The housing bubble was obvious. Sorry. If you didn’t see it forming in 2004 and 2005, you simply weren’t paying attention or were very gullible. Or, like most of the population, you wanted so badly for it all to be true that you couldn’t bring yourself to consider the alternative. Or, you were selling something.
Home prices couldn’t grow at 20% per year forever. Obvious now, but blasphemous during the boom.
And the information wasn’t hidden. Ben Jones, Patrick Killelea, CR, Larry Roberts, Tim Iacono, and even a few decent realtors (cough cough) were sounding alarms from the mountain tops.
But the real problem wasn’t that that more of the population didn’t see the bubble, it was that our top economists and monetary policy-makers were oblivious as well. But how could Alan Greenspan and the rest have been so blind? Did our top economists really think home prices could rise so parabolically?
Robert Shiller explains their failure:
“A half-century ago, there was a lively discussion among economists about the dynamics of price expectations. For example, Alain C. Enthoven, then of the Massachusetts Institute of Technology, and Kenneth J. Arrow of Stanford wrote in 1956 that expectations that extrapolate past price increases can produce economic instability. But that thinking was largely cast aside in the 1960s, when my profession embraced the theory that efficient markets formed by people holding rational expectations could explain virtually all economic activity.
As a result, economists in recent decades have not developed expectations theory much further. That needs to be corrected in coming years. In the meantime, this failing helps explain why the current crisis was generally unpredicted, and why its future course is so poorly understood.”
Where before economists were skeptical, they became blindly accepting, rationalizing the whole of bubbles and booms by the fact that smart and rational people were engineering the parts. Because the parts are logical, then the whole must be correct, regardless of how unsustainable it may seem.
Economists and policy-makers saw the housing and credit bubbles forming, saw the same things that the skeptics were blogging about, but chose to ignore them. It was economic religion instead of economic science. Bubbles formed by rational parts couldn’t be bubbles, so said their text books.
Arrogantly, they gave more weight to their self-formulated theories than the slap-you-in-the-face, obvious events that were unfolding on their watch. It wasn’t that the bubble bloggers were smarter than professional economists, but that they weren’t brainwashed by academic theory.
June 12, 2011 at 11:07 pm
“It wasn’t that the bubble bloggers were smarter than professional economists, but that they weren’t brainwashed by academic theory.”
Amen to that! I’ve been saying this for years. Sometimes it takes an outsider to notice these things. Otherwise, it becomes one giant Groupthink.
Their theories aren’t all wrong – in the long run, the markets do act rationally, which is why the bubble does eventually burst. But I think we are in agreement that we’d rather have a consistent and stable economy, rather than one that shoots up and then crashes down.