. The problem is that economics is an art trying to pass itself off as a science, and, as you said, its theories are untestable. Because of this, the economist who shouts the loudest always wins, and you get the kind of ideological missteps that lead to the financial collapse.

Risks not being properly evaluated, is a great example of this. Wired, along with several other publications, ran articles earlier in the year about how the dominant formula used for calculating risk was fundamentally flawed, but despite warnings from saner minds, it continued to be used until everything came crashing down.

Paul Krugman is full of hot air, too.

Commodities DO price themselves according to available information ... as long as everyone in that market is paying attention only to that information.

If, on the other hand, they get together and decide to act based on external factors — say, consciously colluding to "game the market," or, by contriving to have it flooded with new money put in by novices whose understanding of the information is imperfect — then the commodity will trade according to those additional factors.

We've seen already that bubbles can be created almost at will, and unfortunately, there are always those who think they can keep any given bubble inflated indefinitely and thus profit handsomely from it, never acknowledging that, to date, no bubble has ever failed to burst at some point.

@Notsewfast: yes, but unfortunately many of these "exotic products" are not regulated simply b/c there is no one to regulate them. so, it's not entirely the fault of the regulators. when glass-steagall was repealed, congress wasn't smart enough to realize that they were leaving a huge gap in regulation & banks, insurance cos. & investment houses all jumped into that hole.

so, blame the regulators, but land a lot more of that blame on a congress that was stupid enough to think business could regulate themselves.

@Mr.Duke: Agreed, we spent an entire class today agreeing that he is a very smart person but also very wrong. Principally in his failure to differentiate between Economist with PHDs and those with only a Masters. Fanny and Freddie employ the PHDs who said this was going to happen but Barney Frank said deal in the mortgage packets. The funny part is that now Frank is saying we need more regulation to prevent problems that his own regulations caused.

@tekkierich: Yeah but the Austrians never talk to anyone besides themselves. Believe me I say this from experience, I go to George Mason.

@smartmuffin: Because Monday morning quarterbacks always have the answers.

@smartmuffin: Because he's had a pretty good streak over the past few years on predicting issues. No economist is perfect, but the ones that have a pretty good prediction rate should at least be listened to.

Full Disclosure: The National Review found a paper from 1982 when he was working under Reagan in which he predicted that inflation will be an issue and it ended up he was wrong.

With love and much respect to Dr. Krugman, but this was obvious even to me 30 years ago when I was a child.

Housing, college, health care have been increasing at rates 3 or 4 times inflation for decades, while wages have fallen. At some point, people are broke and the system collapses.

It does not require anything more than a child's grasp of basic math to see this coming. It's NOT THAT DIFFICULT if you THINK FOR YOURSELF.

Fuck!

Could you post a warning when a site you link to is behind a pay/registration wall? It's annoying to click on something and just get rejected.

@tekkierich: Tekkierich absolutely nailed it with that comment.

Wow, you condensed pages of text into 3 bullet points? that's helpful... really gives everyone an understanding of the article.

But, as for "Assets price themselves perfectly according to available information. "

They mostly do, but the issue isn't the pricing, the issue is what information is available and to WHOM. There might have been a few who understood the risks involving in sub-prime morgages and traunching, but the people actually buying the mortgages on their homes, or a lot of those investors buying the bundle mortgages as investments, didn't have the whole picture (either through apathy or inability). Asymmetric information within the market can create huge inefficiencies and can cause major issues. If everyone understood the risks of the product there wouldn't have been such an issue to begin with.

@mac-phisto: Funny how when individuals screw up their lives, everyone gets all "personal responsibility!!1!" but when companies screw up everyone else's lives, it's always the government's fault.

Congress and regulators aren't psychic, and in our country, the system is designed so that anything not expressly prohibited is permitted. Bankers came up with "exotic product" and rather than taking the time to understand it and use it responsibly, they ripped off the packaging, pushed a bunch of buttons, and got their faces blown off Wile E. Coyote style. This is 100% their fault.

I love this conversation.

I've worked in mortgage for the past decade, through the thick of the boom and resulting bust.

My friends think I'm uber awesome because they claim I predicted the bust 4 years ago. I disagree- while I did state that the real estate market was going to crash due to the gap between stagnant income and ever increasing home prices (read: unsustainable) I sure as hell didn't expect what happened, mainly because I believed banks were smarter than they really were and would not overleverage themselves as they did.

Anyways, with my fat mortgage salaries (heh), I put myself through school, and graduated second in my class in economics in May 2008.

What stands out to me is the lip service I had to give while going through my degree to the infallibility of the markets. Most professors I had were the ultra libertarian sort that would argue till they were blue in the face that there were no real inherent market failures, and thus little or no need for regulation and socialized ANYTHING.

Problem is, nothing meets the definition of perfect competition, and being an "everything should be free market" nutcase hinges on the assumption that you can structure perfect competition.

The key missing factor is information asymmetry. You cannot properly value anything without proper info, and this is the key. Investment firms kept buying mortgage backed securities because they didn't understand the product they were buying. Banks knew they were making terrible loans, but assumed the investment firms knew what they were buying and had correctly evaluated risk.

Borrowers assumed the market would bail them out, and assumed that the bank wouldn't have made the loan if they were not somehow capable of paying it back. I mean who gives away hundreds of thousands of dollars if they don't think it can be repaid?

The bottom line is, information asymmetry killed the market, and in the trenches were economists pretending that it doesn't exist and that the perfect competition models would properly predict what happened. Hmmm.

I had to sit on my hands while writing many, many of my policy papers knowing that if I turned in an essay questioning the infallibility of the markets to 85% of my professors, I wouldn't get the grade.

My term paper was explaining the many market failures that require socialized medicine (or alternatively, closing the emergency rooms unless the individual has cash in hand, and abolishing employer paid health insurance anyways). I bet that paper cost me top rank in my class.

They got it all wrong because they were all duplicitous! Do a Google search on "Goldman Sachs Rolling Stones". That pretty much sums it up for you.

"Assets price themselves perfectly according to available information" is a version of the "Efficient Market Hypothesis", sometimes known as the "Efficient Market Axiom". Another version of it is, "You can't consistently beat the market over time."

I first heard about it when I was writing some of the first general-purpose software for evaluating derivatives. It underlay the theory used to generate the algorithms I was implementing in software. As a chemist who had had real-world experience in other areas, it sounded like a load of unrealistic, theoretical crap to me. But when I brought up the reasons why to the experts, they kept giving excuses about why my reasons didn't count. Since my reasons were actually realistic and their excuses weren't, that was one of the factors which ultimately led to my getting out of that field.

As a scientist, I'm used to an approach in which you propose a falsifiable hypothesis, and then if you find one exception to your hypothesis, you have to modify it or toss it or otherwise go back to the drawing board.

Even without hidden information and market manipulation, Warren Buffett and Berkshire Hathaway are a glaring exception to the Efficient Market Hypothesis. Ergo, it's crap. But people seem to want to believe it anyway, and (what's worse) make economic, fiscal, and regulatory policy for the rest of us based on it.

The market is rational when you eliminate accounting acrobatics and poor lending decisions by banks, all created by government regulations.

When you eliminate government regulations in many areas (not all, there needs to be a legal frame work that does not influence the market, but only contains it with regards to illegal activity) and you would see the market is the most fluid and self regulating entity.

When you start to try and regulate certain fundamentals to fit your world view (increasing demand by relaxing lending practices, creating cheap money by lowering interest rates, creating new laws like The Community Reinvestment Act, and such) that's when the trouble kicks in and the market can no longer function naturally.

I'm not saying that the banks are innocent in all of this, they're as guilty as the government, but you can't give matches and gasoline to an arson and expect them to behave. The government created a nightmare by telling banks to start giving loans to people who couldn't afford them, and once saw that Fannie Mae and Freddie Mac were buying this bad debt, those two entities created a market for bad debt that mortgage lenders and banks were only more than happy to sell against, which in turn created insurance for this bad debt if it ever failed (anyone remember AIG?).

So asking the people who helped to create this mess to come up with ways to fix it is like bringing your car to same mechanic who screwed it up in the first place.

@Super Moose: They're too busy drinking their Fosters and chasing kangaroos.

@ARP:
Krugman predicted an imminent recession in 2003, 2004, 2005, 2006, and 2007. Former Enron Adviser Paul Krugman's track record on this issue appears to be as good as any other broken clock.

@ilves: Let's call it what it is: dishonesty. Goldman Sachs created this mess along with AIG and the Feds. Price didn't matter in the same way price means nothing in a casino. Everyone was dupped trying to make a buck while Goldman, Lehman, JP.Morgan, et. al. all made bets on both sides. Yes, it is this simple. You can confuse people with all the rhetoric and terms you want, but when the dust settles, it was a few powerful people making wild bets covering themselves with our money. If it wasn't mortgages/derivatives, it was commodities like oil. Go to Las Vegas and see how casinos make money while the people playing are losing. They all laugh and take the money, all perfectly legally.

@tekkierich: Um, the posters in craigslist's Housing discussion forums saw the bubble coming.
I saw the bubble coming.
Was this really a huge surprise for most people?

My guess is that it has to do with ivory tower academics getting their hands dirty.

@smartmuffin:

Because he won the 2008 Nobel prize in economics? Because he takes a longer, more holistic view at the system than the bankers and brokers?

@Anachronism: We need more people like you in the marketplace. I don't just say that because I'm a raging liberal, and I actually know very little about mortgages or the economy in general. What I do know is that we need people questioning the status quo in a meaningful, productive sort of way.

@smartmuffin: Because sometimes it takes one to know one?

Because generalizations are never accurate?

I'm patiently waiting for Americans to wake up from their American dream and join me in the American Reality.

Economists didn't get it wrong. Everyone I listened to including Ron Paul got it dead right! You people (those of you who named called and voted for liers) are just too stupid to listen to him and all the others. Oh.. he's a Paul tard... no you're a re tard.
I'm not even an economist so how did I know? Because I listened to the people who were telling the TRUTH and not the lying scum bags you listened to.

Yeah I'm mad, and you should be too. Wake up before your house is gone and you're family's living in a Fema trailer.

@tekkierich: A+ YOU ARE CORRECT SIR. Someone give this man/woman a freaking raise.

@gjones77: Can you point to the particular language in the CRA that says that banks must lend money to people who could not afford the mortgage? I keep seeing this reference, but I haven't been able to find that language. I DID find language in the CRA that says that banks can't discriminate against minorities or people who live in poorer areas (with all other factors being the same).

@henneko: except:
1) banks lobbied congress heavily to repeal glass-steagall for the very purpose of delving into these unholy products (read up on john reed/sandy weill & the citi/travellers merger).
2) exactly which banks got their "faces blown off" again? last i checked, banks were back to raking in huge profits, paying huge bonuses & escaped any real regulation that would curtail investing in the very products that brought about the collapse.

congress & regulators may not be psychic, but very few people outside of capitol hill & wall street saw the repeal of glass-stegall as a good thing. the regulators certainly weren't recommending it & eliminating the barriers within banking without eliminating the barriers between regulators was arguably one of the worst decisions congress has made in my lifetime.

@ARP: It ain't there. It's a talking point to wind people up about the evil government insisting banks make bad loans -- generally with the unstated assumption that loans to people with higher levels of melanin in their skin are all bad loans.

@mac-phisto: Good points. Although, saner people, including many economists, were alarmed about the regulatory black hole and the Too Big To Fail implications of repealing Glass-Steagall.
They were blown out of the water by the financial and mainstream press, though. Too much money to be made (snerk!) and too well-organized propaganda units (from the Chicago Boys all the way down) to compete. And, oh yeah, tons and tons of lobbyist money.
So there were many voices out there, Cassandra-like. But the corporate-backed ones won the PR battle.
Like 9/11 should make us never forget we're a part of an integrated, often different world, this other anniversary should make us never forget what happens when the Free Market Fundamentalist types hold sway. Never again to a bankrupt ideology.

@smartmuffin: Because he knows quite a bit more than you do?
@bloatboy: Yet he was talking about the same imbalances, irrationality and fatal system flaws the entire time you mention. The fact that his voice was accurate AND that he called it several years before it happened is actually something that thoughtful people consider a good thing.

@Super Moose: I'm quietly impressed you had the self-control not to mention ACORN.

@smartmuffin: Economists apparently have about as much intelligence as Joe Shmo. So its safe to say anyone can be an economist.

@hi: No single person would have prevented this. It doesnt matter if its Ron Paul or God, this situation has been building up for decades.

And one more thing, dont try to insult people you've never met.

People like you are the reason Ron Paul was shunned from the electorate.

@gjones77:

Not correct. Regulation is needed to force transparency to minimize the information asymmetry.

There is also the issue of agency holdup, in this case the executive vs. the instituition. The executive is hired to maximize profits for the instituition, and typically they are compensated in a way where their pay is based on performance. But the incentives really aren't alignged. When it comes down to it, without sufficient outside force, we have seen that many executives made the choice to grab short term profits to maximize their immediate bonus, at the same time taking insane risks long term, all to the detriment of the shareholders they are supposed to represent.

Regulatory limits that provide sensible rules on what amount of leverage is allowed, reserves, what constitutes sound lending policy help everyone in the long run, and create a solid base for the wonders of capitalism to play.

@katstermonster: Aww poor you...

Too much work?

@Trai_Dep: Wow. Not at all off-topic. Any chance you can dispute the facts?

@bobert: very insightful post (& well put).

@bloatboy: Krugman saw the housing bubble back in 2003 and predicted that it would eventually pop and cause the trouble we're currently living with. He continually published his findings warning about the bubble.

People like Greenspan and Bernake looked at the same data, came to the conclusion that the economy was "fundamentally sound", and proceeded to mock people like Krugman (for accurately predicting what eventually happened). Greenspan and Bernake let the housing bubble build and eventually pop. They then claimed that "no one could have seen that coming", despite the fact that several economists came to that conclusion.

Yet, to this day, Krugman is denigrated while Greenspan is exhaulted. Go figure.

If you want to know how/why this happened, and how to get the economy back on track, Google Peter Schiff and check out mises.org.

If you want to know how to keep our economy from correcting itself, keep reading Paul Krugman.

@t-r0y: Well, to be fair, he brought up Fanny, Freddy, Barney... He railed indiscriminately against people holding advanced degrees... ACORN was, I'm sure, on the tip of his tongue.
That was my only point. (we've covered this ground already, right?)