March 11, 2008

How Can We Tell?

At this moment, it seems like the most important question is: How can we tell whether the financial markets are merely in an irrational panic from which they can be bailed out; or have we arrived at a rational reckoning where bailouts are just money down the rathole?

Have economists developed some sure fire models for distinguishing between panics and reckonings? I realize that economists have been busy lately studying sumo wrestling, but perhaps a few of them have stuck to their knitting?

Or, are we just flying blind?

And if we promise to bail out irrational behavior, doesn't that just buy more irrationality?

My published articles are archived at -- Steve Sailer


numbskull said...

My impression is that economics is a vastly overrated field of "science", or rather "social science". In comparison to physics or mechanical engineering economics is really just conjecture.

That is probably why they are able to hype one-sided arguments such as free-trade for decades without having to worry about the downsides. If a mechanical engineer were to design planes this way, he'd either be facing a court or be out of a job pretty fast.

But economists can always use some vague arguments because it is impossible to accurately measure what's going on due to the sheer size of economies, the volatility of humans and the weather. If that does not work, they can just bully timid politicians into enacting their favourite bogus theories and applying them by brute force, or as the ultimate escape mechanism, convince politicians to go to war.

Ultimately they can just hang around a university with high social cred and spew more nonsense every day whilst enjoying the admiration of younger wannabe economists, status-obsessed businessmen, politicians and clueless journalists.

Anonymous said...

I remember when people were trumpeting the idea of a "sky's the limit" Dow of 50,000 around 2000.

Karl Marx said that periodic crises were a fundamental feature of capitalist economies. Was he wrong?

dearieme said...

Try Galbraith's "The Great Crash 1929" and enjoy his quoting of economists' predictions of the time. It's reminiscent of the "it is contained" rubbish that was propounded only a few months ago.

LemmusLemmus said...

I can't be sure, but I'd think panic isn't exactly economists strong suit. Doesn't fit their model of man well, does it?

And as panic isn't exactly easy to study in the lab, behavioural economists probably haven't given it much thought either.

Anonymous said...

As an individual investor, look at individual companies. When the market gets hammered like it's getting hammered now, quality companies get pummeled along with the crap. How to tell the difference?

- Look for companies first of all that have a decent pile of cash and no debt (there are plenty of them out there) -- these won't have any liquidity problems due to the credit crisis.

- Look for companies that sell a product or service that isn't dependent on fickle consumers.

- Look for companies trading at historically cheap valuations.

- Look for companies that benefit from a weaker U.S. dollar.

- Fred

Anonymous said...

This is easy.

Rational reckoning is what happens when an economic slowdown occurs in the 1st year of a President's presidency. No need to cut taxes that year, because it's time to pay the piper for all those excesses that we've enjoyed.

Irrational panic is what occurs when a recession(greater than 5% unemployment) happens in a Presidential election year. We've got to take every step possible to prevent unemployment from exploding into unfathomable levels, such as 6%.

Leonard said...

Steve, your first para reveals a misunderstanding. A panic is a particular sort of financial episode, wherein an asset or asset class which has been overvalued is discovered to be not so valuable after all. When this happens, everyone rational heads for the exits, but the key aspect to the thing is that the order of getting out matters -- he who gets out earliest loses least.

But contra to your assertion, a panic is not irrational. It is rational, and that is precisely the "problem" -- problem from a certain POV. Furthermore it is exactly one consequence of a "rational reckoning".

In the particular "panic" of right now, people have discovered that housing has been a bubble. (Shocked, shocked!) The entire edifice of debt and financial products surrounding it is now highly suspect. The most solid, supposedly trustworthy agencies are involved: Moody's and the other rating agencies which signed off on a bunch of steaming crap as investment grade paper. This is bad. A reckoning is in the course of happening, but you can be sure that as particular bad investments are discovered they will be trounced in the market. If information is released suddenly, and it is severe, it may be a panic.

In theory, a panic can be stemmed, but practically it is not really possible. The sorts of measures that would be necessary in many panics would require mass infusion of value -- actual real value -- not just "liquidity" or some other meaningless buzz. Put another way: if you discover that a stock you own, currently priced at $10, is really only worth $1, what should you do? Sell it, of course, and as fast as possible. And what might prevent you selling? Well, nothing -- unless someone gives you $9 not to, or else they give the company $9 per share in free money. This is unlikely.

In practice, the main way in which our society deals (badly) with financial problems is inflation. Bernanke is, as we speak, flooding the market with dollars. The effect here is simply to renumber things: your stock with actual value of $1 becomes worth more, say, $1.15 after a year's worth of heavy inflation. Of course this cannot stem a panic, except very slightly at the margin.

As to your questions: are we just flying blind? Yes.

And, "if we promise to bail out irrational behavior, doesn't that just buy more irrationality?" Yes again.

Anonymous said...

"Sure fire models" - in the current five-sigma-event-ridden economic landscape?
Surely you jest.

kurt said...

That is a very good point, Steve. Of course, the wall street people and political classes are not about to come up with any such metrics because the benefit from the obfuscation. The political classes (especially Hillary) get their campaign money from the wall street crowd and the wall street crowd expects a bail-out from the politicians.

Bernanke seems to be getting sucked into this moral hazard. This should be no surprise to anyone with historical memory. Arthur Burns was appointed, with great credentials, as FED chairman by Nixon and he promptly acceded to Nixon's demand for "cheap" money, resulting in 10 years of stagflation.

It is widely recognized these days that monopoly and oligopoly power is bad in any other business. Why do we persist in the delusion that monopolistic institutions such as the FED are necessary for banking and money?

William said...

We continue to bail out people and businesses who locate way to close to flood zones (see: New Orleans). After 9/11, Congress bailed itself out by paying billions of dollars to victims families in exchange for indemnifying airlines against lawsuits, raising the question of why airlines should ever have even been potentially liable for the result of a terrorist act, anyway. Answer: the ATLA, the trial lawyer lobby.

The problem, as with so many of these cases, is that which defines a special interest: a small but politically powerful (or else well-heeled) group with great interest in an outcome versus a large but disinterested group with little to no interest in the cost. A few more $100 billion+ bailouts, one would hope, might change that attitude, but the ratings for shows like "American Idol" just seem to keep going up.

Lucius Vorenus said...

Man, between all the communists on this thread, and all the communists on that Liberation Theology thread, it's hard not to conclude that there are a whale of a lotta bolsheviks in iSteveville.

Who'da thunk it?

Anonymous said...

Economics without ethics is rhetoric.

Anonymous said...

"Sure fire models" - in the current five-sigma-event-ridden economic landscape?
Surely you jest."

Beware of assuming that the odds of various outcomes in financial markets are normally distributed; they usually aren't. Their distributions tend to have fatter tails.

- Fred

Anonymous said...

The mexicans' practice of jamming five families into one home may soon become the norm!!

Sweating Through fog said...

My rule on distinguishing panics from corrections is that panics prompt lawsuits and more regulation. People know internally when they were taken, but they can't admit it - so they want to seek retribution elsewhere. These lawsuits and regulations are designed to punish people who recognized the bubble earlier, and took their winnings off the table.

Similarly my rule for detecting a bubble: When I'm with a group of loose acquaintances, and they all want to impress each other with how savvy they are. They talk about the money they've made in internet companies or real estate. When the panic starts, these people become silent on business matters.

Anonymous said...

"Karl Marx said that periodic crises were a fundamental feature of capitalist economies. Was he wrong?"

No, but he somehow neglected to talk about communism being evil, and the starting point for perpetual crises in which millions die for no reason at all, except for an abstract market system that doesn't work at all in real life.

Since he missed that important piece of information, I can't put a lot of consideration into the idea of legitimacy in the works of Karl Marx.

That is, even though a broken clock is correct twice a day, I don't set my watch by it.

canson said...


Stock brokers, bankers and others of that ilk plunging from office block windows would be a clear sign that problems were real and lasting. Seriously though, an up tick in suicides, accidental deaths, deaths from stroke and heart attacks within the professions that suckle at the WS teat might indicate problems that are resistant to bailouts.

Martin said...

"Lucius Vorenus said...

Man, between all the communists on this thread, and all the communists on that Liberation Theology thread, it's hard not to conclude that there are a whale of a lotta bolsheviks in iSteveville.

Who'da thunk it?"

Huh? I generally find myself in agreement with you Lucius, but on this point I am stupefied. I did not detect any communist leanings in this thread. After all, one does not need to be a communist to mistrust the wealthy and well-connected.

anony-mouse said...

Warren Buffett (granted he can afford it) said that he's like to be around for a few more recessions.

Recessions (which have been getting shorter and fewer) are just a fact of life. Economists trying to solve recessions are like medical researchers trying to end the common cold.

The key is to figure out when they end, not begin. That's when the most money is made.

Martin said...

"canson said...

Stock brokers, bankers and others of that ilk plunging from office block windows would be a clear sign that problems were real and lasting. Seriously though, an up tick in suicides, accidental deaths, deaths from stroke and heart attacks within the professions that suckle at the WS teat might indicate problems that are resistant to bailouts."

In addition to being instructive, it would be entertaining as well.

kurt said...

Actually, Bernanke made a very clever move today by offering $200 billion in financing to these lending institutions while accepting the mortgage backed securities as collateral. My making the FED the creditor of last resort to these institutions, he makes the FED the receiver for any of the institutions that fail to make good on this new loan. Any of the banking institutions that fail to make good on this loan can then be placed in receivership with the FED as the receiver. The FED can then proceed to liquidate all of these financial institutions, which has to happen sooner or later anyways.

I believe that Bernanke had just created the pathway for an S&L-style liquidation of these financial institutions.

The test will be if Bernanke has the moral character to force receivership and liquidation on any of the financial institutions that fail to make good on the loan. We will know this by summertime.

TGGP said...

Bailouts are always money down the rathole. It has nothing to do with whether it's a panic or reckoning. It's just the nature of government. Like we saw with 9/11, Katrina and Iraq they just shovel out money any damn way with jack all to do with squat.

mq said...

Marx is an underrated thinker. He was wrong on the immiseration of the working class and hopelessly fuzzy-headed about what will succeed capitalism. But a lot of his diagnosis of capitalism was very prescient, especially for 1850.

Lenin was where the whole Communism thing turns unambiguously evil.

rast said...

Man, between all the communists on this thread, and all the communists on that Liberation Theology thread, it's hard not to conclude that there are a whale of a lotta bolsheviks in iSteveville.

Reminds me of something Steve wrote a while back...

" arguments are so shameless and stupid that they are rehabilitating the reputation of Karl Marx."

Similarly, the actions of the Fed (and everyone else responsible for the current disaster) have been so shameless and stupid that they're rehabilitating Marx.

As Steve and others have pointed out, much of what we call "capitalism" in this country is simply privatized profits and socialized losses. I personally aren't seeing any of those profits, but I sure am seeing the socialized losses -- my employer gives me the same amount of green paper each month, but each month it buys less food, gas, clothes...

Udolpho said...

Wealth goes to those who grab it, not to those who sit around waiting for their employers to give them a raise. One of the problems with America is a growing culture of passivity and reliance on government to solve any problem (something it is of course not very good at doing).

Titus Pullo said...

Europe has developed pretty much as Marx predicted. Before Leninism, Marx said that Communism would begin in the most developed economies. This did happen, but by creeping Social Democracy rather than revolutionary activity.

God forbid a taboo thinker be correct about something. It wouldn't even be worth mentioning if every jack*** weren't trumpeting the whole Dow 50,000 baloney 10 years ago. Bah, humbug.

dougjnn said...

[Sorry, long, but this isn't soundbite stuff.]

Steve, your rather vague questions, partly rhetorical I realize, seem to be group for some big picture perspective on the current financial crisis. I’ve certainly been thinking about it and web researching it quite a bit, partly in connection with the quite successful energies I expending in medium and longer term investing (with occasionally some shorter term trading when I think, when I think I see enough of and edge).

The economist I suggest you first and foremost seek out to read on the web is Martin Feldstein. He’s the eminence grise of Economics at Harvard and is widely regarded as at least one of our national “deans” of the profession. He’s more in the sound judgement and weighing of factors camp and with those strengths, as opposed to being a flashy new theorist. But he’s definitely an original thinker.

Anyway Feldstein has been saying for years, and especially the last decade, that the low us net household savings rate (after borrowing rate is subtracted out) and very high and until the last six months or so rising trade and current international accounts deficit are not sustainable and will be reversed, mostly likely painfully but not catechismically, but with some danger of a real crash, if no wise policy moves are taken. I think it’s quite clear that the big picture is that we’re getting the first and so far avoiding the second RIGHT NOW, and also that it’s likely we will avoid the second.

BTW, I think the unstated implication (in what I’ve read in his not so terribly technical web available articles) of what the crash scenario would bring is another great depression, though I’m sure he’d say not as severe or long lasting as the 30’s version, because financially leading governments around the world lead by the US but no longer only the US have learned from that experience. What he really thinks is that we’ll avoid anything that could be called that for these reasons and others (much higher levels of world trade which are unlikely to be completely reversed even if it is somewhat chipped away at in the current climate and with the Dems coming in and saying so).

That’s the biggest picture. It likely means that the US will not emerge from this I think long and pretty severe recession with the same sort of preeminent financial position that we had going in, though we’ll remain leading, if in a somewhat shaky way. Sort of like the Brits, NOT after WWI – when they were really bled white and in trouble – but after the turn of the 19th century, with the US and Germany rising fast and in fact overtaking both economically and financially, though that was not yet really reflected in the formal world financial system structures and arrangements.

dougjnn said...

The medium term is of course the housing bubble. We think in the US that that is unique to us, but it isn’t. The same has happened and in fact in many or most ways more so in Britain and Spain, and some other smaller Euro countries as well, but not in e.g. France, Germany or Italy. See the Economist, a couple of weeks ago, web available, at least certainly with a web subscription. The leveraging up of the financial system to support this was however I think worst in the US, with e.g. lots of hedge funds supporting long structured finance mostly mortgage backed securities on a 20 to 1 or greater (as high as 30 to 1) basis.

The investment banks mostly don’t intentionally hold the stuff after creating it except in their semi separate sponsored investment funds, but did end up holding a lot of it when the music stopped last summer and they couldn't find enough chairs to sit down on when it did. What the fed did Monday was come in and relieve some of that pressure on the investment banks and banks and as a result hedge funds, by taking the paper themselves as collateral (since the banks no longer would and in fact are desperate to offload same).

The Fed’s ability to do these things depends ultimately on the credit the world continues to extend to US fed debt (and the price – interest rates – it demands for that credit) most visibly in the form of huge foreign governments and sovereign wealth funds willingness to continue to hold US paper. The most basic reason the world will continue to do so, though not at the margin (but avoiding huge sudden outflows) is because everyone knows if it didn’t another great depression would occur. Why? Chinese holdings cut in half overnight, Chinese and all the related and follow on Asian trade cut in half or by three quarters overnight, massive Chinese urban unemployment and civil unrest and worse, similar in SE Asia and less so but also Japan, Taiwan S.Korea, and also India.

But again a real depression is very unlikely to occur. But a long and deep recession is likely.

dougjnn said...

I don’t think the US overall is likely to see another housing price boom like the oughts in boomer lifetimes – there’s a demographic shift occurring right now. This is partly offset by immigration but most of that immigration will be for some time at economic levels that can’t buy a lot of the boomer homes until they’ve come down a lot further even. So the equilibrium is likely to be house prices that in the worst places, e.g. inland Cali, continue to go down over the next year (not just six months), and then fail to go up all that much for years. Well they may fairly quickly bounce up from a real foreclosure and other panic low if that happens and where it does but not in the overall big picture numbers much.

The way the US saves more and the dollar stop going down forever is if the US consumer, seventy percent of our current GDP, spends less. No more home equity loans and the sense that selling the house maybe isn’t going to completely fund retirement is part of that mechanism. All that suggests to me that a long recession and a slow recovery, with a permanent adjustment upward in the export percent of our economy and downward on the consumer import side – e.g. aspirational European luxury imports. Yeah the rich will still afford them, but the barely upper middle class not.

Now another major tech innovation led boom, like PC’s finally becoming important in offices everywhere in the 80s, and the internet in the 90’s (and again web 2.0 to SOME extent from 2003 or so on) could adjust this whole picture brighter. The same basic dynamics would have to occur but there’d be a big countervailing force. Mobile internet and related looks the most likely but the US isn’t as dominant there area I has been in other computer/telecom related tech – except on the software side. I think we’d need something else as well to have enough countervailing force to really change the balance much. To me it’s a less than fifty fifty shot we’ll come up with something (but way more than fifty fifty that if anyone in the world does, the US will be leading it).

Howard J. Harrison said...

Dougjnn's well informed comments are worth heeding in my view, but what I want to know is this: has your old friend Peter Brimelow weighed in on your question?