Reg comments49

Bet against the bubble - how to head off a subprime crisis

More speculation, not less, is the key

We all know what to do about this subprime mess, the credit-crisis final-end-of-capitalism farrago, don't we? Hang the bankers, hang them high, banish greed and stupidity from the human soul, bring in a very real change to our mass, crass, consumerism and usher in a society free from the shackles of late stage fiancierism? OK, not everyone quite approaches this in the manner of Dave Spart, but there's any number insisting that this burp from the maw of capitalism is proof perfect that we must abandon the very concept.

There are also those equally misguided who insist that it's all been just one of those things, that no changes at all are needed. 'Equally misguided', because a system that allows our method of financing a roof over our heads to (nearly) bring the entire financial system to its knees is not something that we want to allow to continue unchecked. Banks and lending are simply too important to wealth generation and risk dispersal for us to want that sort of fragility to continue.

So what should we do then? A little more regulation? A lot more such? That's not necessarily a wonderful solution, considering that over the past few years we've seen the regulators themselves unaware of the disaster unfolding. Robert Shiller's got an argument that will make some peoples' heads explode in his new book The Subprime Solution - we need more speculation in the housing market.

So what market is that?

OK, OK, deep breaths - the man's got a valid point here. Start with the point that the current structure of the market failed us. We thus need to change the structure of that market: that's not really a controversial point at all, from Spartists through to reasonable people. It's also hardly a surprise to anyone that there are market failures: things which markets don't deal well with, things that are left out of or even deliberately excluded from markets. But we do need to distinguish between things which markets will inherently fail with and things which are failed by current markets, but which could be dealt with by better designed ones.

Worth pointing out here that there is no such thing as the 'free market' - nor even 'free markets'. There are distinctions to be made between ones which are more or less free than others, sure. But the really vital point is that all markets are constructed: you cannot have a market in property unless there is prior agreement upon what property is, who owns it and how it is to be transferred. Those agreements can be cultural, legislated, come from regulations or simply common agreement amongst the participants: but all such markets are constructs, not things which exist ab initio.

Take climate change as an example. Stern (of the Review) has called it the greatest market failure ever: a decent enough phrase but one that's not quite correct. It's the result of the absence of a market: that's why we're all running around trying to create a market in cap and trade allowances to solve the problem. That we're creating a market to solve the problem really does seem to indicate that we've identified the problem as the absence of such a market, not a failure of either a market or markets in general, no?

Shiller's analysis of what happened in the housing market over the past few years is similar in logic: there's something missing from our current structure, something which we need to add.

It's the bubble, stupid

He starts from the point that while there was most certainly fraud, stupidity, larceny and greed involved in what happened they were not the cause. No, rather we had one of those madness of crowds moments when the populace was swept up in the grips of a mania. House prices would continue to rise, continue without risk. Very much a repeat of numerous earlier examples, the South Sea Bubble, Dutch tulip mania, internet stocks in the 90s, the Mississippi land boom in France, economic history is littered with examples. The frauds fed off this, but they needed that mania to exist first - they didn't cause it.

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