

How a Bubble Stayed Under the Radar ("Information Cascades" vs. "Efficient Markets") - toffer
http://www.nytimes.com/2008/03/02/business/02view.html?ex=1362114000&en=976c5223d2a702bc&ei=5090&partner=rssuserland&emc=rss&pagewanted=all

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yummyfajitas
It certainly does not challenge the "efficient markets" hypothesis. The
hypothesis of EMH is that investors are attempting to maximize their profits,
and all have the same information.

The housing bubble was driven by various players with incomplete information
and irrational behavior:

1\. Idiot homeowners: "Buying a home is the American Dream and house prices
will never go down because everyone needs to live somewhere." These people are
making an emotional purchase, not an investment. A conversation I had with
such a person:

Me: You just left your wife. You plan to leave your job. In the next 3 years,
you will probably leave the state, possibly the country. And the housing
bubble just burst. WTF?

Him: Without owning a home, I feel rootless. I need to buy a 3 bedroom house
in suburbia. It's a good investment!

2\. Investment banks were mislead by mortgage issuers. If an investment bank
is buying the loan, the mortgage issuer had less incentive to make sure it
would be repaid. So the issuers slacked off. This means that there was a major
asymmetry of information, violating the premises of EMH.

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trevelyan
The influx of speculative capital into the commodities market is playing havoc
with production networks in Africa and Asia. The subprime crisis was clearly
happening as early as 2005: look at when Soros started betting against the
USD.

When people say "efficient markets" they usually mean "efficient at not
sucking" and/or "efficient at producing socially optimal outcomes". It is
usually considered self-explanatory that people act in what they perceive to
be their self-interest.

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cawel
Do we need a sophisticated theory to describe "herd behavior"? And does it
really challenge the "efficient markets" theory? I would say that an
individual is making a _rational_ decision even if it is based on the behavior
of others. I see that as valuable information before making a decision. If I
understood it correctly, the author sees it as irrational.

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patrickg-zill
The Glass-Steagall Act, which kept commercial banks and investment banks
separate and set up the FDIC among other things, was revoked in 1999.

This removed important barriers between the various players in the mortgage
market which had acted to keep them at least somewhat honest. IMHO, YMMV etc.

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mynameishere
_correct decision_

I can tell you right now that 100 percent of decisions in the marketplace are
incorrect--at least, if I'm right in thinking the nytimes defines a "correct
decision" as: Paying a price currently that will stay the same in the future.

Or, we can acknowledge that every transaction has one buyer, and one seller,
and no matter how you define "correct", _both of them can't be wrong_.

Or, we could say that 100 percent of the decisions in the marketplace are
_correct_ , if we define the word itself correctly: The price that the market
determines.

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eru
If the price is bogus - at least one of buyer or seller will make a bargain.

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aswanson
The first sentence is wrong:

 _ONE great puzzle about the recent housing bubble is why even most experts
didn’t recognize the bubble as it was forming._

Almost every mainstream publication and plenty of regular folks saw the
housing bubble for what it was years before it popped, including our own Matt
Maroon: <http://news.ycombinator.com/item?id=100156>

