Later,

To that end, everyone should have a solid concept of Supply and Demand, and limited resources; think in those terms on most decisions. If you add stealing is the only crime, then you will have an ethics class that will solve most of our problems that “need to be regulated”. As for the consumer, buyer beware has always been the rule. We also allow litigation if a product does not meet customer expectations. I am still surprised no one has not taken a bank to court over their sup prime loan, but then they would have to be determined to be incompetent to understand a contract.

Your post is a perfect example of why the discussion of spotting bubbles is of little value. One of the prevailing memes– and your post states it pretty much perfectly– is that the REAL problem was the American consumer living beyond his means.

As long as we focus on bubbles, we ignore the man behind the curtain: a rotten financial sector. Just because the profligate, irrational American consumer demanded more credit did not mean that the financial sector had to supply it. Since the financial sector have the money (actually, it is mostly our money and not theirs), what right do they have to lend money that they cannot reasonably expect will be paid back?

Perhaps the corrolary to “there is a sucker born every minute” is “there is a con man born every minute.” We can’t regulate stupidity, but we sure can regulate reckless behavior and criminalize criminal behavior, provided that we focus our attention on the real problem, which I guarantee you is not the consumer.

It’s like blaming a child for burning down the house when it was his parent who handed him a box of matches and told him to go into another room and have fun.

All people are influenced profoundly by their emotions in their decisions and acts, and all markets are rigged by their participants, by regulators or by legislators (usually by all three).

This is incredibly difficult, if not impossible. Is anyone even close to this type of model? My limited acquaintance with econometric models is that they look no deeper than the national income and product accounts and the financial flows in order to “postdict” previous cycles, then, cross their fingers and hope that events repeat themselves in almost the same sequence and magnitude as before. They model events without “reaching through” those events to their underlying causes. This activity is essentially trial and error using huge arrays of variables in huge systems of equations without looking carefully at the underlying logic of the theory within which such models are constructed. Trial and error and data-fitting without a narrative that predicts connections and removes surprise in predictable ways is a necessary stage in the evolution of a scientific discipline. But, it’s symptomatic of an immature science. Will it ever be as “easy” to predict economic events as it is to predict the location of the moon at a given time relative to the location and rotation of the earth accurately enough to land a space ship on it?

The guys who predicted this collapse reasonably accurately (or better) were lucky or “perma-bears” (LOL, I love it!). As James so aptly puts it, “what we really want is a reliable indicator of irrational exuberance that will be the same in every bubble.” Economists know how to build models, no doubt, but, they don’t have a good understanding of how to build the type of model that would achieve reliable, replicable predictive accuracy. They just don’t understand people well enough. Who does?

How do we know when “bubbles” are happening? For me, it is like always asking the question: “If what is happening is too good to be true in the normal world, is it real?” In the run up to the current disaster, without the continuous cheerleadership of guys like Alan Greenspan, could we have gotten there? I doubt it sincerely. But, he had had so much adulation from the media and business (and Congress and economists), that it was very unlikely to ever break the momentum that his view of unfettered capitalism sponsored.

I think that the actual lesson to learn is that we, as human beings, need to understand that wealth for the sake of itself is always a bad idea. Only wealth which engenders other non-financial increses in human value is to be admired, desired, and respected.

He also touches on a wonderful of array of history, mathematics, and physics along the way. Thus it’s a fun read even if you are very skeptical of curve fitting.

Forming regulation is one thing, but enforcement requires strong-willed individuals like Paul Volcker..

The credit crisis and ensuing recession may be viewed as a ‘natural experiment’ in the validity of economic models. Those models that failed to foresee something this momentous may need changing in one way or another. And the change is likely to come from those models (if they exist) which did lead their users to anticipate instability. The plan of this paper, therefore, is to document such anticipations, to identify the underlying models, to compare them to models in use by official forecasters and policy makers, and to draw out the implications.

There is an immediate link to accounting, organizations and society. Previewing the results, it will be found that ‘accounting’ (or flow-of-funds) models of the economy are the shared mindset of those analysts who worried about a credit-cum-debt crisis followed by recession, before the policy and academic establishment did. They are ‘accounting’ models in the sense that they represent households’, firms’ and governments’ balance sheets and their interrelations. If society’s wealth and debt levels reflected in balance sheets are among the determinants of its growth sustainability and its financial stability, such models are likely to timely signal threats of instability.

Here’s the link:
http://mpra.ub.uni-muenchen.de/15892/