But Ben, A Bubble Has No National Boundaries

Ben Bernanke is showing himself to be more of a Big-Government politician than a scientist. In his latest speech, he has tried to defend the actions of his predecessors by claiming that their easy-money monetary policy only holds five percent of the responsibility for the high real estate prices that ignited the boom-and-bust bubble that almost broke the back of the global economy.

According to his analysis, 30 percent of the responsibility goes to what he has been calling the "global savings glut." The other 65 percent, he says, belongs to the inferior standards of the US mortgage market. Therefore, his argument seems to be saying that if we cure the standards we cure the problem.

He attempts to prove his point by demonstrating through charts that other countries had even looser monetary policy than the US, and yet they did not show a worse real estate boom; therefore, he concludes, loose monetary policy does not cause bubbles.

This sounds convincing, coming as it does from the highest-placed economic academician in the land. But his logic is flawed.

There are two problems with his argument. First, you cannot isolate these particular variables as he has done. To do so is the equivalent of saying Michael Phelps eats a lot, and he is not obese, therefore a high-calorie diet does not cause obesity. (Michael Phelps is the Olympic medalist swimmer who purportedly eats around 8,000-10,000 calories a day. A scientist could probably prove that he also spends almost 8,000-10,000 calories a day in his sports activities.)


[Thanks to Allfavoriterecipe.com for the image.]

Second, although Bernanke seems to accept the wisdom that a nation's monetary looseness can create excess purchasing media that can then chase relatively fewer goods, he doesn't seem to admit that there is no economic law that restricts a purchasing media's use to its country of origin, at least not in an immediate temporal sense.

Although US dollars must ultimately come to roost back in the US, they may station themselves in any number of places for many years (to wit, China's Current Account Surplus, for example) before they find their way here; and while so stashed, they can be used as collateral for any number of ventures in the meantime, in any currency--say, for example, to buy Spanish pesetas to be invested in Spain's real estate boom.

By the same token, a loose yen, for example, can go on a bubble-blowing spending binge in the US through the carry trade (borrowing in yen to obtain dollar-denominated instruments, or even cash dollars).

Bernanke's effort is a perfect example of the econometrician's Achilles Heel: narrow-sightedness. Markets are fluid, complicated, convoluted, multifaceted mishmashes of changing signals and events. For his analysis to work it must include a variable for each relevant event, not just an isolated one or two.

I find it strange that high-powered government officials feel justified in using such flawed science to defend themselves, even if they were to claim they do it for some lofty cause like the preservation of market confidence.

Blog Commentators Make More Sense than Our Politicians

Every now and then, I'm reminded that your average citizen is not as dumb as some would take him/her for.

A government committee is now proposing to have holders of subprime mortgages compromise with their mortgagors, in order to get our housing boom/bust situation solved and avoid painful foreclosures.


[This illustration is called "Select committee" for some reason. Buy this poster and other beautiful ones from allposters. com.]

All this political posturing is nothing more than grandstanding. First of all, a mortgage is a contract, just in case no one is noticing. You cannot simply wave a wand and renegotiate the terms of a contract because you find it convenient.

Second of all, the mortgagees who are sitting around a table with Treasury Secretary Paulson, going "Yes of course, good idea," have got their fingers crossed behind their back. They are going along with the show but probably have no intention of making any great effort to see that the government's wishes are carried out. In other words, they know that this is grandstanding.

I've read a lot of commentary about this latest federal plan to solve the crisis, among them today's post at the LAland blog at the LA Times website. The suggestion is, in a nutshell, to freeze the introductory rate of the ARMs so that they don't reset higher for several more years.

I had to go no further than the seventh out of 57 comments to find Tim K., Nov. 30, 8:02 a.m., making great sense and explaining in clear English why you can't just change the terms of these contracts--a problem that very few experts (other than gadfly me) have mentioned to date, to my great chagrin. Here is Tim K's simple explanation:

"This will not have any appreciable effect, because the number of loans that will be allowed to [freeze] at introductory rates will be astonishingly small.

"The reason is this - most of the volume of the loans which were made are no longer held by the banks themselves. They have been bundled into SIVs that are held in retirement accounts and pension funds. An example:

"Suppose you bought into Tim's Super Fund, which yields 7% interest over 10 years. This fund was made up of loans which were purchased from hundreds of banks. You, as an investor, bought $5000 of this, expecting to get your $5000 back plus interest after a few years. Now, imagine, that someone from the government orders that these homeowners don't have to pay the expected rate. What happens to your 7% rate? Right, it goes WAY DOWN. Maybe even NEGATIVE. Who would buy into that fund in the future? What value does it have now?

"That's precisely why this will not happen. The naive folks putting together this bill will come to this realization, and like Arnold S, will find out that in fact, this affects less than a few percentage of the total distressed homeowners. But [these few have] already made waves, so for political reasons, [the politicians] will announce it anyway showing 'we care, we're doing something' when in fact, this will have almost no effect at all."

Must I say more?

It's so gratifying to see that the "common mortal" is still out in that misleadingly silent void we sometimes mistake for a black hole of common sense. Thanks, Tim K. You make me realize I'm not spouting off in a vacuum.

And another thing: Why is no one trying to round up those mortgage brokers who filled out all those fraudulent applications? And don't tell me we have to pass a law saying it is illegal to fill out fraudulent mortgage applications. It may not be illegal to sell too much house to someone who can't afford it, and maybe we can't prove that these people lied outright; but it's surely gross negligence not to verify someone's credit and income. (Is anyone out there a legal expert who can comment on this?)

Come on, all you ambulance chasers. Stop chasing ambulances and start hunting for mortgage hucksters and those who hired them. Let's clean up the mortgage business from the ground up, instead of asking the government to do everything for us.