Barney Frank’s disquisition on why you couldn’t have a housing bubble because “houses ain’t tulips” provides a remarkable insight into his thought process and its limitations. In a C-Span video Frank argued that overpriced housing was fundamentally different from historical bubbles, such as the one in tulips because houses had an intrinsic value which flowers did not.
I do want to address this thing about the bubble. I think the bubble is an entirely inappropriate metaphor. Let me just be very clear, houses ain’t tulips. Houses today even with the drop in housing prices are more valuable than tulips were however many years ago when we had the tulip business … bubbles in history haven’t been cases of irrational exuberance. They have been cases of exuberant irrationality. And there really is a distinction. Irrational exuberance means you get a little carried away with something that is basically a good thing. But exuberant irrationality is when you start thinking that tulips or some of those dumb ideas on the internet when there were some of those things that nobody in their right mind wanted to buy, those were excessive.
Considering that Frank was about to become the Financial Services Committee Chairman it was an extraordinary assertion. Economic bubbles happen every time there’s a disconnection between price and value at “high volumes”. It is the disconnection and the volumes involved which makes the bubble. Because the role of different commodities changes in history, bubbles are about different things, but are bubbles just the same. But it’s the price distortion that matters. Historically the worst bubbles arose from financial instruments, which Frank was supposed be on the lookout for. The argument that mortgages were not flowers was irrelevance bordering on intellectual dereliction.
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Once the role of price in resource allocation had been banished from his mind then housing, like a bubble itself, was free to float in his conception unmoored from anything but politics. It ceased to be a commodity that was to be allocated by market pricing. Instead it became a “benefit” to distribute to constituents and Barney Frank was determined to do the distributing. He went on to say:
We weren’t doing anything for Fannie Mae and Freddie Mac. The issue for me was housing. We were doing something for housing. And I agreed with those who argued that because of the markets’ perceptions, Fannie Mae and Freddie Mac got this great benefit to be able to borrow money cheaply yet the benefit was not being adequately returned to the public. There were two things you could have done about that. You could have reduced the benefit. You could have cut back on their ability to borrow as cheaply or you could leave that benefit in place and distribute it more fairly. That’s what we chose to do with the affordable housing fund.
Embedded in this argument is the dim realization that housing was being misallocated; that Fannie Mae and Freddie Mac were receiving a subsidy that enabled them to provide housing more cheaply than it really cost. But this didn’t bother Barney. It was just fine by him so long as this misallocation was passed as subsidy to the ‘public’. He said, “you could have cut back on their ability to borrow as cheaply or you could leave that benefit in place and distribute it more fairly. That’s what we chose to do with the affordable housing fund.” Here was something for nothing, or at least something from people who could ‘afford it’ and therefore it could be safely passed on.
It was an income transfer from the half of American society that paid taxes to the other half that didn’t. Except that it didn’t take the form of a tax. It was nothing so overt. Instead it assumed the guise of a guarantee that allowed Fannie and Freddie access to cheap money, putting the taxpayer on the hook in case things went bad. It was hidden contingent tax. And what do you know? Despite Barney Frank’s assurances that “houses ain’t tulips”, history proved not for the first time, that housing bubbles can in fact exist. And now the taxpayers are on the hook, in part from his misjudgment.
Because bubbles had happened before, and not just to tulips, the risk of a bubble was a known unknown. But for Barney Frank it was an unknown unknown. Or perhaps it was something worse: it was the known known that wasn’t so.
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Well now, I’m somewhat on Barney’s side here. Houses ain’t tulips, and they do have an intrinsic value, and that should make a difference.
But, it does NOT prevent a bubble, which is an orthogonal issue entirely. It is one thing if some bleeding heart fed decides to pick up via Fannie Mae half the interest cost on a fair risk evaluation of the Jimenez family’s purchase of a $200,000 home. But it doesn’t stop there. Because this is a monetizable subsidy, Jimenez is incented to buy a home even more speculatively, because he will profit doubly, first from the putative increase in the value of the home, second by cashing in the subsidy when he sells it. Still OK by Barney, I suppose. But seeing Mr. Jimenez very eager to buy, and backed by Uncle Sugar, suddenly the home is priced at $300,000. Now a rational agent would back off, because that is so above value, the profit potential should be gone, but no, well, maybe that’s a new equilibrium, since the banks and the feds *endorse* it as an investment in America and a way to rise in society! And so, the canny seller thinks, heck, let’s try $400,000! In fact, Jimenez, who bought at $300,000, sells at $400,000, pockets $100,000, buys an Escalade and enrolls his kids in the fanciest Catholic school in town. But, where should he live now? Well, with his credit rating, and the continued backing of TPTB, he buys a $500,000 home! Which was going for $200k not eighteen months ago. He puts no money down, and the $100k windfall, or at least the $50k still left, will pay the mortgage for a few months, even if his income won’t, and then he’ll flip it, make another $100k, and the future looks rosey!
Meanwhile, Joe Hardworker and his working wife Jane, do the math, between them they can put 20% down and just cover the mortgage on a $500,000 home next door to Jimenez. And they do. And then the bubble bursts. Their 20% down is gone. Well, but it’s still a nice enough house, and eventually it will come back, right? Then the house down the block sells for $350,000. Ouch. Then Jimenez runs out of cash, sells the Escalade, and confides with Joe that he is defaulting on his mortgage. The house across the street, with that nice new paint and garden, sells for $279,000. Joe and Jane look at each other. If they default on their current home, and buy another at that price, they’ll save 1/3 of their monthly mortgage payment.
Thanks, Barney.
Not only that, but the intrinsic value of the home, even if that was only $200,000 on a $500,000 mortgage, was NOT AVAILABLE to the financial traders, when the market broke down in 2008. The intrinsic value did not travel with the derivative. The instruments traded as if they homes had an intrinsic value of certainly less than $100,000. An opportunity for the bold, actually because that is the kernel of truth in Barney’s thin tissue of understanding. But Mark and Mabel’s 401k was wiped out, and their broker has left town with no forwarding address.
So then, what – was there ANY WAY, once Barney decided to offer this generous stipend, to keep the bubble down, because wouldn’t it be fair and virtuous, if such excesses could be avoided? Well, no, and that’s because ALL OF THE ABOVE WAS JUST A SIDESHOW. The SAME logic was at work in the schmancy neighborhoods and glitzy new condo towers in Vegas and Miami because Alan Greenspan was offering the same kind of subsidy to real estate speculators, simply because he was holding real interest rates for EVERYONE below inflation. FREE MONEY! Just find ANY place to put it! Because Bob and Barb see it too, and are using their 975 credit rating and $400,000 equity in their current home to move into a new $2,500,000 7,000 square foot mini-mansion with a five-car garage, not because THEY can pay for it – because they can’t. But banks are standing in line to give them mortgages *untouched* by Barney Frank but of no better quality, triple-A credit rating or not.
And Barney, looking around, is very glad that he gives the Jimenez family a chance to play in that same game with Bob and Barb, and within the scope of his comprehension, perhaps he’s right.
Wretchard, I’m guessing this had very little to do with knowledge of economics and everything to do with hardcore outcome egalitarianism.
People with Frank’s worldview believe that everyone gets owned housing, without regard to their wealth or earning potential or ability to manage an income stream. They used that ultimate American leftist trump card – accusation of racism – to stifle any critique or any attempt to return to market restrictions in the decades following CRA. They made sure that market forces that would have kept marginal potential home buyers from actually getting homes were tamped down or eliminated.
They did it for ideology and to pander for votes. No objective assessment of historical economic examples or consultation with authentically American documents like Federalist #10 were made or even considered.
When someone tells you “this time, it’s different”, you can rest assured that they have no idea what they are talking about. Inevitably, the situation resembles something prior in history that the person is either blissfully or willfully ignorant of. I had to learn that costly lesson in the tech bubble, when I was young and stupid. You’d think that more people would have learned from that experience.
A smart man learns from his experience, but a genius learns from the experiences of others. And that is why I come to BC/Wretchard so frequently. Here, we find the thread of history sewn into the fabric of current events in a way that the attentive reader can use to learn more and defend against the charlatans peddling ignorance.
It is important that this man be revealed to be a bit of a fraud, as his reputation for intellectual integrity is the source of his power. Personally, of course, his lack of integrity has been revealed.
The all bubbles are also information problems. Values and prices go out of whack. Where do we find the truth about the real value of things to prevent the emergence of a bubble? This is called the knowledge problem. The classic statement of the problem with respect to economics was by Friedrich Hayek. In his view the best estimate of the value of tulips or houses was the sum of many individual terms of knowledge expressed in the market. He wrote:
When Barney Frank declared “There were two things you could have done about that. You could have reduced the benefit. You could have cut back on their ability to borrow as cheaply or you could leave that benefit in place and distribute it more fairly. That’s what we chose to do with the affordable housing fund,” he was expressing the other view. In that model certain intellects have privileged positions. The enlightened ones have superior knowledge. They can speak of making decisions in the tone that Barney Frank used. This is the central planning or government-knows-best model.
In places where no housing market exists, Barney Frank might have been right to substitute his own knowledge. But where an aggregator of “little people’s knowledge” existed, he was almost certainly wrong. However great his individual intellect, in the aggregate it was smaller than that of the multitude combined. Hayek again:
So Barney’s job was to reduce market imperfections by making sure that information was transparently available. It was not his job to distort the market by giving it false or subsidized signals. People were better placed to make those decisions for themselves provided they could apprehend the real costs or tulips or of houses.
The interesting thing about all commodity bubbles is that they are correlated to an information bubble in which one source of knowledge is wrongly elevated above all others. In the event the other bubble was Barney’s estimate of his own judgment.
Good thing Barney is not talking about paper money, right?
@1 Josh
I have no quarrel with the overwhelming majority of your message, but houses do not have intrinsic value. For example, it is logically possible that a large number of people would decide to live in apartments or mobile homes or 10 people to a house or anything. Actually, a realistic example is that the population is becoming older, so we’ll probably develop a surplus of large houses. An even more realistic example is that some geographical areas become economically depressed for a long time.
Central planning catastrophes aren’t caused by evil people. They arise I think from the creation of a superfluous positions; or positions which have acquired superfluous power. Once the position exists the occupant thinks of ways to occupy himself. Then the mischief occurs.
Some German general observed that the most destructive people in a bureaucracy were officers who both stupid and hardworking, because they created all kinds of pointless tasks for others to fulfill. The best were the officers who brilliant and lazy, maybe because they had the sense to refrain from ordering people around and simply added their contribution to the many, instead of congratulating themselves on being able control the many.
That, I think, is an alternative way of looking at Hayek’s “knowledge problem” insight. The really smart people know they aren’t that smart. And that’s their brilliance.
A big part of this problem is that Barney Frank views himself to be the smartest man on planet Earth and all others to be dumb, thereby removing any reason for Frank to listen to anyone else, or to learn from them.
Houses have as much or as little value as tulips since their value is ONLY what someone else is willing to pay for them.
Think of some mining town where the mine is closed and 500 workers are suddenly out of work and have no future in that town. Suddenly there are 500 houses for sale and perhaps 50 people who want to buy them.
What the buyer is willing to pay for such houses is suddenly a lot less. In Detroit, Michigan (USA) many houses sell for less than US$200 because demand is so VERY low.
@8 Wretchard “That, I think, is an alternative way of looking at Hayek’s ‘knowledge problem’ insight. The really smart people know they aren’t that smart. And that’s their brilliance.”
Yep. It’s AMAZING the way some (emphasis, some) stupid people think they’re smart. You can be smarter than they are, and know ten times as much as they do, and not know what they think they know (and know that you don’t know it).
Here’s what I hope — that this post is wretchard telling Barney, “A man’s got to know his limitations.” Figuratively, of course.
I know I’m not to smart because I can’t understand how people can continue to reelect Barney. He has been on the edge of several scandals, He regularly makes really stupid statements, and he has no understanding of banking or finance. I couldn’t look someone in the eye and tell then Barney Frank is my Congressman and I voted for him. The people in his District are pathetic.
“Some German general observed that the most destructive people in a bureaucracy were officers who both stupid and hardworking, because they created all kinds of pointless tasks for others to fulfill.”
Indeed! Or as I like to put it, the only thing worse than a lazy bureaucrat is one that takes his job seriously.
“Let me just be very clear, houses ain’t tulips.”
Tell that to the folks in Palm Bay, Florida, who have 3500 empty houses in their town and are trying to come up with the money to tear down as many of them as possible. The houses have NEGATIVE intrinsic value because no one wants them and no one – not even the banks who own them – is willing to spend the money to complete or even simply maintain them. At least with tulips you could feed them to the hogs or something. There is no way to invite Godzilla to Palm Bay to do some selective suburban renewal.
The housing bubble was preceded 20 years before by the Housing Crisis Issue, which was a problem created entirely within the city limits of DC. The Warren Supreme Court in the 60’s forced the insane to be let out of the asylums unless they had committed a crime. This led to the homeless problem, and supposedly the answer to this problem was housing. I was in DC when they held housing demonstrations at the Capitol. The CRA was a reaction to that scam, and made as much sense as getting rid of garbage trucks because they cause flies.
Sin
Barney Franks assertion that he is morally superior to the wisdom of the crowd and therefor entitled to extract resources and reallocate them through as opaque and shoddy and certain to be corrupt mechanism as Fannie Mae is a disconnect from reality of monumental proportions that Franks only can get away with because people have been conditioned not to challenge the level of his pretension and the motivation for his hypocritical assertion of perceptive virtue in aiding others when he is really feeding his own sense of power and undermining the stability of the larger system for reasons that remain unspoken. It is his sexual dysfunction. Barney Franks placed his unqualified boyfriend in Fannie Mae to profit from looting the place. Barney Franks is the same Member of Congress who had a male prostitute operating out of his Washington DC residence.
Straight white men can be arrogant and corrupt but they get stopped. What the insanity of PC has done is created categories who cannot be corrected, whose motives cannot be questioned, when they engage in garden variety abuse.
Proposed an Amendment:
No benefit shall be granted except by funds appropriated by Congress and raised from a tax or tariff. Any monies collected in a user fee shall be be used to maintain the service that collects said fee. Any fines penalties or tribute collected shall be expended on maintaining the armed forces and the judiciary.
Tweeted & FBd with “On Barney Franks & back door benefits.”
The concept of intrinsic value only applies to human beings; everything else has relative value.
What makes a house have an intrinsic value of $200,000? If the government suddenly declared a 100:1 devaluation (making 100 “old” dollars worth 1 “new” dollar), the price of that house will fall to $2,000. Of course, everything else will fall in price as well.
One way of thinking about this by comparing goods. On average, people value a $200,000 house 10 times more than they value a $20,000 car, and car makers can produce that car for 10% of what it costs the home builder to produce the house.
The point here is that prices are information that aggregate consumer preferences and producer costs. I can make a car-buying decision without knowing the wage rate of machine shop operators, and car makers can make a production decision without knowing whether I prefer transportation to ikebana.
Because prices are information signals, bad signals and noise can distort them. The massive 1,000 point drop in the Dow recently was (apparently) the result of a bad signal. But left to its own devices, markets will correct quickly. The drop was largely erased within minutes as traders figured out that the signal was bad.
The “fatal conceit” that Hayek described occurs when there is an a priori conception of how the world should be, and those with power react to market signals by, first, ignoring them and then, second, trying to correct them. In other words, by substituting their own judgment for the aggregated judgment of the “little people,” and using the coercive power of the state to force the world to obey.
This is the true stuff of which bubbles are made. The bigger the conceit, the bigger the bubble. And the bigger the bubble, the bigger the mess after it bursts.
All bubbles come to an end – even those that involve huge institutions, like the Federal Government of the United States of America. In fact, if we want to assure the survival of the American Republic over the next Century, we must shrink the size and scope of the Federal Government. If we don’t shrink the Washington bubble it will burst, and we’ll be left with a huge mess.
You see, in nature, there is no such thing as “too big to fail.” After all, even galaxies will die when they get too big.
This is a lesson in humility all too easily forgotten by our betters in Washington.
L3
At Unbelievable
The thought process of those who are ‘smarter than the rest of us’ are discussed, along with their self-image.
Interesting coincidence, IMO.
tomw
Flower child Barney Frank, with his insistence on the tulip bubble, is injecting his idealistic past with a massive dose of misdirection.
Of course there was a housing bubble. Government policies, which he largely created (with the help of ACORN and other activists), had everything to do with inflating it.
HUD mandated quotas for Fannie and Freddie to meet, in buying up loans to deadbeat buyers. So eagerly did they buy them (huge bonuses for F&F executives for exceeding the quota), that no real estate lender needed to worry about holding poisoned mortgages, since F&F would grab ‘em, chop ‘em up into ‘mortgage-backed securities’ and sell ‘em to suckers worldwide.
The speculative frenzy of house-buying based on the careless reliance on those poisoned mortgage ‘securities’ was exactly a bubble, and warnings abounded since the early 2000s that it would collapse.
No sympathy for poor deluded Barney.
I stand by my earlier statement that the financial recovery should have been inaugurated with the head of Frank on a pike outside the Treasury building on Pennsylvania Avenue. Atavistic to be sure, but if houses ain’t tulips then justice ain’t badminton.
L3
“betters in Washington” or bettors in Washington?
Patty,
Or “bedders in Washington”?
Cheers,
L3
Barney Frank would be equally quick to say that the sub-prime mortgage mess is proof that capitalism failed.
I am not so quick to ascribe only lofty motives to Rep. Frank. Fannie and Freddie have since inception been the post-congressional career repository of D.C. insiders who have played nice with the party mandarins. Jamie Gorelick, to name but one of a small army of beneficiaries, was paid millions in salary and bonuses during her short stint at Fannie Mae. It will never be learned but if the amount of money paid out to people moving between confessional/administration jobs and Fannie and Freddie were calculated it would likely be in the hundreds of millions.
Health care is a gold mine of opportunity to reward Members and their staff who play nice with the party leadership even if it costs them their reelection. Who’s to complain about retiring (with a government pension) to a cushy $300k job?
1/3 of the workers on the San Francisco city payroll make over $100k with lavish benefits. The silo rats are grabbing as much grain as they can and they will continue to do so until they are stopped.
In two generations we have moved the American Dream from running your own business and raising a family in the suburbs to getting a government job.
By way of anecdote, I’m currently buying foreclosed and short sale properties near Detroit. Since last August I have looked at more than 200 houses, and scrutinized perhaps 2000 or more listings along that search. The vast majority of these houses are now selling for 70-80% below the “market” from just 2-3 years ago. Without fail, the most stunning price collapses are attached to houses with government notes. Example: last week I closed on a $35,000 house which had a 2007 Fannie Mae loan of $166,000. THAT was a bubble. The prior owner had steadily increased his mortgage in increments beginning in 1999 (Clinton) as if the house was an ATM. The house of cards collapsed for him in 2009. When the traveling notary came to my house for the signing, he was amazed at the price I was paying (compared to California prices) and I showed him the pricing history. He then related to me how his job over the last decade was dominated by these types of cyclical refinancing. He said the owners were typically having face lifts, buying boats and big screen TVs and the same. Go figure. Now they will return to being renters, much as nature intended, until some clown like Frank starts handing out the balloons again.
We now live in the age of billion and trillion dollar swindles. And the real criminals who cause them mostly go unnoticed, unprosecuted, and untouched. The titanic size of their crimes apparently makes it difficult to comprehend, but eventually this sort of thing leads to the storming of Bastilles and the lopping of heads.
@19 I’ve always gone with “bettors” myself, FWIW
http://hotair.com/archives/2010/04/23/barney-frank-sec-workers-were-surfing-porn-because-of-the-gop-or-something/
had those, who were supposed to watch how the market tendencies were going bad, not focused on porn, uh, maye-be… our situation would be better !
On the topic of the arrogance and ignorance (not a good combination) of our alien overlords in DC. This is must viewing, as Pete Stark tells the interviewer that debt is a measure of wealth. He has an MBA, you know!
http://www.youtube.com/watch?v=UjbPZAMked0
Of course, he was a banker before becoming a CONgressman, so it might explain his point of view. And technically, he is correct. Look in your wallet at those bills and notes. Those are effectively short term debt issued by the Federal Reserve that we all count as measures of our own wealth. Nonetheless, I am fascinated by his holier than thou attitude – especially coming from an avowed atheist. Perhaps he thinks he is a god?
Lest we forget: the definitive performance of “Tiptoe through the Tulips.”
http://www.youtube.com/watch?v=skU-jBFzXl0
Herbert Khaury, aka Tiny Tim.
L3, SF, the intrinsic value means it has some utilitarian value, not that it’s fixed at some magic number, and generally a much greater value than a tulip bulb or shares in south sea island real estate.
wretchard, do not look at bubbles as an information function, that would be rational. Bubbles are a behavioral function, or malfunction, like having one more beer for the road, or going home with the charming stranger at the bar. Even most participants in Ponzi schemes can be aware that they are in an unsound enterprise but hope to come out ahead. Like every gambler in Vegas. And the amoral greedheads on wall street. The later have ever bit of information there is, and are the primary sponsors of the situation. The skilled robber has lots of information, more information than you and the police combined. Information does not prevent crime nor foolishness.
The concept of intrinsic value only applies to human beings; everything else has relative value.
Humanist anthropomorphic mathematically ignorant claptrap.
What makes a house have an intrinsic value of $200,000? If the government suddenly declared a 100:1 devaluation (making 100 “old” dollars worth 1 “new” dollar), the price of that house will fall to $2,000. Of course, everything else will fall in price as well.
That would be a perfect example of a house having and keeping its intrinsic value.
This stuff is so widely misunderstood … that Morton Doodslag should soon be a very rich man, and I suppose if I had any sense, I’d get into the game myself.
# 14 LOTM
I take back any and all prior allegations of fussiness or squeamishness, your prodigious 9 line opening sentence notwithstanding.
“Back door benefits”. Magnificent.
I salute you sir.
tomw @ 16 –
Great insight. If you’re bored, you’re not doing it right. Lookout!
I for one am relieved to hear there was no housing bubble and that the drop in prices was overall a good thing. I’m particularly pleased that
ElmerBarney cleared up the common misconception that houses are tulips. In fact, I’m feeling irrationally exuberant about the whole thing. Or maybe it’s exuberant irrationality. I’m not really sure.The government supported a market in bad loans through Fannie and Freddie. The House Financial Services Committee chaired by Barney Frank specifically rejected the warnings of OFHEO, a department within Congress set up especially to regulate Fannie and Freddie. OFHEO said there should be an audit; Barney Frank said don’t bother.
The government put up a sign “We Buy Bad Loans”. Now our politicians complain that evil businessmen created the bad loans that they wanted to buy, granting the loans to people who could not repay the loans, exactly as planned by those politicians.
The U.S. has a history of financial crises based on giveaway housing policy and guarantees to banks. Remember the S&L crisis of the 80′s.
Our Democratic politicians, with some Republicans, are deluded by the Marxist Labor Theory of Value, possibly without realizing it. They push housing because it buys votes, and because they (still) cannot imagine that a house could be worth less than what it takes to build it. They believe that a house is the tangible result of much work (yes), and cannot be worth less than that work (not true). Any decrease in price (they think) is temporary, and everything will bounce back if they can only hold on long enough, and borrow and spend enough money in the meantime.
The current crisis is not a free market failure. It is the result of immensely bad Government policy implemented through market participants.
A lot of banks lost money because they bought debt that they did not understand. The government lost money through its housing policy implemented through Fannie Mae and Freddie Mac, who bought $1,400 billion ($1,400,000 million) of this subprime debt, and pressured the bond rating agencies to stamp AAA (safe investment) on all of the sub-prime debt. Fannie and Freddie were government programs pretending to be private companies. They had the implicit guarantee of the federal government.
Housing was pushed as a government program. Housing is a highly leveraged investment. The homeowner borrowed 80% of the money to buy the home (5:1 leverage). Great when prices are going up, and disastrous in any downturn. The leverage was more like 10:1 for the sub-prime loans. All encouraged by government policy and programs.
We Guarantee It: The Credit Rating Agencies
LOTM @ 14:
Trying on your Victor Hugo?
Gosh, Did my comment get deleted for being homophobic? I repent in sackcloth and ashes if I hurt Mr. Barnie’s feelings. It’s tough enough being an extinct purple reptile… oh wait wrong Barnie. I’ll try to be more sensitive in dealing with unnatural appetites and lisping corruptocrats from here on in.
barney always seems so bored.
Bwaney Fwank is stupid. He’s stupid because he’s never had to be anything but stupid. He’s so stupid, he actually believes PC, Diversity, and Multiculturalism. Along with spread the wealth socialism.
Believe me, if straight White guys were buying houses from Fannie and Freddie subsidies, Fwank would put a stop to it.
Because Fwank is gay, he’s protected. Untouchable. No one can say bad things about him. Which makes him even dumber. A White Straight Male Republican — he’s got to be on his toes. Anyone can say bad things about him, and legally he’s a third class at best citizen. His rights come after everyone else’s.
Leaving aside irrational factors, intrinsic value can probably be thought of as the net present value of a thing assuming that you were ignorant of what it originally cost or traded for. If you found a glass of water in a desert or an alien device in Antarctica the intrinsic value would be what it brought to you in use from that point forward. A bushman may not know what an Ipad cost, but he might find one dropped by accident from an airplane a fine shaving mirror, assuming he shaved.
This is not very different from the book definition of “intrinsic value” — “based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value.” If there were no market in alien artifacts that would not stop it from having a value. But that value would depend on its utility, which in turn depends on other things.
Up in the Snowy Mountains there are some old towns which once grew up around mine strikes or grazing land which are now derelict. Sometimes hikers go by them, but in ordinary circumstances the average person would have to be paid to live there because they are so far from jobs, water systems, electric grid etc that the economic cost of actually living there could not be borne unless you were a caretaker. Indeed, rangers are paid to live there and even they ouldn’t live in those derelict houses, supposing it were legal to do so. The net present value of housing in the deep Snowies is intrinsically negative. It has no utility in use unless you were a hiker coming through. Intrinsic value is almost never purely intrinsic. It usually depends on other things.
I think it was ever the case. The reason why nomads moved was to follow the herds. Those were the jobs of the time. At some point, the old camp became a negative value and they moved on. Is gold valuable? There’s a story told about a sultan who was imprisoned by someone nomad warlord in his storehouse of gold and left to starve as object lesson in the intrinsic value of the bow and the sword? Does gold have intrinsic value? Only if there’s a door in the the storehouse because it becomes valuable in trade. It would be interesting to transport the sultan and the warlord to 21st century Manhattan to see who would fare better: the man with the bow or the man with the two tons of gold. I think the sultan would soon be in a stretch limo attended by a bevy of pretty personal assistants.
The ghost towns in the Snowies could become valuable again if oil were discovered or some other technological development occurred made it viable to live there.
The other thing to consider is that bad investments in “intrinsically valuable” things are also a waste of the intrinsically costly materials which comprise them. Building an obsolete fighter airplane is waste partly because real man-hours, real materials, real electronics are used for something whose residual value can never compensate for the opportunity cost of building that clunker. There are said to be projects in the Gulf where towers of steel and glass are sinking into the ocean as the artificial islands on which they are built settle. When those go down, real steel, concrete, carpets, glass, elevators and wiring will go down with them.
All the money wasted on bad investments could have been used for productive enterprises. Instead of housing nobody wanted we could have had investments in enterprises which generate jobs everybody needs, or we could have built nuclear power plants or something else that is useful. There’s that word again. What’s useful? Maybe the market should decide. It doesn’t always get it right but it gets it right more often than the bureaucrats. I have some sympathy for a person who thinks he is building something he believes will be a social good. But as events proved, society itself when considering all the costs involved has decided differently. Maybe Barney meant well; and the only point is his goals would have been better served by letting the market process go forward as efficiently as possible to begin with.
Who made Barney Bubble the final arbiter of fair? If there is a scale of wealth that descends from the very wealthy to the very poor, should we skip from wealthy to then poor when it comes to opportunity for affordable housing? When immigrants come knocking at the door do we allow the most qualified, the first in line, or do we cater to the law breakers as the most deserving? Inquiring minds want to know.
…and when it comes to tulips, I can think of none more grotesquely spittle flecked in and lasciviously perverse than the squat little side kick.
The Housing Bubble is a superb example of a basic flaw in Leftist thinking.
In truth, the people who were the targeted recipients of government coerced and, eventually, government funded low interest loans were not the main problem.
The biggest problem came from those people who took advantage of all-you-can-eat buffet at the banks to buy 2, 3 or 7 houses and flip them. As Bear Stearns and the Boston Fed asserted, many poor people at last able to buy their own home no doubt would go to any length to keep it. In contrast, people who already had a home and bought a half dozen more to flip them found it in their best interests to walk away the very second the value of the houses ceased going up at no less than the interest rate of the loans.
The promoters of the CRA and of Fannie, Freddy, and Barney (please give me credit for not saying Barney’s Fannie) could argue that their brilliantly compassionate sub-prime loan concept was abused by the decadent bourgeois capitalist exploiters. And of course this always happens with everything they try. Each attempt to manipulate markets, the means of production, taxes, and individuals results in people manipulating right back. In the USSR farmers fed their personal cows bread because it was subsidized. When subsidies were enacted for ethanol all sorts of mischief ensued that cost the taxpayers billions when companies gamed the system. Dr. Thomas Sowell has written an entire book on the results of such failed attempts to attain Cosmic Justice.
And as Leo could no doubt explain, when the housing bubble popped the side-effects led to many of the very people who had indeed been the targeted recipients of CRA largess also losing their jobs and their homes. And led to even more of the same. In rocketry we cannot protect against two different failures, and that is with a hard physical science, which we know far more about than we do the behavior of human beings.
P.S. Lifeofmind #14: Good point on the invulnerability of certain PC-defined “types.” And might I suggest you take advantage of Sears Roebucks’ 2 for 1 sale on semicolons; they can be useful.
LotM, i think you just got a semicolonoscopy
RWE: take advantage of Sears Roebucks’ 2 for 1 sale on semicolons; they can be useful.
Heh! I am still looking forward to reading LotM’s 2 sentences novel.
To RWE,
Fannie and Freddie set the standards for “qualified” loans, the ones that they would buy. Loan originators could only make loans that they could in turn sell to those large institutions. (Othewise, they would quickly run out of money.)
So, why did FanFred and others buy loans made to “flippers” holding many other properties? Only because FanFred’s standards were shockingly, stupidly low.
FanFred and B.Frank cannot reasonably claim that business sharpies took advantage of them, when they had the information and bought the loans anyway.
Actually, Frank could use the defense that he was too ignorant and stupid to understand what he was doing, a defense that is plausible but doesn’t convince me.
- -
What is your source of information about the role of flippers compared to poor, marginal buyers?
I’ve believe there is more than one kind of intelligence. I worked with Philippine hill tribesmen and lots of ordinary people surviving in extraordinary circumstances and came away with the conviction that while I had skills they didn’t have they had skills I could never hope to match. A few years ago there was a story about Chuck Yeager’s grandson in the Second Fallujah. He had apparently walked into an ambush inside a house. What they didn’t reckon with was his preternatural situational awareness which he may or may not have inherited from his grandpa. In a few seconds he had thrown back all the grenades lobbed at him and simultaneously shot all his assailants, like some scene from the Matrix.
Think you can do that? I know I can’t. There’s more than one kind of intelligence. Which is why this comment from NY Books is so interesting and relevant to this discussion. Can you be very smart if you think you’ve got it all down?
Barack Obama, Barney Frank and whole host of other people are probably very, very smart. Anyone who goes to a top rank educational institution will be humbled at the raw talent he encounters there. They are really smart and most are very hard working. But the key thing to remember is that they are smart in different ways. And I think it is fundamental mistake to think that your own intelligence, however great, can encompass it all. That’s why Hayek’s insight into the information problem is so crucial. There are things we don’t know. And the sooner we grasp that, the smarter we are.
http://www.youtube.com/watch?v=_MGT_cSi7Rs
almost unbearable youtube of Dems fighting off suggestions re fixing F&F –back in 2004, when the 50 trillion bucks that evaporated were still available capital in the world’s asset accounts.
barney attacks a phrase used in the plea: ”safety and soundness”.
There is a style of intelligence which can understand and work with complex equations relating economic factors, drawing insights that are far beyond what the average person can do.
Then, this is combined with a stupidity that will follow the results of those equations, betting the economic life of the country that those results are correct.
They congratulate themselves on creating and understanding an abstract system. They are ignorant of where that system differs from reality. They aren’t doubtful enough of their own understanding to realize that they have got it wrong, and that chance will at some point go against them.
Bertrand Russell: The stupid are cocksure, and the intelligent are full of doubt.
- Most people would rather die than think. In fact, they do so.
Andrew #41
My source of info is from two main sources. One is Thomas Sowell’s book on the housing meltdown. The other, less broad but more detailed is Anatomy of a Train Wreck Causes of the Mortgage Meltdown by Stan J. Liebowitz published by the Independent Institute. Two other informative publications are “The Trillon Dollar Shakedown” published in City Journal, Winter 2000 and “The Collapse of the US Sub-Prime Mortgage Market” published by the Institute of Chartered Accountants in Australia. Also National Review did a piece on Barney’s “rolling the dice on the housing market,” to use his own words. Some of these I was made aware of right here in The Club.
I showed this material to a financial advisor at our credit Union, a man formerly employed by Merrily Lynch, and he was deeply shocked, but admitted that the signs were all there. For example. he said he knew that Janet Reno threatened to prosecute firms who denied loans to minorities.
And yes, as you allude, the problem was that standards HAD to be driven down to enable the largess to work. As I think I summed it up here, eventually the standard was that there was NO standard. Asking the wrong questions would lead to at least some of the targeted group being denied, so eventually asking no questions became the standard and the “success” of the program soared – and that led to a need to sell those packaged securities worldwide to keep the ball rolling. Implementation of the CRA got better and better until the financial system collapsed.
The trouble with tulips
The problem with matriarchy is
Nobody wants to work under matriarchy/socialism.
The entitlement mentality is toxic.
Why work? Why work? Why work?
And if you can exist without working.
WHY Work?
Work = slavery to the government.
No wonder people have given up.
Barney prefers to put his tulips on Freddie rather than Fannie.
TIPTOE THROUGH THE TULIPS
With a doff of the hat to PA Cat, who got there first and good for him, I removed the link to Tiny Tim.
When Bahney Fwank sees tulips bloom
His tiny tippy toes
Just glide along with awesome grace
I know, he’s one of those
He does the same with Freddie Mac
As well as Fannie Mae
With subprime deals for favored folks
The rest of us must pay
He’s generous as to a fault
He dances through this life
The question though is Fannie Mae
Or Freddie Mac his wife
Seems areas with recourse loans have recovered or are recovering faster than those with what the brits call “jingle mail” (where people can walk away from their loans – posting their keys to the bank).
What’s the situation in Australia, Wretchard? I saw a recent article which suggested the government is trying to restrain asian investment in the housing market downunder to keep prices affordable for the average citizen(?) (why don’t they just allow more homes to be built ??). Or is home building tradesfolk supply limited?
On Monday I’m planning on emailing the congressman in hopes that he will buy my mom’s house at its “intrinsic value.” Which of course is twice what has been offered by those poor fools that don’t understand what it’s really worth.
Twat’s the problem?/46
And who the matriarch may be? Well, with the exception of the wannabe matriach Nancy Botoxi…
In the former commie countries, there has not been a trace of a matriarchate. Sure, the women were for the most part working, but that was by design–it was not possible to make enough money as majority was concerned in a typical 4 people family if only the male worked. The trend was established when the financial reform took place (CZ), essentially devaluating the earnings. What the state got was the custody of children, more or less, through day care system, to indoctrinate with abandon. Maybe that is what you meant–that if we abstract quite a bit, the state may have been seen as a matriarch.
But the system was carried by males. There were never females in a position of real power in the Eastern Block, just in rubber stamping supporting roles.
The Frankfurt School and Gramsci thought that the best way to subvert the western democracies would be to give females a bigger role. A candy of women’s upward mobility was supposed to break down a family nucleus (resounding success!). Of course, when females started entering the work force, the real adjusted income of males started to decline. That process took nearly 50 years to complete. It is nearly impossible for an average family of 4 to get by on one income, though the amount of debt is just marginally higher than when 2 incomes are in.
As for your “Work = slavery to the government”, the ongoing joke in Eastern Block was that “We are pretending to be working and government is pretending to pay us salaries.”
Mind you, there was no unemployment insurance. You had a “right to work” (or right to pretend to be working), but in reality that meant you couldn’t be without an employment. If you did not have savings or a legitimate source of income (and what’s legitimate other than employment), after six months, you could end up in prison. Nifty system.
I dunno, I can imagine that if them “progressives” get entrenched in power, the lazy bums getting handouts now may be actually unpleasantly surprised–everyone will be under indentured servitude, but some will be more slaves than others. Given the current “handout” demographics, you can probably see the irony.
Unless the ruler class establishes them as overseers. That is a possibility. (I am not using “elites” label, as they are essentially “elitists” or “elite wannabes”).
There are things we don’t know. And the sooner we grasp that, the smarter we are.
Of course. One doesn’t control the wave, one rides it.
Regarding how smart Obambus is and how bored, hah. I know people like that. Maybe I am people like that. Maybe nearly everyone posting on BC is people like that. But the boredom is not a feature, that’s a bug, that’s where you reach your limits, that’s a sign you have not mastered your domain, do not yet know your own limitations – because you haven’t even tried to find them. That’s the Obambus we all know and love, the one who runs his mouth day and night and has never actually done a thing.
21. Peter Boston: Let’s not forget Franklin Raines the former Harvard radical. He left FM with $50+ million in bonuses and recently bought a DC condo for $5 million. In ~2004, FM had to restate earnings to the tune of $13 billion. Enron was a fraud of $4 billion tops and people went to jail for it. Frank and Jamie had been cooking the books at FM so they could meet their bonus targets. Congress responded by decreeing that ~1/2 of new mortgage buys be from the ‘under-served’ sector. Bush made a half-hearted (what else?) effort to say “Hey Wait a minute”, but Barney said his suggestion was DOA.
22. Morton Doodslag: Good price, but what are you gonna do with a house in Detroit? You are correct that even many “responsible” borrowers treated their house as an ATM to fund their lifestyle. This has not gotten enough media attention, IMNSHO.
31. Andrew_M_Garland: Excellent details. But there were also people with NO money down, and there were people with “mortgages” that allowed them to pay what they wanted to; they didn’t even have to pay all the interest. Many of these negative ARMs are resetting this year in the higher brackets.
Finally, realtors, mortgage brokers, and local banks were all eager to join this game. They got their fees, and the loan went into some tranche somewhere that Moody’s said was AAA, and GS sold to somebody as an “investment”. So all the people on the merry go round were grabbing gold rings because they knew it would not be their problem when the whole thing went Tango Uniform. And they were right.
Josh/51
I envy you. I never could quite learn it or grasp it–being bored that is. I’ve noticed quite early on that people were “bored”–so I were told, but what it entailed was always kind of mystery to me. Hence I could never quite fit in. Maybe you are right and most BCers know. How one does such a thing… being bored?
Despite being an old dog, maybe I can learn some new tricks.
“There’s a story told about a sultan who was imprisoned by someone nomad warlord in his storehouse of gold and left to starve as object lesson in the intrinsic value of the bow and the sword?”
The last Caliph when the Mongols sacked Baghdad, I believe.
“‘The concept of intrinsic value only applies to human beings; everything else has relative value.’
Humanist anthropomorphic mathematically ignorant claptrap.”
Anthropomorphic? Glass houses, stone throwing, dangers thereof.
Re intrinsic value… I thunk the problem here lies in the fact that the term has several definitions that are specific to their respective frames of reference.
Philosophically, one may say that animate objects have an intrinsic value (or inherent value as it were), while inanimate objects do not–their value is only relative–their “intrinsic value” can shift depending on circumstances.
Not that animated objects can’t be removed from the intrinsic value considerations. Road killed deer intrinsic value shifts dramatically, to a representation of snacks volume potential.
…ah yes, dining a la car –
I have nothing that will add to the conversation. But I would like to say that 2×4 channeling Whiskey is great! And I agree with 2×4 in his assessment. RWE is spot on.
Also, L III said everything I was thinking as I was reading Richard’s post. We are dealing with constructs of the human mind and as such they are subject to the vagaries of humans.
Marie, The SEC regulators were watching porn because they were told they had nothing to do and would be punished if they did do something to correct the situation.
Valerie Jarrett, the President’s confidante and adviser, say of him: “He knows exactly how smart he is…. He’s been bored to death his whole life. He’s just too talented to do what ordinary people do.”
The thing is, though, her description does not jibe with Obamas’s actual output, nor does it fit the pattern of restless geniuses that anyone with a few decades of life experience has observed.
People who are THAT super-smart tend to go in one of a few directions:
1) Entrepreneurs … inventors, business & creative visionaries. They lead by doing, not by talking. Their legacy is an actual product, creation, or a paradigm-shifting better & more efficient way of doing things. Needless to say, these people tend not to be chronically bored. They keep themselves too busy for that.
2) Underperformers … ranging anywhere from the lazy f*cks who end up sponging off their relatives (who, me, work? why? I’m a genius) to just the uber-brainiacs who are several shades less than they could have been, because they got into the habit of coasting on their natural intelligence rather than building the discipline of regularly working hard.
3) Whack jobs … so smart they are half or mostly crazy. Really, really eccentric and frequently antisocial.
So there you have it: creators, coasters, and crashers. I can’t say as I’ve ever observed or read about geniuses falling outside those patterns.
Barack Obama doesn’t appear to fit any of them. He sure as hell is not an entrepreneur. Far from being a creator adding to the national wealth via spectacular productivity, he became a career spender of other people’s wealth and productivity. And unless he goes streaking in Lafayette Park trying to eat moonbeams with a knife and fork, I don’t think he’s a whack-job type of genius.
The only possibility left is a coaster. If this is the case, his deviation from pattern (i.e. coasters drift into obscurity due to their underachievement, but this guy has become POTUS) would be explainable with outside forces working to ensure that he did not remain obscure. The coaster’s tendencies toward conceit & laziness can be more than compensated for if the coaster has the right “sponsor.”
There is, of course, a completely different possibility: that he is not a genius at all, just a smart guy who is also very glib. (This of course does not preclude also having a sponsor.)
Where are the scholarly publications?
Where are the law review articles?
Where is the ground-breaking legislation he crafted?
Where are the successful community-improvement programs he designed?
Where is there any creation, invention, product, or industry-changing legacy, whatsoever?
Harold Hill was a smart guy. But he was nowhere near the league of, say, Sherlock Holmes for brains and productivity.
Harold Hill talked a lot of shinola and made people feel good about themselves, without ever actually producing any of those boys’ bands he was always promising. Sherlock Holmes, on the other hand, got criminals off the streets. Actual results, actual justice.
I’m not yet convinced that Obama isn’t Harold Hill.
That aside, Valerie Jarrett’s description is ridiculously beyond sychophantic. I’ve personally known at least 3 people whose IQs exceeded 140, and I would *never* say of them what she said of Obama. “Too talented to do what ordinary people do”?
Come on.
That’s a snotty 19-year-old’s opinion of himself. Either that or the snotty 19-year-old’s groupie/girlfriend. Whichever the case, it is not the assessment of a mature personality but a juvenile one.
The smartest person I have ever known was also the most down-to-earth, i.e. wise enough to know that brains aren’t everything; that character is what makes the difference in the end.
Wretchard 5
“All bubbles are also information problems. Values and prices go out of whack. Where do we find the truth about the real value of things to prevent the emergence of a bubble?”
I have been giving this topic a lot of thought recently. I work for a company that provides risk management software for the financial industry, and I have long felt that securitized products such as collateralized debt obligations coupled with credit default swaps were simply too complex for accurately measuring and valuing risk exposure.
While I still hold this opinion, I believe it is only part of the story. The real culprit, I feel, is how management makes decision based upon incomplete information during market bubbles.
At the heart of this recent financial shock was the downturn in the US housing market. While the housing market, like most markets, has historically been subject to periodic downturns, this cycle was different due to the widespread of securities linked to subprime mortgages. The International Monetary Fund estimated that costs associated with subprime write-offs could reach as high as $1 trillion. These securities were linked to subprime mortgages through complex securitized products known as collateralized debt obligations.
The 1968 Charter Act allowed the newly created organization, Fannie Mae, to purchase mortgages from banks and pool them into what is known as mortgage-backed-securities. These new securities were then sold off to investors. As the market for these mortgage-backed securities matured, investment banks found ways for creating new products. One such way was pooling these assets yet again through securitization. This became a method for financing assets that were combined into pools that were then split into shares, or ‘tranches,’ and sold as collateralized debt obligations – ‘CDOs.’ This was a method widely used for packaging and selling subprime mortgages to investors seeking higher yields.
What made these new synthetic instruments difficult to accurately value and model from a risk perspective was their complex structure. A subprime mortgage would be pooled into a mortgage-backed security containing other subprime mortgages and sold as securities. These mortgage-backed securities would then be pooled further into new securitized products, CDOs, that would then be carved into specific tranches and sold. The higher tranches had the best ratings and had the least chance of default. These tranches were rated AAA. The lowest tranches were BBB, and were considered on par with junk bonds, risky, but carried high premiums attractive to investors.
In many cases, insurance products known as credit default swaps would be tied to specific tranches to help increase their credit worthiness. If a tranche were in trouble due to payment default, the issuer of the credit default swap would step in to pay the principal.
Trying to measure a firm’s risk exposure with regards to these instruments is challenging. One of the most widely used risk models is called VaR – Value at Risk. This model measures the boundaries of risk in a portfolio over short durations. In the 1990’s, as the use of derivative securities were exploding, the Securities and Exchange Commission, and later, the Basel Committee on Bank Supervision validated VaR’s calculations by allowing financial institutions to use it for measuring risk exposure and setting their capital requirements to offset that risk.
However, a risk information management system is only as good as the quality of the underlying data used and the ability to accurately model information. Making the risk modeling effort difficult was the complex nature of these securitized of debt instruments. There was insufficient data and the modeling techniques used were poor. The standard risk models used for CDO portfolios failed to take into account the whole risk distribution of the subprime assets within them. It was extremely difficult and time consuming to actually determine the underlying details of a subprime mortgage within a mortgage-backed security, within a CDO, broken out into a specific tranche. Instead, risk managers often analyzed CDO’s by relying on computer simulation techniques such as a Monte Carlo simulation.
The Monte Carlo simulation was the primary risk model used by the rating agency, Moody’s Investor Services, in determining the default risk of specific tranches within a CDO. Despite relying on this sophisticated and highly quantitative model, Moody’s still had problems getting sufficient data and being able to accurately model these complex instruments. During their process for assigning ratings, absent of the necessary data, they had to review each contractual document of the issued CDO and any credit default swap assigned to a specific tranche. This was a highly intensive manual process in a market where over $520 Billion worth of CDO’s were issued in 2006, alone.
Nevertheless, financial institutions were relying on these quantitative models either directly, or through the credit rating agency. This gave a false comfort that their risk models were complete and that everything they needed to measure was within them. These firms tended to focus on risk modeling where there was data, rather than risk modeling where there was risk.
The US Government Accountability Office’s reviewed many of the leading financial institutions and presented their findings in a testimony to the Subcommittee on Securities, Insurance and Investments, Committee on Banking, Housing, and Urban Affairs, in the U.S. Senate. In their ‘Oversight of Risk Management Systems,’ they found weaknesses throughout the risk management systems these firms were using. Even though the weaknesses were known to exist before the crisis occurred, many of the troubled financial institutions still used their results to justify capital reserves. These reserves proved to be grossly inadequate, causing a liquidity crisis where the government was forced to step in.
Despite the faultiness of these quantitative models, there were warning signs that the US housing market was in trouble. Two such signs were the rapid growth of the number of subprime loans that were being packaged into CDOs, and the alarming concentration of these loans in specific areas of the country.
In 2000, there was $130 billion in subprime mortgage lending, with $55 billion of that repackaged as Collateral Debt Obligations. By 2005, there was $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. In 5 years, the total number of subprime mortgages had grown by 400%, while the number of subprime mortgages that were packaged into securitized products had grown over 820%. Equally alarming, was that the historical average home price ratio to income was 3:1. However, it had increased to over 11:1 in Los Angeles, 8.5:1 in Miami, and 8:1 in New York. It was these distortions that caught the attention of the few firms who spotted a problem in the subprime housing market.
As early as 2004, Ivy Zelman, the housing market analyst for Credit Suisse voiced her concern. It wasn’t just the unprecedented distortions in certain areas that alarmed her, but also that many of the buyers in these areas were not real buyers, they were speculators. All that was required for a BBB bond tranche, the lowest tranche in a CDO to go to zero was for the default rate on the underlying loans to reach 14 percent. Areas such as Los Angeles, Miami and New York could easily hit these default rates.
Why weren’t alarm bells going off in the standard risk models that were being used? This goes back to the difficulty in understanding the risk distribution of the subprime assets within them. Due to the numerous layers of securitization that took place, it was a challenge to determine what percentage, if any, of the tranche was concentrated in these high-risk regions and what the default rates were.
Francis Diebold, a professor of economics, finance and statistics at Wharton argues that it is important for users of models to maintain a healthy skepticism about those models. Managers involved in analyzing their firm’s risk exposure must constantly question the models that are being used and assume something can be terribly wrong.
There were a few firms that managed to get out in time. These firms were able to spot early signs indicating that the subprime market was in trouble, and they managed to avoid its collapse. What separated these firms from everyone else was that when the warning signs began to appear, they refused to solely rely on their quantitative models, and instead, verified their skepticism through alternative approaches that the market was in trouble.
This skepticism is what helped Steve Eisman, general partner at the Hedge Fund FrontPoint Partners, a firm that successfully shorted the subprime market. Prior to FrontPoint, Steve was a finance analyst that researched companies tied to the housing market. By the spring of 2005, FrontPoint was convinced that the underpinnings of the US mortgage market was in trouble. Where Steve turned next was not to his risk models, but to examine what was actually happening in the market, particularly to the major players, the mortgage brokers themselves.
Throughout the subprime industry, by 2006, mortgage brokers and firms specializing in subprime mortgages were in trouble. In January 2006, Ameriquest Mortgage Company, one of the largest subprime lenders, was investigated and fined $325 Million for misleading and predatory lending. By Q4 of 2006, New Century, the third largest mortgage broker in the US was in trouble suffering major losses, and in early 2007, two Bear Stearns hedge funds that invested in subprime mortgages were shut down suffering losses of over $4 Billion.
Paulson and Co., a hedge fund that reaped significant profits of almost $15 Billion by shorting the subprime market between 2007 and 2008, became concerned as early as 2005. In his statement before the U.S. House of Representatives Committee on Oversight and Government Reform, Paulson stated that due to weak credit underwriting standards and excessive leverage among the firms investing in these assets, he began tracking published delinquency rates and determined that the subprime mortgage market was in trouble.
If the quantitative risk models were not picking up that something was wrong in the subprime mortgage market, there were still numerous warning signs that were widely available. Why didn’t firms such as Lehman Brothers, who filed for bankruptcy on September 15th, 2008, see them?
Between 2006 and the first two quarters of 2008, Lehman Brothers sought an aggressive 13% annual growth model for revenues. This was reflected in its share price. On January 29, 2008, Lehman reported revenues of nearly $60 billion and record earnings in excess of $4 billion for its fiscal year ending November 30th, 2007. On September 12th, 2008, Lehman’s stock declined to $4 per share. Three days later, Lehman Brothers filed for Chapter 11 protection.
During this period, as a way to achieve this incredible growth, Lehman increased its use of leverage and its risk appetite with a major concentration in the subprime market. By 2007, the firm had raised its risk limits from $2.3 billion to $3.5 billion, eventually reaching as high as $4 billion in early 2008.
Using this expanded increase in acceptable risk, in early 2007, Lehman was still aggressively expanding its presence in the subprime market through its Aurora subsidiary. This was occurring at a time when Lehman’s own housing analysts were sounding alarms about disturbing trends with regards to Aurora’s mortgage maker program. In the United States Bankruptcy Court Southern District of New York. In Re: Lehman Brothers Holdings Inc. Chapter 11 – Case No. 08-13555, the examiner, Anton Valukas provided internal emails of those sounding alarms:
“Looking at the trends on originations and linking them to first payment defaults, the story is ugly: The last four months of Aurora has originated the riskiest loans ever, with every month being riskier than the one before – the industry meanwhile has pulled back during that time”
By May, 2007, Lehman got further involved in real estate investments through the $22 Billion acquisition of Archstone, a massive real estate investment trust, even though this deal would cause the firm to completely exceed its already increased risk limits and wipe out any liquidity.
Lehman was not alone in their reliance on complex risk models in navigating through the decline in the U.S. housing market. AIG was in a similar situation. The Financial Products unit at AIG had made billions of dollars by underwriting insurance through credit default swaps that were packaged into CDOs. Throughout 2007, AIG was increasingly alarmed at their exposure to this declining market. Internal emails at AIG show their executives laboring to understand the flaws in Financial Product’s once vaunted mathematical models and debated how much to disclose to investors.
By the end of 2007, AIG was in a dispute with their client, Goldman Sachs, regarding the valuation methods that they were using to measure a number of CDOs that they insured. PriceWaterhouseCoopers, AIG’s auditors, demanded that AIG provide greater disclosure on the risks in the credit insurance it had written. By forcing AIG to pay the terms on the insurance products, which totaled $6.6 billion, Goldman pushed AIG into a liquidity crisis
In comparing AIG and Lehman, we see a common pattern of two firms who relied heavily on questionable risk and valuation models in making decisions on their capital reserves. Due to the prior enormous growth and profitability, these firms became overzealous and stopped being careful, despite clear warning signs that the US housing market was in trouble. As a result, these firms took greater risk where they became overly leveraged and ill prepared for when the market deflated.
While I think that there were many dirty players, Franks Schumer & Dodd were among them along with Fannie and Freddie. They were just as bad as the mortgage brokers pushing this junk. However, it takes two to tango and investors were at fault as well.
Risk models such as VaR, were inadequate for capturing the complex information necessary for measuring risk associated with securitized products such as collateralized debt obligations and credit default swaps. Until risk models such as VaR can accurately value and measure risk, financial firms should not be permitted in using them to justify and set their capital reserves.
shivermetimbers @ 59: thanks for a great post. I’ve been around the edges of this stuff for many years, and had an early and up-close relationship with an early wannabe rocket scientist type who I and my buddies started calling “Larry the Genius”, who kept coming up with mathematical models, and managed to talk a major bank into guiding some serious money by what they said. Now I, was responsible for making the software that Larry had written, run faster, and that I did. But I sat with Larry, and now and again he’d emerge from the frumious cloud of cigarette smoke in which he worked (this being a period when that was still allowed) and write up a new equation on the white board for whatever he was working on next. But then he stopped doing it and y’know why, is I would take his equations to the limit, and they always did something absurd. Now, Larry was clearly a charlatan, but the lesson was that the silver hairs in charge of the bank had no resistance at all to his type of crap. Let us assume that most of the wall street rocket scientists are far more earnest and competent than Larry, and maybe some of the wall street execs have at least a tiny handle on their work. I’d say the present models may be just fine, if you simply adjust the magnitudes, so that the third tranch on your average CDO should yield 35% instead of 12%. A reasonable argument can be made for this, and especially now, after the fact, this is clearly the right magnitude for the numbers. Only, of course, the system won’t move volume at these numbers, the wall street firms won’t be distributing billion dollars in bonuses. Greed and nothing but greed, broke the models. That’s one interpretation.
Another is that the entire idea of separating risk from principle is bogus, and 99% of what has been taught in business schools for the past forty years, is so much phlogiston.
I happen to believe both of these alternatives are partly true.
–
bogie wheel – please have more respect for my All-American man, Professor Harold Hill, Gold Medal Class of ’05.
Isn’t a semicolon just a comma with a Press Agent?
Thanks for taking the time to jot down your thoughts so well, shivermetimbers.
While greed has no doubt had a big role in what went on bringing through this bubble and to this crisis, the real driver has always been hubris rather than greed. This was the hubris that led so many to conclude that they’d solved the problem of risk. It could all be managed, by those in the know. This was always the fatal conceit that guaranteed the current outcome.
Perhaps the Barney should be introduced to this little game: http://www.crackshackormansion.com/
He might rethink his ideas on housing bubbles. But I doubt it. And by the way, this is in Vancouver, Canada. They don’t have a freddie or fannie or CRA, and yet they still have a huge bubble in real estate, at least in some areas.
One thing I find frustrating is the tendency of conservatives to blame this financial mess entirely on the CRA and Carter and Clinton. The financial problems we face go far deeper than that. The problems we face today came about from a mentality of entire generations of people who were convinced they could have a middle class or even upper class life without really working for it. Not just poor people trying to own a home when they don’t even have a steady job. Not just the entitlement mentality that says, I won’t work, but I expect all the trappings of a secure middle class life. It also included middle income people using their homes as money machines to fund lifestyles they couldn’t afford, and people going in hock to the tune of tens of thousands of dollars in student loans trying to buy their way into a higher standard of living. And older people who think they can retire at 55 and live on generous pensions with full boat health care for the next 30 years.
The fact is we aren’t guaranteed anything in this life. You may work hard, and still be poor. You may never get what your neighbor has. Not the house, the car or the vacations. This crisis will not be over until everyone, and I mean everyone, understands that. You want something? Work for it. And even then you may not get it.
Life ain’t fair. Deal with it.
JFSanders031: But I would like to say that 2×4 channeling Whiskey is great!
Was I? Well, one problem. Assessment is one thing, conclusions are another.
As opposed to Whiskey, I say that encouraging racial divisions is actually doing work for the other side. In the case they want to establish the overseers. But also in the prep-phase. The liberals can claim, backed up with specific pointers, that right wing is racist.
They do it in any case, whenever they can’t argue coherently. But that does not mean one should supply them ammunition.
There are now 32 black republicans on primaries’ tickets. I checked some of them, and so far no RINOs, solid conservatives. The more the merrier. I’d like to shred the liberal soft racism.
2×4, “The Frankfurt School and Gramsci thought that the best way to subvert the western democracies would be to give females a bigger role. A candy of women’s upward mobility was supposed to break down a family nucleus (resounding success!). Of course, when females started entering the work force, the real adjusted income of males started to decline. That process took nearly 50 years to complete. It is nearly impossible for an average family of 4 to get by on one income, though the amount of debt is just marginally higher than when 2 incomes are in.”
No offense intended my friend. I wasn’t suggesting that you were drawing conclusions such as his. I was suggesting that your form was similar in presentation. You did not condemn women for what happened you just presented the facts. But it was this doubling of the workforce that in the simplest economic terms caused a reduction of payscale in real income of men in general. As in women would do the same job as a man for less renumeration.
you may be onto something there, lotM –the comma is root-worded as well as glyph-shaped from the comet, which marks time cadences as commas mark thought cadences. And in olden days comets were presagers, or press agents, of coming events.
smt/59; great clarity, sir –and surrounding the system you describe was the interest rate environment, now universally appreciated as having been “kept too low for too long” (tho semi-understandably as an attempt to repair with easy money both the dot-com bust and the 9/11 depressed confidence in the ever-better future). But the low rates certainly made “yield-chasing” *the* job requirement and performance measure of financial executives, a subtle sea change which, combined with the continuity-breaking digital revolution sent the wizened old analog graybeards into black & white history and brought on before ready and without proper leaven the new masters of the universe rock star financiers.
twoby/64; you could not be more right on the race observation –wellsaid and amen.
Thus far this discussion ignores the fact that speculative bubbles are typically a function of easy money. One could reasonably argue that the subprime crisis would never have occurred had Paul Volcker remained Chairman of the Fed. Greenspan’s pedal to the metal on the growth of money supply remains, in my view, the root cause of the sub-prime crisis. There had to be some speculative bubble as a result of that extraordinary policy. Rubin put in place the regulatory framework (or lack thereof) to accommodate Wall Street’s abuse of Frank and the Socialist Democrats’ mortgages for everyone, regardless of the 3 C’s of Credit (which when I learned the trade were character, cash flow and collateral).
With respect to intrinsic value, as best I can tell from the video, Frank never used that particular word. In the economic sense of utility value, a house, whether a log cabin or a trailer home, would have a much higher utility value than a tulip, the utility of which is limited to a few weeks. So I think he is right in that limited sense. And Wretchard is right that Barney doesn’t know what he doesn’t know. I’m not so sure that’s true with Greenspan. He certainly understands that speculative bubbles always result from easy money. I have not yet discovered a sufficiently satisfying explanation for his policy decisions, except for possibly the fact that he married Andrea Mitchell.
rab 47 – haha! The unbearable lightness of Barney.
I just received an email from the inimitable Arlen Specter in which he brags of his votes on Obamacare I and II, and explains all the wonderful government giveaways contained therein. Funding for this, funding for that, funding for everyone, and everyone will benefit! He left out: just like everyone benefitted from government intervention in housing! What a card.
JFSanders031/65
None taken. I just wanted to make things a bit clearer to cursory readers.
Besides, I love women. Especially the ones that can stand with me eye to eye. Cherry 2000 is not my idea of a companion.
I’ve spent quite a bit o time in the flyover country, and I know that there is a lot of them, real women (not the hip fashionista flunkies Whiskey is familiar with). I have nothing but respect for them.
59. shivermetimbers
Great comment. I think I understand some of it, but it makes my brain hurt.
Am I wrong in seeing parallels with the reliance on computer modeling to determine financial risk, global temperature changes, and the ash cloud from the Icelandic volcano?
I have been giving this topic a lot of thought recently. I work for a company that provides risk management software for the financial industry, and I have long felt that securitized products such as collateralized debt obligations coupled with credit default swaps were simply too complex for accurately measuring and valuing risk exposure.
While I still hold this opinion, I believe it is only part of the story. The real culprit, I feel, is how management makes decision based upon incomplete information during market bubbles.
Thanks ShivermeTimbers. I think there are two parts to this problem, each of which must addressed separately to be understood.
The first is the phenomenon of outrunning your information headlights. The players stop knowing enough or the lag becomes so great that the market effectively becomes seriously impaired. The price no longer captures the information because the trades are made in material ignorance.
The second is the agency problem. In complex trading situations we rely on agents in whole or in part for the completion of the procedure. When the interests of some of these agents diverge from the principals that creates a second set or problems.
But these affect the regulators too. The same opacity that handicaps the market handicaps any human being who seeks to allocate the resources more “efficiently”. When information is lacking or an agency problem occurs there is no inherent reason why a bureaucracy will perform better than the market.
The solution, it seems to me is either to improve the information flows or to simplify things things so that valuation occurs in a subsidiary environment in which the price is more or less reliable. It’s like breaking up a complex piece of spaghetti code into individual, debuggable modules when nobody understands what is going on in the original spaghetti. Ultimately something is comprehensible or it is not. If it is incomprehensible to the market why should it be comprehensible to a bureaucrat?
Yeah, buddy, puzzled that some people don’t see it. It is of course my conviction, but also a logical strategy. The other side thrives on division. The best strategy is not to play their game.
twoby, agreed.
wretchard, re your the phenomenon of outrunning your information headlights. The players stop knowing enough or the lag becomes so great that the market effectively becomes seriously impaired. The price no longer captures the information because the trades are made in material ignorance
In the recent debacle, this issue was indeed prominent and the industry’s response was to either create, or sponsor, or (inexplicably, one would judge, considering the enormity of the stakes vs the thin mysterious record of this tiny out-of-nowhere group) choose in a fell swoop to completely rely on, the pricing of credit default swaps by the Markit Group, of London. This group’s work proved to be analgous to, say, the Otto Skorzeny command which donned GI duds and infiltrated Eisenhower’s army behind the Bulge and changed all the road signs they could find, to bollix the Allied movements at the schwerpunct.
(from my link above, the markit group)
(open quote)
Conclusion: Ten years ago, there was no such thing as a credit default swap. Six years ago, a very small number of investors traded credit default swaps as hedges against the long-shot possibility of corporate defaults. Nobody looked to credit default swaps as reliable indicators of corporate well-being.
Then, suddenly, there were over $60 trillion in credit default swaps outstanding. That is, over the course of a few years, somebody had made over $60 trillion (many times the gross domestic product) in long shot bets that borrowers would default on their debt. As this derivative risk marbled through the system, the trading in credit default swaps was completely opaque. Nobody knew who bought them, who sold them, or at what price.
But starting in 2001, we knew the “prices” of CDSs. We knew the “prices” because two Canadians, a developer of Bulgarian real estate, and four mysterious hedge funds had founded a small, black-box company in London. That company, the Markit Group, achieved near-monopolistic power to publicize the “prices” through its magic process of aggregating quotation information provided by 22 hedge funds and broker-dealers who could well have been betting on the downstream effects of sudden price changes.
These “prices” were not prices in any meaningful sense of the term. But, suddenly, these “prices” became perhaps the single most important indicator of corporate well-being. Assuming that those four hedge funds and the 22 “contributors” (or hedge funds affiliated with them) bet against public companies, it seems more than possible that short-sellers got to run the craps table, call the dice, and place bets, all at the same time.
So perhaps it is not surprising that a lot of long-shot rolls paid off quite nicely.
(close quote)
Also, on the topic of ‘information’ –that is, the knowing of what is really going on and what isn’t –Nyquist’s weekly column delves into that very topic, positing three different categories of info, and leading off with
“Information warfare is being waged against you, constantly, whether you like it or not, whether you know it or not. “The leading imperialist powers,” noted a Soviet text from the 1980s, “essentially maintain that, unlike other fields of international relations, internal information and propaganda should not be subject to regulation and should function independently of the various international agreements. Actually, this means justification and legalization of any and all forms of subversive propaganda, including psychological warfare, misinformation, interference in the internal affairs of other countries, and even outright violation of foreign legislation. Such external-oriented propaganda is supposed to resort to misinformation and anti-Soviet and anticommunist hysteria so as to create and maintain tensions between countries with different social systems.”
@53 twobyfour
“Josh/51 I envy you. I never could quite learn it or grasp it–being bored that is. I’ve noticed quite early on that people were “bored”–so I were told, but what it entailed was always kind of mystery to me. Hence I could never quite fit in. Maybe you are right and most BCers know. How one does such a thing… being bored?”
Never? I recall being bored many times when I was a kid, but I haven’t known boredom as an adult. It’s not that I’ve been “interested” during all my time as an adult, but I haven’t had the distinct feeling of being bored. Where I otherwise might be bored, I’m just “there” (present, or something like that). I think about something, or do something, or go to sleep, or whatever. I wonder if there’s something wrong with adults who say they’re bored, or something wrong with me. I don’t absolutely exclude the latter possibility.
Bogie #58:
Shivermetimbers #59:
Josh #60
I work for a company that does risk management engineering analyses for missiles and space launch vehicles. We study what has gone wrong and what happens when it does and try to figure out what the expected results will be (risk X effects = expected results).
A problem we have recognized but have trouble dealing with is that of a change in a management or even just in philosophy at a company that has proven track record. The hardware is the same, most of the workforce are the same but they are operating under a different set of circumstances from the top down. We know that things get worse, at least at first. They might then get better after some disasters have woken people up – and got some of them fired.
One thing I have been reading about recently is the flight of people from the financial services sector. There is no more work for them and they are leaving. They got into the area back in the heady days of the last decade, and often had no education in anything normally thought applicable to the area, and were attracted because of the amount of money they could make, period. In my mind this represents a change on philosophy in the financial sector, the introduction of “Whiz Kids” who were good at the doing
the old soft shoe but not much else. A change in management a change in philosophy, with the results the same as in our business: a big expensive smoking hole in the ground. And with no guy watching the TM and radar scope to hit “destruct.”
Elby #63: You have hit upon a key Belmont Club concept: that of Design Margin.
Josh/Cowboy – thank you for your note:
Wretchard,
“The first is the phenomenon of outrunning your information headlights.”
I attended a recent lecture with Jonathan Lu, professor of structured finance at MIT where he spoke about the risk of data silos and the difficulty in concentrating on complex data sets, especially with outside noise that could distract us.
In this exercise, he played this video (there was no narration in his), and to make things challenging, he counted out random numbers to distract us:
http://viscog.beckman.illinois.edu/flashmovie/15.php
Smoking Frog /76
Maybe you are right. But from time before I was 20 months old, I remember only a few fragments. Thus I can’t really tell if I were bored or not. At 20 months, that was the first time I died. I died more times, but were always told to go back. At age 3, then when I was 8, then 10, then 25 and then 51, at which time I already knew it is not my time and the departure was marked by extremely short duration, did not need the nudge. You can probably see that due to these circumstances, there was not much room left to boredom.
I think of myself as a cat person. 6 lives. That means I still have 3 lives left.
I have no fear of death. Just wish I did not have to pay for it by a return that is usually very painful, admittedly I’d rather skip that part. Well, they say no pain, no gain. Must be some sort of an universal law.
60. Josh: I don’t think any of the heads of any of the Wall Street firms knew what the quants in the back room were doing. They did know that the quants were making the firm piles of money, and 2) that they could easily quit and go down the street to work. So the quants were left alone.
jWarrior @ 80: The oldline firms like Merrill Lynch or Citibank, probably not. The go-go investment banks like Goldman, the quants *are* the company. I think your image is backwards. My question is this – how many quants stood up at the meeting and said, “My numbers say this will lead to disaster”, but were overridden by the executive committee (and their fellow, less-competent quants) that wanted the billions in fees.
My father, who was a small businessman, very bright but no scholar, taught me as a child, that a thing is worth what someone else will pay for it, no more and no less. Years later I found out that this is a great one-sentence summary of the Austrian School of economics.
A house is not a tulip, but if there are more houses than households to live in them, and people’s economic situation means few want second homes, the value of the marginal house is relatively small and may well be less than it cost to provide. Whereas if there is only one blue tulip in the world and Bill Gates really really really wants to give a blue tulip to Melinda, it might be quite valuable.
Frank’s idea is really quite Marxist, that there is an intrinsic value that exists separate from the market and how people with money evaluate it.
The market price can and will change, sometimes greatly, because markets are imperfect and granular, but Frank’s idea (to use a generous term) is fundamentally not only wrong, but surely the source of many wrong decisions. It can only be held by someone who has never had to function in the real competitive economy; e.g., a politician, academic or celebrity.
M/82; for sure –that theme is all over every aspect of Marxism –the dialectic can’t include ‘time’ –the dogma for example can’t allow for a series of different individuals across time to occupy a given statistical unit. A poverty rate must be only a poverty rate –mobile individuals moving in, through, and out, destroy it as an tool of oppression propaganda.
In the same way as Marxism, a photograph of nature is powerfully truthful about a point in time –the image reflects dynamic nature but excludes the nature dynamic, existing in a static antithesis. IOW, no one can dispute the truth of an image of the truth, and the stronger the image, the deeper the lie.
Where are these “women would do the same job as a man for less renumeration” you speak of, JFSanders031 (#65)?
Warren Farrell, author of Why Men Earn More, suggests these thought experiments: consider how high the wage offered would have to be in order to attract enough females to make just half of applicants for jobs in, say, construction women; and consider the expense of making jobs in, say, mining safe enough to suit enough females that an employer could get enough women to apply at any offered wage to achieve a 50% female workforce.
Think twice and you’ll see that it’s men, not females, who are the underpaid workforce. Most U.S. workers are men and employers tend to hire the cheapest labor, don’t they?
@Marty 82 “Frank’s idea is really quite Marxist, that there is an intrinsic value that exists separate from the market and how people with money evaluate it.”
That goes back before Marx. Marx got it from Adam Smith and others. I’m not sure that Marx or any of them used the term “intrinsic value,” though. They distinguished use-value from exchange-value.
Likewise, many people mistakenly believe that the Labor Theory of Value originated with Marx. Actually he got it from Smith, Ricardo, and others.
Somewhat forgiving the source, I would be interested in what anyone here has to say about this article. Admittedly it is over my head.
So, could anyone comment on this please.
Hedge fund manipulation, not error, was behind market plunge
Thank you.
Papa Ray
Smoking Frog @ 85
Yes. I know the idea of value as something intrinsic predates Marx, but I didn’t off the top of my head know the full provenance so I only went back as far as I was sure of.
For all I know, there’s an unbroken intellectual thread back to Sumer. Surely the idea is very old.
Papa Ray @ 86
I can’t say what happened last Thursday but in general it is plausible that such manipulation can occur—and if it CAN occur, it WILL occur, if not last week, eventually.
Automated trading systems and lack of protections such as the old uptick rule make it possible for a trader to make trades with the aim of provoking certain responses from the automated systems, creating a market opportunity which they can then take advantage of. Presumably the people who create and use the automated systems are aware of this possibility and take steps to trap such transactions, in a Darwinian process of threat and counter.
Whether all this can be used to manipulate the whole market for political ends (i.e., the Obama 2008 scenario) is a whole ‘nother thing, and would be at least an order of magnitude more difficult to do without detection, and to ensure the desired political result. In 2008, how could one have know what McCain’s reaction would be, and how the electorate would react to that? Possible in theory, perhaps, but hard and risky.
The notion of home ownership as an American “right” was first planted in the public mind by an article written by the progressive philanthropist Herbert Hoover in 1920. It must have taken hold rather quickly, because in his one short term as President, Hoover established the predecessor to Fannie Mae, right smack in the middle of an unfolding depression.
A Republican, because of his progressive outlook, helped plant the seeds of entitlement and government profigacy several years before FDR even took office. The policies that Hoover employed to counter the depression were not what we’d think of as “Republican” now, but were a variant of the progressive virus that infects us to this day, much as venereal disease was pervasive in the Middle Ages.
As to Barney Frank’s role in the financial meltdown: he has nowhere to hide when even lefties like Alec Baldwin state on the air that he had been told that Frank was one of the chief architects of the disaster. Had Frank been private sector, he’d be playing checkers with Bernie Maddoff right now.
My father, who was a small businessman, very bright but no scholar, taught me as a child, that a thing is worth what someone else will pay for it, no more and no less. Years later I found out that this is a great one-sentence summary of the Austrian School of economics.
The federal government, through the IRS, disagrees with this philosophy with a vengeance. I remember many years ago (early 70′s or earlier) when the cubist sculptor David Smith died, the IRS slapped his estate with a $1 million dollar tax bill, since that was the appraised value of all the unsold sculptures strewn about his large upstate NY property. Smith’s widow countered with the fact that that is what they’d be worth if they were sold under normal market circumstances. Obviously an estate sale to pay taxes would only raise a fraction of that. Her lawyers argued that they were worthless until sold. Unfortunately, I don’t recall the final outcome of that debacle, or whether those specific IRS rules still apply. I do know that the art community was up in arms, and I do know that this general mentality by the IRS still exists.
These kinds of absurdities are nothing new. The cause of the Whiskey Rebellion was precisely the same as with the Smith case: The feds (Alexander Hamiltion) wanted to tax all whiskey produced. The farmers countered that a lot of the whiskey was for personal consumption, and not for sale, and should not be taxed.
Elby at post 63 said:
“The financial problems we face go far deeper than that. The problems we face today came about from a mentality of entire generations of people who were convinced they could have a middle class or even upper class life without really working for it. Not just poor people trying to own a home when they don’t even have a steady job. Not just the entitlement mentality that says, I won’t work, but I expect all the trappings of a secure middle class life. It also included middle income people using their homes as money machines to fund lifestyles they couldn’t afford, and people going in hock to the tune of tens of thousands of dollars in student loans trying to buy their way into a higher standard of living. And older people who think they can retire at 55 and live on generous pensions with full boat health care for the next 30 years.”
I couldn’t agree more. Unparalleled (and to some degree, unearned) success over a few decades has created this mindset, and, as you go on to say, it’ll take nothing less than a total reset of this by now hardwired attitude to set things straight. It won’t be voluntary. Nor will it be pretty.
“Houses ain’t tulips, and they do have an intrinsic value,”…
ever seen a Ghost Town?
if not, you are at least familiar with that american phrase.
a house that nobody wants to live in has a value of zero.