6 ms·

Was the fall of 2008 "extremely close" to optimal? I'd submit that worldviews based on 1-dimensional criteria like "market!" or "hayek!" fall pretty far short

by jbooth 15y ago

Was the fall of 2008 "extremely close" to optimal? I'd submit that worldviews based on 1-dimensional criteria like "market!" or "hayek!" fall pretty far short of the mark. Although I can see the attraction. It's nice to simplify things to a level where a human being can actually have the answers with a high degree of confidence. Both the tea-party-hayekians and the linked paper fall into this trap.. what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"? A friend was telling me at his old job, they actually worked in season tickets to a luxury booth at Yankee stadium into a very significant tech purchase. Is that market efficiency?

CWuestefeld 15y ago
I'm not sure you understand what the free market is, or how it works. The fall of 2008 wasn't a free market. In particular, the government was forcing lenders to accept more risk (viz sub-prime borrowers) than they would otherwise have done. Also, the lenders themselves incorrectly modeled their risk exposures. None of your objections: what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"? hold any water: Information asymmetry (also, incorrect information as with lenders in '08): This has nothing to do with the efficiency of markets. The efficient market hypothesis depends on actors behaving rationally to achieve their goals. That does not mean that those actors will always be correct. For example, in The Myth of the Rational Voter[1], Caplan describes how it's actually rational behavior for voters to vote irrationally: the benefit of the degree they can sway the election is far smaller than the cost of acquiring sufficient knowledge to determine what candidate would most benefit them. Bad incentives: it's the incentives (see "Invisible Hand") that make things work properly! To the extent that the incentives are wrong, these are the regulations, the aberrations that make things deviate from the free market. In your '08 complaint, that was the Congress forcing lenders to take on borrowers that would not normally have qualified. It also comes from externalities, places where our laws prevent the free market from completely accounting for the costs of an action. For example, because air and waterways are held in common by the government, without a real owner, there is nothing capturing the cost of pollution. Thus, incomplete property rights leads to market failures. If the government got out of the way, the market could resolve it (see "Coase Theorem") Stupidity: as separate from your other points, well, there's no such thing -- at least not that we can perceive. Mises shows that (a) each person acts to maximize his own utility, and (b) it's impossible for outside observers (and frequently even the individual himself) to know what ends he is attempting to achieve. Thus, if your hypothetical golfer places some personal value on the relationship with his golf buddy, it may be perfectly rational for him to spend extra few bucks buying from the guy. And you and I certainly aren't privy to enough information to decide that it's not so. Fraud: your Yankees example seems to be an example of fraud, and thus can't be considered a free market transaction. Fooling someone into a transaction is no different from forcing them into a transaction. That said, research in psychology and econometrics has shown that people do systematically misconstrue very large or very small values, leading us to sometimes choose differently from what we really intend. The only solution to this, of course, is to formally model the problem to enable us to act rationally. In this day and age, such models are de rigeur, but -- as I note above -- the investment in the models itself has some risk: we're balancing correctness against cost to develop and feed the model. As with the rational voter, this can lead us to "rationally irrational" behavior, but this is just a meta-behavior of the free market, not an indictment of it. Moreover, there is no way around any of the issues that you cite. All of these things can be applied equally -- if not more -- to government regulators (see "public choice economics", "regulatory capture", etc.). Why would you want to give power to entities who won't be able to use it any more wisely than the people themselves? [1] http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter [2] http://en.wikipedia.org/wiki/Human_Action http://en.wikipedia.org/wiki/Human_Action
- jbooth 15y ago
  So, no true scotsman? We're in the real world here. If the real world held up to a given person's theory, communism would've worked. You just have a different theory. I'm not claiming markets are terrible, they're usually the best way to do things. But when you pigeonhole yourself into an absolutist position, you've guaranteed that you're going to be flagrantly wrong sometimes.
  - CWuestefeld 15y ago
    when you pigeonhole yourself into an absolutist position That's a fair criticism of my reply. My initial statement almost had a flavor of "free markets are perfect", whereas what I really believe is that "free markets are the best system possible". So, no true scotsman? But I don't think that's a fair criticism. There is a clear, well-defined concept of "free market"; it's not like I keep backing off my statement every time someone scores a hit on my argument. If the theory can explain exactly why the various regulations on the market have the observed result -- that is, if it has scientific predictive value as opposed to an irrational belief system -- then I don't think I'm susceptible to this criticism. In high school physics we did Newtonian mechanics assuming a frictionless surface, etc. It turns out that our experimental results didn't match up with what really happened, because we had friction and other factors. But we learned more physics, so even though we didn't have access to that frictionless surface, we could explain why the results differed, and predict just how those differences would appear (friction is proportional to downward force, etc.). You're criticizing the market theory because the observed results have those "frictional" differences, even though we can tell you what is causing the friction, and predict (albeit to a limited degree at this point) what the future effects of proposed "friction" (i.e., regulation) would be.
    - jbooth 15y ago
      I'm criticizing fundamentalist market theory, and the practice of turning your brain off. The crash of 2008 was preceded by 20 years of deregulation. And the explanation? Too much regulation! A billion dollars in loans to minorities must explain the 2 trillion dollar problem! There's nothing wrong with thinking a free market's the way to go for a given problem, provided you got there by engaging your brain rather than taking it on faith. Once you do that, you might find yourself thinking things like "Hm, maybe capital gains should be taxed as ordinary income", or "Hey, turns out it's mathematically impossible to balance the budget by cutting domestic discretionary spending".
yummyfajitas 15y ago
Was the fall of 2008 "extremely close" to optimal? Home prices crashed and then more or less stabilized. So yeah, I'd say the crash was close to an optimal price correction. http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=199 http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=19... I'm a little confused how why you would believe people who follow Hayek are unfamiliar with questions of information asymmetry and borked incentives. After all, don't they form the basis of "The Road to Serfdom"?
- jbooth 15y ago
  I'm confused because everyone who follows Hayek seems to have the solution in hand before they've even heard the problem statement, and that solution doesn't acknowledge those concerns. I've never heard a self-proclaimed Hayek follower (note that word, follower not thinker) say "I'm worried that the private sector doesn't arrive at the correct incentives in this case" about anything, ever. That's why I'm confused.
  - yummyfajitas 15y ago
    You should try reading Hayek, rather than listening only to straw men who claim to have read his books. He was well aware of information problems, externalities, etc. You might dislike the fact that he believes politicians are also subject to these problems, but he is hardly unaware of them. If you want to see Hayek followers concerned about such issues, go read the blogs of assorted gmu economists (Tyler Cowen, Robin Hanson, Bryan Caplan, etc). http://www.overcomingbias.com/2009/11/require-baby-paternity-test.html http://www.overcomingbias.com/2009/11/require-baby-paternity... http://havemorekidsbook.com/ http://havemorekidsbook.com/ Or see anyone who pushes the signalling model of education.
    - CWuestefeld 15y ago
      He was well aware of information problems That's an understatement. It was a significant theme throughout his work.
jerf 15y ago
As much fun as the other reply is, the real defense against your point is that "efficient" doesn't mean what you think it does. Efficiency in a market means that there exist no long-term arbitrage opportunities, because they will be exploited and thus cause prices to shift until those no longer exist. It emphatically DOES NOT mean "good" or "desirable" or anything like that. The market very efficiently went over a cliff, efficiently responding to incentive misalignments created by government regulation and efficiently ensuring that you had no significant arbitrage opportunities in the meantime. The free market is more force of nature than construct of man, like gravity or a huge river. It can be harnessed, but it will efficiently crush you if you get in its way. It is also like the forces of nature in that it is extremely difficult to successfully harness it when one willfully chooses to not understand it because one does not "like" it, which is why the track record of social systems that start out with "Let's pretend the market isn't a force of nature but that we can will it into compliance with our ideology" tend to fare so poorly in practice; it's hardly any different than assuming gravity won't actually hurt you if you just love hard enough, then trying to get into rocket design. (The problem isn't that you won't get a rocket off the ground with such a plan, the problem is that you will....)
- jbooth 15y ago
  Well, I certainly can get behind your definition more.. but a gigantic 10 year bubble sticking out to the side and then bursting doesn't seem efficient by that definition. You'd think the wizards of the market, with the billions of dollars in pay they're collectively bringing home, would've corrected for that sooner, no? This concept that in 2008 the market was responding to incentive misalignments created by government regulation.. what regulation? All we did was deregulate from 92 onwards. Are you gonna claim that a billion in fannie/freddie loans to minorities caused the problem? What about the overleveraging, the AAA credit ratings? Those were government problems? It seems like a whole bunch of individuals played the "greater fool" theory as long as they could, and what we wound up with was the opposite of efficient, by your definition. I'm not necessarily saying more regulation would've prevented that, aside from generally being a brake on everything, but it's a hell of a bad case for the wisdom of markets.
  - 15y ago
nirvana 15y ago
I would say the fall of 2008 was pretty close to optimal, especially in terms of what Heyek would predict. That is not to say it was good for the population, but it was a reasonably efficient reaction to the information the market had about the state of affairs. Note that it didn't fully reflect the entire state of affairs because the market did not have sufficient information, and still doesn't. (I think if it did, the S&P 500 would be about half where it is now.) The thing that makes me listen to people like Mises and Heyek is that other people who follow their teachings were telling me in 2001 that there would be a housing boom and bubble, and that it would crash eventually due to the inevitable excesses of a bubble. I researched this hypothesis and decided I agreed with it. This made it very easy for me to watch housing prices go up, profit from it, notice when things were ready to change, and then profit from the change. I think the question of whether markets are efficient or not is one that is placed in a vacuum and thus meaninglesss. Is the market more efficient than government? Yes, always. (It is impossible for a central planner to have sufficient information to set prices correctly.) Were there people who had the same information as I did, but lacked the economic perspective that I did and thus made bad investments? Yes there were. This is happening today, in fact. We have politicians saying a lot of economically silly things, and the market reacts to this "information". The question of market efficiency ignores the issue of perspective. You can talk about information asymmetry, and people can debate the amount to which it exists, but I'm absolutely certain that there is perspective asymmetry. I'm going to make a killing in the markets simply because so many people's perspective of economics comes from people like Krugman. Is that efficient? Maybe-- the markets reflect the perspective of most people, even though they are wrong. But I don't really care. I'd love it if I couldn't profit from this perspective asymmetry... the benefits to society would far outweigh the profits I'd loose from not being able to bet on these sure things. But so long as people will continue to roll their eyes when an austrian is mentioned, I'll take my profits as a consolation prize.
- CWuestefeld 15y ago
  I voted you back up because I don't think you deserve to be negative. But I'd challenge your claim that you can actually profit from the general economic ignorance. The reason I'm so skeptical is because the market is so good at working around inefficiencies that even when we think something's got to collapse, it finds a way to keep going. (if you'll excuse me for anthropomorphizing)
fleitz 15y ago
Yes, the fall of 2008 was extremely optimal, did the US gov't see the problem beforehand and fix it? No they didn't, it was the market that brought the information to everyone that something was seriously amok in the financial system. (eg. Bear Stearns is bankrupt). It was short sellers, and all the people we love to hate that brought the problem to attention and moved prices to reflect the true value of these companies. (eg. zero) Efficient market hypothesis does not predict that the market will have perfect information or perfect pricing, or that stock prices will go infinitely up. It predicts that over the long term the market provides reasonably accurate pricing.

by jbooth 15y ago

CWuestefeld 15y ago

I'm not sure you understand what the free market is, or how it works. The fall of 2008 wasn't a free market. In particular, the government was forcing lenders to accept more risk (viz sub-prime borrowers) than they would otherwise have done. Also, the lenders themselves incorrectly modeled their risk exposures. None of your objections: what about information asymmetry? What about borked incentives? What about just plain stupid? "I played golf with the guy so I'll buy it"? "I know these instruments are crap but I'll sell them to my clients to get them off my balance sheet"? hold any water: Information asymmetry (also, incorrect information as with lenders in '08): This has nothing to do with the efficiency of markets. The efficient market hypothesis depends on actors behaving rationally to achieve their goals. That does not mean that those actors will always be correct. For example, in The Myth of the Rational Voter[1], Caplan describes how it's actually rational behavior for voters to vote irrationally: the benefit of the degree they can sway the election is far smaller than the cost of acquiring sufficient knowledge to determine what candidate would most benefit them. Bad incentives: it's the incentives (see "Invisible Hand") that make things work properly! To the extent that the incentives are wrong, these are the regulations, the aberrations that make things deviate from the free market. In your '08 complaint, that was the Congress forcing lenders to take on borrowers that would not normally have qualified. It also comes from externalities, places where our laws prevent the free market from completely accounting for the costs of an action. For example, because air and waterways are held in common by the government, without a real owner, there is nothing capturing the cost of pollution. Thus, incomplete property rights leads to market failures. If the government got out of the way, the market could resolve it (see "Coase Theorem") Stupidity: as separate from your other points, well, there's no such thing -- at least not that we can perceive. Mises shows that (a) each person acts to maximize his own utility, and (b) it's impossible for outside observers (and frequently even the individual himself) to know what ends he is attempting to achieve. Thus, if your hypothetical golfer places some personal value on the relationship with his golf buddy, it may be perfectly rational for him to spend extra few bucks buying from the guy. And you and I certainly aren't privy to enough information to decide that it's not so. Fraud: your Yankees example seems to be an example of fraud, and thus can't be considered a free market transaction. Fooling someone into a transaction is no different from forcing them into a transaction. That said, research in psychology and econometrics has shown that people do systematically misconstrue very large or very small values, leading us to sometimes choose differently from what we really intend. The only solution to this, of course, is to formally model the problem to enable us to act rationally. In this day and age, such models are de rigeur, but -- as I note above -- the investment in the models itself has some risk: we're balancing correctness against cost to develop and feed the model. As with the rational voter, this can lead us to "rationally irrational" behavior, but this is just a meta-behavior of the free market, not an indictment of it. Moreover, there is no way around any of the issues that you cite. All of these things can be applied equally -- if not more -- to government regulators (see "public choice economics", "regulatory capture", etc.). Why would you want to give power to entities who won't be able to use it any more wisely than the people themselves? [1] http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter [2] http://en.wikipedia.org/wiki/Human_Action http://en.wikipedia.org/wiki/Human_Action

jbooth 15y ago
So, no true scotsman? We're in the real world here. If the real world held up to a given person's theory, communism would've worked. You just have a different theory. I'm not claiming markets are terrible, they're usually the best way to do things. But when you pigeonhole yourself into an absolutist position, you've guaranteed that you're going to be flagrantly wrong sometimes.
- CWuestefeld 15y ago
  when you pigeonhole yourself into an absolutist position That's a fair criticism of my reply. My initial statement almost had a flavor of "free markets are perfect", whereas what I really believe is that "free markets are the best system possible". So, no true scotsman? But I don't think that's a fair criticism. There is a clear, well-defined concept of "free market"; it's not like I keep backing off my statement every time someone scores a hit on my argument. If the theory can explain exactly why the various regulations on the market have the observed result -- that is, if it has scientific predictive value as opposed to an irrational belief system -- then I don't think I'm susceptible to this criticism. In high school physics we did Newtonian mechanics assuming a frictionless surface, etc. It turns out that our experimental results didn't match up with what really happened, because we had friction and other factors. But we learned more physics, so even though we didn't have access to that frictionless surface, we could explain why the results differed, and predict just how those differences would appear (friction is proportional to downward force, etc.). You're criticizing the market theory because the observed results have those "frictional" differences, even though we can tell you what is causing the friction, and predict (albeit to a limited degree at this point) what the future effects of proposed "friction" (i.e., regulation) would be.
  - jbooth 15y ago
    I'm criticizing fundamentalist market theory, and the practice of turning your brain off. The crash of 2008 was preceded by 20 years of deregulation. And the explanation? Too much regulation! A billion dollars in loans to minorities must explain the 2 trillion dollar problem! There's nothing wrong with thinking a free market's the way to go for a given problem, provided you got there by engaging your brain rather than taking it on faith. Once you do that, you might find yourself thinking things like "Hm, maybe capital gains should be taxed as ordinary income", or "Hey, turns out it's mathematically impossible to balance the budget by cutting domestic discretionary spending".

yummyfajitas 15y ago

Was the fall of 2008 "extremely close" to optimal? Home prices crashed and then more or less stabilized. So yeah, I'd say the crash was close to an optimal price correction. http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=199 http://research.stlouisfed.org/fred2/series/SPCS20RSA?rid=19... I'm a little confused how why you would believe people who follow Hayek are unfamiliar with questions of information asymmetry and borked incentives. After all, don't they form the basis of "The Road to Serfdom"?

jbooth 15y ago
I'm confused because everyone who follows Hayek seems to have the solution in hand before they've even heard the problem statement, and that solution doesn't acknowledge those concerns. I've never heard a self-proclaimed Hayek follower (note that word, follower not thinker) say "I'm worried that the private sector doesn't arrive at the correct incentives in this case" about anything, ever. That's why I'm confused.
- yummyfajitas 15y ago
  You should try reading Hayek, rather than listening only to straw men who claim to have read his books. He was well aware of information problems, externalities, etc. You might dislike the fact that he believes politicians are also subject to these problems, but he is hardly unaware of them. If you want to see Hayek followers concerned about such issues, go read the blogs of assorted gmu economists (Tyler Cowen, Robin Hanson, Bryan Caplan, etc). http://www.overcomingbias.com/2009/11/require-baby-paternity-test.html http://www.overcomingbias.com/2009/11/require-baby-paternity... http://havemorekidsbook.com/ http://havemorekidsbook.com/ Or see anyone who pushes the signalling model of education.
  - CWuestefeld 15y ago
    He was well aware of information problems That's an understatement. It was a significant theme throughout his work.

jerf 15y ago

As much fun as the other reply is, the real defense against your point is that "efficient" doesn't mean what you think it does. Efficiency in a market means that there exist no long-term arbitrage opportunities, because they will be exploited and thus cause prices to shift until those no longer exist. It emphatically DOES NOT mean "good" or "desirable" or anything like that. The market very efficiently went over a cliff, efficiently responding to incentive misalignments created by government regulation and efficiently ensuring that you had no significant arbitrage opportunities in the meantime. The free market is more force of nature than construct of man, like gravity or a huge river. It can be harnessed, but it will efficiently crush you if you get in its way. It is also like the forces of nature in that it is extremely difficult to successfully harness it when one willfully chooses to not understand it because one does not "like" it, which is why the track record of social systems that start out with "Let's pretend the market isn't a force of nature but that we can will it into compliance with our ideology" tend to fare so poorly in practice; it's hardly any different than assuming gravity won't actually hurt you if you just love hard enough, then trying to get into rocket design. (The problem isn't that you won't get a rocket off the ground with such a plan, the problem is that you will....)

jbooth 15y ago
Well, I certainly can get behind your definition more.. but a gigantic 10 year bubble sticking out to the side and then bursting doesn't seem efficient by that definition. You'd think the wizards of the market, with the billions of dollars in pay they're collectively bringing home, would've corrected for that sooner, no? This concept that in 2008 the market was responding to incentive misalignments created by government regulation.. what regulation? All we did was deregulate from 92 onwards. Are you gonna claim that a billion in fannie/freddie loans to minorities caused the problem? What about the overleveraging, the AAA credit ratings? Those were government problems? It seems like a whole bunch of individuals played the "greater fool" theory as long as they could, and what we wound up with was the opposite of efficient, by your definition. I'm not necessarily saying more regulation would've prevented that, aside from generally being a brake on everything, but it's a hell of a bad case for the wisdom of markets.
- 15y ago

nirvana 15y ago

I would say the fall of 2008 was pretty close to optimal, especially in terms of what Heyek would predict. That is not to say it was good for the population, but it was a reasonably efficient reaction to the information the market had about the state of affairs. Note that it didn't fully reflect the entire state of affairs because the market did not have sufficient information, and still doesn't. (I think if it did, the S&P 500 would be about half where it is now.) The thing that makes me listen to people like Mises and Heyek is that other people who follow their teachings were telling me in 2001 that there would be a housing boom and bubble, and that it would crash eventually due to the inevitable excesses of a bubble. I researched this hypothesis and decided I agreed with it. This made it very easy for me to watch housing prices go up, profit from it, notice when things were ready to change, and then profit from the change. I think the question of whether markets are efficient or not is one that is placed in a vacuum and thus meaninglesss. Is the market more efficient than government? Yes, always. (It is impossible for a central planner to have sufficient information to set prices correctly.) Were there people who had the same information as I did, but lacked the economic perspective that I did and thus made bad investments? Yes there were. This is happening today, in fact. We have politicians saying a lot of economically silly things, and the market reacts to this "information". The question of market efficiency ignores the issue of perspective. You can talk about information asymmetry, and people can debate the amount to which it exists, but I'm absolutely certain that there is perspective asymmetry. I'm going to make a killing in the markets simply because so many people's perspective of economics comes from people like Krugman. Is that efficient? Maybe-- the markets reflect the perspective of most people, even though they are wrong. But I don't really care. I'd love it if I couldn't profit from this perspective asymmetry... the benefits to society would far outweigh the profits I'd loose from not being able to bet on these sure things. But so long as people will continue to roll their eyes when an austrian is mentioned, I'll take my profits as a consolation prize.

CWuestefeld 15y ago
I voted you back up because I don't think you deserve to be negative. But I'd challenge your claim that you can actually profit from the general economic ignorance. The reason I'm so skeptical is because the market is so good at working around inefficiencies that even when we think something's got to collapse, it finds a way to keep going. (if you'll excuse me for anthropomorphizing)

fleitz 15y ago

Yes, the fall of 2008 was extremely optimal, did the US gov't see the problem beforehand and fix it? No they didn't, it was the market that brought the information to everyone that something was seriously amok in the financial system. (eg. Bear Stearns is bankrupt). It was short sellers, and all the people we love to hate that brought the problem to attention and moved prices to reflect the true value of these companies. (eg. zero) Efficient market hypothesis does not predict that the market will have perfect information or perfect pricing, or that stock prices will go infinitely up. It predicts that over the long term the market provides reasonably accurate pricing.