Gradual Decline before the Crash?

Barkley Rosser says the period after the peak of a speculative bubble can often be broken into two periods, the first characterized by a gradual decline, i.e. a period of "financial distress," and a second where there is a massive panic and crash. He also says he has a model that can explain how this happens, though I trust he will understand if I hope that the second stage prediction of the model does not come true for the present financial crisis, or that a key condition necessary for the second stage to occur fails to be realized (I'm hoping Barkley will have the time to give the intuition behind the transition between stages, and how certain he is that the critical linkages are in place):

Falling from the Period of Financial Distress into the Panic and Crash, by Barkley Rosser: In 1972, Hyman Minsky described the "period of financial distress," in a paper in a journal that no longer exists..., "Financial Instability: The Economics of Disaster." Charles P. Kindleberger picked up on this and followed Minsky's analysis in his famous book, Manias, Panics, and Crashes: A History of Financial Crises, the 4th edn of which appeared in 2000... The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revivial, but finally giving up in the final collapse. According to Appendix B of Kindleberger's 2000 edition, 37 of the 47 great historical speculative bubbles exhibited such a period before the final crash, even though all the theoretical models predict a crash immediately following the peak with no such period.

In 1991 I published the first mathematical model of such a phenomenon in my book From Catastrophe to Chaos: A General Theory of Economic Discontinuities_(Kluwer, Chap. 5)..., although nobody seems to have noticed... In 1997, I published a paper describing this model (and related matters)... This paper has never been cited. More recently I have coauthored a paper that ...[is] now under a long revise and resubmit, still waiting for an answer ... with Mauro Gallegati and Antonio Palestrini, "The Period of Financial Distress in Speculative Markets: Interacting Heterogeneous Agents and Financial Constraints" (available at my website), that lays all this out in much more up-to-date mathematical modeling.

So, why am I boring all of you with this self-citation? Well, Dean Baker is constantly claiming credit for his forecasts of doom and gloom. It looks like we might be finally reaching the big crash in the US mortgage market after a period of distress that started last August (if not earlier). I and my coauthors are the only people to have provided actually formal models of this phenomenon, beyond the verbal and historical discussions provided by the brilliant Minsky and Kindleberger (both of whom I knew...). I have been forecasting this in unpublished lectures all over the globe for years, but never have put it up into the blogosphere. So, I am claiming credit, to the extent it is due, although the basic ideas were clearly laid out earlier by Minsky and Kindleberger.

I will add one more story. Three years ago I presented an earlier version of the still-unpublished paper with Gallegati and Palestrini in Tokyo at Chuo University. In the middle of the presentation the biggest earthquake in 13 years hit Tokyo, in fact right at the moment I said the word, "crash." Some of the Japanese in the audience blamed me, not entirely humorously, for having caused it.

Comments

[Bill Liles]

Iam not an economist by education but I find myself increasingly concern as to how all this " disterss " will work its way out. From my pov nobody is raelly doing much but jawboning hoping if theyignore it long enough it will go away. Does it finally come down to the dust clearing and the losers just throwing in the towell?

[Robinia]

Hmmm. This translates out in an interesting way from the economic to the social. So, in the same social model as witchhunts, pogroms, and genocidal campaigns such as took place in Rwanda, as gradual decline makes the society aware of impending and inevitable loss, that loss is concentrated in a scapegoating maneuver on the powerless, who will bear the burden of the final descent into chaos that brings catharsis ("correction") and allows the society to move beyond the loss.

Fannie Mae and Freddie Mac debt became attractive again this week as investors realized that any impending losses would be socialized-- take that, suckers! Now who, do we think, the ol' US of A can find to make a goat of? Grover Norquist says Nancy Pelosi? The Office of Thrift Supervision is blaming Senator Schumer? If I were a member of an outcast group ("illegal" immigrants? Muslim "terrorists"?), I'd be ready to hit the floor at the smallest unexpected sound.

[Bruce Wilder]

Does leverage imply investor heterogeneity?

[a]

I thank our gracious host and BR for advertising this paper. My comments may sound churlish; I'm afraid my only excuse is that is my nature. I guess my other excuse is that, even if this paper were a major advance in the literature (which it might well be), I don't have the qualifications to recognize that fact.

But anyway, here goes.

The reason BR cites for advertising the paper is that Dean Baker claims credit for his "doom and gloom" predictions. Okay, but when I read the paper, I see a model, but no predictions. That is, it's great to provide a model that traces out the behaviour of a market pre-crash, but there is no claim that we are undergoing that behaviour *now*. So, even if the market crashed tomorrow, I'm afraid I won't be able to credit BR with any foresight. Baker is claiming, I guess, to have had foresight, in a qualitative way. That's very different.

So, I ask BR, with all deference, is he claiming to have made any predictions, in the past or now, about crashes? It's fine if he hasn't or isn't, but I thinks it's worthwhile to be clear about the point. If he hasn't then the paper looks like (disparaging remark, apologize in advance) glorified curve fitting. It may well be a substantial advance in economic theory, but obviously I'm not too keen on that kind of economic theory. Okay, okay, I know, so much the worse for me. Anyway...

To be precise about predictions (just in case that is the intention), did BR ever predict that the actual trajectory of any past or current market fit his model *before* it crashed? It sounds that he is saying that the current mortgage market may be in the pre-phase crash. Does he make that connection, i.e. he is predicting a crash? *What* is a crash in the mortgage market? That is, generally a crash in an equity market is considered to be a one-day movement of x% or more (I'd use x = 10 but others differ). Is he thinking of an index in the mortgage market and if so which one and what is the movement required and over what period? Or is he predicting a crash in the equity market? If so which one? (China? U.S.? A world index?)

[Aaron]

Houses are not Tulips

The price for houses are set obvously in the housing market by the forces of supply & demand. When demand shoots up and starts to resemble a bubble I think the only thing you can do is to try to make some sort of intrinsic value estimate . Such an estimate could be done looking at market values versus constuction costs and also rents.

A recent statistic for new homes sold in April is about $246,000 while the second hand values are around $222,550. So if the new building represents construction costs (which I have no idea if it actually does) then it would seen that overall houses accross the USA are selling near their construction costs, which would argue that much of bubble has already been deflated.

Another estimate would be to take a rent and divide it by a capitalization rate:

More made up numbers follow:

$1,600 / (.075/12) = $256,000

where $1,600 : is the monthly rent
(.075/12) : is the monthly borrowing rate

So if one were to do a real analysis are we going to see a significant bubble in the housing market?

Another issue is that demand for housing is largly a function of income. From a buyers perspective they often think about how much they can afford to pay per month.

Let's say a person it willing to pay $2000 per month.

At 4.5 percent interest this would allow the person to afford a house worth $2000/(.045/12)=$533,333. At 7.5 percent interest the same $2000 gets you only a $320,000 home. So your income did not even go down and your willing to pay the same monthly mortgage rate but the rising interest caused you to lower what your willing pay by 40 percent. I guess the bottom line is that there is a large but finite group of individuals sitting in their golden cages that they bought with cheap money and now are looking for a way out and to be bailed out by the taxpayer. I would rather they stay fettered to their cages until market values recover and future instrinsic values equal (in a nominal sense) what they paid.

[ndd]

Sorry, I don't do downloads.

Anybody care to cite an example that jibes with the model?

Certainly the great stock market crashes happened pretty suddenly (~2 months after the exuberant market top) after quick market declines of 20%.

For real estate, the cycle is different and has been frequently cited. Market declines seem to have lasted about the same period of time as the booms. This cycle appears to be following the model.

Maybe it's the word "crash" that is throwing me. What specifically constitutes a "crash" that the author says is called for by his model?

[yamada]

Bubble is caused by peoples’ expectation that the price of asset(real estate) will soar in future, with pouring high-powered money to the asset side of economic units’ balance-sheet. So, to solve this problem, such asset bubble on economic units’ balance-sheet must get ridden of in order, by the new system as below. Though it may be seen contradictory, high-powered money enables to work this new system. Please remember, no one has ever invented the solution in history, which fact that entraps economic dispute into confusion nowadays.

1. Every economic unit’s(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic units.
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all.
4. Other economic unit that gets profit from the written off by the bank should next enforced to, by using the profit from the written off as original fund, write off it’s loan(or trade claim) to its each debtor, according to the amount of insolvency of each debtor. If the economic unit is unable to use all profit it earned, the remainder is taxed all. These processes are to be repeated operationally.
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. It’s up to the Government how they dispose of their above tax claims, considering the situation of economy, of each bank and of each economic unit. Talking about the latter two, as a option the Government should examine the possibility of the bank’s and economic units’ turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic unit(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic unit), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and tracable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic unit, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic unit that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic units, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. In case inflation expectation exists, the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic units.
10. FRB should carefully watch the rate of the number of insolvent economic units to the number of all economic units in the US, when deciding the amount of the loans(trade claim) written off on 2.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

says...

nobody is really doing much but jawboning hoping if they ignore it long enough it will go away

Only half right. They're hoping to tread water until at least January 2009 so it will be someone else's problem.

[Steve Salmony]

Did anyone here notice that that July 11th was World Population Day, that human population numbers worldwide are exploding and that too many of our leading politicians and mass media moguls did not take advantage of World Population Day by so much as mentioning the "mother" of all human-driven global challenges?

Yesterday was World Population Day. Can anyone name one world leader or mass media organization to direct our attention to this momentous event?

After all, if Earth cannot be expected to sustain the skyrocketing growth of global human population, AND TOO MANY HUMAN CONSUMERS AND POLLUTERS ON EARTH COULD INADVERTENTLY PRECIPITATE SOME KIND OF COLOSSAL ECOLOGICAL WRECKAGE SOON, perhaps there is a case to be made for political leaders and mass media "talking heads" to advocate family planning, health education and contraception programs universally, freely and immediately available for voluntary use.

Steven Earl Salmony
AWAREness Campaign on The Human Population,
established 2001

[Bruce Wilder]

I cannot tease out differing intuitions: the effect of leverage from the psychology of expecting that things will go on as they have, despite fundamental change.

[athEist]

ndd: The stock market crash did indeed occur about 2 months after the peak, but then after a decline of 20% and great volatility it seemed to settle at this new plateau into the spring and summer of 1930. It appeared as though this would be one of the stock market crash not followed by a depression(about one half aren't). But in the earlt fall of 1930 the great hordes of unemployed appeared and the market resumed dropping (crashing)hitting bottom(after 3 sucker rallies)in 1932. I think "the period of uncertainty" referred to (in the 1929 version) is this 9 month period after the Oct crash.

[Peter Schaeffer]

Barkley Rosser is a chartist!

The truth comes out.

We should have suspected.

[GoatGuy]

Folks ...

I think that BR's observations merit inclusion: that in a nutshell, 'experts get out first, then the suckers hopefully hang on, then finally quit en masse' (paraphrased). We've all observed just this play out, I'm sure.

The FED is running scared - and it is as glaring as a 1000 watt bulb in a candle-lit cave: Fannie and Freddie (after market close) blithely spirit forth claims of being nice and healthy, a bit crunched, but nothing to worry about. Meanwhile, again after the bell, the Fed siezes IndyMac and places it into receivership ... the second largest bank failure in history. Oh yah, I'm sure everything is as tight as a drum, fit as a fiddle, and primed to parade -- NOT. It wouldn't have helped to have announced the failure during the trading day, or after hours on a Tuesday, would it? No, one has to let the panicky-types cool off over the weekend.

I think that markets have a lot of elasticity in accomodation to misfortune during periods of economic expansion and even relative stasis. Things can fail, but like a well planned electricity grid, the whole thing doesn't come crashing down, just because of a short circuit in a tiny corner of the system. Yet, very much like the electric grid, the capacity-to-absorb deliterious events is also quite finite, where above some number (and size) of failures, the system becomes hair-triggered and brittle.

In the recent past, moderate periods of recession and moderated recovery from economic bubbles have been powered by remarkably rapid developments in the technology, information and computational sectors. What is different this time around is that it doesn't appear that there is much opportunity to deploy a fresh layer of cunningly nimble technology to restore profitability to our globalized Economy. We're already running pretty damned efficiently it seems to me. I'm not saying it couldn't be better, but I don't think there is a huge untapped reservoir of yet-to-be-deployed technology that will create a broadly expansionary economic phase in the short term. Certainly not iPhones, if you know what I mean.

So then my question becomes, "is BR right... that this current recession is primed to become a full-on market crash due to too many failures building up?"

The answer depends a lot on whether the Perfect Storm of

* Rising fuel
* Rising baseline inflation
* Diminished durable goods consumption
* Squashed mortgage-credit funds
* Rising unemployment
* Frustration, hopelessness, fear

is as deep as it seems. We're whining about $4.79 gasoline, yet the supply-demand elasticity has us all just using less of the stuff. Environmentalists and Carbonosophers should be pleased.

Rising baseline inflation is making the Weekly Market tab all that much higher - while simultaneously people have less disposable income to afford the goods. I've personally noted many of my very-middle-class circle of friends buying a lot more chicken and non-premium pork, foregoing those salad-in-a-bag things and making a head of lettuce do the trick. It isn't to the point where we are significantly taxed by the rise, but the local Food Bank has become literally innundated every week with all sorts of people are just aren't making it. Its not reported, and it is alarming to me.

Durable goods sales are sliding fast - again only anecdotally, but talking with several of the older 'career' sales-staff at Sears reveals significant fear: almost nothing is selling, except to those who either have to get replacements for failed apparatus, or to construction folks doing necessary/planned upgrades to rental properties. Simultaneously, appliance-repair operations are backlogged. Again, per the idea that it ain't a depression yet, but a good round of belt-tightening ... I think there is something laudable about people weaning themselves from the 'just replace it' mentality. Yet, there are a LOT of jobs that depend on those durable goods being manufactured, marketed, warehoused, sold, delivered and so on. I wouldn't want to be Sears right now.

Squashed mortgage-credit funds (AKA 'ReFi Piggy Bank') is the most significant cause for the durable goods / custom home improvements decline. People came to embrace that periodically they could tap "their house" for a few tens-of-thousands from time to time to do a Big Thing, be it home improvement, car purchase, personal-credit payoff, college education for the kids, or more vanely, a boob-job, Lasik treatment, non-insurance covered knee-replacement, a Boat, a Cruise, or a Car. Point is, those accumulated funds were being tapped by a large fraction of the home-owners in order to fulfill their expectation of status quo, a la The Joneses. That money is gone, for all intensive purposes - except if you lived under a rock for the last 15 years and never got a 2nd Mortgage or ReFi (i.e. if you still have sizeable equity in your hut). I don't see ANY mechanism (and I mean ANY!) that the Government could institute that would create a fiat money supply analogous to the ReFi Piggy Bank in the short term, or mid. Only sizable, sustained and broadly applicable inflation could do that.

Rising unemployment is almost hidden by the stretching of the unemployment mean-layoff period. But again, I've been polling plenty of people from around the country on their experiences, or their second-hand recounting of friends experiences. It seems that we're in a period where many people can't find work until well past when the last unemployment check is cashed. In part, it has to do with costs: there is a sizable gap between what employers are willing to pay and what people desire to be paid for many of the current semi-professional and production jobs. Oddly, most job openings aren't filled quickly because the offered pay is simply too low to be embraced in this inflationary cycle. I don't think this is a healthy trend.

Finally, the feeling of hopelessness, fear, and uncertainty is on the rise, no matter how rosy the Government says are the Consumer Happiness Indexes. People are watching their friends fall into bankruptcies, mortgage failures. They're noticing the little old lady next door collecting aluminum cans, and going to the Food Bank - driving 3 of her neighbors in their 25 year old car to save gas. Oh sure, the "brushed aluminum" generation [18 to 36] are timelessly upbeat, as they're not yet affording mature children of their own, ageing parents assistance, significant unemploymeent or declining health. But the 40-55 sector is smarting from the wholesale failure of the system.

It is easy to blame The Administration. It sounds so sterile, faceless, and vaguely evil. Yet it is not The Administration that imposed hard austerity measures on the home-mortgage market early on (which would have brought about this recession's exagenesis all that sooner), nor did it incautiously engineer a persistent round of inflation or legislate prudently generous prepaid margins on home-owner's loans. It didn't tax the Internet (transactions and data), it didn't impose broad taxation to bail out the deficit. It didn't impose multilayered tariffs on foreign goods, and it didn't create a preemptive-strike mandate to quickly fill giant strategic oil reserves. It didn't do so, because the People ultimately didn't want it. Today the same people are preposterously decrying that The Administration failed(!) by not having the prescience to prepare for this current Purgatory, and they're to blame.

OK, technically that would be so, but also we must acknowledge that our predicament is entirely non-partisan and certainly not even something that can be pinned on the tail of the Elephant-in-charge. Congress's charge is to draft, debate and enact Laws. It is also to ratify budgets, to question the Executive powers, to inspire its constituency into progressively acting to optimize the economic path through the jungle of future "problems" (and opportunities). Has our Congress and Senate done so? Not by my reckoning. Not at all.

At this point it really is more up to Congress than any other body to determine how the future will be approached. Will they come to their senses and begin to act progressively? I'm certain that until the Market actually crashes, or until the Commerce Department finally fesses-up to the Economy being headed rapidly into a depression, that they won't.

I just wish that on every ballot, for every candidate, there was an additional box: "None of the Above". Anyone want to bet that such a choice would instantly change the face of our Electorate? I think it would be profound to give the public the power to have the Veto Vote. Let the veto be just as democratic as the Vote.

Bob Lynch AKA GoatGuy
Alameda, CA

[Barkley Rosser]

a,

The paper is a simulation model, the earlier work was a theoretical model with heterogeneous agents, some of them fundamentalists, some of them chartists. No, I have not used it ever to specifically forecast successfully the exact turning points, either peak or crash, of any specific bubble.

In the model in the paper that you have accessed, the wealth constraint is a key part of the crash phenomenon, think margin calls triggering asset sales that trigger margin calls that trigger asset sales that... We may be getting into a slow motion version of this with financial institutions, as accounting rules force asset sales as balance sheets worsen, which further devalue assets that... Of course, once clear shifts happen, psychology plays a big role, going from euphoria of the boom through the distress of the pfd to the panic of the crash.

Aaron,

Certainly houses are quite different from tulips. Houses themselves are assets whose market declines are least likely to go as crashes, as people may not be forced by financial constraints to sell them, but they just sit on them. So, we are more likely to see long slow declines, with the decline in Japan having gone on for nearly 16 years now, although it probably hit bottom in Tokyo a few years ago.

Interestingly, the 1637 tulipmania is an example of one of those that did crash straight from the peak, one of the handful in Kindleberger's Appendix B that did so, with a few others doing the gradual decline with no crash that policymakers (and Mark Thoma) are hoping will occur with this one, although a decline that drags on too long can get to be pretty depressing (see Japan).

In 1929, the stock market peaked about Sept. 1 and then crashed on Oct. 24. In 1987, the stock market peaked in mid-August and crashed on Oct. 19. In the Mississippi Bubble, it peaked in Dec. 1719 and crashed in May 1720. The South Sea Bubble peaked in May 1720 (it had started in Dec. 1719, not a coincidence), and crashed in September, 1720. However, several of those recorded by Kindleberger had pfd's that lasted for more than a year.

BTW, the 2000 high tech crash looks like it was probably one of those ones fitting the theory, a sudden crash from the peak, although even that one is a bit murky, as the day of steepest decline came about a month after the peak.

Peter,

I am neither a chartist nor a fundamentalist. The sorts of heterogeneous agent models that I think describe reality involve people changing strategies according to what works. So, the balance in the population shifts back and forth as agents adjust their strategies, which in turn affects the dynamics, as having more chartists tends to be destabilizing. But that is what happens. During the 90s, nearly all the "value" funds disappeared to be replaced by "growth" funds, with that more or less completely reversing itself after the crash in 2000, for awhile anyway.

Regarding forecasting, well neither Dean nor I have called specific dates, just issued the darned warnings.

In my case that has been done more in public lectures rather than in publications or in big blog postings. I long warned that the housing market was a bubble, whose turnaround would lead to severe problems in the financial derivatives markets related to housing. I did that repeatedly in several venues, and once housing clearly turned around I warned about the derivatives, and picked up on Geithner's lecture in Sept. 2006 to warn that we would have a crisis in the derivatives market. That happened last August and we have been in a period of distress since, with some further crises. I do not know if this will continue as it is for a long time with these periodic crises as happened on Friday, or if in fact we will see a culminating, full-blown crash.

Note, I am talking about the financial derivatives market and the mortgage market more generally, not the housing market itself, which I think is much less likely to exhibit a full-blown crash. For reasons already stated, it is more likely to do a long slow dive without jumping off the board. But, there is plenty of reason to be scared in general, and Jim Hamilton on econbrowser recorded Janet Yellin as exhibiting "fear" recently at UCSD. I am pretty certain the Fedsters are having trouble sleeping.

Oh, and what I claimed was that the paper, and my earlier work, were the first to show how one could have such a period of financial distress. All the theoretical models have been of the crash follows peak immediately type. This is intuitive if one is in a homogeneous agents world (with the agents fully rational). The bubble only happens because they are expecting further price increases. Once those stop, then the price must immediately revert to the fundamental (assuming that is known, which the models do). But with heterogeneous agents, we get the "insiders" getting out at the peak while the "suckers" are left holding the "hot potato" while it does its pfd decline, either gradually, or as history has shown, more frequently ending in a final panic and pullout by the suckers in the crash.

[Bob Diener]

Goat guy does not want to be the goat, and I don't blame him, but he is not even a pawn in the game.

The principle that the market crashes after the decline -- when the sheep finally smell the stench and go running -- not only makes sense but is consistent with my experience. An honest man I know who used to be a stock broker quit that business many years ago because he realized the game was rigged. By the time the recommendation came down to his level to sell a stock, the Company and its wealthiest clients had already sold.

The stock market runs on euphoria and fear, greed and panic. Most people are chasing last year's or last month's winners and running away from the losers, having no more idea of the value of the stock they are buying then the home they bought. (I agree with Aaron that most people buy a house based on what they can afford to pay, not what it is intrinsically worth.)

I do think that the Administration -- meaning the Fed and the illustrious Mr. Greenspan -- are to blame for much of the current mess. Unregulated capitalism has always been a disaster. It brought us the Great Depression and now this mess.

The American economy has depended on inflows of capital from big money around the world. The U.S. dollar had a premium for stability. China and Dubai, for example, bought U.S. Treasuries. But when they yielded such paltry returns, the demand built up for some other kind of safe investment in which they could get a little better return. Mortgages were historically safe investments. So mortgages were bundled and new instruments were created to sell them to big money. And big money craved more, so more and more of these CDO's and SIVs were created to satisfy the demand. No one, particularly the ratings companies, apparently paid much attention to the fact that mortgages were historically safe investments because people had put 20% down. And the Fed failed in their responsibility to regulate the banks by allowing them to hold these instruments in SIVs, which are off balance sheet obligations. Remember Enron. Supposedly, they rewrote the rules so that off balance sheet obligations could not be used to defraud investors, but there's an exception for the big banks. So no one knew that CitiBank was holding $10 billion in bad paper until it shocked the world by writing it off and selling a stake to Dubai.

Now we have this incredible credit crisis. Everybody knows that there are barrels with a lot of rotten apples out there, but no one knows who's holding them. The banks are afraid to lend to one another. The shadow markets dry up. Bear Stearns collapses. Interest rates rise on jumbo home loans. And people with good credit cannot get loans.

Yet I know a guy who bought eight properties in the bubbly, all at negative cash flow, because prices had to go up, who has defaulted on all of them, has nothing left, but just got a new $8K credit card. Is there a sun rising on the horizon?

We are in a mess. There's no doubt about it. The down draft is still dragging, and we have further to fall. The chartists talk about the Bollinger Slide and proclaim that we are in a 5 year decline. But don't worry too much, we're already one and a half years into it.

While the dollar has lost its premium for stability, and the euro is stronger, the U.S. economy remains the strongest in the world, rivaled only by Europe. World population is not only growing, but the number of people craving our lifestyle and products and becoming "middle class" in the developing world is growing even faster.

There is lots of trade. The ports are busy. Shipping demand and transportation rates are high (excluding the cost of oil). Prices are strong for cement and steel and all the things needed to build infrastructure around the world and the companies that are building it -- both at home, where we need to rebuild, and abroad where it has never existed.

Lots of money is being poured into developing new energy technologies right here in the US of A. We may not see big productivity gains in the near future, but within five years it is likely that we will see the development of new energy technologies, as well as more investment in the existing technologies of wind and solar, as well as cleaner coal. The cost of wind power is already getting close to coal. So I think that there will be opportunities for growth and employment.

The credit crisis will unwind. All the barrels of rotten apples will be found, and the banks will be willing to lend money to each other -- and us -- again.

Times are tough, and they will get tougher. Big money has taken a hit, but not a ruinous one. I see the Dow sinking below 10,000, and that could come with a crash of panic selling by the sheep, but I, for one, do not see a true depression, with massive unemployment and hardship.

[a]

"I long warned that the housing market was a bubble, whose turnaround would lead to severe problems in the financial derivatives markets related to housing. " Then you have been making the same kind of qualitative predictions as (I suppose) Dean Baker has been making. But it seems to be confusing the issue when you bring in work of a non-predictive model of crashes. As you say the housing market is going down steadily, rather than in a crash-like way. Perhaps your theoretical model is much better than previous ones (the philistine in me would say it could hardly be worse if the previous models predicted that the crash occurs always at the market peak, which is easily falsified by the historic record), but it does not appear to be predictive at least at this stage.

I'd just note that in predictions about the financial markets timing is everything. At any point in time and at any level in an index or underlying, there is a strong probability that the index or underlying will be worth more or less at some point in the future. So predictions of "up" or "down" do not have great informational content, and people who make general, vague predictions may post hoc think they have been particularly prescient, when in fact the probability of their prediction (because of its generality or vagueness) was actually high or even quite high. I'm not claiming you fall into this camp, because I don't know any of your predictions, but it's a fairly widespread phenomenon. Look, Brad DeLong has patted himself on the back for having seen the housing mess; the mind boggles. Brad Setser, who IMHO is pretty top-notch and has great knowledge and real insights into forex), made a prediction when the dollar first went to 1.30 vs the euro that it would go to 1.45. (This is from memory, the exact numbers are probably off.) Now, without any timing at all, the prediction is remarkably weak, because the probability that it will go to 1.45 once it has been at 1.30 *some* time in the future is actually quite high. When he was called to set a timing, he did, and then of course the dollar rose back to 1.20, and his timing was missed.

Or consider this case. Suppose someone identified a housing bubble in 2002. Would you call them right? Or wrong? Housing prices are generally still higher than those in 2002 in most parts of the U.S., and generally you could sell your house for more than you paid for it in 2002. So anyone who talked about a housing bubble in 2002 and acted on it would have lost money. Maybe that's still being "right", but I have my doubts.

[mik]

Robinia says...

If I were a member of an outcast group ("illegal" immigrants? Muslim "terrorists"?), I'd be ready to hit the floor at the smallest unexpected sound.

I don't really expect an answer, but here it goes.

When you say "illegal" immigrants, do you mean:
1. They in fact are legal and there is no illegal immigrants?
2. Or, there is no immigrants, legal or illegal?

When you say Muslim "terrorists", do you mean:
1. There are no Muslim terrorists, only non-Muslim ones?
2. There are no terrorists at all, only freedom fighters?

[Lafayette]

Frenzied behaviour

BR: I and my coauthors are the only people to have provided actually formal models

But, how do you know that your models are not just predicting the past rather than the future. All models are historically based. The problem with such data is that history, though it does repeat itself, rarely does so in the same manner.

Empirically, there is no reason for a calamitous crash. There is no very large swing in GDP, the mortgage market affected is not an overwhelmingly large portion of the total market, and though dampened consumer demand is not on its last legs.

Given, therefore, the economic conditions, it takes one helluva lotta chutzpah to claim Gloom and Doom is right around the corner.

Lehman Brothers comes out with a report that Fannie Mae and Freddy Mac are insolvent according to normal accounting standars AND they state clearly that these standards do not apply -- but the market picks it up and decides to nosedive anyway. The shock wave reverberates around world markets.

Couple this fact with that of a frenzied oil-price futures speculation and people start tearing their hair out.

Where, pray tell, does any model predict this sort of purely random behaviour that provokes a downside frenzy?

There's lunacy in the air. The only behaviour that is worth noting is that the same frenzy on the way up seems to have overcome the market on the way down. Frenzy is never a characteristic that was easily predictable, either by econometric modeling or crystal balling.

Which is why it is called frenzied behaviour.

NB: frenzy: a fit or spell of violent mental excitement; a paroxysm characteristic of or resulting from a mania
manic behaviour: The excitement manifested by mental and physical hyperactivity, disorganization of behavior and elevation of mood

[cm]

GoatGuy: I believe employers have difficulty filling sub-par paying jobs because they are typically not looking for those desperate enough to take them -- generally those out of "related skills" employment for a longer period or with non "prime" credentials, whether unemployed or underemployed. Potential takers with recent related employment history or "prime" credentials quite likely have not yet given up the hope for something better and keep on searching, or can still find something better. And then you have those who have figured out how to get by on less and are waiting it out, for the time being.

At least that's my perspective for "skilled" professional jobs in the local "tech" industry.

[Jew]

Saving Robinia the trouble, I'll take this one:

When you say "illegal" immigrants, do you mean:
1. They in fact are legal and there is no illegal immigrants?
2. Or, there is no immigrants, legal or illegal?

When you say Muslim "terrorists", do you mean:
1. There are no Muslim terrorists, only non-Muslim ones?
2. There are no terrorists at all, only freedom fighters?

None of the above. What would make Robinia afraid is being someone who might
be PERCEIVED as being one of those things. Thus, e.g. almost all Muslims are not
terrorists, even if all terrorists were Muslims (which they are not, obviously).
But any Muslim, or even anyone who looks like they might be a Muslim, might
be in danger from behavior driven by fear of terrorists.

[Lafayette]

The Gloom & Doom Thing

The jobs market in general, not just tech jobs, may not be as moribund as one may think.

A good barometer is the number of jobs postings that are matched. Check it out, here. After an exaggeration in '07 and '08, it is back to its trend line.

This Gloom & Doom Thing is perverse summer blog-folly. Let's move on, shall we?

Get out to the seaside/mountains -- anywhere away from the computer. There's life out there ... somewhere.

[ken melvin]

Lafayette - I suspect the charting is meaningless, i.e., most all postings are filled.

[Barkley Rosser]

Lafayette,

Well, not all models are based on "history." Many are purely abstract, based on essentially nothing. At least our effort was made to try and explain or model what happened in most historical bubbles in contrast to the previously published models, none of which did. Of course I agree that every actual bubble has its own peculiarities.

Regarding this one, we may be able to hold off a huge crash, but we have seen some very dramatic efforts by the regulators and policymakers to do so. Last time I counted, the Fed had invented seven new policy tools since August to try and keep things on the pfd glide rather than the total panic-crash scenario, and here they are still floundering and having to bat one crisis after another, the FM business and Indymac being just the latest round. So, I am not saying that there will definitely be a crash, but the threat of one has most definitely not gone away.

Noting that there has been no big fluctuation of GDP proves nothing. Actually, if anything it is a reminder that what we are dealing with are speculative bubbles. Those are price changes not justified by underlying market fundamentals. The underlying bubble here was in housing prices (go read Vol. 2 of Shiller's Irrational Exuberance). That bubble is still in the process of working itself out in a pfd, and I think it is less likely to end in a crash, but that is not out of the question, especially if the mortgage and other financial markets related to housing crash, which is more likely.

Indeed, what we are dealing with here is really a bubble on a bubble. The underlying bubble was housing, and as long as housing prices continue to decline, more mortgages will go bad and there will be continued pressure on the financial markets related to housing, irrespective of what is going on with the GDP. On top of the bubble has been a bubble in the derivatives markets based on housing mortgages, part of a broader explosion of derivatives and an increase in their complexity. In some of the speeches that I gave on this I pointed to the 50% increase in derivatives in the forex markets in just the first half of 2006, something replicated in other derivatives markets. It was the blowup of various swap instruments last August that nearly crashed Deutsche Bank and BNP-Paribas that was the first sign of the peak of that market and the beginning of the very unpleasant pfd that we are still in.

[Barkley Rosser]

That should have been Edition 2 of Shiller's excellent book, not Vol. 2. He added a chapter on real estate, documenting very clearly that between 2000 and 2005 we saw a rise in real estate matched historically in the US only by the period 1946-1950, when there was a very clear excess demand situation in the fundamentals (returning war vets with booming babies demand, but no houses built basically since the 1920s). No such situation held in 2000, and the subsequent rise in price to rent and price to income ratios to all-time highs was exactly the sort of data that had people like Dean Baker and me frothing at the mouth about how we were in a housing bubble, even as various "experts" in the newspapers were telling us that housing "can only go up," just as we had similar fools telling us such things about high-tech stocks at the end of the 1990s.

[a]

"I am not saying that there will definitely be a crash."

Well you're not even making explicit the instrument or index that will crash. There have already been crashes in certain indices and underlyings. Vague and general predictions are fine, but the probability of them happening are far higher than the predictor would like us to believe.

I went on the record with my boss in Sept 2007 that there would be an equity crash in the Eurostoxx 50 before the cycle is finished. I imagine the probability of that prediction coming true was around 10% - 15% when I made it. It's now probably moved up to a probability of 20%. (The probability would be far lower if I had given a specific timing.) If I'm right, then I'm right; otherwise wrong. I don't get my knickers twisted about it, but at least at the end, I know whether I was right or wrong.

[Lafayette]

a: I went on the record with my boss in Sept 2007 that there would be an equity crash in the Eurostoxx 50 before the cycle is finished.

The index is back to its value at the end of 2005. It's still far up from its value in 2002, at the beginning of its recovery (after it had REALLY crashed).

So, it's crashed ... again? And in between 2002 and February 2007 when it peaked -- that was a boom? Never heard anyone call it that.

You're fired, doomsayer! ;^)

[Real Person from the Real World]

CM is right - about jobs in Tech at least. Sup par paying jobs have problems when the employers get spoiled and picky and want only recent skills. Unfortunately, those employed get better pay and may not be inclined to move elsewhere for less. You may have a manager from an economic area that has been hit or taken a beating over the last few years available for a sub-par paying job, but employers get picky.... they have new green cards competitors available, in addition to the disenfranchised baby-boomers. Then again, they maybe don't need to fill the job that quickly, especially when no one knows how things will shake out. This may not be the time to take on new hires. Be picky, ignore perfectly good managers who are out of work for no fault of their own, and hire someone who doesn't need the job, IF you find one.

[cm]

Lafayette: What is the graph supposed to mean? Percentage of job ads that are eventually filled (through "our sites")? Percentage of ads withdrawn because they are supposedly-filled?

For the time being, I speculate you want to make the point that only a minority of job ads are filled, and hence the job market is not tight.

Well, let me tell you about some categories of job ads:

"Fishing" ads. Some employers are constantly on the lookout for candidates with certain "skill" profiles, in case they ever need them so they always have some irons in the fire. E.g. some project that may or may not start either soon or in the next budget cycle. So keep interviewing candidates "just in case" and turning them down if it's not yet happening.
Variation on the above - fishing for "suitable" employees without a specific job opening, let's see what comes and which group can use them. (OK, here there is arguably a job, only it is not nailed down.)
"Statement" ads - "we are looking to hire". (Several applications, from justifying visa hires to projecting growth perceptions.) Plus it keeps HR busy so they don't get used to no work being done, or start quitting over concerns for their own jobs.
Plain unrealistic ads - looking for somebody with a 3-year degree and 2 years experience but laundry lists of "skills" and "expertise" requiring at least a decade under your belt or too diverse to be reasonable for anybody.
Ads typically don't state compensation levels and potentially discriminatory requirements, but there are enough employers out there who are lowballing and at the same time excluding candidates who would actually accept the lowball offers (e.g. the unemployed, underemployed, or nominally underqualified). If you want currently employed "heavy hitters" for mundane jobs with not too great pay and at best lukewarm career prospects, yes it will take some time to fill the job to say the least, and quite likely you have to lower your sights first.

So yes, at any given time most job ads will not be filled, especially these days where the barriers to posting ads have come way down. Was it ever different?

[cm]

I forgot to add the category where the combination of "hard" requirements is such that the pool of qualified candidates is restricted to begin with, e.g. looking for people with long history in a specific industry segment, citizens-only, specific rare certifications, etc. That's probably not a major category, but it is there.

[Bruce Wilder]

a: "at least at the end, I know whether I was right or wrong"

I don't know how, since your actual prediction was conditioned on a metaphoric (bayesian?)probability.

When it crashes, the probability of it crashing is "1", so you, who said ".20" are wrong. No?

[Bruce Wilder]

Barkely Rosser: "The underlying bubble was housing, and as long as housing prices continue to decline, more mortgages will go bad and there will be continued pressure on the financial markets related to housing, irrespective of what is going on with the GDP."

Thank you for your work in this area, and discussing it.

I think you are wrong, though, in identifying the underlying "bubble" as lying in housing. It makes it sound like people were evaluating what houses were worth, based on fantasy or false reasoning. I don't think that was usually true. That's why so many economists could argue contemporaneously that the alleged housing bubble did not clearly deviate from "fundamentals" so that it could actually be hard to "prove" out the bubble.

The market that was malfunctioning was the market for mortgages. Given the "price" of a mortgage, the prices of houses were usually within reason. The problem was, that the "price" of a mortgage had gone out of control.

The original, underlying "bubble" should be thought of as existing in the market for mortgages and mortgage-backed securities.

And, of course, that's where the persistent period of financial distress is centered, and where a "crash" threatens.

[Barkley Rosser]

a,

Hmmm. Seems that you wish to be given some kind of award for making very specific forecasts about very specific markets while I should be sent to some kind of reformatory for my various remarks. OK. However, it sounds like your forecasts were part of a job for which you are being paid, so presumably you have gotten your reward. Or maybe you were just giving your boss private investment advice?

Bruce Wilder,

One of the nearly universal accompaniments of almost all bubbles is some looseness in credit and lending. The low interest rates in some recent years certainly made it easier for the bubble to inflate, but I do not think it is the whole story. I think the initial push was the money running from the crashing high tech stock market. Then, once it got going, it was the usual psychology with people pursuing strategies that made money in the short-run, the flippers and others buying and then reselling real estate quickly. Indeed, the parts of the market where such activities were going on have been the ones that have seen some of the sharpest declines, such as the condo market in Northern Virginia.

[Ryan]

This looks suspiciously similar to The Kondratieff Theory

[Lafayette]

BR: Then, once it got going, it was the usual psychology with people pursuing strategies that made money in the short-run, the flippers and others buying and then reselling real estate quickly.

This is comforting commentary, because the sort of short-term speculation described ("flipping") is easily avoided.

High capital gain rates on any primary residence realty asset that is not held for a minimum of five years, with pro rata (proportional) diminishing of the capital gains tax for each additional whole year (360 days) before the resale date.

For example, 90% capital gains rate if sold in the first year, 75% if sold in the second year, 50% if sold in the third year, 25% is sold in the fourth year and 5% if sold in the fifth year.

Secondary residence would be taxed at 95% of the capital gain for the first five years. If sold at resale price plus correction for inflation during the five year period, no capital gain tax would be applicable. (A penal offense would be constituted were agents /lawyers to sell property with undeclared payments in order to avoid the capital gains tax, resulting in loss of license to practice.)

The reason for such draconian capital gains rates is to assure real estate is intended, not for speculation, but for habitation, either as an owner-residence or rental.

Landlords should invest in real estate to obtain a capital gain realized only after amortization of the mortgage fees by long-term rental. Meaning, they are long-term investment vehicles. (An example: Investors could assume the individual-unit mortgage in a large housing development programs that are rental-managed by developers, thus relieving them of the responsibility for managing the property. A bit like time-sharing without the sharing. (Of course, retirement homes could be offered on short-term leases in some areas, thus allowing owners to benefit from the property during vacations.)

[a]

"Seems that you wish to be given some kind of award for making very specific forecasts about very specific markets while I should be sent to some kind of reformatory for my various remarks."

Not seeking an award, or seeking to send you to a reformatory. Remarks like that IMHO are cheap shots, and you can do better.

You seem to want to be considered prescient, and you seem to be making general remarks about a "crash" without offering anything specific as to what you mean by it. This means that, post hoc, you can pretty much claim to be right no matter what happens. It's what astrologers do. Maybe that's you intend, maybe not. I've tried to give you the opportunity to clarify, and at this point it seems more to be that you don't even care, which I find discouraging, but I'm a big boy and I've been discouraged before, so no problem. Basically, predicting a crash now, without explaining what is to crash or when, is a prediction that will turn out to be true with nearly 100% probability. So what's the point, that is the additional information content?

I'd just say, incidentally, that I tend to like your *qualitative* analysis (not all, obviously, but I like much more of yours than I like most "mainstream" economists).

[Lafayette]

cm: Lafayette: What is the graph supposed to mean?

Quite the opposite of what you surmised. Here's the site's explanation of what it shows: With Employment Trends, you can compare the frequency of job titles, companies, skills and industries in the US employment market.

Consequently, I understood that the Trend Line was an indication of job posting within th economy has as a whole and that the Overall Trend Line (in blue) was indeed back to its long-term upward trend. (You can select Engineering Job, which trends downwards, if that pleases you. Have a look, here.)

You can presume also that the polling is suspicious if you wish. I don't. I agree that companies play shenanigans with job postings but feel that a trend line is a trend line, not of shenanigans but of real need to hire personnel. Also, given the presumption that the data is pulled from more than one multiple source of job postings.

Otherwise, the job sites from which the data is obtained would not be in business were it dealing in theatrics.

[Lafayette]

cm: Lafayette: What is the graph supposed to mean?

Quite the opposite of what you surmised. Here's the site's explanation of what it shows: With Employment Trends, you can compare the frequency of job titles, companies, skills and industries in the US employment market.

Consequently, I understood that the Trend Line was an indication of job posting within th economy has as a whole and that the Overall Trend Line (in blue) was indeed back to its long-term upward trend. (You can select Engineering Job, which trends downwards, if that pleases you. Have a look, here.)

You can presume also that the polling is suspicious if you wish. I don't. I agree that companies play shenanigans with job postings but feel that a trend line is a trend line, not of shenanigans but of real need to hire personnel. Also, given the presumption that the data is pulled from more than one multiple source of job postings.

Otherwise, the job sites from which the data is obtained would not be in business were it dealing in theatrics.

[Lafayette]

cm: Lafayette: What is the graph supposed to mean?

Quite the opposite of what you’ve surmised, I think, from your comment.

Here's the sites explanation of what it does: With Employment Trends, you can compare the frequency of job titles, companies, skills and industries in the US employment market.

Consequently, I understood that the Trend Line was an indication of job postings within the economy has as a whole and that the Overall Trend Line (in blue) was indeed back to its long-term upward trend. (You can select Engineering Jobs, which trends downwards, if that pleases you. Have a look, here.)

You can also presume that the polling is suspicious if you wish. I don't. I might agree that companies play shenanigans with job posting but feel that a trend line is a trend line, not only of shenanigans but of real needs to hire personnel.

Otherwise, the job sites from which the data is obtained would not be in business were it dealing in theatrics.

[Lafayette]

Thank you, Typepad, for the multiple entries.

Sheeeshh!

[Barkley Rosser]

a.,

We all know what a crash is, although sometimes one can argue about whether or not a particular event constitutes one. It is a very sharp and sudden decline in the price of some asset. By how much? Oh, I would say at least 10% in one day, but that is indeed fuzzy.

In this situation there are several markets involved, including the higher level credit default swaps, which arguably have already crashed, lower level assets linked to the mortgage market (shares of the FMs for example), all the way down to the houses themselves. I forecast that these were all bubbles before they peaked, and that we would have problems with dealing with their respective workouts. I did not specifically forecast that any of them specifically would crash rather than experience period of financial distress more gradual decline.

I did point out that historically most such bubble declines have taken the path of a pfd followed by a crash and provided a model that shows how that can happen, something not done previously, which is what I was claiming credit for. I was not forecasting that any particular market was going to crash, much less when it would.

You have been the one bragging about how you made a specific forecast to your boss. It remains unclear if this was part of your job, part of a bet, part of private advice to him, or just shooting off your mouth to him to impress him. It appears these are the possibilities. You want credit for having done so without explaining why you were doing so? Fine. Credit is given. You are a genius who makes specific forecasts for unknown reasons, and I am just a bullshit artist.

[cm]

Lafayette: Only one of the job groups I mentioned is in the "theatrics" category. The others are "real jobs", or at least represent "actual worker demand" of some form.

Again, this is in the speculation category as there is no systematic public research, but I have gotten a distinct impression that in the post-dotcom labor market employers have developed an attitude/expectation that everybody can realistically hire the "top talent", and "exceptionally qualified" workers at bargain prices.

That has probably happened after every boom was over, and job ads were probably always somewhat overdescribed. I'm in no way claiming it is a new phenomenon.

It also has probably happened before, and not too rarely, that many projects are "stretch" or "nice to have" projects that are undertaken only under favorable conditions, e.g. when they can be cheaply enough staffed and executed, and/or budget is allocated to them.

What I don't know is whether it has been in vogue in the past to expect to get let's say 10 years equivalent "experience" with only 5 years of job history. (Or to put it more bluntly, the experience of an e.g. 40 year old from somebody under 30.)

[a]

"You have been the one bragging about how you made a specific forecast to your boss." That's not bragging - it hasn't happened yet. I could have egg on my face, if it doesn't happen. I don't know, and I don't particularly care. It was given an example of what a more-precise prediction about a crash might look like.

You however are the one who wrote, "So, why am I boring all of you with this self-citation? Well, Dean Baker is constantly claiming credit for his forecasts of doom and gloom. It looks like we might be finally reaching the big crash in the US mortgage market after a period of distress that started last August (if not earlier). I and my coauthors are the only people to have provided actually formal models of this phenomenon..."

Only people! Dean Baker is constantly claiming credit and I want some too because I was right, too! Now that's bragging.

"You are a genius." Ah yes, and this is how it ends with you. You have to see everything in terms of claims of who is smarter than who. I've made no such claims, about me or you, because *I don't care*. I've tried to make a point about predictions in financial markets. It you make a fuzzy prediction ("It looks like we might be finally reaching the big crash in the US mortgage market"), the probability of something like that coming true is much higher than if you make a sharp and clear prediction. Based on your reaction, this seems to be a novel idea to you. But anyway, apparently for you it all comes down to a question of the size of your intellectual dick. Bye, I'm out of this.

[a]

"It was given an example" should be

"It was given as an example".

"It you make a fuzzy prediction" should be

"If you make a fuzzy prediction".

[Lafayette]

Much ado about very little indeed

a: We all know what a crash is, although sometimes one can argue about whether or not a particular event constitutes one. It is a very sharp and sudden decline in the price of some asset.

There is no real definition, in terms of lost value of a "stock market crash". It depends upon the context, rather than absolute values.

Try this on for a definition, here.

What is happening presently is a psychological phenomenon in market values stimulated/provoked by rumor and innuendo, based upon a notion of banking insolvency and oil price speculation, the latter of which has as much to do with real oil pricing as betting on a baseball game has to do with its final score.

Most stock market crashes that we consider generally as the "real thing", such as 1929 and again 1987 are NOT similar to what is happening presently.

So, perhaps, just maybe, with the globalization of stock market values, the expanded global equity markets are innovating a new and more deadly kind of stock market crash virus based upon rumour, lies, innuendo and negative Feel Good Factor. Meaning, "whatever".

But, if it pleases anyone that a stock market crash HAS occurred because he promised it to so-in-so on such-and-such a date, then, for God's sake, let them have their way.

There is nothing more boring than a pissing contest.

[Eric Dewey]

Barkley, thanks both for the paper and for the additional commentary here (ignoring the non-essential aspects).

As a banker, I'm interested in the link between link between loose credit standards and the changes in fundamental values of the collateral upon which the credit is based.

Has there been any work that you're aware of that delves into that link - particularly in terms of the ratio between the timeframes leading up to a peak that subsequently led to a crash? (I.e., if the timeframe during which loose credit standards exist is extended, the decline is either faster/slower or deeper).

[Barkley Rosser]

Eric,

There were a couple of papers by some folks at one of the Feds a few years ago that argued in effect that the housing prices were justified based on the lowered interest rates. I know there have been some papers on the loosening of credit standards, but I do not have a good one at hand on the latest round, unfortunately.

It is a part of the general literature on bubbles, certainly in both Minsky and Kindleberger, that booms are usually accompanied by and further stimulated by loosening of credit standards. They feed into each other, with the boom often being used to justify the loosened credit standards. People are making money, so let us lend them more so they can make more and make us some more also. Clearly this went on with the housing market, with the increase in sub-prime mortgages coming in the later stages of the bubble. I became fully convinced there was a housing bubble, although I had been warning about it earlier, in 2005 when it was reported in WaPo that a majority of mortgages during that year (first report was for early in that year) were of the interest-only or related sup-prime type. It was clear that these were only justified by assuming that housing prices would continue to appreciate sharply so people could refi down the road, and that the prices were already too high because buyers needed the loosened credit standards to be able to buy. Actually, when those reports first surfaced I declared that we were at the peak of the bubble, and by late 2005 the northern Virginia condo market was declining, although the more general real estate market in the Washington metro area did not peak until sometime in 2006.

BTW, I apologize to one and all for getting cranky with a. Sure, a., I was being egotistical. But, I never claimed that I was making any specific forecasts. You were the one who came in demanding that I do so, or arguing that given that I had not done so, as you proudly proclaimed you had done for your boss for whatever reason, that I had done nothing of much interest or worth to talk about in a blog. All I ever claimed that I was doing was to have come up with (originally all the way back in 1991 in work never cited by anybody else) and more recently the only models to show how this very common historical pattern of bubbles could happen. I confess to having become frustrated both that my earlier work has not received citation or attention, and that this current paper has now gotten dragged out in a really annoying and long review process, with publication happening who knows when and where.

So, this was really a matter of publicly claiming credit for an intellectual innovation, before somebody else starts publicly claiming the credit after producing such a model. I have presented this recent paper in many places, not just during an earthquake in Tokyo three years ago. I will not go on about the details, but I have more than once in my life come up with an idea, only to get the publication of it bogged down, and then to have somebody else get ahead of me and get the credit. As an academic economist, this is very annoying and frustrating, even if it is something that you do not find to be legitimate, interesting, or serious, a. In any case, I took advantage of my co-blogging on the not-very-widely-read Econospeak to stake my deserved claim. I thank Mark Thoma for spreading it somewhat further, even if you consider it to be of no interest or legitimacy, a.

[Eric Dewey]

Thanks for the info, Barkley - and don't let the sniping from others get you down. It's got to be as frustrating for economists to have others claim credit for their work (or simply ignore it) as it is for those of us in the corporate world.

Part of what is good about blogs is the ability to avoid the excessive pretentiousness of academia or corporate execu-speak in order to get to the real nub of an issue with a broader audience; unfortunately, that audience too often either demonstrates that it is very difficult for most of the human species to behave with common courtesy, or provokes those of us who know better into sinking to their level.

And of course, anytime you get close to the real nub of an issue and not just engaging in meaningless chatter, it means that someone's likely to feel threatened.

I'll try to look up the fed info, although I haven't much hope that it will be enlightening.

It does seem intuitive to me that, the longer the initial period of loose credit standards, the larger the problems will be down the road - and if there's quantifiable evidence to back that up, then one should be able to use a sort of "fuzzy logic" model to refine the mathematics used in determining how far is too far. I.e. Bear Stearns went down at about 30% leveraged - how does that compare with past failures (although with Fed intervention it might not be the best example).

Since the FDIC has been closing banks for decades, it stands to reason that there's some good evidence out there...

[Barkley Rosser]

Eric,

Thanks. It is clearly the case that the longer there are loosened credit standards, the longer and more serious the bubble can be, although of course these go together, as the loosened credit standards usually pretty much end with the bubble.

Going back to our model, we do not have endogenously changing credit standards in there per se. Indeed, the wealth constraint, which could be viewed as that, does not change and plays the role of triggering the crash when it finally gets hit big time on the way down. The dynamic is in terms of agentst changing strategies to follow those that do well, which could be attributed to psychology, but we do not model that as such. I will note, however, that the "willingness to switch strategies" (based on their relative, recent, past performance) is a crucial parameter in the stability of the model, along with the degree to which agents imitate each other, or "herd." More herding and greater willingness to switch strategies (which can be said to represent a psychological factor) tend to increase bubbles and instability in the model.

[Patricia Shannon]

Lafayette,

At my previous job, there were notices, required by law, on the bulletin board that they were openings for IT people that they couldn't fill, so they were hiring people with H1-B visas. I qualified for some of the jobs, but was not considered. I'm sure it was because of my age.

[cm]

Patricia: That's a possibility, but there are other factors, like e.g. you wouldn't stick around and make a nice face to all the crap you get because your employer-tied Greencard application would be terminated if you left or were let go, in which you would be the more invested the longer you would have stayed and "paid your dues". (It is not transferrable over much of its lifetime, unlike the H1B visa.) Some nationalities are subject to long backups, so it can take a number of years until your Greencard application comes due or becomes "portable", after it has been submitted. Once you get the Greencard, things change, but it is likely to take more than 3 years and possibly quite a bit more. It's a powerful "motivator". HR and management know that quite well.

And many, though not all, visa workers come from societies that are more hierarchical and top-down than the version of the US you grew up in, and are supposed to show less resistance to taking orders and unreasonable requests. I have seen enough evidence, and could also "test" this hypothesis against anglophone "locals" who were putting up arguments and in cases showed rather elevated levels of recalcitrance. Pretty much all of them left after some time.

[Lafayette]

PS: I qualified for some of the jobs, but was not considered. I'm sure it was because of my age.

And, there is no law that prevents Age Discrimination?

Frankly, I think you have an open and shut case. It is difficult to "prove" age discrimination, but less so than sexual harassment -- for which witnesses are necessary.

But, if you applied for the job and were refused, they had to give you a reason, didn't they?

We can have all the laws and regulations we want, but it takes a couple of well-publicized convictions to assure they are observed.

Yes, I know, that is easier said than done. Which is why I like the idea of an company ombudsman (a person who investigates and attempts to resolve complaints and problems, as between employees and an employer or between students and a university). Does that sort of function exist in the US?

It's a concept that has worked in Sweden for over a century.

[cm]

Lafayette: "But, if you applied for the job and were refused, they had to give you a reason, didn't they?"

I don't know whether they have to give a reason, but you will usually hear "we filled the position with somebody who is a better fit", or in the case where the position was not filled, "you were not a good fit for this position" which can usually be backed up by citing some items from the usually available "skills" laundry list.

Which I believe is a major reason for those laundry lists to be there - selective waiving of requirements for "desirable" candidates and "blocking out" the undesirables that cannot be rejected for reasons unrelated to the subject matter. I have seen and heard of enough underqualified or "compromise" hires to conclude otherwise. Everything is negotiable when there is a pressing enough need, including "plus" qualifications.

It may also be the case that the manager/organization has delusions of grandeur as to what "top talent" it takes to execute the business, but how is that so much different -- the definition of "top talent" is more along the lines of personal attributes as opposed to strong track records than is commonly acknowledged.

What do you expect to hear? "We figured you are too old, disgruntled, and used up"?

[Lafayette]

Like It Or Not

cm: I don't know whether they have to give a reason, but you will usually hear "we filled the position with somebody who is a better fit", or in the case where the position was not filled, "you were not a good fit for this position" which can usually be backed up by citing some items from the usually available "skills" laundry list.

A posting generally has the "laundry list" of qualifications necessary. This is the starting point for any lawyer bringing charges against existing employment fairness laws, presuming those laws exist.

I don't know what is happening in terms of US Labor Laws. I admit this disadvantage. I know what happens in France, though. First the complaint goes to an ombudsman who tries to un-knot it. Then it goes to a Labor Tribunal constituted to hear just such cases.

When a company gets caught up in enough of these cases, it learns that lawyer fees for defending oneself against wrongful discrimination is ... uh, not cheap.

Of course, the legal framework needs to exist. And, I don't know if that is true in the case of discrimination as regards a job posting. The blacks had the same problem in the 1970s, and they overcame it by systematically pursuing the offenders.

A squeaky wheel gets oiled. And, it's always more effective than bitching-in-a-blog.

Frankly, I've been hearing for years, from French union managers, who know what is happening internationally, because they too use the Internet, that the US is very backwards regarding Labor Law. But, then, France has Labor Laws that practicably bludgeon employers, so I am not sure where the proper perspective is.

What inspires me nonetheless is the way the French are Very Willing to go down into the streets and demonstrate for their rights. I see this, reported on TV, practically every week. I mean it, every week. That too is democracy-in-action.

Rather than sitting back and taking meekly, like sheep, what employers have to offer -- Like It Or Not.

[Real Person from the Real World]

The mentality here is screen to weed out. Even people who are good fits for a job can be weeded out on flimsy factors (someone from MI, who worked for a big automotive company having been laid off and taken jobs beneath him/herself OR not in the same field - lack of "recent" experience). We have these pseduo psych questions too, and personality tests. Do these REALLY predict future behavior or really identify people who will be a problem? See "The Cult of Personality" by Annie Murphy Paul. Personally, I think this is out of the 60's when you had a few piddling law suites over age and racial discrimination. Employers decided to quash the trend and started putting in HR who started using these tactics, so if you don't get the job, they have some excuse to fall back on. Did you not get hired job because of age? While the circumstantial facts might back you up, the company can point to some obscure question, or as CM points out, some skill among a laundry list of skills. Furthermore, there are tons of suggestions on how to ace these. How well the advice works may be something else, but the fact is, the people with the power to hire hire who they want they want, despite any biases, not necessarily someone who is qualified, and they do this with impunity. Meanwhile, we bring in visa folks, and their vendors try every trick in the book, including under the table pay and the buddy/spy network, to get their people in somewhere. That doesn't mean the worker is bad, but it certainly is not fair to other job applicants. Lately, there is a trend toward VMS, vendor management systems, or even hiring contractors to handle vendors. These guys have their own quirks, and the web based vendor management systems are a major pain in the butt, that is riddled with other problems. In a day and age when software can basically inhale a resume, why is someone stuck quizing their consultant to fill in webform after webform that sometimes is not working right or has incorrect information the managers cannot go in and fix? And has it's own process of discrimination. The hiring system in the US sucks big time.

[Lafayette]

cm: Some nationalities are subject to long backups, so it can take a number of years until your Greencard application comes due or becomes "portable", after it has been submitted. Once you get the Greencard, things change, but it is likely to take more than 3 years and possibly quite a bit more. It's a powerful "motivator".

This was also typcial of the "B Permit" I had in Switzerland. It happens in a good many countries.

Just what are you trying to get at?

[Lafayette]

An intriguing ploy

BR: I became fully convinced there was a housing bubble

Excuse me, I don't wish to question your powers of perspicacity, but lending to people who are unable to pay back balloon payment loans is not that, uh, astute.

This was Gross Fraud and word has it that some people (mortgage agents at credit institutions) are going to go to jail for it. Those accrediting agencies who gave the aggregated SIVs with this toxic waste a green light (in order to be monetized) are also in for charges of criminal delinquency or professional responsibilities.

So, the hard part is not to understand what has happened. That's the easy part. The difficulty is in determining the ultimate consequences of this massive fraud. Your model sounds interesting, but I have my doubts about calamity models. They are so dependent upon the probability of a great many factors that I suspect that they are beyond competent prediction. Of course, I could also be very wrong, since I am just voicing a subjective suspicion.

The housing bubble may have burst, but the sub-prime calamity has not fully spent. It could, if it seriously affects consumer demand. And, since consumer demand depends upon a psychological variant called "propensity to spend", then it is indeed possible.

Still, any psychological variant also has its dependencies. One is called the self-fulfilling prophecy, by which if a disaster forecast is made and sufficiently repeated by the media -- and there is no competently articulated rebuttal or action policy -- then that forecast begins to have a lasting dynamic. It could come true. Even if based upon fictional sentiment. It is not veracity that fuels it, but simple repetition by word of mouth (or blog).

For instance, greed is so endemic in financial institutions, I sense that the following scenario is entirely probable: Some Golden Boys, having read about the precariousness of F&F, decide that Lehman Bros could make a killing by shorting F&F stocks under the right conditions. So, they come out with an "advice" to their customers, after shorting F&F, indicating how "technically" both agencies are insolvent. They carefully include a text stipulating that such insolvency is of course only "theoretical" because of inevitable backing of the Fed.

The advice nonetheless goes out to a volatile stock market, in July when it is seasonably thin, that duly panics -- and, of course, Lehman's ploy returns enormous profits for the Golden Boys.

Tell me I'm fantasizing ...

[cm]

Lafayette: The visa question first -- how does your experience with Swiss visas weaken my point? I'm making a claim about the US Greencard process, not comparing it to other countries. If you want to debate this, then please put forth an argument showing how long and nonportable visa processes are immaterial to labor relations.

As for discrimination, I'm not talking about discrimination by one of the "protected" categories. One big factor is always money, and also general "personal attributes". Employers are bargain hunters too. When they think they get a "good deal", they will bite. Everybody would like to have carefree workers who take vaguely specified orders and enthusiastically mold them into great products, and also do all the unglamorous chores that are lying around without need for pushing. Unfortunately the good deals are rare, esp. the combination "top of class, creative, willing to take orders, will not shirk tedium".

I have it from people whose judgement I trust that there is a lot of lowballing out there, and many employers want "extra skill" for the "going rate", or are offering only "discounted" rates for the "going skill". It seems like the market is in a pickle, and a substantial gap between employer and employee expectations prevents "market clearance".

With laundry lists, it is often not necessary (and probably rarely practiced) to include frivolous items unrelated to the subject matter. In many "tech" environments, the complexity and scope of the work, and it underlying domain, is large enough, and also most positions and projects are not formally described. You have activities ranging from bug-fixing over development applying known principles to known problems to research of new solutions to previously unsolved problems (at least previously in the organization, industry, or product market).

This maps to the "skill scope" of the position being negotiable in a fairly large range too. If we can get the "extra skill", great, otherwise we can settle for the "base skill" and either figure the "extra" part out otherwise, or not implement this today. And of course it's usually a multidimensional problem, not a linear scale of "more" or "less" skill.

And even in "high skill" environments (or perhaps particularly there as they are more ambiguous), personal attributes like "engagement", "passion", "motivation", "self drive", etc. are often prized as much as or more than the "dot on the i" of technical sophistication.

You should know that, you have been a manager.

[Patricia Shannon]

I have seen IT job requirements that included experience with IBM utilities. This is totally ridiculous. Anybody otherwise capable of the work could learn how to use an IBM utility from the manual in 15 or 30 minutes. If they needed to call a user-written routine, a little longer, but in such a case, the company probably already has examples that are already working.

[Lafayette]

cm: You should know that, you have been a manager.

The companies I worked for were all "fair-play", with the exception of ITT, which was amongst the most corrupt I've ever witnessed.

What tires me about your stories is that they always take the employee as victim. Frankly, you may indeed be right. I don't know what employment laws in the US are ... I never really had need to recourse to them.

But, about visas, I do know how vulnerable one is when retaining one. But, at the same time, it is a rather elite chance to learn new ways and methods and to bring them back with you. All in all, it's well worth the effort. In my long career in European IT, I never once saw directly an exploited visa-holder, and I've seen plenty -- particularly from Iron Curtain countries who were, in fact, refugees. These people did not even have a home to go back to, if they were let go.

Unless, of course, the visa holder sticks around long after their authorized stay has terminated. That's another story, but one I also witnessed in Switzerland and England.

Yes, visa holders are exploited for their talents. But, unless they are reduced to outright slavery, I don't see the sense in this argumentation.

Elucidate me.

[cm]

Lafayette: There is perhaps little sense in the conversation aside from sharing perspectives. As for my viewpoint, I'm a worker, not an employer, so that's from where I'm looking.

I did not specifically want to highlight "exploitation" and "slavery" aspects, and I have not been using those terms.

What irks me about the whole "talent shortage" and "skill update" argument is the apparent exclusion of large talent pools by employers by way of prejudice, lackluster recruiting efforts, and refusal to build or even just facilitate in-house expertise, either deliberately or out of stupidity. My anecdotal evidence suggests a fair amount of "deliberately", but of course doesn't prove it.

In my opinion those employers shoot themselves in the foot, but then that's just me. Actually some form of "agency problem" is probably involved, in that the professional management in most companies acts in their own perceived interest, not the firm's.

I don't see a way around large businesses (for my purpose here headcount in the thousands) in principle, as I firmly believe that projects/efforts of a certain scope, complexity, and duration can only be handled by large "collective" efforts in long-lived organizations bundling (and too often, unfortunately, bungling) the efforts of many individuals.

[Lafayette]

One Helluva Fight

cm: I'm a worker, not an employer, so that's from where I'm looking.

Well, then, you should be a unionizer as well.

I am not saying your perspective is wrong. Just biased. There is nothing inherently wrong with bias. In fact, for unions to function correctly, they MUST BE biased towards the best interests of their membership. Given that management is certainly biased towards making profits, upon which it is principally tasked.

Where this has failed, in both Europe and the US, is to fixate on compensation in a context of "US" (the workers) and "THEM" (the owners). This has relegated US to the unfortunate position of being part of the problem and not the solution. Owners participate in the rewards of taking risk. Workers are simply an input factor cost, like Capital, but obviously not as well remunerated as Capital.

When the world was going fine, during the previous paradigm that lasted from post-WW2 up till the early 1990s, fixating on compensation, though blind to the future, was generally accepted by union members. They, like a good many people, did not see the paradigm shift coming. That is, by means of global political changes (the demise of the Iron Curtain and the subsequent doubling of the Supply of Labor) and the GATT agreements lowering protective tariff barriers, that their high compensations would become untenable in a New Paradigm.

When Labor factor costs become intolerable, the market whacks a company. Meaning, either it goes out of business or it tackles the cost problem. Most of what you complain about apparently is due to this concurrent problem. And, it befalls the worker more than management. This is unfair, I will agree with you, but nothing can be done about it unless the structural makeup of the "system" changes as well.

Meaning This: I have suggested an alternative whereby Labor stops fixating on compensation (ie. labor input costs) and accepts significant reductions. This should be compensation-neutral if laws would allow Labor representatives onto the Board, allowing them the supervisory vision that Labor must have in order to surrender higher wages, compensated for by Profit Sharing.

I see no other alternative than co-opting Labor into the Capitalist mechanism with its focus on the bottom-line (i.e., profits) and from this to sharing net profits. This would be done by the same mechanism by which profits are shared with the public in general who are shareholders.

Most importantly, as shareholders they would be protected by "property ownership rights". And, I suggest that gives them an inherent right to supervisory oversight on the Board of Directors, though not necessarily inherent access. Meaning, that right must be allowed by national legislation.

Which is going to be One Helluva Fight in the US of A.

[Bradley Stark]

Social and political revolutions have been well studied...tend to have a certain cyclical nature to them. Wonder if it would be instructive to see if these areas offer us any ideas on predicting bubbles (financial revolutions)?