Courtesy of LSH’s resident econ expert, Nagasaki.  The rest can be found here.  He says its the best explanation he’s seen yet for what happened with the mortgage crisis.

Also, I’ve been reading a lot of people lately who wish to spread and water down the blame for our current economic predicament. Yes, the american consumer has a problem with too much spending and credit and not enough savings, but like one of my favorite right-wing-nut-jobs, Ross Douthat, says, there are hierarchies of blame:

So yes, the mistakes made at the top of the American economic and political pyramid might have been the same kind of mistakes made by people in the middle and the bottom, and might have been motivated by the same logic, and the same psychology. But they were made by people who had a far, far larger responsibility than the average American to be careful, and risk-averse and, dare one say it, wise … by people who, for the most part, came from the upper rungs of the meritocracy, with advantages arguably unparalleled in the history of the world … and thus by people whose risk-taking mistakes were worse than those made by the average homeowner or investor, because it should have been their business to be safer.

There is a pretty robust discussion about this over at the Atlantic Voices, involving liberal, libertarian and conservative writers.

Closed Circuit to Nagasaki:  Do you feel better now?

Well, now food, agriculture, and nutrition have moved out of the airy and effete realm of health and into the Real American, ‘Aw Shucks’/Horse Sense domain that even a Republican doesn’t have to be embarassed to discuss. Terry Gross of Fresh Aire fame recently did a great interview with Michael Pollen, who’s written a number of books in this area, including a very smart and controversial editorial in The Times that shows just how food production is tied up in more familiar topics:

After cars, the food system uses more fossil fuel than any other sector of the economy — 19 percent. And while the experts disagree about the exact amount, the way we feed ourselves contributes more greenhouse gases to the atmosphere than anything else we do — as much as 37 percent, according to one study. Whenever farmers clear land for crops and till the soil, large quantities of carbon are released into the air. But the 20th-century industrialization of agriculture has increased the amount of greenhouse gases emitted by the food system by an order of magnitude; chemical fertilizers (made from natural gas), pesticides (made from petroleum), farm machinery, modern food processing and packaging and transportation have together transformed a system that in 1940 produced 2.3 calories of food energy for every calorie of fossil-fuel energy it used into one that now takes 10 calories of fossil-fuel energy to produce a single calorie of modern supermarket food. Put another way, when we eat from the industrial-food system, we are eating oil and spewing greenhouse gases.

So if you’re interested in these topics, the interview is fourty minutes well spent, and the editorial is awesome, if long. Pollen’s work in general is eye opening and smart, the stuff educated Citizens should know.

People have a hell of a time changing things about themselves – that’s no secret. Want to be as hot as Brad Pitt? For most of us it’s not going to happen, at any price and through any effort. But what if it could? What if you could look like Brad Pitt instantly? And then, the next instant, you could look like George Clooney? Or whoever. If you make the scarce resource not scarce anymore, what would that mean for attraction, status, and desire?

I’ve been thinking about this for a story I’m writing. It strikes me that the closest you can get to answering that question (and yes, I realize it’s not close at all) is in online virtual worlds. You can make your avatar whatever you want. You can look however you want. Physical apperance doesn’t matter, or at least, it fails to matter in that way. Maybe it matters in other ways that don’t have to do with scarcity, or with other kinds of scarcity. Someone who plays these games will have to tell me.

But I’m trying to imagine what life would be like if we could physically remake ourselves completely. It’s a tough thing to imagine. Let me know if you have any ideas.

The failure of the Efficient Markets Hypothesis is, perhaps, an even more significant outcome of the crisis than the end of the Great Moderation.

The EMH implies that, provided governments get prices right (avoiding distorting taxes, internalising externalities and so on) it’s impossible to improve on the allocation of investment capital generated by private markets. The converse doesn’t hold automatically. Even granting that private markets are subject to bubbles and fads, and that their investment decisions may not make sense in the light of publicly available information, it doesn’t necessarily follow that governments can do better. Still, for large scale infrastructure systems, the case for leaving investment planning as, in Keynes words ‘the by-product of the activities of a casino’, looks a lot weaker now than in did before this crisis. Of course, for anyone who cared to look, the ludicrous investment decisions made during the dotcom boom had already undermined the EMH.

Once the EMH is abandoned, it seems likely that markets will do better than governments in planning investments in some cases (those where a good judgement of consumer demand is important, for example) and worse in others (those requiring long-term planning, for example). The logical implication is that a mixed economy will outperform both central planning and laissez faire, as was indeed the experience of the 20th century. I’ve written a more detailed version of this argument here here

For all my bitching and moaning, I believe the EMH gets it almost as close to right as possible; and when it doesn’t, I think the reasons it doesn’t have less to do with the fundamental chasm between rational and irrational behavior, but simple obfuscation. For instance: global warming, and the nations’ uniform lackluster response to it, is not a market failure anymore than a rained out baseball game is a baseball failure. Rather, the market never really got to have its say. If the externalities of energy consumption are so obscured that some people have no idea that they’re even there, well, you shouldn’t be surprised when there’s so much idiocy everywhere.

This happens whenever you isolate people from the consequences of their actions. Trust fund babies are fucked up weirdos because they’ve never had to earn a living and never had to deal with real people; the rules of the world, as they know it, are different from the rules of the world as we know it. Within their bizarro universe they are reasonable people; the problem is that their universe is a tiny subset of the larger universe. They’d all be just as fine and dandy as anyone else if the larger realities had been taken into account.

Is this just splitting hairs? I dunno. My point is that even in cases of “market failures” the first 80% of redress should be in making sure all the information required by the EMH is actually reflected in the market, not buried from ten levels of indirection in SEC filings, but right in front. A lot of people made some really, really stupid decisions because they honestly didn’t know any better. Fuck, if real estate gains twenty percent a year for the entire period of your awareness you’d be stupid not to buy in. You’re actually making a RATIONAL DECISION with the data you have.

And anyway, the market _is_ behaving efficiently, right now. Economic conditions were built on smoke and mirrors, and now they’re gone – that’s efficiency. If you find this sort of mega-efficiency to be too slow, or too clumsy, the first redress should be to reduce the grain of these giant market cycles. Give people the tools to be more rational and often times they will be. Creep carefully into the dangerous territory where the Government decides what’s the best economic policy, even a ‘hybrid’ policy, even one informed by behavioral- and neuro-economics.

(I wonder if I’ve ever written a post the legions of LSH readers have ever cared about less. Votes?)

Under questioning from Rep. Henry Waxman (D-Calif.), the committee chairman, Greenspan acknowledged that the failure of that expected self-regulation represented “a flaw in the model” he used to analyze economics. “I was going for 40 years or more on the perception that it was working well.”

Of course, this admission was roundly panned by Objectivists and their brethren in market fundamentalism, libertarians. And there’s the classic response that the guvm’nt is really the cause of all the market’s problems.This is how so much discussion of the markets goes, with free-market zealots expressing their faith in the omnipotence of markets, and market-haters making arguments that ignore the success of markets in dealing with many of the problems that face us today.

What bothers me is that there really is a lot of science being done on the kind of decisions real human beings make in economic matters, which is largely ignored in the media’s analysis. Behavioral Economics and Neuroeconomics are becoming well developed fields, and recent books (like Michael Shermer’s The Mind of The Market) provide accessible and fascinating analysis of these experiments (though that book has a baffling ending where Shermer relapses completely).

The author of another such book, Predictably Irrational, explains this in a way I though was really intuitive in this post. The post is short, so rather than explain it I’ll just inline it here:

I always found the appeal to the market gods a bit odd. Why would the market fix mistakes instead of aggravating them?  When the Chicago economists sometimes (reluctantly) admit that people make mistakes, they claim that people make different types of mistakes that will eventually cancel each other out in the market. Behavioral economics argues that, instead, people will often make the same mistake, and the individual mistakes can aggregate in the market.  Let’s take the subprime mortgage crisis, which I think is a great example (but a very sad reality) of the market working to make the aggregation of mistakes worse.  It is not as if some people made one kind of mistake and others made another kind.  It was the fact that so many people made the same mistakes, and the market for these mistakes is what got us to where we are now.

A statement like this can enhance your understanding, be falsified, etc. Either way, it isn’t simply an assertion of faith or hatred. It’s a nuanced view, which is what the truth almost always is, especially when dealing with a complex emergent system like the market. Why aren’t we hearing more from the behavioral and neuro- economics people during this downturn?

California Gov. Arnold Schwarzenegger, alarmed by the ongoing national financial crisis, warned Treasury Secretary Henry M. Paulson on Thursday that the state might need an emergency loan of as much as $7 billion from the federal government within weeks.

The warning comes as California is close to running out of cash to fund day-to-day government operations and is unable to access routine short-term loans that it typically relies on to remain solvent. The state of California is the biggest of several governments nationwide that are being locked out of the bond market by the global credit crunch.

And this while we are still awaiting the House bail-out vote.

I guess we better start printing more money.

Democracy is the theory that the common people know what they want, and deserve to get it good and hard.

Resisting peer pressure isn’t pleasant. The banker who insisted on a 20% down payment for all mortgages got less business during the bubble and was seen by his colleagues as a burden on the bank and an obstacle to helping customers. The regulator who insisted on a 20% down payment for all mortgages was seen as denying the poor the good investments that were available to the rest of the country, and as an obstacle to home ownership [...]

I can imagine the caterwauling so vividly that it might as well have happened right in front of me: outraged liberals calling down the wrath of God on the evil, corrupt institutions that are keeping the poor from owning houses and getting their slices of the American Dream.

Now, my hands are clean on this crisis. I wasn’t borrowing in recent years, for mortgages or anything else. But I was absolutely just as much a fucktard during the great mass hysteria of the late 90s. Fortunately I came out ahead on that one, but if you eliminate the one big win I had, which was based on pure dumn luck and nothing more, then I just broke even.

I know a lot of fucktards. Most are not bad people, nor stupid. Maybe the guys running the universe are just like me and my friends, only richer.

Normally this would have been bad for both the homeowner and the guy who wanted to get paid for his hamburger, which might very well be the mortgage lender, but not really a big deal for you or me. (If enough of this occurred, of course, it could lead to a general slowdown and hurt pretty much everybody.) But this impact was magnified by the fact that most of the mortgage lenders sold the right to the payments under the mortgage to third parties. These third parties broke up the rights to the payments from the mortgages into lots of little pieces, combined these pieces with the rights to payments for little pieces of lots of other mortgages, repacked these in “creative” ways, and re-sold them to fourth, fifth and sixth parties. Four, five and six then used these promises as their own equity in order to raise further debt of their own. This would be like you using an IOU from your neighbor as your down payment for a mortgage. So when lots of these over-leveraged homeowners started to miss mortgage payments, parties four, five and six had less money than they expected, and they had problems making their own debt payments if they themselves had taken out enough debt. Oh yeah, many of these debt contracts are in fact between parties four, five and six.

Unfortunately for you and me, parties five and six are the financial institutions where we have our life savings deposited.

Shouldn’t Wall Street know better than to ride the bubble this far down the drain?  I’ve always been told the glorious market would prevent stupid or poor behavior through the idea of “moral hazard.”

And now the consequences of doing nothing:

If investors lose confidence in the safety of money market funds, mutual funds, demand deposit accounts and the other storehouses of value in the modern economy, we would have a problem that would make somewhat higher taxes and moral hazard seem like child’s play. Trust me – you do not want to experience a full-scale bank run in contemporary America. I’m not sure how many people realize how close we were to the wheels coming off at about noon yesterday, as major commercial-paper processing banks like State Street lost 30% – 60% of their value in about 2 hours. Want evidence: When was the last time you heard of the U.S. government identifying a problem, developing a multi-hundred-billion-dollar program and announcing it within about 48 hours?

From everything I’ve been reading, a bailout of some sort seems necessary – the only question most people seem to have is about giving away a blank check and getting nothing in return.  But I do know there are commenters who know a lot about this stuff.  Maybe they could find the time to let us know what they think about this article?

And lastly, one thing about all this stands out – there are many different and competing strategies about how to handle this crisis.  So many so, that it seems ludicrous to imagine it doesn’t matter which path we choose because they all end in the exact same clearing.  

Just more evidence, if the last 8 years weren’t enough, that it matters who wins elections.