What went wrong with economics

OF ALL the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself. A few years ago, the dismal science was being acclaimed as a way of explaining ever more forms of human behaviour, from drug-dealing to sumo-wrestling. Wall Street ransacked the best universities for game theorists and options modellers. And on the public stage, economists were seen as far more trustworthy than politicians. John McCain joked that Alan Greenspan, then chairman of the Federal Reserve, was so indispensable that if he died, the president should “prop him up and put a pair of dark glasses on him.”

In the wake of the biggest economic calamity in 80 years that reputation has taken a beating. In the public mind an arrogant profession has been humbled. Though economists are still at the centre of the policy debate—think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain—their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.”

In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.

And if economics as a broad discipline deserves a robust defence, so does the free-market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. Their logic seems to be that if economists got things wrong, then politicians will do better. That is a false—and dangerous—conclusion.

The Economist

1984

How a Bubble Burst's

The photograph, taken by Richard Heeks, of Exeter, shows a soap bubble with one half still perfectly formed while the other shatters in a distinctive pattern of streaks.

"There's something so satisfying about picturing something in your head and then finally seeing it on the camera," he said.

The Telegraph

Brain Freeze

Our brains are telling us it’s painful to price our homes to reflect 20 percent to 50 percent losses in market values. So buyers overprice houses and wait for something to happen.

A myopic, loss-averse view of the market, for example, means listing for $500,000 or more when comparable upscale homes are selling for $400,000 or less. I have seen it in my suburban Chicago neighborhood, where homes have been on the market and unsold for years.

Logic Circuits

Our loss-aversion fears are so powerful that they override our logic circuits. We tend to ignore economic reality because we are emotionally anchored to our homes and values based on boom-era prices. It’s like holding on to a favorite stock long after it has tanked.

There are also influential cerebral centers for optimism and self-confidence. We hang on to properties, falsely believing that prices will rebound to the bubble years of 2005-2006.

Bloomberg

I Stand Alone

This is from a poster on a blog that I make sure to read The Housing Bubble
we are about 1 year to 18 month's behind the curve here.

Ireland's Dr Doom

Nama is in effect Fianna Fáil’s shrine to the property bubble for which the party still yearns. Prepare to pay 10 per cent more in income tax for the next 10 years to pay for it all . . . we are headed for national bankruptcy, argues MORGAN KELLY (Ireland's Dr Doom)

WRITING HERE two years ago, I pointed out that the exuberant lending of Irish banks to builders and property developers would sink them if the property bubble burst. Since then, the bubble has burst, the banks have sunk, and we are all left wondering how to salvage them.

Underlying Nama is the delusion that the collapse of our property bubble is a temporary downturn. In a few years time when the global economy recovers we will be back building houses like it was 2006. All the ghost estates, empty office blocks, guest-less hotels and weed choked fields that Nama has bought on our behalf will once again be worth a fortune.

The reality is that, because of our surfeit of empty housing, there will be almost no construction activity for the next decade. Empty apartment blocks in Dublin will eventually be rented, albeit at rates so low that many will decay into slums. However, most of the unfinished estates that litter rural Ireland – where the only economic activity was building houses – will never be occupied.

Nama is a variant on the “Cash for Trash” scheme briefly floated in the United States last year where the government would recapitalise banks by overpaying for their bad loans. Our Government is proposing to buy €90 billion of loans and will reportedly pay €75 billion for them.

The International Monetary Fund (IMF) guesses that Nama will cost us €35 billion, and this is probably optimistic. The narrowness of the Irish property market meant that banks effectively operated a pyramid scheme, bidding up prices against each other. Now that banks cannot lend, development assets are effectively worthless.

The taxpayer is likely to lose well over €25 billion on Anglo alone. Among its “assets” are €4 billion lent for Irish hotels, and almost €20 billion for empty fields and building sites. In fact, I suspect that the €20 billion already repaid to the casino that was Anglo represents winners cashing in their chips, while the outstanding €70 billion of loans will turn out to be worthless. And it is well to remember, as the architects of Nama have not, that although the problems of Irish banks begin with developers, they do not end there.

The same recklessness that impelled banks to lend hundreds of millions to builders to whom most of us would hesitate to lend a bucket; also led them to fling tens of billions in mortgages, car loans, and credit cards at people with little ability to repay. Even without the bad debts of developers, the losses on these household loans over the next few years will probably be sufficient to drain most of the capital out of AIB and Bank of Ireland.

The Irish Times

Sarasota Revisited

Anglo Irish Bank will take a 33pc haircut on a parcel of land it's selling in Florida that was acquired by developer Paddy Kelly in 2004 for $60m (€42m).

It's believed that the state-owned bank has agreed in principle to sell the land to US property developer Zeb Portanova, who must complete the deal to buy the 15-acre site by September 1. It's understood that a $40m (€28m) purchase price has been agreed. The site, Sarasota Quay, was to incorporate a landmark $1bn (€707m) commercial and residential development.

Despite Anglo Irish Bank's effort to sell the site, it has been reported that Mr Portanova may struggle to meet the September 1 deadline.

Two former partners of another planned $1bn development in Sarasota, the Proscenium, have filed a legal action against Mr Portanova in Florida. They claim he defaulted on a deal to pay them nearly $5m. In April, Cadence Bank filed a $3m foreclosure suit against Mr Portanova and the Proscenium.

The Sarasota land owned by Mr Kelly became the subject of legal action more than a year ago. Irish American Management Services (IAM), the company behind the planned development of the site, was backed by Mr Kelly, John McCabe of McCabe Construction, and John Walsh, a long-time investment partner of Mr Kelly. Legal action was taken by Bussoleno, registered in the British Virgin Islands, seeking foreclosure in January last year on mortgages it granted IAM for parcels of land at Sarasota. Bussoleno claimed that IAM was delinquent on $7.7m in loans.

This week, Bussoleno brought a legal action in Ireland against the three men to enforce a $5.77m judgment granted in the dispute by a court in Florida. Legal representatives for Bussoleno told the Commercial Court that the company was concerned that Mr Kelly was subject to debt-recovery proceedings and that he had said his liabilities may exceed his assets.

The Indo