Monthly Archives: October 2008

When Past meets Present — Or, how prices fall up quicker than they fall down!

Aug. 8, 2005 — Oil hit a record high of $64.  Gasoline hit a record high as well at $1.86 per gallon.

Oct. 27, 2008 — Oil falls below $64. Gasoline is currently priced at national average pf $2.66.

Remember when the price at the pump reacted to the mere news of an increase in spot prices?  (Yeah, just last month).  That kind of responsiveness is missing today… wonder why?

[Source of data is AAA]

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Market Failure – WallStreet to blame for Subprime Crisis?

That is what Alan Greenspan thinks:

But Mr. Greenspan, who was first appointed by President Ronald Reagan, placed far more blame on the Wall Street companies that bundled subprime mortgages into pools and sold them as mortgage-backed securities. Global demand for the securities was so high, he said, that Wall Street companies pressuredlenders to lower their standards and produce more “paper.”

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,” he said.

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Market Failure – Theory vs. Reality

Greenspan admits he has found a flaw in the theory many believe to be immutable law:

“I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms,” Mr. Greenspan said.

Referring to his free-market ideology, Mr. Greenspan added: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.”

Mr. Waxman pressed the former Fed chair to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.

“Absolutely, precisely,” Mr. Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”

When evidence (fact) is presented that contradicts one’s belief system, one ignores the evidence. 

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Market Failure – Timeline – A decade or more

NYT continues to ask questions about who knew what when

In an hourlong interview with The New York Times, Mr. Paulson defended Treasury’s actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that had built up over the past decade. “I could have seen the subprime problem coming earlier,” he acknowledged in the interview, quickly adding in his own defense, “but I’m not saying I would have done anything differently.”

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Government by Gold(man) Standards

NYT piece confirms the ubiquitous nature of the GS machine present within government:

Indeed, Goldman’s presence in the department and around the federal response to the financial crisis is so ubiquitous that other bankers and competitors have given the star-studded firm a new nickname: Government Sachs.

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Great quote

From the category of “don’t take your discipline so seriously”:

The only function of economic forecasting is to make astrology look respectable.
John Kenneth Galbraith
US (Canadian-born) administrator & economist (1908 – 2006)

[Taken from QuotationsPage.Com]

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Market Failure — applications of principal agent theory

Just some thoughts that need expanding:

The collapse of the financial systems provides demonstrations of how the assymetry of information can undermine the foundation of a sound, efficient market system.  Evidence of adverse selection (principal lacks sufficient information to select the best agent) and moral hazard (principal lacks information necessary to understand whether the agent is performing as contracted).  Self-regulation clearly struggles to meet these two challenges, and that is where public interest, and public value, justify public intervention into market regulation.

Washington Post analysis on the possibel demise of American style Capitalism describes the failures:

Given that the United States has held itself up as a global economic model, the change could shift the balance of how governments around the globe conduct free enterprise. Over the past three decades, the United States led the crusade to persuade much of the world, especially developing countries, to lift the heavy hand of government from finance and industry.

But the hands-off brand of capitalism in the United States is now being blamed for the easy credit that sickened the housing market and allowed a freewheeling Wall Street to create a pool of toxic investments that has infected the global financial system. Heavy intervention by the government, critics say, is further robbing Washington of the moral authority to spread the gospel of laissez-faire capitalism.

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Market Failure – a recession

WSJ economists have now uttered the R word:

This is the first time that survey forecasts for those periods have turned negative. If those predictions bear out, it would mark the first time U.S. GDP—the total value of goods and services produced—has contracted for three consecutive quarters in more than a half century. Economists put the odds of recession in the next 12 months at 89%, up from 60% in last month’s survey.

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Justification for Public Intervention in light of Market Failure

Bernanke, using history of the Great Depression, opines:

Finally, Mr. Bernanke, who is an authority on the Great Depression, said that the country and its federal officials had learned from history that inaction or delayed reaction to financial calamity could be disastrous.

“This is not the situation we face today,” he said, predicting that official Washington’s fast response “together with the natural recuperative powers of the financial markets” will pave the way toward recovery.

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Mark-to-Market : Public Interest causes Market Failure?

From Congressional testimony excerpted in the NYT:

AIG says the rules forcing information into the market regarding debts caused their downfall:

In his testimony, Mr. Willumstad attributed the company’s failure largely to mark-to-market accounting rules that forced A.I.G. to recognize tens of billions of dollars in accounting losses, as well as a “tsunami” of market instability ignited by the collapse in value of mortgage-backed securities.

Congressman Waxman thinks otherwise:

“A.I.G. is blaming its downfall on accounting rules which require it to disclose losses to its investors,” the specialist, Lynn E. Turner, the former chief accountant at the Securities and Exchange Commission, said. “That’s like blaming the thermometer, folks, for a fever.”

So, basic econ theory says there is an assumption of perfect information which supports an efficient marketplace.  But, AIG (and others) say a rule forcing disclosure of “more” information than the company ordinarily would have disclosed — caused the market to devalue their company.

This argument causes one to question whether the markets were overvalued because of inefficiencies due to imperfect information.

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