We’ve only just begun
on September 19th, 2008 at 9:53 am
I’ve had a couple of very enjoyable chats this week with Red Symons, on the ABC Breakfast Show in Melbourne, and some friends have been trying to get me to throw some old Skyhooks song lines into the conversation–such as “Horror Movie” and the like (for any non-Australian and/or non-”Living in the Seventies” readers, Red was a guitarist–and played drums on the one occasion I saw them live, at Sydney University’s Union Building in the early ’70s–and lyricist; here is a link for the lyrics).
Though they’re definitely apt, the piece of 70′s music that most came to mind when I spotted this new feature on the US Federal Reserve’s website this morning was from The Carpenters (which in contrast to The Skyhooks, was not one of my favourite bands): “We’ve only just begun“.
It’s an interactive map of the subprime and alt-A mortgage catastrophe in the United States. The numbers, which are also available for download as Excel spreadsheets, are simply staggering.
The scariest part of the data relates to what are known as ARMs (“Adjustable Rate Mortgages”)–fixed rate mortgages that began with a “teaser” low rate, and then reset after a number of years to a higher rate (the standard US mortgage is a fixed rater, unlike Australia where variable rate mortgages are the norm).
Of the almost 3 million subprime loans (the precise number is 2,919,604, representing 2.5% of America’s 115,904,641 housing units), almost 2/3rds are ARMs (the national average is 62.9%), and just over 30% of them will reset to the higher rate in the next 12 months (with another 10% to follow over the next two years).
That’s why this crisis has “only just begun”. There are two sides to this catastrophe, and whatever is done about it, one side or the other is bankrupt.
IF the ARMs go ahead, then the number of American households that will go bankrupt is at the minimum 1 million–because there’s no way these borrowers can pay the higher rate. At the simplest scale, this is because the rates will rise from an already high average rate of 8.8% to a usurious 14.8%. But on top of this, the effective rate for the loans throughout has been the higher rate–and the gap between this and the initial teaser rate was capitalised onto the debt.
So a borrower who took out a loan in 2006 of $183,900 (the average subprime loan size–note by the way how small this is compared to median Australian housing loans), and whose loan resets to the higher rate next year, will go from paying 8.8% on 183,900 to paying 14.8% on $219,200–a doubling of annual interest payment commitments, from $16,180 to $32,440.
This for a cohort of borrowers who are already massively behind on their payments–though not as massive as it will get (currently 10% are behind 30-60 days, 5% 60-90 days, 10% 90 days plus, and 11% are in foreclosure). There’s no way they can manage this: they are, as the Americans put it, “toast”.
But what if they are freed from this obviously onerous burden by legislative fiat? Then the people and institutions who bought the residential mortgage-backed securities (RMBSs) that these mortgages finance are “toast”: the bonds will be next to worthless.
And it won’t end there. After the subprimes come the “Alt-A” mortgages–ones not high enough grade to qualify as prime, but above subprime in past credit history. There are roughly 2 1/4 million of them, with much higher debt levels (average of US$321,000), lower average interest rates (6.6%), currently lower default rates (5.6%–half as many in foreclosure as the subprimes), and lower levels of arrears (just over 10% behind, versus 25% of the subprimes).
But just over half of them also have ARMs, and about half of them are scheduled to reset to a 3% higher rate in 2010 or later. By then, economic conditions will have deteriorated so much that their own finances will be “subprime” at the time, and the snowball will continue rolling down the Highway to Hell.
So We’ve Only Just Begun. And it is a Horror Movie, though not “right there on your TV”–if you’re American, you’re living in it.
And if you’re not American, then it’s still almost guaranteed that some of your investments will suffer–whether indirectly if you own shares or property, or directly if you or an agency that affects you purchased the RMBSs that funded the subprime scam. You may well wish that you were still “Living in the Seventies“.
Oh well now an hour or two after the first post did not show, they are all there. Please fell free if possible to clean them up to just the last one. Thanks
David and others
One big problem that I see is that Australia has enormous foreign debts which cannot be paid off with Australian dollars. We have also destroyed our ability to earn enough foreign currency for our continuing needs let alone pay off any debt. The debt boom is larger than the mining boom but that is being ignored. Along the way we have sold off most assets. Our ability to service the debt faded several years ago and our ability to borrow the necessary interest payments has reached it limits. We now have no ways to further distribute this debt and spread the burden of servicing it across the community. The creditors are also realising that they have “done their dough”.
The US situation is similar but they have the de-facto world reserve currency and have been more creative in creating dodgy financial “instruments”,”securities”, and “derivitives”.
We need to blame the culpable, the “Economic Rationalists”, “and Neo-Classical Economosts”. Their “Free Trade” policies have not resulted in free trade but purchase on the never never. It has been neither free nor trade. For several decades now THEY have devised and operated the world’s first CARGO CULT for their own benefit and the detriment of the world.
They deserve to be indicted not rescued.
BrightSpark,
This is entirely the beef that Steve has with the economics profession: neoclassicism doesn’t lend itself to helping economists and others to understand how markets operate in the real world. Most of Keen’s critique can be found in his book, Debunking Economics (2004), apart from various other journal papers and PowerPoint presentations.
Given the current backlash against neoclassicism, for example, as embodied by the Post-Autistic Economics Network (http://www.paecon.net/), I wonder how long the prevailing doctrines will continue to be preached within the economics departments.
It is well worth reading the journal paper: McCauley (2006) “Response to ‘Worrying Trends in Econophysics’”, Physica A, 371, 601-609, to gain an insight as to how economic theory can change for the better.
The conclusion is a classic:
“The real problem with my proposal for the future of economics departments is that current economics and finance students typically do not know enough mathematics to understand (a) what econophysicists are doing, or (b) to evaluate the neo-classical model (known in the trade as ‘The Citadel’) critically enough to see, as Alan Kirman put it, that ‘No amount of attention to the walls will prevent The Citadel from being empty’.”
“I therefore suggest that the economists revise their curriculum and require that the following topics be taught: calculus through the advanced level, ordinary differential equations (including advanced), partial differential equations (including Green functions), classical mechanics through modern nonlinear dynamics, statistical physics, stochastic processes (including solving Smoluchowski–Fokker–Planck equations), computer programming (C, Pascal, etc.) and, for complexity, cell biology. Time for such classes can be obtained in part by eliminating micro- and macro-economics classes from the curriculum. The students will then face a much harder curriculum, and those who survive will come out ahead. So might society as a whole.”
Phil
I would like to add, Feedback control theory, including Laplace transforms (part of DE theory) and Nyquist stability theorem. Also the sampling theorem and more depth in statistics than is currently covered in “econometrics”.
BrightSpark,
There are certainly a lot of alternative schools of thought that could be brought into economics departments, including those that have traditionally remained outside of economics. Some would be econophysics, complexity theory, system analysis, evolutionary theory, sociology, and some of the more well known ones such as Austrianism, Post-Keynesianism, institutionalism, etc.
You would think that pluralism would be a requirement in economics departments given the numerous other schools of thought, but no. I wonder as to how neoclassicism monopolized teaching of economic theory around the world – certainly not on its merits, that’s for sure. Probably the worst part of neoclassicism is it’s adherence to unrealistic assumptions, while at the same time it’s practitioners claim they don’t distort the underlying models.
It’s interesting to look back at the last 30-40 years since the emergence of neoclassicism and see that under its guidance, the rich are much richer and bubbles/crises are occurring more often and are much larger in size. Probably the major reason for the third world being the way it is, is because of neoclassicism’s “not so invisible hand” working it’s magic there, while first world countries develop by making select violations of neoclassical free market theory.
On this note, Ha-Joon Chang’s “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism” (2007) should be a good read.
BrightSpark, Phil and others,
I wonder, could this be a simple start. 1=1, 1 does not equal 20 does not equal 20×20 does not equal 20x20x20x….
This is my immediate thoughts with no claimed authority, and may or may not be useful. While a good logic and scientific base would be useful background for economics, as any engineer knows the simpler the system the more reliable. I think this situation is not complicated at its root and is all about super low interest rates and multiple credit and a false assessment and management of risk based on a limitless principal of expansion. Perhaps it is too late but if we can we need to look at what society is about and protect the community and keep ‘main street’ functioning. Regarding housing, at the end of the day the banks are the mortgage home owners who took the RISK and BENIFIT of inflated house prices. They need to take responsibility and what government intervention should occur should be directed to those who acted in good faith of a stable market, that being depositors and home owners (not multiple house speculators). So here are some ideas for crisis intervention to pick holes in before or incase we find ourselves where the US in right now: Create a government socialized bank with specific tasks. Change the law so people cannot be evicted from their homes. Let asset prices and weak banks fall, and have bankrupt fire sales (or at least assess on that basis), but give homeowners or renters first choice to buy their own mortgages/homes at the fire sale prices by borrowing from the new socialized bank. Protect reasonable individual deposits by insuring they will be covered in the new socialized bank after any bank failures (this should also assist against risk of bank runs and limiting to reasonable scale withdrawals could also be considered). Scrap the central bank or at least broaden representation and constrain it to rules that require lending to be consistent and responsive to GDP growth and offering reasonable interest on savings to make this a positive choice rather than seeking speculative destructive alternatives. Directly finance ‘main street’ projects at reasonable interest rates from the new socialized bank and use its profits to finance infrastructure and social needs. Also tax any foreign investment at high rates to offset the carry trade of low interest overseas borrowings and that well compensates loss of local opportunity value, particularly in resources and land real-estate.
Once stable, review. but particularly constrain future banks to a community responsible charter and from adopting complex risk models in the name of profits. Certainly what ever future economic model, have it account for size limiting instability/failure principals that occur in any physical system.
David,
A number of interesting ideas there, though it should be noted that financial markets are intrinsically unstable, despite what the neoclassical doctrine states: equilibrium, rational exceptions, etc.
It was the promise of the Internet: that information could be transmitted instantaneously around the world, thus leading to increasingly efficient markets. But because markets are intrinsically unstable to begin with, what the Internet has done is to transmit information faster, which amplifies the irrationality of inefficient markets to astronomical levels.
This is precisely why neoclassicism needs to be thrown out: public and private policy is based upon economic models that are about as useful as an astronomical model of the solar system with the sun, moon and gravity missing.
Neoclassicism can’t even get the basic supply-and-demand model for the product market right: empirical studies (Eiteman and Guthrie 1952; Blinder 1998) have shown that the vast majority of firms (> 85%) have constant or falling marginal costs. Thus the supply curve should be either horizontal or slightly downward-sloping. Making P=MC is a recipe for bankruptcy across many industries because the model of perfect competition ignores fixed costs. One can only imagine how the rest of the neoclassical models are flawed.
In regards to the looming housing crisis in Australia, it is literally mind-boggling that the RBA officials and conventional economists have missed the massive housing bubble. The RBA sees wage inflation (the domain of workers) everywhere and anywhere and will immediately take actions to clamp down on it, but totally misses asset inflation (the domain of the rich). The U.S. housing bubble reached $US8 trillion in paper wealth before it collapsed. No Fed official noticed this. Typical replies are “how could we know”, “what could we have done”, “I didn’t see this”, etc. No doubt the RBA will act this way as well.
The U.S. economist Dean Baker wrote a paper in 2002 noting that the U.S. was in the midst of a growing house bubble, yet the Fed officials have access to 1000 times the data anyone else has. You would think that conventional economists would think twice about their theories (for example, the efficient market hypothesis) when bubbles and crises are becoming more common and astronomical in size.
Apart from political science, neoclassicism is probably the leading pseudoscience taught in universities these days.
Some of the above ideas are very interesting. I would add one item to my list of things to study in economics: Common Sense.
The S&P had huge, complex computer models showing how AAA rated tranches of CDO’s and CDO^2 were bullet proof. The world of derivatives was meant to decrease risk by enabling counter parties to spread risk throughout the system. Buried somewhere in here was a complete lack of worry about the person actually paying the debts back. I guess that didn’t matter so long as on paper the risk could be explained away with a computer model. Even more amazing, financial institutions must have believed it or else they wouldn’t be in so much trouble! They could have just made money off transactions on this toxic waste. Instead their books are riddled with the stuff. And now the solution is to give these complete morons a handout?
The amazing thing is that people actually believed the fundamentals were strong and that this heralded a new era of “asset prices at a permanently high plateau”. Such simple concepts were not grasped by most main stream economists. A few predicted it (Steve Keen being one). Our hats must go off to them – they must surely get a big say in how to move forward.
Guys Like Paulson and Bernanke on the other hand are complete Muppets. Not once did I hear them predict anything correctly. Two weeks ago, we had a “sound financial system”. Today it is “Bailout or Financial Armageddon”. Amazingly, we are trusting these guys going forward. The definition of stupidity is doing the same thing over and over hoping for a different result. I am sure next year we will be just one more trillion dollar bailout away from reviving that housing market.
JHill, just one clarification with the 500 Trillion of debt (including derivatives). The issue with derivatives is that the same underlying asset is used over an over in multiple derivative transactions, so although the number looks high, it doesn’t actually represent a number that the world is on the hook for. The problem with derivatives is that everyone thinks it spreads risk, which I think meant that institutions were willing to take on more risk. Essentially what they have done is increase systematic risk to a point where the entire financial system is at risk and not just a few key organizations. This is exactly why we are seeing so many companies go under. Buffett summed it up best: Financial weapons of mass destruction.
Phil
That this garbage is being preached at publicly funded universities is a travesty of logic even the neo-classicals’ prophet would not own them. He would also be very disappointed that they only noticed his “invisible hand” which he only mentioned once in his “Wealth of Nations”.
On the supply and demand “Curves”, I think that they are way out. “Economies of Scale” predominate for most manufactured on mined commodities. The curves are not just slightly downward sloping. They also vary with time as the commodities go through various cycles. This is fully understood by the Engineering disciplines involved in manufacturing and mining. The turkeys choose to use only the terminology of Engineering (gearing etc.) and none of the wisdom.
This also ruins their “Principle of Comparative advantage” consigning it to the realm of economic science fiction. Flaws in their theories abound but it is not possible to argue with them because their logic is their theory is their logic etc.
The instability is largely caused by parasitic feedback loops which could be eliminated by government regulations. I note that the turkeys have identified and got the governments to eliminate one of these (caused by short selling). Other techniques such as compensation in the other loops (they have not yet noticed these) could improve stability.
Emil,
I agree that these officials are morons, and yet they are educated at the most prestigious universities (Harvard, MIT, Chicago). Interestingly enough, these are the grand temples of neoclassicism, where the high priests must ensure that nothing else is taught. Sometimes glimmers of hope appear, but it is extremely unlikely that any other school of thought will be able to penetrate the intellectual fog any time soon.
On Henry Paulson’s idiotic comments throughout, this timeline graphic from the NYTimes lays it out (http://www.nytimes.com/imagepages/2008/09/20/business/20080920_PAULSON_GRAPHIC.html).
If blame can be laid at anyone’s doorstep, it’s Greenspan for letting the housing bubble build on his watch at the Fed. Fed officials are hawks pertaining to wage inflation, but are totally blind to asset inflation. It thus becomes obvious that central bankers are very ideological in how they perceive the economy in this respect. The Fed may state that they have limited tools in manipulating the economy, but their most effective by far is the loudspeaker: when the Fed speaks, everyone listens.
The Fed could’ve taken note of the housing bubble way back, as Dean Baker did (http://www.cepr.net/documents/publications/housing_2002_08.pdf), but to no avail. The U.S. housing bubble could’ve been stopped in it’s tracks years ago, with a minor bubble deflation, but it was allowed to grow way out of all proportion. So far the average U.S. residential property has lost $US110,000 in value, and still has a long way to go before it reaches it’s long run averages, that is, tracking the CPI – as Robert Shiller’s work has shown.
Australia is totally screwed in this regard, but at least the federal government is running a budget surplus, which will be used to pump-prime the faltering economy.
BrightSpark,
I assume that when you say “parasitic feedback loops”, you mean economic functions that result in downward spirals?
You’re right about the neoclassical travesty, Adam Smith would be rolling around in his grave should he know what is been done in his name both within the university and business sectors. He mentioned the “invisible hand” only once, and neoclassicals have given it such importance, raising it to the level of the holy spirit. Essentially, this means that whatever the outcome is in the economy, the “invisible hand” must have determined it, so therefore it is correct. Until it hits a roadblock, that is, the rich suffer, so they must go running to the nanny state (http://www.conservativenannystate.org/cnswebbook.pdf), for all sorts of protection as we see now in the U.S.
The market will only be stable again once everyone is sure that this mess won’t get any bigger. The problem is, no one knows how big the mess is, or which mop to use to wipe it up.
So far, Sub-Prime and Alt-A loans have been identified. The biggest question is – what about ‘prime’ loans?
This Federal Reserve bail out only really covers off the expected losses from Sub-Prime and Alt-A, but in reality I think we will see just as many losses from ‘prime’ loans over the next 5 years.
In times of a recession or economic downturn, do large corporations get rid of the subprime blue collar worker at the bottom, or maybe some of the ‘prime’ white collar fat sitting in middle management? Usually the middle management fat is trimmed first.
Working for the Australian operation of a large Michigan based American automaker, they have just announced over the last month that they are going to eliminate roughly 15% of their white collar workers globally. I very highly doubt that many of these white collar workers would be binned in the subprime category.
The same thing is happening in Australia. ANZ has eliminated 500 middle management roles and Telstra has eliminated even more then this. This goes on top of the many thousands that are being eliminated silently one by one by SME’s. In further detail, I would argue that whilst the overall employment figures are still looking good in Australia, the amount of jobs in the 80k-120k p/a bracket would have most likely signifcantly declined in Australia in the last 12 months.
In both countries, a large portion lot of these people are now working for a lower salary or could be unemployed ( many people refuse to accept a lower pay level ). The reality is that a lot of these people have debt commitments based on earning a ‘middle management’ wage. Many may have savings to tie them over for a while during tough times – but what happens when this runs out?
The biggest unknown right now is the risk on ‘prime’ loans in both Australia and the U.S.
Phil
About the feedback loops, I am using terms from Engineering. I am an Electrical Engineer. By “parasitic” I mean unintended but predictable. The loops which cause trouble are the ones which are positive and increase the effect of the input stimulus. For example short selling, any selling, reduces the price of securities and this rewards the short selling process and encourages further short selling. The housing bubble was caused by a very similar positive feedback loop.
These effects are well understood in Engineering which takes into account all factors including time. However to learn and understand this you need to be able to understand very advanced mathematics (well beyond current economics curricula) including Differential Equations and Transform Theory. Compensation can include such factors as reduction in loop gain, and forced delays. The aim of compensation is to create stability. These principles are used in Aeronautical Engineering as well. In EE we deal with time constants down to less than a picoecond and in AE they have time constants up to seconds. In economics the time constants seem to range range from hours to years. The internet has provided a “parasitic” influence by reducing total time delay in some of these loops. I have not been able to discover any application of this control theory in economics. Adam Smith did write about some of these feedback effects. The Neos seen totally unaware of all of this. If this were not fully understood we would not have the Internet and we would not have safe passenger aircraft.
What really make me laugh is that the sacred “Invisible Hand” is not in the conclusion and is heavily qualified by Adam Smith in the sentences which follow it’s mention. I read right through his book and missed it! I later found it using a search on the project Gutengerg release. It’s what is not called “spin”.
Phil,
Certainly you identify practices and ideology that create instability but I’m not sure it is a truism to say “financial markets are intrinsically unstable” except we may not be able to have independent financial markets but rather ones inevitably played by the ‘invisible hand’ of vested interests that make them intrinsically unstable.
All may not be as it seems and vested interests as you identify and global maneuverings (carry trade as example) may play a part in all this and we should not assume it is just the result of officials folly. On how enlightened the Fed and co was, I repeat the critical historical words of Alan Greenspan.
“The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. …As a result, the American economy collapsed.”
(Greenspan 1966, as stated by Mike Whitney, reference above)
BrightSpark,
“For example short selling, any selling, reduces the price of securities and this rewards the short selling process and encourages further short selling.”
I’m not sure I agree with short selling, however, does it not attempt to balance to the same buy process dynamic.
JHill – I have to agree with your last post. I know lots of people who are highly geared with multiple investment properties who are relying on capital appreciation.
The bubble is already bursting in Oz at the fringes – how widespread it becomes hinges on jobs in the middle-high income brackets.
there is also the ‘cashed up bogan’ (no offence intended) phenomenon, which you would expect has been largely linked to the home renovation boom. As this peters out there could be many tradies left stranded.
David,
While vested interests do exist, it is becoming ever more apparent that financial markets do not work according to the neoclassical synthesis as found in conventional textbooks. It is not just the folly of the officials but mainly that of neoclassicism.
The assumptions behind the economic and financial models are horrendous: “homo economus” borrows unlimited amounts of money at the same interest rate as everyone else, has the same expectations, can “know” the future, and plans everything at time = 0. If these conditions can be met, then yes, markets are stable as the models suggest. But guess what? These assumptions are insane and aren’t found in the real world.
It will help to read Keen’s Debunking Economics (2004), especially Chapter 11: Finance and economic breakdown – Why stock markets crash.
Maybe the two relatively new schools of economic thought, neuroeconomics and behavioural economics can help?
BrightSpark,
You’re right about the passage of the “invisible hand”. It reminds me of the passage early in The Wealth of Nations where Smith is describing the efficiency gains of the division of labour in the pin factory. This is heralded by conventional economists as to why the modern corporate division of labour is so wonderful. Unfortunately, the cheerleaders don’t preach what Smith says soon after: that the division of labour is a form of mental mutilation and that the government should intervene to save the workers. Interesting, isn’t it?
JHill,
You certainly make a good point there, as commentators seem focused only on the subprime mortgages, rather than the Alt-As or primes. As Keen points out, strife will befall the U.S. once again as the ARMs reset to their higher rate. Once the economy sinks (as it will also do in Australia), then even the comfortable middle and upper classes with mortgages will face problems. The average mortgage in Australia is larger than that of the U.S. I guess that only time will tell, but we can make some elementary predictions based upon the economic and financial data.
David
On the short selling parasitic loop.
It does apply to buying and both give positive feedback increasing the effect of the stimulus. May be another form of compensation would work better.
Also buying may have less loop gain than short selling. This would need to be investigated. My guess is that the loop gain for any selling can rise dramatically at the time of a market crisis so compensation may be needed for normal selling.
Hi Steve,
Long time reader, first time poster! Well done on such a great website. I really enjoy reading your views & feedback, keep it up.
My open question to everyone is this: Do you really think that governments globally and locally will allow the real estate (and asset inflation in general) fall?
It seems to me that too much of a vested interest exists in society today for a ‘natural correction’ to take place.
My take on the current situation is that for every problem created, a ‘nice’ solution will be conjured up (whether it is fair or equitable is another matter!). It is my belief that we are already seeing this as taxpayer funds are handed out recklessly to avoid a meltdown. What will come next? Access to superannuation funds? Where are the lawyers at the moment?
I just cannot shake this feeling that no matter what happens, a solution will be sought to protect the vested interest of a lot of greedy people who have binged on debt (but also a lot of innocent people caught in the crossfire). My view is that the house of cards is too tall to fall and the governments know this.
All the best with your work Steve & the many others who have contributed!
I hadn’t really thought of the ‘cashed up bogan’ mindset too much. In times of economic recession the tradesman types are still required. For it is these people that add value to society and actually possess a formal tangible skill. The biggest hit you are going to see is in the business/finance world. There are a lot of middle managers in the finance and banking industry that ‘add little value’. Yes, they may be able to analyse a balance sheet, or manage people, but alarmingly many of them do not possess a formal qualification.
So long as the government continues to invest in infrustucture projects, and people still need essential services, and there is a shortage of people qualified to work in that industry, the ‘cashed up bogan’ types are most likely in for a softer landing.
It is a lot of these middle management types that have three of four investment properties and are dependant on two middle-income wages to support them.
The other thing to consider is that there is the obsession with property mindset. When he was 21, his father assisted him as guarantor and he bought a property. This person was ( and still is ) on a minimum full time wage – around $30,000 per annum. He has a mortgage of over $250,000 and can only afford the loan repayments because he is able to rent out the other two rooms of the 3 bedroom property. There are a lot of people out there in Gen Y that may be repaying property, but are relying on other people renting to pay it off for them.
The most dangerous thing I have noticed looking at my Gen Y friends is that those who can ‘least’ afford it have been encouraged to invested in property. Those that earn substantially higher incomes and are better educated are still living with their parents or renting. Whilst there is no doubt there is a debt bubble in Australia, it is heartening to know that there are also a number of Gen Y that have taken the good times the economy has enjoyed over the last couple of years to stockpile some serious cash.
Allow me to recommend Chapter 8 of Studies in Mutualist Political Economy, “Crisis Tendencies”, which can be read here: http://www.mutualist.org/id79.html
In fact, the whole book is pretty interesting.
“The direct intervention of the state on behalf of corporate elites becomes ever greater, and impossible to conceal. This fundamentally contradicts the official ideology of “free market capitalism,” in which the state simply acts as a neutral guarantor of a social order in which the most deserving win by their own efforts. Therefore, it undermines the ideological basis on which its popular legitimacy depends. Thus, parallel to the fiscal crisis of the state, state capitalism likewise moves towards what Habermas called a “legitimation crisis.”
According to bourgeois conceptions that have remained constant from the beginnings of modern natural law to contemporary election speeches, social rewards should be distributed on the basis of individual achievement…. Since it has been recognized, even among the population at large, that social force is exercised in the forms of economic exchange, the market has lost its credibility as a fair… mechanism for the distribution of life opportunities conforming to the system.
When the state capitalist system finally reaches its limits, the state becomes incapable of further increasing the inputs on which the system depends. The fundamental contradictions of the system, displaced from the political/administrative realm, return with a vengeance in the form of economic crisis. The state capitalist system will reach its breaking point.”
Phil,
Perhaps I am out of my depth here but I make no defense of such models that are applied to a market, but they are not the market, which would it be right to say might be considered at its fundamental, is the exchange of stuff at an agreed value of money or stuff? The stock market may be another story.
Also, I don’t think economics can be independent of ideology or politics and hence as a principle, ideological and political underpinnings and motives need to be explored in an attempt to understand any economic model. I should add you show considerable awareness of this.
BrightSpark,
“Also buying may have less loop gain than short selling”
Are you including credit expansion in the above opinion?
David,
I agree with your idea, and I think that economics degrees should integrate more history and politics, especially the history of economic thought and economic history. These days, barely anything pre-1970s makes it into the classroom. Classical liberals barely get a mention, which is usually something about the grandeur of Smith’s “invisible hand” and “division of labour”, Ricardo’s “comparative advantage”, etc.
The main problem of conventional economic theory is that it sees the economy (product, labour, and capital markets) as being in a state of equilibrium and therefore stable. However, reality shows that the economy is in the process of dynamic disequilibrium. Then the neoclassicals come along who advise the public and private sectors, essentially creating policy that tries to force markets and firms into the mould found in textbooks. But reality is far different from these neoclassical models and thus the economy becomes buggered. The models are far removed from reality and nowhere near complex enough for economists and others to see how a market capitalist economy truly works. That’s why economics needs to be reformed, in part, by introducing physics, engineering (as BrightSpark has mentioned), hardcore mathematics, and so on.
It’s not going to be the political economy group that can reform things, but the more mathematically-oriented economists who can employ their craft to correctly model markets properly so as to create much better policy.
It’s interesting to note how the current events in the U.S. are seen as a crisis of capitalism now that the wealth of the rich is now threatened. But during the “good times”, the top 1% own 48% of productive assets, 47 million citizens don’t have health insurance, wages for the bottom 80% of workers actually peaked on a per-hour basis back in 1972, hedge fund CEO John Paulson was compensated $US3.5 billion for a year’s work, and so on, and yet this isn’t seen as a crisis of capitalism, but how it is allegedly functions.
Once static analysis is thrown out and replaced with disequilibrium dynamics, economists will have a much better idea as to who earns what, how markets price this, that and the other.
Big Game Hunter,
To answer your question, even if the governments wanted to act and prop up the real estate bubble, they will fail. The value of the stock of real estate is measured in the trillions of dollars, yet what the government can yield in terms of subsides and other forms of intervention will be tiny in comparison. I can’t imagine any government putting a price floor on housing.
Worse still, it is likely that the housing market will over-correct and temporarily fall below it’s historical long-run averages, before recoving. Remember, housing trends tend to track the CPI. It will be the best time to buy property when that occurs, but attempting to locate the very bottom will be difficult.
Hi JHill, I count myself as one Gen Y who has taken the opportunity to build up cash. I’ve considered getting into property a couple of times but when it comes down to it, I can live in much better dwellings and locations as a renter that I couldn’t afford as a buyer. I’m happy to sit and wait for a serious correction.