Effecient Market Hypothesis: Inconsistent Defense

JEREMY J. SIEGEL in his article Efficient Market Theory and the Crisis (WSJ, October 27, 2009) asks the question

is the Efficient Market Hypothesis (EMH) really responsible for the current crisis?

and replies

The answer is no. The EMH, originally put forth by Eugene Fama of the University of Chicago in the 1960s, states that the prices of securities reflect all known information that impacts their value. The hypothesis does not claim that the market price is always right. On the contrary, it implies that the prices in the market are mostly wrong, but at any given moment it is not at all easy to say whether they are too high or too low.

However, somewhere else in the article he says:

From 2000 through 2006, national home prices rose by 88.7%, far more than the 17.5% gain in the consumer price index or the paltry 1% rise in median household income. Never before have home prices jumped that far ahead of prices and incomes.This should have sent up red flags and cast doubts on using models that looked only at historical declines to judge future risk. But these flags were ignored as Wall Street was reaping large profits bundling and selling the securities ..

This seems inconsistent. Is not the case that according to EMH you could not have known whether the prices are too high or too low?

John Quiggin & Refuted Economic Doctrines

* Refuted economic doctrines #1: The efficient markets hypothesis
* Refuted economic doctrines #2: The case for privatisation
* Refuted economic doctrines #3: The Great Moderation
* Refuted economic doctrines #4: individual retirement accounts
* Refuted economic doctrines #5: Trickle down
* Refuted economic doctrines #6: Central bank independence
* Refuted/obsolete economic doctrines #7: New Keynesian macroeconomics

Self Interest

Great Article on Adam Smith Moral Sentiments

Crisis: Causes and Cures

Here are some useful link:

1. the effects of fiscal policy in 2009 and beyond a discussion of Cogan Cwik Taylor WielandBy Brad Delong.
2. What Really HappenedBy Lawrence H White.
3. Liquidity, Default, RiskBy Brad Delong (This is a response to White)
   

Gotha Programm

This is part of the Gotha Program, the program of the Socialist Democratic Party of Germany in 1875:

[7] The Socialist labor party of Germany, in order to prepare the way for the solution of the social question, demands the establishment of socialistic productive associations; with the support of the state and under the democratic control of the working people. These productive associations, for both industry and agriculture, are to be created to such an extent that the socialistic organization of all labor may result therefrom.

[8] [In addition to the demand for universal suffrage for all above twenty years of age, secret ballot, freedom of the press, free and compulsory education, etc.,] the socialist labor party of Germany demands the following reforms in the present social organization: (1) the greatest possible extension of political rights and freedom in the sense of the above-mentioned demands; (2) a single progressive income tax, both state and local, instead of all the existing taxes, especially the indirect ones, which weigh heavily upon the people; (3) unlimited right of association; (4) a (619) normal working day corresponding with the needs of society, and the prohibition of work on Sunday; (5) prohibition of child labor and all forms of labor by women which are dangerous to health or morality; (6) laws for the protection of the life and health of workmen, sanitary control of workmen’s houses, inspection of mines, factories, workshops, and domestic industries by officials chosen by the workmen themselves, and an effective system of enforcement of the same; (7) regulation of prison labor.

It is interesting. The demands of the socialists 135 years ago (except probably for socialistic productive associations) is what liberal democracies of the west uphold now.

Evolution of Income Inequality in the US

This year Emmanuel Saez won the John Bates Clark Medal. He is a leading researcher on the causes of wealth and income inequality. The graph on page 6 of this paper:” Striking it Rich: The Evolution of Top Incomes in the United States” shows how much inequality in income has been increasing since end of 1970.
Here is what Peter Orszag, the director of the white house office of management and budget has to say about him.

Ideology of Deregulation

Krugman:
“Fed shrugged as subprime crisis spread,” was the headline on a New York Times report on the failure of regulators to regulate. This may have been a discreet dig at Mr. Greenspan’s history as a disciple of Ayn Rand, the high priestess of unfettered capitalism known for her novel “Atlas Shrugged.”

In a 1963 essay for Ms. Rand’s newsletter, Mr. Greenspan dismissed as a “collectivist” myth the idea that businessmen, left to their own devices, “would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings.” On the contrary, he declared, “it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product.”

It’s no wonder, then, that he brushed off warnings about deceptive lending practices, including those of Edward M. Gramlich, a member of the Federal Reserve board. In Mr. Greenspan’s world, predatory lending – like attempts to sell consumers poison toys and tainted seafood – just doesn’t happen.

But Mr. Greenspan wasn’t the only top official who put ideology above public protection. Consider the press conference held on June 3, 2003 – just about the time subprime lending was starting to go wild – to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.

Also in attendance were representatives of financial industry trade associations, which had been lobbying for deregulation. As far as I can tell from press reports, there were no representatives of consumer interests on the scene.

Two months after that event the Office of the Comptroller of the Currency, one of the tree-shears-wielding agencies, moved to exempt national banks from state regulations that protect consumers against predatory lending. If, say, New York State wanted to protect its own residents – well, sorry, that wasn’t allowed.

Pakistan: A Disaster in Waiting?

Is Pakistan going to collapse to the Taliban? Cole believes not. He thinks that the Pakistani government is strong enough to withstand the onslaught by the Taliban. So what is behind the portraying the situation in Pakistan in a way that in any minute the relatively democratically elected government may collapse? He thinks that the situation is framed as being very unstable under the democratically elected government by those who are preparing the ground for a military coup, those who want to remove the nuke from Pakistan and those who want to have access to more financial aid. He warns Obama not to fall in the trap.

Home Ownership in the US

There is discussion now about the merits of financial innovation. One benefit of financial innovation that is mentioned by some people is the increase in the home ownership rate in the US. It is argued that people who otherwise could not have any hope of home ownership could acquire mortgages with very affordable terms and become home owners because of financial innovations. Let’s first have a look at the data and see how home ownership rate has changed in the US? This link gives the facts about home ownership in the USA since 1900. This graph illustrates the change in home ownership rates between 1990 and end of 2007. Here is another link that contains more recent data.The home ownership rate remained around 46% between 1900 to1920. It raised in 1920’s to just below 50%. It then took a plunge in the great depression. After World War II the rate consistently raised to about 60% by 1960. As it is clear from the graphs, in 8 years between 94 and 2002 the rate increased from 64% to 68% and it jumped from 68% to 69% between 2002 and 2004 when subprime lending was at its height.
This research by San Francisco Fed attributes part of the rise in home ownership after 1990 to aging of he population and speculates about the possibility that financial innovation could be partly also responsible. This research by University of Southern California shows that the rise in home ownership could be inflated due to falling household formation in people who rent houses.
As far as the effect of financial innovation on home ownership is concerned, the data shows that all the gains in home ownership rates between 2002 and 2004 that could be most clearly be attributed to financial innovation has already been vanished and the rate has fallen to below its 1994 level. The blog Calculated Risk states that “the home ownership rate is back to the level of Q2 2000. So much for the home ownership gains of the last 8+ years. Gone”. In this article Krugman mentions this point and also talks about the disastrous effect of ideology on deregulation policies that the Fed followed under Greenspan.
There is also this question that whether the goal of increasing home ownership a really good goal? Krugman cast doubt about this.This is also a good article in economist about this.
The other point is that some observes see the “supposed” push by government sponsored enterprises, Fannie Mae and Freddie Mac to help low income people to have access to cheap and easy mortgages as the root cause of recent financial crisis. Therefore from this point of view the increase in home ownership was not the result of financial innovation but it was a policy pushed by the government that has led to the current financial crisis.

Child As a National Treasure

In this article “Seriously, What Is a Child?” published in New York Times, April 25, 2009, Uwe E. Reinhardt, a health economist in Princeton argues that, like in all other industrial countries children should be considered not like pets but as national treasures. In that case the provision of health care for children would be considered as social good and not private consumption good and would be provided but tax dollars.