Quick Links

• Following up on a post I made a couple weeks ago: Geithner is going before Congress today, and will be questioned on the AIG bailout. FT has a fantastic writeup on this topic. The article does a wonderful job of giving the reader background on the entire saga, and goes on to analyze many of the issues that brought us to a crisis. I quote from the concluding paragraphs of the article:
  

  The disputes struck, too, at the heart of a growing conceit in the financial world that nearly any asset could be priced and traded. This development was interpreted as a sign that markets were growing more “free” since the pool of tradeable assets appeared to be growing.
  ...
  What the AIG drama exposes is that much of the recent innovation on Wall Street was dedicated to creating assets that barely traded and whose values were determined almost exclusively by computer models used by the banks and rating agencies.
  In this 21st-century hall of mirrors, it has been possible for tens of billions of dollars of value to vanish or reappear at the click of a computer button – or at the behest of the rating agencies or through a change in accounting rules. That in turn makes it hard for the US government to explain whether the taxpayer really got “value for money” by bailing out AIG – or whether Americans will ever get back all the billions already spent.
  

• Financial Services: From Servant to Lord of the Economy. This relates to a post I made very early on in this blog: should commercial banking be a public utility?
• Mish Shedlock is campaigning hard against Bernanke.

Bernanke

In any other profession, a performance as bad as Bernanke's over his first term would get someone fired. Under his watch, our financial sector collapsed and sent our country into a recession. That he has done a decent job cleaning up in the aftermath is inconsequential: in industry, he'd be gone. So why is it that he has a good chance of getting a second term? Other than a made-for-TV grilling by Congress in which he got yelled at, Bernanke has hardly suffered for all his blunders.

Anyway, sorry for the pointless rant.
Let's hope Bernanke can help to turn our economy around in his next term, assuming he gets it.

Krugman has a good writeup on this topic:

What happened here? My sense is that Mr. Bernanke, like so many people who work closely with the financial sector, has ended up seeing the world through bankers’ eyes. The same can be said about Timothy Geithner, the Treasury secretary, and Larry Summers, the Obama administration’s top economist. But they’re not up before the Senate, while Mr. Bernanke is.

Given that, why not reject Mr. Bernanke? There are other people with the intellectual heft and policy savvy to take on his role: among the possible choices would be my Princeton colleague Alan Blinder, a former Fed vice chairman, and Janet Yellen, the president of the San Francisco Fed.

But — and here comes my defense of a Bernanke reappointment — any good alternative for the position would face a bruising fight in the Senate. And choosing a bad alternative would have truly dire consequences for the economy.

Furthermore, policy decisions at the Fed are made by committee vote. And while Mr. Bernanke seems insufficiently concerned about unemployment and too concerned about inflation, many of his colleagues are worse. Replacing him with someone less established, with less ability to sway the internal discussion, could end up strengthening the hands of the inflation hawks and doing even more damage to job creation.

That’s not a ringing endorsement, but it’s the best I can do.

If Mr. Bernanke is reappointed, he and his colleagues need to realize that what they consider a policy success is actually a policy failure. We have avoided a second Great Depression, but we are facing mass unemployment — unemployment that will blight the lives of millions of Americans — for years to come. And it’s the Fed’s responsibility to do all it can to end that blight.

New Year Reading

• John Taylor, inventor of the Taylor Rule, responds to Bernanke's speech in the WSJ. I add emphasis in the excerpt below:
  

  ...Mr. Bernanke focused most of his time on my research, especially on a well-known policy benchmark commonly known as the Taylor rule.
  This rule calls for central banks to increase interest rates by a certain amount when price inflation rises and to decrease interest rates by a certain amount when the economy goes into a recession. My critique, which I presented at the annual Jackson Hole conference for central bankers in the summer of 2007, is based on the simple observation that the Fed's target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom. The deviation from the Taylor rule, which had characterized good monetary policy during the previous two decades, was the largest since the turbulent 1970s.
  
  ...Stepping back from the fray, an objective observer of all this evidence would have to at least admit the possibility that monetary policy was too easy and a possible contributor to the crisis.
  Not admitting the possibility raises concerns. One is that if such a large deviation from standard policy is rationalized away, it might happen again. Indeed, some analysts are worried now about the Fed holding interest rates too low for too long, causing another boom-bust and a shorter expansion.
  Another concern is that, rather than trying to be vigilant and avoid causing bubbles, the Fed will try to burst them with interest rates. Indeed, one of the lines from Mr. Bernanke's speech most picked up by Fed watchers is that "we must remain open to using monetary policy as a supplementary tool for addressing those risks." We have very limited ability to fine tune monetary policy in such an interventionist way.
  Finally, there is a concern that the line of analysis in Mr. Bernanke's speech puts the full burden of preventing future bubbles on new regulation. Clearly the Fed missed excessive risks on and off the balance sheets of the banks that it supervises and regulates. That policy needs to be corrected. However, it is wishful thinking that some new and untried macro-prudential systemic risk regulation will prevent bubbles.
  

• Models & Agents criticizes both Bernanke and Taylor:
  

  If there was one major disappointment with Bernanke’s speech at the AEA meetings last weekend it was his choice to fight insular battles will equally insular arguments.
  Part of the reason was tactics of course. Inane criticisms arguably deserve a commensurate response. So when you have somebody like (Stanford economist) John Taylor on a self-appointed mission to prove that his own Taylor rule can explain absolutely anything—from the Great Inflation, to the Greenspan put, to (coming soon!) life on other planets—, using the “enemy’s” own weapon to neutralize him is a cunning strategy.
  ...
  Ben’s focus on the house bubble is misplaced, if not narrow-minded. There was a giant credit/asset bubble underway, which struck not only housing but also the credit-card industry, auto loans, stock prices, credit spreads, commodities, what-have-you. Qualitative explanations abound and include the bout of financial innovation that seemed to permit a structural, economy-wide increase in debt(/leverage) “risk free.”
  Against this backdrop, gauging the role of monetary policy in all this will have to rest on more than distinctly macro arguments like the ones above. Indeed, a key question emerging in the aftermath of the crisis is whether developments at the “micro” level (i.e. in financial institutions, shadow banks, etc) have transformed the transmission mechanism as we know it, and hence the appropriateness of the current framework guiding monetary policy. The fact that none of this budding research was mentioned, even as a hint, leaves one wonder how long before our monetary authorities start adhering to the spirit, rather than the letter, of macroeconomic stability.
  

• The Economist warning that we're back in bubble territory (gee, ya think?). Also from The Economist, "The Fed discovers Hyman Minsky". Again, emphasis is mine:
  

  Not only was Mr Minsky on the fringe of mainstream economics, his core insight is antithetical to the Fed. The Fed’s raison d’etre is stability: stable prices, stable employment, financial stability. But Mr Minsky argued that economic stability encourages more risk taking and leverage, and ultimately produces more instability and bigger recessions.
  The Fed's economists have traditionally personified the technical, evidence-based, progressive school of economics which holds that individuals are mostly rational, innovation is mostly good, and given sufficient examination and enlightened action, recessions can be avoided. This is one reason the Fed has traditionally been reluctant to assign a lot of importance to greed, fear and bubbles. This paper’s embrace of Mssrs Minsky, Shiller and Kindleberger may bely a subtle shift to a less utopian, more fatalistic view.
  

• In a similar vein about the death of, essentially, efficient-market-hypothesis, Krugman claims the Chicago school of thinking is done. He's been beating this anti-EMH drum for a while now.
• Walk away from your mortgage! This is actually an interesting topic that Mish Shedlock has talked about often. There is some stigma associated with abandoning one's house, but for many, it is the best option:
  

  There are two reasons why so-called strategic defaults have been considered antisocial and perhaps amoral. One is that foreclosures depress the neighborhood and drive down prices. But in a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. We are all economic pinballs, insensibly colliding for better or worse.
  The other reason is that default (supposedly) debases the character of the borrower. Once, perhaps, when bankers held onto mortgages for 30 years, they occupied a moral high ground. These days, lenders typically unload mortgages within days (or minutes). And not just in mortgage finance, but in virtually every realm of our transaction-obsessed society, the message is that enduring relationships count for less than the value put on assets for sale.
  

• Will the Fed catch the next bubble?
  

  The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?
  

• How money prevents financial reform. Nothing surprising.
• The Mess That Bernanke Is Making Worse.
• Finally, an article everyone should read simply because it's so well-written and insightful. Warning: it's very long. How America Can Rise Again.
  

  Through the entirety of my conscious life, America has been on the brink of ruination, or so we have heard, from the launch of Sputnik through whatever is the latest indication of national falling apart or falling behind. Pick a year over the past half century, and I will supply an indicator of what at the time seemed a major turning point for the worse. The first oil shocks and gas-station lines in peacetime history; the first presidential resignation ever; assassinations and riots; failing schools; failing industries; polarized politics; vulgarized culture; polluted air and water; divisive and inconclusive wars. It all seemed so terrible, during a period defined in retrospect as a time of unquestioned American strength. “Through the 1970s, people seemed ready to conclude that the world was coming to an end at the drop of a hat,” Rick Perlstein, the author of Nixonland, told me. “Thomas Jefferson was probably sure the country was going to hell when John Adams supported the Alien and Sedition Acts,” said Gary Hart, the former Democratic senator and presidential candidate. “And Adams was sure it was going to hell when Thomas Jefferson was elected president.”
  

This Isn't Needed Regulation

I'm appalled by what the government is up to right now.
In case you haven't heard, the Pay Czar, Kenneth Feinberg, just started instituting pay cuts at Wall St. firms that used TARP money:

Mr. Feinberg, the Treasury Department's special master for compensation, will lower total compensation for 175 employees at seven firms including AIG, Citigroup, Bank of America and GM, by an average of 50%, people familiar with the matter said. He will also demand a series of corporate-governance changes at the firms, including splitting the positions of chairman and chief executive officer; requiring boards of directors to create a committee to assess risk, and eliminating staggered boards.

Some of that actually sounds not so bad, such as splitting the positions of chairman and CEO. However, this is not the way to go about fixing anything! What is Feinberg trying to accomplish? Here's the best I've found:

Summers said Feinberg's rulings -- which are expected to be publicly released in the coming days -- will ensure taxpayers' interests come before those of shareholders and incumbent management at the beleaguered firms.

Let's do a quick history. First of all, lest we forget, the government forced these companies into accepting bailout money. Some argue that hey, if you take public money, you have to be prepared for public oversight ... but they didn't have a choice! Beyond that, it's not as if there were any particular requirements associated with the TARP money. For example, one way to look out for taxpayers might have been to get the banks taking TARP money to lend more, during a time when credit was/is tight. Did that happen? No. "Geithner did not require the Big Banks to loan money for commercial loans as a prerequisite for additional borrowings from the Fed."
And now Obama & Co. start trying to trim their pay? What are they accomplishing?? All that I'm seeing here is this: Dear Big Banks, if you get in trouble, we'll give you tons of money. In fact, we might even force it down your throats, but at least no matter how bad you screw up you know you won't go under. Then we'll let you do whatever you want with that money and achieve mind-blowing profits during a recession, which will naturally lead to fantastic compensation and plenty of public outrage. And since we used to work on/with Wall Street, we could basically predict all this would happen. And it's kinda messed up that we used to work with you and now we're giving you more-or-less free public money, but hey, that's what friends are for! But look, we'll have to pretend to be totally bewildered and fake some anger at you so the public doesn't tar-and-feather us.
Honestly, as far as I can tell, that's more or less the story so far. Ugh. Instead of focusing on useful policies that might prevent future issues (such as reinstatement of the Glass-Steagall Act, or something similar, which is sadly looking like it won't happen), they do worthless stuff that won't even really have a lasting impact:

Pay is the wrong way to tackle this problem. It’s a lazy, crowd-appeasing, intellectually dishonest approach. The out of line pay is a symptom, and any attempt to treat symptoms as causes is likely to be ineffective, more likely dysfunctional.
...
Now why is trying to control this through pay not such a hot idea? First, one hundred years of performance appraisal systems have proven them to be abject failures (aa 1992 paper by
Patrick D. Larkey and Jonathan P. Caulkin, “All Above Average and Other Unintended
Consequences of Performance Appraisal Systems,” did a brilliant job of dissecting why, but it was too heretical to get published. You can read a few key points here in the section “The Illusion of Meritocracy”). Second, comp systems are supposed to solve what is called a principal-agent problem. You the person hiring someone to work on your behalf wants to make sure they are operating in accordance with YOUR best interests in mind, not theirs.
But what did we learn from 20 years of executive rewards schemes that had lots of equity incentives that would supposedly align the interest of top brass with that of shareholders. We got instead an explosion of CEO pay and companies that are so fixated on quarterly earnings that they are reluctant to invest in growth. How did that come to pass?
BECAUSE THE AGENTS AND NOT THE PRINCIPALS DESIGNED THE PAY SCHEMES!  The foxes were running the hen house. Oh, sure, we had some fig leaves, it was the HR department that hired the compensation consultant, and the board (nominated by the incumbent management) that signed off on it, but it is pretty clear that a comp consultant that did not deliver a CEO-wallet-fattening plan was unlikely to get much repeat business.
And is anything going to be materially different? No. The conventional wisdom is that having employees take a high level of pay as equity is a magic solution, conveniently forgetting that Bear and Lehman both featured very high levels of shareholding among its top management and employees. Feinberg is only intervening in outliers, to collect a few scalps. He is in a very difficult position and is trying to make the best of it.
The financial services industry now has an unimaginably rich deal: privatized gains and socialized losses, and with tons of leverage too, which amps up the apparent profits and hence the pay levels these looters can claim they deserve. The way to attack this problem is to constrain the level of risk assumption. That in turn requires understanding the products and the markets, something the authorities have completely abdicated. With so much “talent” looking for jobs, now would be the perfect time to invest in catching up.

Sorry for the angry, poorly-written rant. And please keep in mind, I'm not exactly trying to defend banks here. In fact, I think I've been quite open on this blog about how immoral they've been and how dangerous they are to our country as they're currently constructed. The point here is, nothing useful is being done to correct this! All this Pay Czar junk is just political maneuvering. Real reform is not happening.

More On Fed-Induced Boom-and-Bust Cycles

The Baseline Scenario adds to the chorus of economists discussing two issues: one, how the Fed has perpetuated the boom-and-bust cycle over the last few decades; two, that serious regulatory reform is needed.
Again, I don't think anything will come of this. However, it's still worth reading and understanding how things work, because if the system remains as is, we're virtually guaranteed to have another great bubble and another great crash. The reason it's worth understanding is because one can at least profit from all this mess by playing the market correctly. Understanding macro cycles is helpful in that regard.

A couple nice paragraphs from the article:

In successive financial boom-busts over the past 30 years, the Fed undertook smaller versions of what Ben Bernanke did over the past 12 months. In the Latin American debt crisis of 1982, the savings-and-loan crisis of the late 1980s, the Asian financial crisis and the collapse of Long-Term Capital Management in 1998 and during the bursting of the dot-com bubble in 2001, you saw the same pattern: First, of course, the financial system grew rapidly, bank profits were large and a bubble emerged. At a certain point, we reached the market peak and stared down the mountain. Bankers frantically called the Fed, and it dutifully stepped in to prevent an economic collapse — by lowering interest rates and providing credit to “maintain liquidity.”
...
In today’s nascent global recovery, we are already seeing bubble-like rises in the prices of real estate and assets, from Hong Kong and Singapore to Brazil. And many more emerging markets will likewise soon boom. The details of who makes which crazy loans to whom will no doubt be different from what they were from 2002 to 2007, but the basic structure of incentives in the system is unchanged. The same people are running the American banks, and the same regulators are regulating them, so you can easily get the same outcome here as we have just seen.

Regulatory Reform Is Wishful Thinking

Sorry for not posting all of last week - I was extremely busy. I'll attempt to make up for it here with some worthwhile reading, though I still have some posts with content I want to do. Hopefully, I'll get to them sometime soon.
As usual, in quotes below, any emphasis in bold is mine.

• An excellent read on the history of the Fed and why it perpetuates our boom-and-bust cycle: "We have seen this spectacle--the Fed saving us from one crisis only to instigate another--many times before. ... The fault, to be sure, doesn’t lie entirely with the Fed. Bernanke is a prisoner of a financial system with serious built-in flaws. The decisions he made during the recent crisis weren’t necessarily the wrong decisions; indeed, they were, in many respects, the decisions he had to make. But these decisions, however necessary in the moment, are almost guaranteed to hurt our economy in the long run--which, in turn, means that more necessary but harmful measures will be needed in the future. It is a debilitating, vicious cycle."
  
• Serious doubts we'll see any useful reform: "Let's be clear: The Street today is up to the same tricks it was playing before its near-death experience. Derivatives, derivatives of derivatives, fancy-dance trading schemes, high-risk bets. "Our model really never changed, we’ve said very consistently that our business model remained the same,” says Goldman Sach's chief financial officer...The only difference now is that the Street's biggest banks know for sure they'll be bailed out by the federal government if their bets turn sour -- which means even bigger bets and bigger bucks."
• More doubts. This article has a real gem in the conclusion: "One solution ...: break up big banks. Citigroup is splitting itself up after years of empire building that created a company many considered to unwieldy to manage effectively. But that won't really fix things. Lehman was far from the biggest Wall Street bank, in fact it was the smallest of the big four still standing after the collapse of another relatively small firm, Bear Stearns, in March. Interconnectedness was the problem. And in our increasingly sophisticated and complex global financial system, it still is. How to eliminate that risk? This may be tough to swallow, but the truth is that you can't."
  
• An argument against making GDP too important in measuring societal well-being. This is a point I've debated before (not on this blog as of yet). I think there's been a problem over the past few decades in that we've come to view economic growth as the end instead of the means. Keep in mind that GDP growth is really supposed to be a way of improving quality of life; in other words, a means to an end. However, recently, we've been so wrapped up in maximizing growth and GDP and profit margins and whatnot, that *that* has become the end. The article suggests that had we paid more attention to indicators like median income, we would have had a better measure of societal well-being and things might not have looked so (artificially) rosy during the bubbles.
• As mentioned before, banks too big to fail are even bigger.
• BoA may not get off so easy after all!
• Krugman defending himself from criticism of his article. As mentioned before, I strongly encourage everyone to read his piece.
• Funny stuff.

A must-read

Krugman put up a must-read piece at the New York Times. I think it is slanted to the Keynesian school of thought, but it is also an excellent history of modern macroeconomics and how we got to where we are. There are a few paragraphs I want to quote and discuss, but please do read the article in full. It is particularly good for those who want a quick grounding in economic history.

Any emphasis in the quotes below is mine.

1. The birth of modern economics and the Efficient Market Hypothesis
"The birth of economics as a discipline is usually credited to Adam Smith, who published “The Wealth of Nations” in 1776. Over the next 160 years an extensive body of economic theory was developed, whose central message was: Trust the market. Yes, economists admitted that there were cases in which markets might fail, of which the most important was the case of “externalities” — costs that people impose on others without paying the price, like traffic congestion or pollution. But the basic presumption of “neoclassical” economics ... was that we should have faith in the market system."
This is foundational. Note that it relies on rational individual decision-making.
"There was a telling moment in 2005, at a conference held to honor Greenspan’s tenure at the Fed. One brave attendee, Raghuram Rajan (of the University of Chicago, surprisingly), presented a paper warning that the financial system was taking on potentially dangerous levels of risk. He was mocked by almost all present — including, by the way, Larry Summers, who dismissed his warnings as “misguided.”"
Krugman details much more, but essentially, makes clear that the belief in Efficient Markets had taken hold to such a degree amongst mainstream thinkers and policy-makers, that any thought to the contrary was dismissed out of hand.
"By October of last year, however, Greenspan was admitting that he was in a state of “shocked disbelief,” because “the whole intellectual edifice” had “collapsed.” Since this collapse of the intellectual edifice was also a collapse of real-world markets, the result was a severe recession — the worst, by many measures, since the Great Depression."
I linked an Economist article on this a few days ago. I think what one can see here is the beginnings of a fundamental questioning of Milton Friedman's faith in rational markets. This is a very, very serious question, as a reversion back to Keynes would be greatly at odds with what we've been used to for nearly 20 years now (it's arguable that Bernanke's stimulus is Keynesian, but I do still think that the core belief system of key modern policy-makers leans towards deregulated markets). Also, this is why I have the blog The Mess That Greenspan Made in my list of favorite blogs. =)

2. The Stock Market
It is generally accepted that the goal of a public corporation is to maximize value for its shareholders. This is a principle that I, at least, have never questioned. I am beginning to, however:
"By 1970 or so, however, the study of financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss, who insisted that we live in the best of all possible worlds. Discussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse. The field was dominated by the “efficient-market hypothesis,” promulgated by Eugene Fama of the University of Chicago, which claims that financial markets price assets precisely at their intrinsic worth given all publicly available information. (The price of a company’s stock, for example, always accurately reflects the company’s value given the information available on the company’s earnings, its business prospects and so on.) And by the 1980s, finance economists, notably Michael Jensen of the Harvard Business School, were arguing that because financial markets always get prices right, the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices. In other words, finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a “casino.”"
I find this very interesting. How did corporate leaders view the stock market prior to 1980? Was it simply a means to raise cash - in other words, allowing the stock to fund your activity and judge your value rather than forcing your activity so as to increase the stock price? The former seems far more rational to me.
My dad, Pramod Khargonekar, with whom I discussed parts of this article, brings up further points and questions on this topic:
There are some really fundamental questions: Consider a public company such as IBM.
Who owns the company? Legal answer: Stockholders (there are many classes of shares which makes this a little more nuanced. There are also debt holders who have a higher priority in terms of ownership which makes this answer even more complicated. Finally, taking into account externalities, society where the company operates have a legal and societal stake in the company. This is not always acknowledged.)
What is the role of mgt? Flip answer: maximize the value of the company. But what does this mean? Stock price in the next day, week, month, year, ...? Not all stockholders have the same view on this. BoD is supposed to represent the interests of the owners but they are often beholden to the management. Often CEO is also the Chairman of the BoD. The entire area of corporate governance is supposed to deal with this but has been quite dismal in this regard.
Where does the larger society fit into this? Flip answer -- no role. But then when the company creates toxic dumps, we the society pay for it and thus it becomes a subsidy from the nonowners to the owners. Unless the cost of externalities is fully reflected in the taxes paid, this is often in favor of the management of the company.
It is critical to realize that the corporate/government structure is constructed by us: it is not ordained by nature. It operates in the physical world and has humans as players. Behavioral finance, economics is probably the best direction for understanding how these things work and what to do about them for the long term good of the society.

3. Keynesian Economics
Back to quoting more Krugman:
"I like to explain the essence of Keynesian economics with a true story that also serves as a parable, a small-scale version of the messes that can afflict entire economies. Consider the travails of the Capitol Hill Baby-Sitting Co-op.
This co-op, whose problems were recounted in a 1977 article in The Journal of Money, Credit and Banking, was an association of about 150 young couples who agreed to help one another by baby-sitting for one another’s children when parents wanted a night out. To ensure that every couple did its fair share of baby-sitting, the co-op introduced a form of scrip: coupons made out of heavy pieces of paper, each entitling the bearer to one half-hour of sitting time. Initially, members received 20 coupons on joining and were required to return the same amount on departing the group.
Unfortunately, it turned out that the co-op’s members, on average, wanted to hold a reserve of more than 20 coupons, perhaps, in case they should want to go out several times in a row. As a result, relatively few people wanted to spend their scrip and go out, while many wanted to baby-sit so they could add to their hoard. But since baby-sitting opportunities arise only when someone goes out for the night, this meant that baby-sitting jobs were hard to find, which made members of the co-op even more reluctant to go out, making baby-sitting jobs even scarcer. . . .
In short, the co-op fell into a recession."

4. No one could have predicted this!
"Take, for example, the precipitous rise and fall of housing prices. Some economists, notably Robert Shiller, did identify the bubble and warn of painful consequences if it were to burst. Yet key policy makers failed to see the obvious. In 2004, Alan Greenspan dismissed talk of a housing bubble: “a national severe price distortion,” he declared, was “most unlikely.” Home-price increases, Ben Bernanke said in 2005, “largely reflect strong economic fundamentals.”
... there was something else going on: a general belief that bubbles just don’t happen. What’s striking, when you reread Greenspan’s assurances, is that they weren’t based on evidence — they were based on the a priori assertion that there simply can’t be a bubble in housing. And the finance theorists were even more adamant on this point. In a 2007 interview, Eugene Fama, the father of the efficient-market hypothesis, declared that “the word ‘bubble’ drives me nuts,” and went on to explain why we can trust the housing market: “Housing markets are less liquid, but people are very careful when they buy houses. It’s typically the biggest investment they’re going to make, so they look around very carefully and they compare prices. The bidding process is very detailed.”
Indeed, home buyers generally do carefully compare prices — that is, they compare the price of their potential purchase with the prices of other houses. But this says nothing about whether the overall price of houses is justified.
...In short, the belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient-market theory also played a significant role in inflating that bubble in the first place."

I leave the rest of the article to you. It makes for great reading.
The key points this article brings up:

• Lack of faith in the Efficient Market Hypothesis (I've brought this up before, and am wondering if we're beginning to see a more serious questioning).
• Too much belief in mathematical models that make for an ideal world rather than modeling the real world.
• A need to incorporate Behavioral Economics more strongly as the field moves forward.

I want to make a post later in further detail on the principle of maximizing shareholder value, how that's currently defined, and how it should be defined. I will quote my dad's note in that again, but expand on some points it makes brief note of (corporate governance and behavioral economics).

Wednesday Reading

Never mind that bit about this being a slow news week. Plenty of good reading.

• Too early for talk of bailout returns.
• A discussion on how Ben Bernanke is using inflationary monetary policy to combat the recession. This is a good read, and again seems in line with some of my recent posts: long-term, we're headed for inflation, and it will hurt. However, it would be nice to get someone else to judge this piece - it's a bit above my head. Also, more in line with my recent posts: short-term deflation already starting to take place? More in that vein.
  
• $9 trillion? Not even close! Try $14t.
• Nice read on the recent history of large-cap companies. They're back, apparently, though they were never truly gone. Yeah, okay, that sounds dumb, but it's still a good read: "Two further developments are shifting the balance of advantage in favour of size. One is a heightened awareness of the risks of subcontracting... A second is the emergence of companies that have discovered how to be entrepreneurial as well as big." It's the second point, particularly among large-cap tech, that I think is most relevant.
  
• Further proof (furthering the Hussman commentary linked yesterday) that this recession is simply not in line with previous post-war recessions.
  

Wednesday Reading

• Transcript of Bernanke's speech at Jackson Hole. In case you didn't know, Obama's having him back for another term, with fairly widespread support. The topic's a little too politically sensitive for me to bring up my own feelings.
• One analyst saying we have plenty more bank failures coming.
• Sent by a reader: large-scale agriculture in cities. This could be pretty amazing if it's ever proved to be feasible (economically and practically).
• Mish still banging his looming-foreclosure-disaster drum.
• Despite all the 'green shoots', and announcements that we're coming around, the Philly Fed is showing we still look like we're pretty deep in a recession, and have a ways to go yet. (Speaking of green shoots, this article is linked for no better reason than quoting the great Inigo Montoya)
  
• Perma-bear Nouriel Roubini still making arguments for an ugly U-shaped recovery, and as mentioned here before, is getting more and more worried about W. FT.com requires registration (I've got a free 30-day window through my employer) so I can't say much more. Good read if you do have access.
• A fascinating debate is taking place at The Economist regarding how much population the world can support. Great read.
  
• A little off-topic, for all the engineers out there: Keep It Simple, Stupid!
• Krugman giving further details on his recent opinion that we're in a jobless recovery.