Comments for Rortybomb

Comment on Who believes market efficiency? by Marco

Marco — Sun, 08 Nov 2009 01:19:33 +0000

“Some economists do try to produce necessarily true statements about economics that purportedly don’t depend on the psychology of the species comprising the market, but this attempt has so far been an abject failure. Usually it relies on substituting a theoretical psychology that doesn’t resemble any actual market-making species and then ignoring differences between the behavior of markets of theoretical entities and markets of real organisms.”

I believe you are close to the answer.

The problem, as I see it (and this is merely my personal opinion), is that, once the model fails (as it did in Prof. Fama’s own 2004 study) most economists blame reality for not following the model (as Prof. Fama seems to do in the statement quoted above). This psychological reaction has a name: denial.

In the context of intellectual debate (as in the present exchange of ideas on Prof. Fama’s statement), this denial is merely “bizarre” and has not consequences by itself.

But intellectual debate is not isolated from policy and when flawed models are applied -just because authority figures are in denial- people get hurt, as we have seen.

The current practice in economic research is obviously the opposite of what science is supposed to be: once the model fails empirical testing, then it should either be modified (if there is something that can be salvaged) or discarded altogether.

And one would not rush to apply economic models to policy-making, without having strong empirical reasons to believe they actually work.

On a separate note: the very notion of efficiency, as used in economics, does not make sense. It’s used in all sorts of different contexts to denote entirely different things.

Some form of “efficiency” may make sense for simple systems: a car’s fuel-efficiency, for instance. But it does not make sense for an economic system with infinite outputs and inputs. But I’ll leave this for another occasion.

Cheers,

Marco

Comment on What was a subprime loan modeled on? by Ron Stone

Ron Stone — Sat, 07 Nov 2009 22:22:06 +0000

It’s all about greed. Subprime loans were fast and easy to issue so the borrower got a quick, usually painless loan to buy a home and the lenders flipped them for quick profits. Everyone was happy until reality set in. I believe the concept of a subprime loan was good. And while there were a good many people that got loans that shouldn’t, the big problem came from pre-payment penalties and ARMs. Without these two elements, the defaults would have been dramatically reduced.

Comment on Consumer Financial Protection, Vanilla Products by Ron Stone

Ron Stone — Sat, 07 Nov 2009 22:10:35 +0000

Simple is better. While in the mortgage business (recently exited), I found most of my customers really didn’t understand the various types of mortgages and particularly all the forms they had to sign. So while I like the idea of simpler mortgages, no matter how simple the mortgage is we need simpler loan documentation to go with it otherwise the benefit will not be there. Unfortunately, the government regulators are racing in the opposite direction.

Comment on Solving Too Big To Fail by Not the Mike You're Looking For

Not the Mike You're Looking For — Sat, 07 Nov 2009 21:48:21 +0000

Sorry, that last comment may have been confusing. I meant to express skepticism that anyone could make a workable resolution plan for a dynamic firm.

Comment on Solving Too Big To Fail by Not the Mike You're Looking For

Not the Mike You're Looking For — Sat, 07 Nov 2009 21:44:49 +0000

“… am I wrong to be skeptical that this ‘living will’ for large institutions will look more like a Jackson Pollock painting than a coherent roadmap …”

… or create a living will for a firm whose assets and liabilities are continuously changing? That’s the part that I find most mysterious.

Comment on Student Loans as the New Indentured Servitude by Matthew

Matthew — Sat, 07 Nov 2009 20:01:14 +0000

Too many people feel screwed. I felt screwed when I had debt. I didn’t blame Sallie Mae! There does need to be “advisors” for students who get between the student, loan officer, and student advisor. Someone real who has the students interest on top.
Sure, S&M is corrupt to the max! They didn’t make students sign, only contributed to the brainwashing that everyone needs college.

Comment on My friendly Nudge of the day. by JOhn

JOhn — Sat, 07 Nov 2009 00:58:09 +0000

As long as you also put the cost per person of all the other entitlement programs we pay for.

Comment on Solving Too Big To Fail by financeguy

financeguy — Fri, 06 Nov 2009 23:39:53 +0000

This may be contrarian to popular sentiment, but I’m starting to worry more about the shadow banking than the TBTF problem. Everyone’s got TBTF in the crosshairs. I’m not so sure enough people understand how shadow banking works, and why it can be really dangerous. No liquidity backstop, as you note. Also the larger the shadow banking system, the less effective your monetary policy is going to be. And if you regulate the TBTF punitively (i.e., make them somehow pay for the implicit TBTF “insurance”), will that drive more players into shadow banking? And, and, and … lots of questions. I don’t think shadow banking will be a problem immediately, but soon enough complacency will set into the financial system again, risks will ramp up. I think the regulators have to sit down and figure this one out.

Comment on Who believes market efficiency? by financeguy

financeguy — Fri, 06 Nov 2009 23:27:43 +0000

Agree that it’s not strong form EMH. I definitely don’t believe in a rational market where the sane can arbitrage away the insanity (in fact, what we find instead is that, after the rational guys fail on say their short plays, they jump in and partake of the insanity, trying to time the leap out later so they don’t get burned). I think the market is efficient in a sense, but I know my use of “efficient” is sort of special and can be confusing.

Comment on Who believes market efficiency? by gabe

gabe — Fri, 06 Nov 2009 21:51:00 +0000

financeguy-

Yes i think we are using two forms of efficient, one about allocating capital and one about beliefs. I think the latter is closer to a concept of rationality, that investors were rational to expect increases in housing demand. It can be rational for investors to think ex-ante that building lots of houses in the desert around Phoenix is profitable, but this is obviously a poor allocation of capital hence inefficient. Maybe this is because I’m coming from a macro perspective, but I can’t see how financial markets can be “efficient” while allocating capital poorly.

And I thought that efficient markets meant that underlying values were based on fundamentals, so any irrationality is arbitraged away by the rational part of the market. If everyone is irrational, or rational arbitrageurs can’t return the market to fundamental values, it’s not strong form EMH.