A response of my own
Thanks for inviting me.
I'm no Pangloss-ian sort, but I'm generally of the view that bubbles are necessary. Note: That is not the same thing as saying they are good in all of their manifestations and impacts -- it would be foolish to argue so specific a case -- but the nature of economic systems and innovation is such that periodic "enthusiasms" are required to effect change.
Consider: Who would have spent billions building out a national fiber optic network without the late-90s fiber bubble? It was necessary, even if it caused an unholy amount of collateral economic damage.
The venture industry, where I spend most of my time, is a bubble business. If you net out returns from the late-90s Internet bubble and the mid-80s PC bubble, there is no venture business -- returns fall below the public market and no rational investor would put money there. But add back those two bubbles and you have, at least in the top quartile of performers, outstanding returns.
Does being a bubble(-blowing) business make the venture business a bad one, in some moral sense? Of course not. Schumpeterian waves of economic destruction require such paroxysms, as well as the resulting waste. It is just the way that things work, with a great deal of time and money needed to get people from one technology platform to another.
Finally, Jesse is troubled above by the "thin gruel" bubbles bring many in the economy. In particular, he points to the real estate market where it is not clear, he says, what the "infrastructure or economic benefit" from a housing bubble will be. Again, it is a mistake to look for benefits in every aspect of every bubble, but that is the correct bias, and usefully different from the usual bias that says all bubbles are bad.
Specifically, in the case of real estate, there are benefits to which you can point. Among them: It has unleashed a huge amount of technological innovation, including companies like Zillow and Redfin, making more liquid and less-expensive a highly illiquid and expensive market. Putting a few brokers out of business in the brutally over-rigid real estate market is definitely some collateral bubble damage to be applauded.
Given this original question asked by Daniel Gross: "Given how the U.S. economy works, do we need this sort of process?", the answer is no.
Investment is a good thing.
Promotion of good investments is a good thing.
Open-ended speculative bubbles that encourage the unwitting to risk their precious savings is a bad thing.
If you're trying to make the case that irrational exuberance is a good thing because it helps to feed some cash into needed investments, you're wrong.
There are other means of achieving the same end without the collateral damage...
May 14, 2007 10:58 AM | Reply | Permalink
Hello Paul
Welcome to TPMCafe. I look forward to your column each weekend at RealMoney.com.
Is there any evidence that the benefits of bubbles and the pain of their deflating are offsetting? I am thinking of Cramer's point that there is money to be made in bubbles and to worry about their ending results in passing up a lot of income.
Might that be true for people who would never have a chance to make so much money without the bubbles?
Daniel A. Greenbaum
May 14, 2007 11:01 AM | Reply | Permalink
I have yet to be convinced that it makes sense to call the current real estate market a bubble at all at least taken as a whole. And a lot of cause and effect are being read into things that are not causative in themselves.
As an example sub-prime did not cause the bubble, it fueled it and in the end fell victim to it, but it did not cause it. As always greed feeds bubbles, you see people on the gravy train and so everyone is tempted to jump on without stopping to calculate how many seats there were. But the pure speculators were concentrated in a limited number of markets, markets that were also higher end in pricing. If you subtract out LA and Phoenix and look at markets more locally you see a very mixed bag with metropolitan markets even now roughly split between gainers and losers year over year. Nor is it clear that year over year price changes are the right way to measure real estate to start with. If you think about that it really only makes sense to speculators and people with teasers, which is why most of the anecdotes are about people with ARMs resetting and speculators sitting on blocks of houses. Because most everyone else is going to be able to ride this one out.
In other words the Toll Brothers not getting richer at exactly the same pace they did a year or two is not necessarily my problem.
The housing boom put a lot of inventory out, sub-prime lending put lots of people in that inventory, and neither is a bad thing in itself. The first lesson in a real estate class is that housing is cyclical. And in any cyclical market, if you jump in with a restricted time frame for exit even a moderate downdraft hurts, and a severe one wipes you out.
Personally I think the jury is still out on this, too much of the reporting is anecdotal, too little driven by data that actually means something (because national aggregates don't). There is something about real estate that causes people to inject emotion into what in a lot of cases is just an investment choice that didn't pay off. Risk/reward is a feature not a bug. There was a time in Southern California when using an exotic mortgage to leverage yourself into a house was a perfectly sound, if risky investment. Unfortunately for some latecomers that time was back in 2003. The model stopped working in late 2005, which didn't keep people from trying to use it.
People losing homes is a tragedy. People losing houses is not. It is not at all clear what the balances between owner-occupiers and speculators are in some of these markets. Because people do not walk away from equity. People who entered into this market at the wrong time on a 100% Loan to Value loan structure don't really have any skin in the game and relatively few of them were "unwitting".
A wave of speculators is being washed out of the market. And people are losing homes, but there is a risk that sentimentality about the latter is causing people to underestimate the former. People losing money on a risk investment is not a tragedy, it is not even a "bad thing", and current attempts to blame it on that 'bad old broker' maybe are missing the larger picture.
May 14, 2007 11:45 AM | Reply | Permalink
Unfortunately, the small investor is rarely the person who profits from a bubble. As in any casino (and a market riding on a speculative bubble is a casino), the croupiers generally fare better than the guests that they invite to their tables.
As money manager David Tice pointed out when testifying before Congress in 2001: "The unsuspecting are gulled by those more skilled at the game of speculation--which is why individual investors (as opposed to large institutional investors) wound up holding 75% of all Internet stocks. They not only bought them; they held onto them.
Experienced investors (who sold them to individual investors) were the "price makers" the small investors were the "price takers."
This is not to say that insitutional investors did not also lose money--at least they lost their clients money. (If they tried to get out of the bubble and go into bonds or cash, they would lose clients or their job.) But, in 1998, if I asked an experienced money manager where he had put his own money--or the money he was saving for his children-- the answer was rarely "U.S. stocks."
You could see what was happening if you looked at the IPOs of the late nineties. Once a stock like Ariba was in orbit, the investment bankers and other institutional investors who had launched it began lightening their positions, often on the first day of the trading, leaving small investors holding the bag.
May 14, 2007 12:14 PM | Reply | Permalink
David Tice is a regular on CNBC. He makes his money from shorting stocks and as best I can tell is close to a perma-bear. He is always predicting an end to the good times.
When you talk about the small investor and the large one I agree that the individual investor does not always end up well. There greed gets the best of them. However, most small investors are invested via 401ks, IRAs and pensions so they are not investing on their own but are part of the institutional investor universe.
Daniel A. Greenbaum
May 14, 2007 12:18 PM | Reply | Permalink
Daniel--
It's true that individuals have much of their money in mutual funds run by professoinals--but as I noted above, during the boom, the professionals had little choice but to invest that money in over-priced stocks. Jeff Vinick, the brilliant manager of the Fidelity Magellan fund, was fired for putting the fund's money into bonds in the late nineties-which was the right move.
As for Tice, yes he tends to be a skeptic--most short-sellers are. And there is nothing wrong with shorts: they are some of the smartest people on the Street, and quite often, among the most honest. (For example, Jim Chanos is the short-seller who exposed what was going on with Enron's accounting.) This is why Tice was asked to testify before Congress--to help legislators understand how so many people had been cheated out of so much money.
And Tice's bearish mutual fund has been a great safe harbor during down-turns in the market. If an investor was smart enough to buy it, say the spring of 2000, he would have made a lot of money. But it's not a fund you buy and hold for 10 yeras. It's meant as a hedge in a rising market --to give you some protection-- and Tice, unllke many of today's hedge fund managers actually knows how to hedge.
May 14, 2007 1:42 PM | Reply | Permalink
If one can limit one's intellectual frame to exclude moral and ethical measures, as capitalism largely does by limiting every question effectively to being about profit as a measure, then I would largely agree with you, Mr. Webb.
If, however, one places importance, or indeed, value, on moral and ethical questions at all, then such considerations as losing one's home far outweigh the capitalist's measures depending only on profit.
As for me, by now, I can't even begin to make profit more important, on just about any question. Yes, that means I'm not a capitalist. But more importantly, my perspective suggests to me how much people like you and Dr. Kedrosky, with all due respect to both of you, are proponents of something which is nothing short of a religion, a religion that can so coldly and ruthlessly dismiss motivations other than profit, motivations which have more altruistic moral and ethical dimensions at their heart.
Jesus said, "Fear not one who can destroy the body but not the soul. Fear one who can destroy both soul and body in Hell."
Maybe folks like you don't realize the respects in which your opinions are religious. Maybe you should think about it.
May 14, 2007 1:52 PM | Reply | Permalink
I can't tell from your bio what you're a Dr. of, Dr. Kedrosky, but I will allow you the benefit of the doubt, to ask a question.
I'm not an economist, but the notion of creative destruction seems a coarse emotional view, not an analytical view at all. The term creative destruction implies both gain and loss, in the midst of change. So, the scientist in me asks, both overall and in specific terms, are Schumpeterian episodes of creative destruction conservative?
I.e., do the gains and losses cancel each other, or are one greater than the other? Is the situation the same after as before in economic and other terms? If they aren't equal, how are they specifically different? Is there any specific research regarding such questions related to this sort of phenomena? Would different weightings of the specific areas of difference lead to different views of whether the situations before and after were better, worse, or largely the same?
I'm curious, because in all the mention I've seen of Schumpeter and creative destruction, I've never seen anything that takes the whole idea seriously enough to flesh it out empirically, let alone to discuss the whole idea, i.e., that technology threatens capitalism inherently, a threat that Schumpeter himself thought would have to be answered with socialism.
Second, how is it that you and Mr. Gross are able to conclude that such Schumpeterian episodes are due to economic factors, more than to technological factors, or in the extreme, due to technological factors entirely, independent of economic factors? Didn't Schumpeter in fact suggest that technological progress was more a factor than economic investment?
I was involved in the technology of the fiber buildout of the late '90's. It had to start somewhere; it didn't start, from my perspective, by investors jumping onto a bandwagon; it started from technologists making progress and over-hyping its economic potential, to people who knew no better but who had money to spend, if not to burn.
I.e., investment didn't come first. (Partly misplaced) confidence in the technology came first. I predicted the burst of the bubble in '00, while working at one of companies that was a prime inventor of the technology, while non-technical executive management were trying to find ways to sell it. I was but one of its 2500 or so technical Ph.Ds.
Without the benefit of data, I would like to suggest that along with other things, such stages in technological advancement are not at all conservative, but leave an economy that is fundamentally different in deeply important ways: more productive, yes, but more destructive than creative on balance, and that, because of the increase in productivity, not in spite of it.
The net effect of Schumpeterian episodes is almost certainly an economic environment that appears to be continually growing (albeit in fits and starts) by some measures, but which is continually shrinking by other measures. I.e., not cyclic at all, but monotonically changing along different dimensions. How so? I'll let you think about that. But to see it, answer the question of which measures of Schumpeterian transition, or other technological change, are more important, and to whom? Indeed, some such measures may give the appearance of a bubble, while others should suggest trouble well underway.
More important than the idea of creative destruction, I would like to suggest that there's a deeper truth at work: that technology devalues labor in capitalist terms, and because it's a truth (that can be empirically observed, if one looks at the relevant measures objectively) the overall effect is not cyclical.
Another response to Mr. Gross suggests there is now a global bubble. Indeed.
May 14, 2007 1:56 PM | Reply | Permalink
Hi Maggie,
I like that you present evidence for your opinions; you seem well informed, and that makes me trust your opinions and judgement (the latter, because you apparently recognize the value of justifying your opinions). Good for you.
So, let me ask you a question, if you don't mind (after a bit of setup). The tech bubble burst of 2000, seemed to me to be at least partly due to the gross overcapitalization of the telecom sector, which was at the time the buyer of 40% (by estimates I recall seeing) of all information technology at the time. They were in turn using this overcapitalization to build products their limited base of customers couldn't hope to afford. There was no value, no marginal utility, to what they were offering.
I could see all this as a technologist, with no economic sense to speak of. The whole economic climate, top to bottom, smacked of nothing short of stupidity to me, albeit driven by greed towards the end. Had I been so inclined (which would have crossed various boundaries for me), I could have sold short the stock of just 2 companies in particular, and made a 90x return on my investment. Not 90%, but 90 times.
Here's the question. What is it that gets people to think that this kind of behaviour is in any way, shape, or form, intelligent behaviour? And why is it that even so-called liberal intellectuals still presumptively depend on the brain-dead rationales that led to this sort of behaviour as a frame for the more pressing issues of the society, e.g., the prospect of universal health care?
Finally, a comment, not a question. People who take this kind of thing seriously, need to get over themselves, and realize that we have brains for a reason, not simply to stiff other people with our marginally more clever greed. The long-term survival of civilized human society requires we get past this kind of selfishness. Even species of insects do better. The excuse that every one has to be greedy, because everyone simply is greedy, needs to be put to rest.
If people like me had had a voice, the tech bubble of 2000 would never have happened in the first place. But not many are listening to people like me. Too many think they know better. And to those who think they know better, try inventing some of that technology you take for granted, both technically and economically, yourselves, without the help of people like me. We might be a lot smarter than you think, and you might be a lot dumber than you imagine.
Rhetoric and logic are different things. Logic is hard science. Mathematics can be applied to rhetoric, but it's still rhetoric, not logic at all. And it seems, from where I'm sitting, that economists don't have a clue that there even is a difference, let alone a clue about what the difference is.
The profit motive is an assumption; an unprovable one in logical terms, but one economists seem to elevate to mathematical axiom. It's too easily refuted as axiom. Any single, simple counterexample refutes it. Any single person otherwise motivated, refutes it.
The Apostle Paul, in the same chapter where he wrote "For capitalism is a root of all kinds of evil," also wrote, "Command those who are rich not to be arrogant, nor to put their trust in wealth, which is uncertain..."
Yes, the word he used was a single word (philarguria, literally "affection for silver", idiom for advocacy of wealth) which even thus transliterates as capitalism, but more importantly, what he wrote is just as true as I write now as it was when he wrote almost 2000 years ago.
Some things, if they change, don't change all that quickly. That, by the way, is also the nature of truth. That which is cyclic cannot embody truth; even the assertion of being cyclic is impossible, in general, to verify as truth.
For those who would loosely reference Schumpeter for justification of their religious beliefs, I would note that Schumpeter didn't coin the term "creative destruction," and I would further suggest that his respect for Walras might have had something to do with Walras' own clear mathematically rigorous respect for the unprovable. He shares that respect with computer scientists and mathematical logicians who have codified the whole subject into the subdiscipline of decidability theory.
Truth and speculation are so, so different.
May 14, 2007 2:56 PM | Reply | Permalink
Wow, that might be the first honest thing I've read from a Venture Capital guy about the Venture Capital Industry.
Net out the bubbles, which no investor can time, and returns stink.
But, I have to ask -- given that you only make outsized returns during unpredictable bubbles, how in the heck do you all justify fees of 2% a year and 20% (or more) of profits? And, given that you all take a percentage of profits, why don't you give back a percentage of losses?
thosethingswesay.blogspot.com
May 14, 2007 8:39 PM | Reply | Permalink
Wow.
People lose homes all the time. The question at hand is whether the housing bubble created a net loss of homes. As yet the answer seems to be no, more people are in homes than before.
A lot of people are trying to turn this into a moral issue when the reality is that sub-prime put a lot of people who wouldn't otherwise qualify. A by-product of that is going to be an uptick in the number of foreclosures. But in many cases this just means people going back to being renters for a while until they can rebuild credit and try again for homeownership.
People are desperately trying to turn this into a narrative of predatory lending and hence morality when the real story is a more technical one of exactly how we should set underwriting standards so as to maximize home-ownership while minimizing failed loans. It is far from clear that the collapse in sub-prime and the tightening of underwriting standards are actually doing prospective homeowners favors here. Instead we are recreating barriers to entry.
John I am afraid you just have fallen victim to the hype.
May 15, 2007 8:10 AM | Reply | Permalink