“We have not seen—and don’t expect—a broad deterioration in mortgage credit quality,” the Fed staff said in a June 2006 report to policy makers. (excerpt from WSJ Article here).

“An inability to imagine how an outcome  might come about leaves you convinced that it will not happen.”(1)

(1) Thinking, Fast and Slow by Daniel Kahneman – Farrar, Straus and Giroux NY,NY Copyright (c) 2012 by Daniel Kahneman, p. 331.

Here’s my Weekly Whiff of Economic $cents for December 12, 2011:

Pulitzer Prize winning economist Joseph Stiglitz has written in Freefall: – America, Free Markets, And The Sinking of The World Economy:

 “This book is about a battle of ideas, about the ideas that led to the failed policies that precipitated the crisis and about the lessons that we take away from it. In time, every crisis ends. But no crisis, especially one of this severity, passes without leaving a legacy. “(p.xii). (emphasis is mine)

As Stephen Johnson says in The Ghost Map:

“The river of intellectual progress is not defined purely by the steady flow of good ideas begetting better ones; it follows the topography that has been carved out for it by external factors. Sometimes that topography throws up so many barricades that the river backs up for a while.” P. 135

I lived in Washington State on May 18th 1980 and distinctly recall the eruption of Mt. St. Helens that morning. The debris laden mudflows and caused both forks of the Toutle River to become raging torrents carrying fallen timber like toothpicks and lifted homes from their foundations – smashing them into one of the few remaining bridges left temporarily in tact.

Clearly, the river of economic ideology  is raging and backing up. There are so many ideas floating around, battling to become the assemblage of strategic economic policy (both globally and domestically) – that what appears to be a breakthrough of the logjam one week – becomes a discarded pile of rubbish beside the swollen banks of the torrent the next.

History is littered with the devastation of comparable, cataclysmic economic events….many of which, just like Mt. St. Helens – were not predictable in terms of timing and scope. Yet, I am reminded that the resolution of these matters is a process, not an event. Of course, we humans have the penchant to believe that the current economic challenges that occur during our lifetimes are both unique and unprecedented.

Ideas about what to do about debt, deficits, taxes, R&D, stimulus, Medicare, immigration reform, defense, budgets, social services, the disabled, Social Security, healthcare, Medicare, fiscal policy – unemployment, homelessness, hunger — all currently creating the logjam – clogging the flow 0f the river of economic progress. Here’s an insight from last week to throw onto the pile:

The OECD – Organization for Economic Cooperation and Development  released a report last week measuring tax revenue as a percentage of GDP.  The United States ranked 27th out of the 30 nations examined. In the U.S., taxes are currently the lowest since the early 1950s.

Hmmm…which ideas will break free from the logjam and unleash the flow of employment, certainty, trust and progress that we so desperately require? During the next several weeks, I will be looking at the ideas of thought leaders about how truly constructive ideas come together to form breakthroughs – when the River’s Backed Up.

This week, I’ll leave you with two thoughts from author and thought leader Stephen Johnson:

“Part of coming up with a good idea is discovering what those spare parts are, and ensuring that you’re not just recycling the same old ingredients.” (p.42)

The River’s Backed Up – I just have the sense that recycling the same old ingredients – just ain’t gonna cut it. If we continue on that course, the outcome may be a history for this period where the folks who write it well after we’re gone characterize this historical epoch akin to Stephen Johnson’s observation in his work, The Ghost Map:

“But the blind spots on the map, the dark continents of error and prejudice, carry their own mystery as well. How could so many intelligent people be so grievously wrong for such an extended period of time?” (emphasis is mine – p.15)

It’s that time of year….for the last two weeks our snail mailbox has bulged with junk mail from every imaginable (and unimaginable) source. Our digital in boxes are being pounded hourly by every retailer on Earth (Earlier today, my wife had 535 emails in her in-box having been away from her laptop for 10 days). Mail…coming at us from every conceivable source and direction. Heck, we’ve never heard of most of these folks that seem to have our addresses. The mail has become burdensome – a nuisance – a pest. Actually, it’s become primary source of fodder for our recycling bin. It’s in the spirit of recycling ideas that I write today.

You won’t find me in agreement with columnist George Will very often. However, his November 25, 2011 op-ed in the Washington Post is an exception. It seems to me that although the U.S. Congress cannot agree about basically anything that might translate into a comprehensive action agenda for moving this country forward, perhaps we’re  going to forced to chisel out one piece of a solution at a time. Re-engineering the U.S. Postal Service may be a great place to start.

As Will points out in his column, “USPS lost $5.1 billion in the latest fiscal year — after serious cost-cutting. Total 2012 losses may exceed $14 billion, a figure larger than the budgets of 35 states. “

Wow! I mean can you agree that this is unacceptable? If the USPS was a private company, there would be a horde of management consultant types walking around the place examining both the internal operations and the external reality to determine the viability of this outfit. Again, assuming the USPS was a private company, the management consultants would likely recommend one or more of the following:

a. Sell the entire USPS operation to an amalgam of private equity funds.

b. Arrange an immediate injection of very expensive capital.

c. Trim the labor force substantially (see Will’s column – Labor costs at USPS are  at 80% of overall costs.

d. Substantially reduce the daily operational requirements of the enterprise (Translation: reduce the number of days mail is delivered in America).

e. Identify strategic partners who might be willing to take the risk of doing certain aspects of the USPS business model profitably.

f. File a Chapter 11 bankruptcy petition to reorganize the whole bag of mail.

From where we sit in our family, we would be fine with mail delivery once a week. Frankly, we’d even go pick it up at a location within a reasonable proximity. We have to go to a USPS location to obtain the postage for outgoing packages etc.

You see, oftentimes, moving forward  requires leaving something behind. It may initially seem like sacrifice, feel strange, uncertain or even uncomfortable. Change is like that. It contains each of the aforementioned dimensions.

Are you willing to sacrifice to move forward together as a nation…or is your commitment to the future of our country just a bag of hot air? Change that involves a sacrifice by all is a notion that will carry the mail for this country. Let’s discard all our unique notions about the inconveniences we may suffer from. This is simply one opportunity to come together and leave behind some notions about inconvenience and sacrifice that are now clearly labeled, return to sender.

You can email or snail mail this to your elected representatives. The operating losses are yours – their mine – their ours – our U.S. tax dollars.  After reading this, maybe you might prefer the USPS to return to sender – your portion of the $14 billion dollars they are projected to lose in 2012.

Fat chance…you can throw that last one in your recycle bin.

An Accounting of a Uniquely American Conversation – or What’s Boiling After Bin Laden?

By Bill Dahl – 2011 – All Rights reserved

Mark and Margaret – a typical American couple – Married for over 20 years, in their late 50’s early 60’s. They have a mortgage and bills and kids and grandkids. They’re seated in their living room in mainstream America. Here’s their conversation after watching the evening news.

Mark to Margaret: “Well, they finally got Bin Laden.”

Margaret: “Yes – And it’s time to move on with America’s other unfinished business.”

Mark: “Your point is?”

Margaret: “The United States had a housing bubble. When that bubble broke and housing prices fell from their stratospheric levels, more and more homeowners found themselves “underwater.” They owed more on their mortgages than what their homes were valued. As they lost their homes, many also lost their life savings and their dreams for a future-a college education for their children, a retirement in comfort. Americans had, in a sense, been living in a dream.”[1]

Mark: You’re right Margaret. It’s now our nightmare. “Today, the major controversy is over “marking to market:” reporting the value of a firm’s assets on its balance sheet at its current market value.”[2]

Margaret: “Mark, are you telling me those banks wrote their mortgages down to market – without reducing the amount of the mortgage due from us, and others like us?”

Mark: That’s exactly right Margaret. “In the current crisis, moving away from mark-to-market accounting has had a particular adverse effect: it discourages banks from restructuring mortgages, delaying the financial restructuring the economy needs so badly.”[3]

Margaret: “There is no construct more important in American political discourse than the “middle class.”[4] We’ve been smashed in this downturn Mark! The American middle class continues to garner the brunt of the unfinished business.

Mark: “You’re right Margaret – it’s all lip service.” “In social terms, homeowners had at least as valid a claim to public aid as did Wall Street investors.”[5]

Margaret: What’s we do wrong Mark? We’ve become collateral damage by virtue of the systemic failure in this meltdown. We’re the losers. “The losers are disproportionately those people who have prudently been staying out of the housing market bubble.” [6]

Mark: Those folks are absolutely right who’ve said: “Every plan we’ve heard from Treasury amounts to the same thing – an attempt to socialize the losses while privatizing the gains.”[7]

Margaret: Why doesn’t the U.S. Congress get it? “The balance sheet problems into which people fall if their homes lose value are purely financial losses. But they can be converted into substantial real losses to the economy if they are allowed to destroy public confidence.”[8] And that’s what’s happened – American middle class mortgage holders like us, have been left with huge craters in our financial affairs.

Mark: Yep – We live in “a great nation lost its financial mind.”[9] Maybe Congress will turn its attention to addressing this issue Margaret. Sounds like that’s what your unfinished business is referring to.

Margaret: That’s correct. It’s not like reasonable folks like us didn’t see this coming. “All the red lights were blinking in the run-up to the crisis. But until the “accident,” many financial leaders in the United States – and indeed, many academics – were still arguing that “this time is different.”[10]

Mark: Margaret – here’s my concern: “Put simply, a homeowner with little or no equity has little or no reason to maintain his/her obligations.”[11] How can the American economy recover if middle class mortgage holders are drowning in underwater mortgages?

Margaret: “How much inequality can be tolerated? When bets go sour and the economy nosedives, who gets bailed out and who are left to fend for themselves? At what point does an economy imperil itself politically, as large numbers conclude that the game is rigged against them? Most fundamentally, what and whom is an economy for?”[12]

Mark: That’s right Margaret! The game is rigged against the American middle class. “Capitalism works only when institutions are forced to absorb the consequences of the risks that they take on. When banks can pocket the upside while spreading the cost of their failures, failure is almost certain.”[13]

Margaret: “Seems like the U.S. Congress has come down with a bad case of amnesia. “In place of the magical thinking that dominated Wall Street in the years leading up to the near collapse of the financial market had arisen a kind of willful amnesia.”[14]

Mark: The banks got billions in bailouts[15] while the American middle class mortgaged holder remains mired in the unthinkable! This isn’t the American Dream – it’s an ongoing nightmare we wake up to each and every day.

Margaret: Yes, but that’s not the half of it. “The loss of some $7 trillion in household wealth is an albatross around the neck of the economy (emphasis is mine). This dour effect is clipping a robust recovery. Millions who have little or negative home equity are shackled to houses they can’t sell and a debt burden that keeps them from moving ahead. They can’t save, either, although they desperately need to boost their cash reserves.” [16] Like I said, this is the real unfinished business Mark.

Mark: Unfortunately Margaret, America continues to suffer from a “colossal failure of imagination.”[17]

Margaret: Has anyone considered the American middle class is too big to fail? A guy from the NY Times wrote a book about that subject – but I don’t think he focused on American middle class mortgage holders.[18]

Mark: I wonder if the U.S. Congress truly appreciates the reality that “markets can remain irrational longer than you can remain solvent.”[19]

Margaret: Well Mark, I remain quite concerned and somewhat dismayed regarding the absence of any tangible help to the American middle class mortgage holder. Don’t our elected officials realize that, “To understand how economies work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people’s ideas and feelings, their animal spirits. We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.”[20]

Mark: There’s nothing mental about the amount of our mortgage and the current value of our home Margaret. “Our ignorance and our false beliefs are likely just to make our circumstances worse.” [21]

Margaret: This is bullshit! Our elected officials have absolutely no appreciation where we middle class Americans live! “Bullshit is unavoidable whenever circumstances require someone to talk without knowing what he is talking about. Thus the production of bullshit is stimulated whenever a person’s obligations or opportunities to speak about some topic exceed his knowledge of the facts that are relevant to that topic. This discrepancy is common in public life, where people are frequently impelled whether by their own propensities or by the demands of others-to speak extensively about matters of which they are to some degree ignorant.” [22]

Mark: That’s my wife! This is our life! – Maybe now the U.S. Government will turn their attention to addressing the terror of the American middle class mortgage holders who remain underwater…

Margaret: I feel like we’re being slowly boiled in a pot on the stove…..

NOTES:

[1] Stiglitz, Joseph E. Freefall – America, Free Markets, And The Sinking of The World Economy, W.W. Norton & Company New York, NY Copyright 2010 by Joseph E. Stiglitz pp.1-2.

[2] Ibid., p.156.

[3] Ibid., p. 159.

[4] Johnson, Simon and Kwak, James 13 Bankers – The Wall Street Takeover and the Next Financial Meltdown, Pantheon Books – A Division of Random House, Inc., New York, NY Copyright © 2010 by Simon Johnson and James Kwak. P.53.

[5] Lowenstein, Roger The End of Wall Street, The Penguin Press, New York, NY Copyright © 2010 by Roger Lowenstein, p. 156.

[6] Shiller, Robert J. The Subprime Solution – How Today’s Global Financial Crisis Happened and What to Do About It, Princeton University Press, Princeton, New Jersey Copyright © 2008 by Robert J. Shiller. Pp. 92-93.

[7] Krugman, Paul Zombie Financial Ideas, The Conscience of a Liberal Blog, The New York Times, March 3, 2009, available at http://krugman.blogs.nytimes.com/2009/03/03/zombie-financial-ideas/

[8] Ibid 6., p.105.

[9] Lewis, Michael The Big Short – Inside The Doomsday Machine, W.W. Norton & Company, Inc. New York, New York Copyright © 2010. P.xiv.

[10] Reinhart, Carmen M. & Rogoff, Kenneth S. This Time is Different – Eight Centuries of Financial Folly, Princeton University Press, Princeton New Jersey Copyright © 2009 by Princeton University Press. p.xlii & xliii.

[11] McLean, Bethany & Nocera, Joe ALL THE DEVILS ARE HERE – The Hidden History of the Financial Crisis, The Penguin Group New York, NY Copyright © 2010 by Bethany McLean and Joe Nocera. p.92.

[12] Reich, Robert B. AFTERSHOCK – The Next Economy and America’s Future, Alfred A. Knopf New York, New York Copyright © 2010 by Robert B. Reich. P. 5.

[13] Mallaby, Sebastian More Money Than God – Hedge Funds And The Making of a New Elite, Penguin Press, New York, NY Copyright © 2010 by Sebastian Mallaby.p.13.

[14] McGee, Susan Chasing Goldman Sachs – How The Masters of the Universe Melted Wall Street Down … and Why They’ll Take Us to The Bring Again, Crown Business New York, NY Copyright © 2010 by Suzanne McGee – reacting to CEO of Citigroup –  Vikram Pandit – that “the write-down on troubled assets may be largely behind us.” P. 310

[15] Farrell, Greg Crash of the Titans – Greed, Hubris, The Fall of Merrill Lynch, and the Near-Collapse of Bank of America, Crown Business, New York, NY Copyright © 2010 by Greg Farrell, p. 417.

[16] Wasik, John F – The Audacity of Help – Obama’s Economic Plan and the Remaking of America, Bloomberg Press, New York, NY  Copyright © 2009 by John F. Wasik

[17] Wessel, David In Fed We Trust – Ben Bernanke’s War on the Great Panic – How The Federal Reserve Became The Fourth Branch of Government, Crown Business – An Imprint of the Crown Publishing Group, a division of Random House, Inc. NY, NY Copyright © 2009 by David Wessel, p. 4.

[18] http://www.charlierose.com/view/interview/10973#frame_top – Andrew Ross-Sorkin.

[19] In Lowenstein, Roger – When Genius Failed The Rise and Fall of Long Term Capital Management Random House Trade Paperback Edition Copyright © 2000 by Roger Lowenstein, p. 123 – quote from John Maynard Keynes.

[20] Akerlof, George A. and Shiller, Robert J. – Animal Spirits – How Human Psychology Drives the Economy, and Why It Matters For Global Capitalism, Princeton University Press Princeton, NJ USA and Oxford, UK Copyright © 2009 by Princeton University Press, p. 55.

[21] Frankfurt, Harry G. On TRUTH, Alfred A. Knopf New York, NY Copyright © 2006 by Harry G. Frankfurt. P.60.

[22] Frankfurt, Harry G. On BULLSHIT, Princeton University Press Princeton, New Jersey Copyright © 2005 by Princeton University Press. P. 63.

About The Author:

Bill Dahl is a freelance writer from Oregon. He blogs at http://www.BillDahl.net.

The Catastrophe of Certainty

In his fascinating book entitled “On Being Certain – Believing You Are Right Even When You’re Not,” neuroscientist Dr. Robert A. Burton concludes the work with this poignant phrase: “We do not need and cannot afford the catastrophes born out of a belief in certainty.”(pp.223-224).

Well, the Wall Street Journal’s Scott Patterson chronicles the catastrophe that Dr. Burton’s conclusion alludes to in this riveting volume entitled, THE QUANTS – How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It. Patterson states his case bluntly: “In other words, there is no single truth in the chaotic world of finance, where panics, manias, and chaotic crowd behavior can overwhelm all expectations of rationality. Models designed on the premise that the market is predictable and rational are doomed to fail. When hundreds of billions of highly leveraged dollars are riding on those models, catastrophe is looming.” (P. 294).

Human history appears to be replete with disasters wherein one group seems ‘certain’ they have captured the ‘truth.’ The ongoing U.S. and global economic crisis is no different. Listen to Patterson:

The Truth was a universal secret about the way the market forked that could only be discovered through mathematics. Revealed through the study of obscure patterns in the market, the Truth was the key to unlocking billions in profits. The quants built giant machines – turbocharged computers linked to financial markets around the globe- to search for the Truth, and to deploy it in their quest to make untold fortunes. (p.8).

It was about money, of course, but it was also about proof. Each added dollar was another tiny step toward proving they had fulfilled their academic promise and uncovered the Truth (p.8)

To the quants, beta is bad, alpha is good. Alpha is the Truth. If you have it, you can be rich beyond your wildest dreams. (p.8).

What happened? Patterson’s perspective on this historical epoch is essential reading for those interested in economics, culture and human behavior. It is also a treatise about man and machine. He writes, “Always trust the machine” was the mantra.” (P.128). It’s also about our human appetite for order and predictability, as well as our propensity to become victims of the illusory: “The model created an illusion of order where none existed.” (P.196). “To quants, unprecedented is perhaps the dirtiest word in the English language. Their models are by necessity backward-looking, based on decades of data about how markets operate in all kinds of conditions. When something is unprecedented, it falls outside the parameters of the models. In other words, the models don’t work anymore.” (Pp. 271-272).

Patterson does an absolutely spectacular job profiling the key players, organizations and belief systems that fueled the growth in hedge funds from $39  billion in assets in 1990 to $490 billion in 2000, and $2 trillion in 2007. How? How could such a rate of growth be sustained? Patterson’s take: “the model was a jury-rigged formula based on the irrationally exuberant, self-reinforcing, and ultimately false wisdom of the crowd that assigned make-believe prices to an incredibly complex product. For a while it worked, and everyone was using it. But when the slightest bit of volatility hit in early 2007, the whole edifice fell apart. The prices didn’t make sense anymore. Since nearly every CDO manager and trader used the same formula to price the fizzing bundles yet another instance of crowding that results from popular quant methodologies – they all imploded at once.” (P.195).

I can’t wait for the next book by Scott Patterson. THE QUANTS – How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It is distinctly a five star work of art. Essential reading. You’ll love it. Spellbinding!

The Humpty Dumpty Perspective on the U.S. Economic Crisis

Stiglitz, Joseph E. Freefall – America, Free Markets, And The Sinking of The World Economy, W.W. Norton & Company New York, NY Copyright 2010 by Joseph E. Stiglitz

We all know Humpty Dumpty sat on a wall and subsequently “had a great fall.” What we don’t truly understand is:

a. How ol’ Humpty got in that precarious position in the first place (What was he thinking? What were his assumptions? Why did he go up there anyway?).

b. Why “all the king’s horses and all the king’s men – couldn’t put Humpty together again.”

Columbia University’s Nobel Prize winning economist, Joseph E. Stiglitz, provides the perspective that other authors who have authored volumes on the U.S. economic crisis have overlooked. It’s a terribly important work that proposes explanations for the questions posed above. It’s truly about ‘freefall’ – “When the world economy went into freefall in 2008, so too did our beliefs. Long-standing views about economics, about America, and about our heroes have also been in freefall.(p.xvi). Well, what might this all mean? Stiglitz is hopeful: “The crisis will, I hope, lead to changes in the realm of policies and in the realm of ideas.” (p.xiii).

From Stiglitz’ perspective, “This book is about a battle of ideas, about the ideas that led to the failed policies that precipitated the crisis and about the lessons that we take away from it. In time, every crisis ends. But no crisis, especially one of this severity, passes without leaving a legacy. “(p.xii).

It is distinctly a crisis of our own creation, as Stiglitz says: The system that failed so miserably didn’t just happen. It was created. Indeed, many worked hard-and Spent good money-to ensure that it took the shape that it did. (P. xxiv.).

According to Stiglitz, the crisis is evidence that the marketplace of ideas failed us (particularly as this term relates to ‘herd instinct’): “The marketplace for ideas is no more perfect than the marketplace for products, capital, and labor. The best ideas do not always prevail, at least in the short run. But the good news is that while the nonsense 0£ perfect markets may have predominated in, certain parts of the economics profession, some scholars were trying to understand how markets actually worked. Their ideas are there, now, to be used by those who wish to construct a more stable, prosperous, and equitable economy.” (P. 274).

The crisis pointed out the central role of the “human element” that remains so dramatically misunderstood in economic behavior: “But the central bankers were, in a sense, right: no one with credibility in their circle challenged the prevailing view, but there was a tautology: no one challenging the prevailing view would be treated as credible. Sharing similar views was part of being socially and intellectually acceptable.” (p. 253) — a terrible cost to pay for ignoring the voices of dissent, in favor of a perceived “socially acceptable” policy position.

Now what? Stiglitz is clear: “The old rules, whether they worked well in the past, are not the right rules for the twenty-first century.” (P. 207)…the final parts of this volume provide specific examples of what the authors suggests.

Finally, one sentence from Stiglitz really caught my attention. He writes, “Trust is the grease that makes society function.” (P. 289). “Freefall” is really all about the process of how the marketplace of ideas ‘greased trust’ throughout the entirety of our economic system, facilitating our fall, and what we might approach putting the pieces back together again.

Needless to say, the latter is hardly a completed process and/or one where the marketplace of ideas is moving toward consensus. Will we be more successful than “all the King’s horses and all the King’s men?”

Imagine not having your head attached to your shoulders correctly…

When Genius Failed: The Rise and Fall of Long Term Capital Management by Roger Lowenstein is one of my favorite books. Any author who can write a “Can’t Put It Down – Thriller” about a hedge fund’s origins (LTCM) and then its fall, as  a globally significant financial cog — Well, you just can’t wait for the author’s next work of art. Lowenstein did NOT disappoint this reader with The End of Wall Street (April 2010 – Penguin Press – New York, NY).

An obscure sentence in the book really resonated with me, in terms of Lowenstein’s particular perspective on the U.S. financial crisis. He writes:

“Real life is messy and admits to doubt.” P. 85.

The origins, maintenance and subsequent disintegration of this particular U.S. financial crisis was inhabited by, (once again), man’s certainty about the uncertain – to put it plainly. Certainty has consequences, as Lowenstein points out, the intellectual “model” behind this particular bubble was flawed or, as he says, “This was absurd -  because of the arrogance and self delusion embedded in such fine, decimal-point precision.” P. 46.

“What truly failed was the post-industrial model of capitalism. The market’s tools for measuring risk simply did not work.” P. 287.

Yet, more specifically, the characterization of risk morphed into something that had little basis in fact. Lowenstein writes:

“The new finance was flawed because its conception of risk was flawed. The banks modeled future default rates (and everything else) as though history could provide the odds with scientific certainty-as precisely as the odds in dice or cards. But markets, as was observed, are different from games of chance. The cards in history’s deck keep changing.” P. 288

Once again, as was the case in the failure of Long Term Capital Management, the ability to use historical data as the predictive basis of future performance of the  “innovative” financial instruments of the day” proved to be a force that fueled the ongoing deception; Lowenstein characterizes this observation in the following:

“Forecasting is the most hazardous of scientific endeavors. Like meteorologists, modern economists employ computers to project trends from the visible present into a future yet obscure. The reliance on standard (and backward-glancing) models is their great weakness. Any knave can project a continuation of a trend. To call a turn requires judgment-the capacity and courage to read the data and analyze the factors likely to cause a reversal. Very few individuals can do it with any reliability. It is less likely that a group, which naturally strives for safe-seeming consensus, will ever do it.”  p. 150.

In his introductory remarks, Lowenstein suggests that “Capitalism without capital is like a furnace without fuel.” (P. XXV). By the end of the book, one has the distinct appreciation that “fuel without a furnace can burn up your home, your neighborhood, your country and imperil the global financial system.”

Nobody can tell this particular story any better than Roger Lowenstein. After reading House of Cards by William Cohan, When Giants Fall by Michael Panzer, In Fed We Trust by David Wessel, 13 Bankers by Simon Johnson and James Kwak, and Too Big To Fail by Andrew Ross-Sorkin, TheQuants by Scott Patterson, Freefall by Joseph Stiglitz and A Colossal Failure of Common Sense by Lawrence McDonald and Patrick Robinson — Lowenstein rules!

To ALL of the above, I savored your works as well…we are fortunate to have such a group of profoundly talented literary artists whom, each in their own way, have provided a unique and robust perspective on this important historical tragedy.

Something tells me the “last word” has yet to be written. Then again, maybe there isn’t such a thing.

Robert J. Shiller

His partial bio reads like this (From Yale University): Robert J. Shiller is the Arthur M. Okun Professor of Economics, Department of Economics and Cowles Foundation for Research in Economics, Yale University, and Professor of Finance and Fellow at the International Center for Finance, Yale School of Management. He received his B.A. from the University of Michigan in 1967 and his Ph.D. in economics from the Massachusetts Institute of Technology in 1972. He has written on financial markets, financial innovation, behavioral economics, macroeconomics, real estate, statistical methods, and on public attitudes, opinions, and moral judgments regarding markets. There is much more to his bio here.

I finally got around to reading Subprime Solutions – How Today’s Financial Crisis Happened and What to do about it. (Princeton University Press, Princeton, New Jersey USA Copyright (c) 2008 by Robert J. Shiller

Admittedly, Shiller’s other recent books entitled Irrational Exuberance (2005) and Animal Spirits (with George Akerlof – 2009) are terribly tough acts to be compared against. My review of Animal Spirits is here. I am devouring Irrational Exuberance at the moment.

I enjoyed this book yet, found many of the proposed solutions (continual workout mortgage, equity insurance for homeowners etc.) lacking in their application to the new dimensions of the U.S. homeowner crisis that now exist, in 2010.

Yet, Shiller always has insights that I find appetizing. I always learn from his work. Clearly he remains both a central and highly regarded advocate for the “unfinished business” that U.S. policy makers must embrace to thwart the ongoing loss of home ownership by the American middle-class and establish safeguards to this will not happen again.

Here are some excerpts from Subprime solutions that I really appreciated. I’ll let Shiller’s words speak for themselves:

“More importantly, this crisis has set in motion fundamental societal changes-changes that affect our consumer habits, our values, our relatedness to each other. From now on we will all be  conducting our lives and doing business with each other a little bit differently.” P.1.

“Allowing these destructive changes to proceed un impeded could cause damage not only to the economy but to the social fabric – the trust and optimism people feel for each other and for their shared institutions and ways of life – for  decades to come.” P.2

“Today the typical household has as its principal investment its home. A home represents a highly leveraged exposure to a single, stationary plot of real estate-about the riskiest asset one can imagine. The standard mortgage provides no protection against difficulties in repaying the lender due to changes in the marketplace. But mortgages can and should be designed to compensate for these changes by including provisions to ensure homeowners against their major risk.” P. 22.

“strengthen the social fabric, and create the conditions for greater economic stability and growth.” P. 22

“Real home prices for the United States as a whole increased 85% between 1997 and the peak in 2006.”  p 32

“The most important single element to be reckoned with in understanding this or any other speculative boom is the social contagion of boom thinking, mediated by the common observation of rapidly rising prices. This social contagion lends increasing credibility to stories – I call them “new era” stories-that appear to justify the belief that the boom will continue.” P. 41.

“He (Greenspan) does not seem to respect research approaches from the fields of psychology or sociology.” P.43

“What seems to be absent from the thinking of many economists and economic commentators is an understanding that contagion of ideas is consistently a factor in human affairs.” P.43

“The losers are disproportionately those people who have prudently been staying out of the housing market bubble.” Pp.92-93.

Religion and response to the Depression – “Even religious thinking returned to more traditional forms. The public amusement at religious foibles so evident at the time of the 1925 Scopes trial, when the Bible was put on trial versus the theory of evolution, was fading, and being replaced by a desire to find in religion some comforting interpretation of life.” pp. 96-97

“We must always be concerned about public perceptions of fairness and evenhanded treatment, about public confidence that our economic system is moving forward to provide opportunities for all. That confidence is being seriously eroded in today’s subprime crisis.” P.100.

“The loss of trust and belief in the economic system can have consequences not only for the economy itself, but for the social fabric as a whole, leading us all to suffer needlessly. P. 101

“The balance sheet problems into which people fall if their homes lose value are purely financial losses. But they can be converted into substantial real losses to the economy if they are allowed to destroy public confidence.” P.105 –

“There is an inherent unfairness in our economy, evidenced by its sharp income inequalities.” P.106

“We have to be willing to spend money on securing economic justice. That means allocating resources to determining-to the extent that this is possible-who among mortgage borrowers were misled and mistreated, and then focusing the bailouts on them.” P. 112

“In a similar vein, the human sciences- psychology, sociology, anthropology, and neurobiology-are increasing our understanding of the mind by leaps and bounds, and this knowledge is now being applied to finance and economics. We have a much better grasp of how and why people make economic errors, and of how we can restructure institutions to help avoid these errors. Pp. 118-119

“Denying the importance of psychology and other social sciences for financial theory would be analogous to physicists denying the importance of friction in the application of Newtonian mechanics.” P. 119

“A new kind of home mortgage that I call a continuous-workout mortgage would have terms that are adjusted continuously (in practice probably monthly) in response to evidence about changing ability to pay and changing conditions in the housing market.” P. 157

“Decreases in home values can reduce or even eliminate a homeowner’s equity, making it difficult or impossible for the owner to refinance with a new mortgage. The homeowner may conclude that it is impossible to move to another home, even if such a move would allow her to take advantage of a lucrative job offer. The mortgage .I’ may eventually end in default, especially since the homeowner may decide that it is just not worth struggling to make further payments on a mortgage when she can just walk away from the whole mess.” P. 161

“Louis Uchitelle, in his 2007 book The Disposable American: Layoffs and Their Consequences, discovered that those on whom this misfortune falls are truly suffering –but suffering mostly in silence, out of a sense of shame and of being at fault.” P. 164

“Risk-avoidance behavior also has an impact on the behavior of city, regional, and even national governments. Fearing the uncertainties associated with new economic development initiatives, these governments typically choose to play it safe and model themselves along conventional lines. They slavishly imitate other successful entities when they ought to be cultivating their locales as vital centers for specific emerging technologies or industries.” P. 168 –

“The key to long – term economic success is rightly placed confidence in markets. In contrast, bubbles are the result of misplaced confidence.” P. 171.

A great read written to be consumed by a broad audience. I recommend it.

Kling, Arnold and Schulz, Nick From Poverty To Prosperity – Intangible Assets, Hidden Liabilities and the Lasting Triumph Over Scarcity, Encounter Books, New York, NY Copyright © 2009 by Arnold Kling and Nick Schulz.

About the authors. From the book jacket (below):

ARNOLD KLING was an economist on the staff of the Board of Governors of the Federal Reserve System from 1980- 1986 and served as a senior economist at Freddie Mac from 1986-1994. Kling is the author of several books, most recently Crisis of Abundance: Rethinking How We Pay for Health Care. He lives in Maryland. NICK SCHULZ is DeWitt Wallace Fellow at the American Enterprise Institute and Editor of American.com. He is a columnist for The Mint newspaper in Mumbai, India. His writings have appeared in The Wall Street Journal, the Los Angeles Times, The Washington Post, Slate, and Forbes.com, among others. He lives with his wife and children in Maryland.

This book is about “Economics 2.0″ - an emerging field of economics whose impetus for evolving has been the blatant miscues, misunderstandings, assumptions, math, models and people that have contributed to the ongoing global financial crisis. I will let the following excerpts speak for themselves:

“This book presents the main ideas of what we call Economics 2.0. Economists have developed these ideas in order to explain the enormous differences in quality of life over history across countries.” P. 2

“Economics 2.0 says that these differences reflect intangible assets and invisible liabilities. The intangible assets are knowledge bases.” P. 2

“Invisible liabilities, on the other hand, are institutional and cultural impediments to innovation and productivity. These range from the structure and conduct of government to the attitudes and customs of ordinary citizens.” P. 2.

“Economics 2.0 says that overcoming market failure requires innovation. Innovation is best delivered by markets.” P. 3

Economics 2.0 is about abundance, which arises from technological progress.” P.4.

“We use “recipes” to refer to innovation, ideas, know-how, science, and technology. We use “the operating system” to refer to customs, rules, norms, laws, regulations, and methods of intermediation.” P. 10-11.

“The past decade also saw gains in jobs that involve imagination and creativity – designers, architects, photographers, actors and directors. The hairstylists and cosmetologists category rose by 146,000 jobs. Many occupations that use analytic reasoning have continued to grow, too, but computer operators and others are beginning to see their numbers fall. The occupations in eclipse are generally those that involve muscle power, manual dexterity and formulaic intelligence.”pp.46-47

“The software layer creates the possibility that growth will accelerate. As more and more of the value in goods and services come from ideas, our standard of living will tend to increase at a faster pace.” P. 75

“By far the largest contributor to growth of our price adjusted GDP, or value added, has been ideas – insights that leveraged physical reality.” P.76

PAUL ROMER is a senior fellow at the Stanford Center For International Development (SCID) and the Stanford Institute for Economic Policy Research (SIEPR). His contributions to field of economics include being the primary developer of new growth theory, which deemphasizes the traditional idea of the scarcity of objects and directs attention to the power of new ideas.

“Newton said that he could see further because he stood on the shoulders of giants.” P.80.

“The set of possible ideas, the set of things there are out there to discover, is just so incomprehensibly large that we’ve only begun to explore the tiniest subset of possible  ideas or discoveries.” P.81

“As long as we keep freeing up labor from bending metal and stamping out pills and put more and more of it into discovery, we can keep pushing up that rate of growth, by directing more and more resources in that direction.” P. 98

“You want people to be aware of what others are doing so that you don’t end up with a whole lot of replication of effort. Part of what A communications technologies are doing is coordinating  these discovery efforts worldwide: as soon as somebody discovers something, it gets broadcast very quickly to others throughout the world, and people can change the directions they explore based on what they know others are doing.” P.99

Question to Paul Romer:  “Are there one or two key things that our politic class, broadly speaking, doesn’t sufficiently appreciate or understand about economic growth?” Pp.104

Well, one thing that’s important to persuade everyone of is that everyone wants growth but nobody wants change, and you’ve got to have both or you’ve got to have neither – it’s what I was talking about before, that it’s all about rearrangement and finding better ways to rearrange things. The only way you can create new value with new rearrangements is essentially by doing things differently; and any time you do things differently, there will be change, so people have to buy into the idea that change accompanies growth. It’s not going to be just more of the same for everyone.” P.104

We have to agree that, one, there will be change, and two, there are some winners and losers and there are no guarantees: everybody who is engaged in economic activity takes a certain amount of risk. There are always winners and losers when there are risks. We all commit to that, and on average we’re all going to be better off, but we don’t let the  losers have veto power over progress. This is clearly a very acute question right now in Europe, where the existing elite, the existing well-off, do have a very strong position of veto power, a choke- hold on change and innovation.” P.105

JOEL MOKYR is the Robert H. Strotz Professor of Arts and Sciences at Northwestern University. He holds a joint appointment in economics as well as a Sackler Professorial Fellowship at the Eitan Berglas School of Economics at the University of Tel  Aviv.

“The degree to which we hold fast to the wisdom of earlier generations is an incredibly important element in how innovative a society is, because if you think about it, every act of invention is an act of rebellion.” P. 130

Kling & Schulz — “Tribalism tends to cause resistance to innovation. People in isolated villages view new productive techniques as threats. In part, this is because innovations are associated with outsiders. Moreover, innovations threaten to disrupt local traditions that have sustained community cohesion for many generations.” P. 139

DOUGLASS NORTH is the Spencer T. Olin Professor in Arts and Science at Washington University in St. Louis. He was awarded the Nobel Prize in economics in 1993. His major interest is the evolution of economic and political institutions and the effects of institutions on the development of economies over time. He is the author of Structure and Change in Economic History (1981), Institutions, Institutional Change and Economic Performance (1990 ), and many other books. P.148

“We’re trying to broaden how we think about problems, and. The frame is not economics; it’s all of the social sciences. You cannot separate economics from political science and sociology at all. All of the interesting issues are on the borders between them.” P.149

Question to Douglas North — “What other obstacles prevent economists and policymakers from seeing what really matters?” Until they understand that our understanding of the world is very fragmentary, is not complete, is – I believe – partially incorrect, no matter how intelligent we are, we’re not going to make sense of the world.” p. 151

“Behavioral economics, which has gotten a couple of Nobel prizes in the last couple of years, is the beginning of a recognition that traditional economics is too narrow, and cognitive science is now becoming a flourishing area of interest to social scientists.” P.152

“We still don’t understand how beliefs get formed, how they change, why they change, when they do, and how that underlies the choices people make.” P.153.

“It factors in in that I keep on saying it’s a non-ergodic world, which means the world is changing. And therefore, we’re always behind. And if we’re way behind, of course, our theories are completely wrong. And indeed, all of economic theory is predicated on models that are derived from the past. Now the models, if the world isn’t changing very rapidly, may be perfectly fine. But if the world is changing very rapidly, the models are out of date.” P.154.

Question to Douglass North: “What do you make of the emphasis on math in economics?” It was vastly overdone. Math should be a tool, and what’s happened is that it’s become an end in itself. We build elegant models, using very elegant mathematics, but they are so abstracted, so divorced from the problems we’re trying to confront that they don’t deal with them at all. We borrowed again from the physical sciences, and in the physical sciences, elegant mathematics is essential. That’s not so clear for most of the social sciences.” Pp.160-161

“We should be very tentative about how we understand the world. That doesn’t mean you don’t do things. You’ve got to do things, but you’ve got to recognize you may be wrong. We don’t know enough. And so it’s terribly important to recognize that you can be wrong. And, to be, therefore, very susceptible to modifying the theories you hold in the light of new evidence. Now as I said, that doesn’t mean you don’t do anything; you’ve got to do things. It does mean that you’re willing to be adaptively efficient [in the face on change and to rethink the problems as you evolve.” P.163

“What particularly bothers me is that the world is evolving more rapidly now than it ever did before. The degree to which we can catch up with it and deal with it, I think, is more and more strained now that we’ve devised ways to blow each other off the face of the earth. The time horizon we have to solve problems is much more abbreviated than it used to be; whereas before we could make mistakes and kill a few hundred thousand people, now we can blow everybody up. And we don’t seem to have gotten very far in solving social disorder. I hope I’m wrong.” P.164

Kling & Schulz: “The entrepreneur’s task is to overcome resistance to adoption of new ideas and the discarding of unsuccessful or obsolete practices. This in turn requires that people accept change.”  P.183.

“Economic development is best served by searchers.” P.195

“Economics 2.0 says that the abundance that arises from innovation and economic growth depends on the work of entrepreneurs and searchers. We see economic activity as an ongoing battle between upstarts and incumbents. Incumbents try to consolidate and defend the existing modes of operation. Upstarts try to apply new knowledge and techniques. When the upstarts succeed, incumbents are reluctantly forced to follow.”  p. 197.

“In Economics 2.0, we emphasize the importance of what is unseen and unknown. In the case of financial intermediation, it  is the problem of unseen risks that merits attention.” P. 229.

“As with any bureaucracy, the internal dynamics tend to favor those who question innovation and put roadblocks in the way of those with new ideas.” P.245

“Economics 2.0 looks at the economy primarily in terms of its adaptive efficiency – how effective it is at incorporating new recipes and discarding outmoded ones.” P.239

“Incumbent organizations – resist adopting the best practices that challenge the status quo. The gradual diffusion of innovation is a process that has long fascinated economists.” P.249.

“The material portion of our GDP is declining, and the intellectual portion is increasing.” P.274.

“The most successful economies have been those in which people have been most willing to accept and promote change. Poverty tends to be concentrated in countries where people and cultures tend to resist change. This means that those countries will either remain backward economically or confront difficult social tension.” P.278

The excerpts above are simply a few tidbits. A wonderful contribution. Devour it.

In their new book, George Akerlof and Robert Shiller suggest that:

“The confidence of a nation, or of any large group, tends to revolve around stories. Of particular relevance are new era stories, those that purport to describe historic changes that will propel the economy into a brand new era.” (p.55).

Akerlof and Shiller go on to state: “Confidence is not just the emotional state of an individual. It is a view of other people’s confidence, and of other people’s perceptions of other people’s confidence.” (emphasis is mine p.55) .

Stories, changes, a new era, emotional states, perceptions — confidence — all terms that John Maynard Keynes might point to as sources of explanatory power for economic fluctuations and the instabilities that inhabit capitalism. Keynes, Akerlof and Shiller refer to these influences as animal spirits.

Accordingly, the thesis of this work is captured in the following:

“To understand how economies work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people’s ideas and feelings — We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.” (p.1)

“The human mind is built to think in terms of narratives, of sequences of events with an integral logic and dynamic that appear as a unified whole. In turn, much of human motivation comes from living through a story of our lives, a story we tell to ourselves and that creates a framework for motivation. Life could be “just one damn thing after another” if it weren’t for these stories. The same is true for confidence in a nation, a company, or an institution. Great leaders are first and foremost creators of stories.” (p.51).

This is a groundbreaking work in macroeconomics. Macroeconomics, as it has evolved over the last several decades, might lead one to  succumb to the sheer beauty and mystery of the mathematical portrayals and the inter-related interpretations thereof. This book reveals a new frontier that will hopefully spawn solid research and new explanatory tools – inter-disciplinary in nature (psychology, sociology and perhaps neurological) that may form the new theories of macroeconomics and lead us to courageously consider what we think we know about economic behavior, economies, and the motivations of economic beings — from a variety of perspectives.

The dawn of new era stories in macroeconomics is upon us. Read what Akerlof and Shiller have to say. Enjoy! I certainly did.