US or UK?

In the US they can build houses when they need more supply and they are not too upset at knocking down old building in their cities to create more supply. The UK is stuck with the Town and Country planning act which makes sure hardly any houses are built. In addition there is the welfare state creating huge levels of demand for rented accomodation. The end result is what we have now, sky high house prices. Its only because the credit crunch means people cant borrow as the banks have no cash that prices are falling, the real market price is very high because demand exceeds supply. Governments always cause markets to fail.....

Good Article

When I read the strapline I was prepared for the usual end of civilisation, behead the bankers tosh. But it turned out to be a good review of a well reasoned and original book.

Housing markets desparately need a mechanism that prevents bubbles or at least bursts them early.

Also why is everbody so glad when house prices go up? They would get pretty pissed of if the price of bread or beer went up 100% every year. Housing is a basic commodity everybody needs, long term, cheaper housing would make everybody better off; Gods knows I would rather spend my wages down the pub than giving them to the bank manager.

Grand Larceny .... Dire Straits Money for Nothing

"In which case, the solution is to design the market needed to solve our problem."

QuITe so, Tim, with New Market Leaders taking Over Overall Control ..... or are you hanging on the the Notion that Present/Past Incumbents have any Credibility which could possibly be Useful in the New Markets Leadership .

Surely the very fact that such is the Solution extraordinarily renders them as the Problem to be discarded and replaced with the Solution.

After all, they've had a good Run at Gambling for Free with Invented Money, time for them to move over and off the Pot to let more Accomplished Players Spend their Winnings rather than Fleece the Punters.

Or do you see nothing basically changing, with everything in effect just being a whitewash job.? ...... with more of the same death spiral to come for their Rigged System?

cat in the hat

Which bubble has been saved by options? All of them had futures contracts, and they all had bubbles. So I think the proposal is historically blind, and therefore stupid.

Mortgage backed derivatives are exactly a bet against risk, and they made things worse not better, for the obvious reason that the stated risk was fraudulently misrepresented, and there was a conspiracy of greed and political expediency to maintain the illusion.

Exactly who didn't know this was a bubble? Are they suprememly stupid, incompetent, or just motherfuckers? Mervyn should be sacked for allowing a Ponzi scheme to mature, as should Brown. Well he probably will be at the next election. What an idiot.

"Zero Sum Game"

Oh yeh. And it almost always plays out thus:

Winners = Them

Losers = Us

Unconvinced

When the threat of climate change has been eliminated, then we can use cap and trade as an example of how markets solve problems. At the moment it just looks like a way for a) politicians to defer the introduction of unpopular measures while pretending that they are tackling the problem and b) bankers to make even more money from this deferment.

Re: cat in the hat

"Exactly who didn't know this was a bubble?"

This is an interesting question given all the backslapping about inflation being at a manageable level while house prices soared. According to "Consumer Prices Index and Retail Prices Index: The 2008 Basket of Goods and Services" from the Office for National Statistics, "mortgage interest payments... are excluded from the CPI", although they feature in the RPI, but given the usual amount of political spin involved in any policy matter this surely makes it very easy to apparently meet those inflation targets and keep interest rates conveniently low.

Attacking the symptoms, not the root cause

The argument is compelling, but misses the real root cause of the current financial turmoil. The Credit Crunch is, at its heart, a bubble in the (low) cost of credit; an under-pricing of the risk of lending money. This in turn cause excessive lending (and sub-prime lending) at prices not commensurate to the risk, which fuelled an asset bubble.

The market in 'asset backed securities' that allow banks to re-distribute lending-risk is the market that needs addressing first. I am personally very doubtful that the presence of short selling in any market would 'head off' a bubble, there are plenty of counter examples.

Heads they win - tails we lose

A recent (but accurate) summing up on Radio 4's Today programme:

"The banks have an innate tendency to privatise profit & distribute loss".

Accurate and depressing at the same time.

Who's got an endowment which is on target? No me neither.

Who's got a pension which is going to achieve what they promised? No me neither.

On the other hand - the traders & managers all had lovely bonuses this year...bless them.

"Wealth generation" - fnarr, fnarr -

is the primary source of inflation.

As others have pointed out the market failed as most of the do from time to time. The regulation in the US failed technically because of the inaccurate assessment of risk by the ratings agencies although it could be argued that the regulators failed in letting the agencies rate products where the risk was probably incalculable. As for the rest: as nearly everybody involved gets paid enormous bonuses as long as the bubble expands and only risk losing their job briefly when it crashes. But I read The Economist for this kind of stuff unless it's funny or got tits in it. According to The Econmost next bubble could well be renewable energy with investment currently far outstripping supply.

Supply & Demand

I suggest we allow the Chinese, who are getting pretty great at rapidly building out nice quality residential skyscrapers at low cost, to come over to UK and build a bunch of them in all the major city centers.

I've been sitting around waiting for 6 years to buy a house because of the stupid UK house prices - and a lovely house-price correcting recession is finally in sight. But then I see all these news stories about the government trying as hard as they can to keep the house prices up to stop the young folk being able to buy into the property market at sane prices.

It would be nice for the younger generation to have an extra 100K or two in their pockets to spend over their lifetime. Some of us might even use the extra money on something useful...

Little off topic, but...

...am I the only one who re-read the title of this article and was disappointed to find that it wasn't about Bubblegum Crisis?

Beer processing...

"..if you spent a year drinking beer, which you are quite prepared to pay for, how do you feel when you find that at the end of the year you can sell the beer you just drank for double what you paid for it?.."

Well, once I have drunk the beer, I put a lot of specialist chemical processing to work on the liquid. So I am not surprised to find I have bought a raw material, added value, and can now sell it for more.

Is this what is called taking the piss?

But risk WAS offset by the banks

Anyone heard of Monoline insurance? The big problem was that as the financial instruments being used got more and more remote from actual assets it became hard to compute the real risks and the insurers didn't know their actual exposure.

The house buying public were most of the cause here. They could see low interest rates and fast rising prices. They wanted in on this any way they could, and without them chasing house prices upwards this wouldn't have happened. The banks were awash with cheap money, which they needed to lend out to make a profit, so they weren't looking too hard when people asked for a mortgage. The media was in there whipping things up with articles and TV shows on how to make money in the property market. Then, like the emperors new cloths, everyone suddenly found themselves over exposed in public.

How to stop it happening again is a bit more problematic. Some kind of legal obligation on the lender to ensure that the loan is affordable for the term perhaps?

Market failure

It was a the market in Collaterilised Debt Obligations that triggered this whole mess in the first place, in turn fuelled by artificially cheap money. It's always puzzled me that even the 'red in tooth and claw' capitalists from Adam Smith don't suggest a 'free market' in Bank base rates. Why let the Fed mess it up by setting interest rates? Why not let the market decide? Err..because they don't work...

As for housing no-one has mentioned the obvious point that a market in land does fail since you can't realistically make more of it - hence supply is capped. This becomes painfully obvious to people in the UK forced to buy new builds on flood-plains. That being the case adding more speculation is hardly going to help.

A comparison with the German housing market is instructive - what's really needed is a change to people's expectations around home ownership. Sorting out the dismal lot of private tenants in the UK would go a long way to address this.

@Greg

No, because you're the only person I know who's so into Babes in High-Heeled Powered Armour ;-)

New theory? - try July 1944

The root problem is nothing to do with lack of markets, cheapness of credit or a supply/demand imbalance. It is the imbalance caused by one part of the market sucking up cash well beyond the total underlying value of the assets involved.

JMK warned against exactly this type of problem at Bretton Woods and in particular the need to have a correcting mechanism to redistribute surpluses when they threatened to imbalance the whole system.

Of course the Yanks couldn't see this. They thought (and still do) that they could carry on accumulating surplus with no negative effects. So we have the 'natural economic cycle', the rich getting constantly richer and the developing world left ever further behind.

As for the book and the housing market:

The model proposed would merely allow speculation on whether the credit market for domestic property would speed up or slow down - nothing to do with the underlying value of the assets themselves which is going to be fairly stable (and way below the 'market' value). It would do nothing to address the ever increasing pile of cash and credit that is being tied up (unproductively) in domestic bricks and mortar rather than getting out into the real world and driving some sustainable growth.

You've got to love the sheer audacity of the financial sector in the housing market - getting consumers to drive up prices for them so that they can cream even more off the top. No wonder developers won't build anything - what's the point when for a fraction of the cost you can simply resell something that was built a hundred years ago. The cost of new build is practically all loss.

What is needed in the UK is a healthy rental sector encouraged by some sane legislation that encourages someone other than the naked greed idiot brigade (AKA close your eyes and plunge in blindly buy-to-letters) to become landlords. The immense feeling of schadenfreude as this mob lose their shirts doesn't make up for the misery that our housing model causes.

Of course we did have the beginnings of a rental sector but we flogged it under right-to-sell your children into homelessness. Isn't it curious how the licenced thievery that was endowment mortgages coincided with that particular scam - let 'em sell their futures to us and pay us three times for the privelege - 1) for the interest on the loan, 2) for the crappy insurance premiums and 3) for the shortfall when the crappy insurance policy (surprise, surprise) fails to deliver the riches of Croesus as promised - at least the salesman and insurance company got their bit (that was what the premiums were).

Personally, I thought the cheekiest bit was when it was becoming clear that endowment mortgages were actually a stinking pile of rotting fish. Were the financial services sector at all dismayed - not at all - like the widest wide boy flogging pirate DVDs at the car-boot they slapped a new label on, put the price up and sold them as 'pensions'.

It would be funny if so many people weren't going to be condemned to old-age poverty because of it.

Creating more "markets"

Seems very complex solution for what is a simple problem - measuring the risks that borrowers will be able to repay the money they borrowed and lend accordingly. Done properly it would put an upper limit on the money lent to buy houses - so prick the bubble before it got too high.

If the market is unable to do that - simply put a law that they can only claim 3.5x the amount the borrower paid tax in the 12 months before the loan was taken out when there is a default - thus spell out the risks to the lenders if they fail to do their job (oh and make selling defaulted property at too low a price illegal).

MaJIC Tricks ..... Real Solutions

A Bank full of Money is a Failed Institution in that it has found Nothing of Value for Money Supply/Inventor Spend 42 Create. And written off/written down Funds are Credits Freely Available and Floating around with a Home/Spender.

I should Like to Avail myself of a Fair Packet of that Action........ for I have a Cunning Plan ..:-) which Guarantees no Loss of Investment.

Lots of lovely theory, why not start fixing NOW?!

Another article suggesting we tinker with the fringes of the system. This doesn't address the basic problem which is that the system is fundamentally broken because the major players are basically corrupt, gambling in an unregulated manner with other people's money, keeping the winnings for themselves not their customers, and not taking any of the losses themselves but simply passing their losses onto their investors/customers. The corrupt broken system is not going to be fixed because the people in charge are beneficiaries of that corruption. A different answer is needed.

Close your existing current account, move it, and your mortgage, your home and car insurance, and anything else you can think of, to financial services providers where the idea of gambling with other people's money is heresy (literally).

Don't know what I'm on about? Fair enough. Shariah finance (aka Islamic banking) is what you need to look at, and the more folk that take it up, the less there is for bonuses for the ungodly money-worshippers in the City, and their followers around the world.

Whatever your religion, if you have children, you owe it to them to vote with your wallet once you have done the research and convinced yourselves that this is the future, and then the CIty will see that things can and WILL be done differently in future, and your children, and their children too, will thank you for it.

How do the bears

It's the vaguest proposal with no understanding of how things work. Discussing it just seems impossible. I keep starting then stopping again trying to find anything that could be a starting point.

One area, a trader defaults on his geared bet and commision. Which currency would you trade in for homes, what about the Basel II capital reserves and risk %, how do these differ. Would a spiral of the trading partner such as a bank owning assets which it secures loans on, falling in value , be caught by being unable to cover other commitments, I presume we don't just bet futures on the value of housing.

The insurer would be covering an entire country, how could they possibly secure even a fraction of the total. The system as described with no ratings, regualtion, capital or indeed money means I would make a bet, win or lose, bet more and so on. When I had 100 Billion after losing 100 Trillion and making 100 Trillion 100 Billion after 4 years, who was supplying the capital to cover this risk and....

Next week on The Onion...

Great column. Sprayed tea all over the laptop.

@Mike Street

Mike hit the nail on the head - the corporate form of governance isolates top managers from any downside to risky behaviour (as long as it is not provably illegal!) while compensating them highly for risky behaviour that pays off.

Frankly, ANY other discussion is a fail if it does not address this - any discussion of market dynamics, demand curves for resources, self-correction, etc...they are all just re-arranging the deck chairs. As long as you have top corporate managers who's only reaction to risk is to assume MORE of it if it looks profitable in the short-term, and believe they personally can make a bundle during that short-term, then no systemic fixes will work. There is always SOME way to game the system (mis-calculate that risk, hide it in sub-corporations or outside players, put it off-balance sheet, create "off-sets" that aren't really offsetting, etc.) that smart people will find - and you are dealing with people smarter than those regulating them in many cases.

The root of the problem is the broken corporate governance model, especially in the huge number of cases where the board is actually under control of the CEO or outside investors who only care about short-term profits. Until this structural deficiency is addressed, the rest is just mental masturbation...

Sub-prime loans

What was mised was the way banks were able to make these loans

Normally a bank is allowed to lend £10 (dollars) for every £1 it holds on deposit(rough guess but its there in the regs somewhere)

What the banks wanted to do was lend more people money, thus making more money from the interest, but once that £1 had been lent out 10 times that was it.

So they packaged the debts together, and sold them on

In effect for every £1 on deposit, they lent it out 20 30 even 40 times creating a vast mountain of debt, sold on the markets to anyone who would buy it.

The managers took home big bonuses for being clever and the regulators could only see the banks lending out their deposit money 10 times as per the rules

Quite frankly the managers responsible for the mess should be up on charges of fraud and not standing in line at the government's door begging for money

more causes

Perhaps the most direct, tangible cause is that realtors and mortgage brokers are paid on commission. Their cut is a percentage of the sale price, so they have an incentive to make as many sales as possible and at as high a price as possible, regardless of the borrower's ability to repay the mortgage. Many falsified documents and used other means of fraud to make clients look more credit-worthy. However, this alone would not be enough to cause a crisis; banks would have noticed that many loans made by certain brokers were defaulting, and investigated why this was happening.

The next problem is the complexities of financial dealings. A package of, say, 1000 mortgages could be sold as an investment that would be sold as an investment that would return $250 million over the next 20 years. But the details of the loan, such as interest rate and income of the borrower, are lost in the paperwork. It comes as a complete surprise when people start defaulting en masse and the value plummets to $100 million.

There are tens (hundreds? more?) of trillions of dollars on paper floating around the financial industry. Only a fraction of this corresponds to a real entity or can be readily converted to actual money. Recall the dot-com millionaires, who were wealthy on paper, but were left with nothing when the stocks crashed. For a more recent example, see the collapse of auction-rate securities earlier this year. When the market for them died, hundreds of millions of dollars were trapped in these securities which could not be sold or accessed by investors.

What is needed is not another market for intangible assets, but more transparency. Even experts at major financial institutions admit that no one really understand how the industry works. Until we do, this sort of thing will continue to happen, as it simply cannot be predicted.

DeadHead Rule ..... AI Natural Default

"Mike hit the nail on the head - the corporate form of governance isolates top managers from any downside to risky behaviour (as long as it is not provably illegal!) while compensating them highly for risky behaviour that pays off." ... By Robert Hill Posted Monday 1st September 2008 23:20 GMT

Robert, It is all illegal because the gambling is all done with money created by peoples toil and production since time began and which is salted away/denied them by the Usurers who would even then charge them more to Use what is already theirs, but which has been stolen/spirited away by Suits who think they are Invincible/Invisible/Smarter than the Average Bear. They are no more than Crooks of the Most Vile and Putrid Kind for their Love of Money is the Root of All Evil, it is truly Said.

"Lots of lovely theory, why not start fixing NOW?! " ... By Anonymous Coward Posted Monday 1st September 2008 19:05 GMT ..... is a Valid Starting Point for the Great Fix ........ and who knows, if there is any Intelligence in Wall Street Capitalism, their Bankers will SWIFTly convert to Shariah finance/Islamic Banks or watch their Funding Streams Divert and Disappear as Investors Realise the Deceptions played upon them for the Obscene Pleasure of Unnecessary Greed and Intellectual Arrogance. The Live Evil/Cancerous Growth in their Midsts.

"What is needed is not another market for intangible assets, but more transparency. Even experts at major financial institutions admit that no one really understand how the industry works. Until we do, this sort of thing will continue to happen, as it simply cannot be predicted." .... By Kanhef Posted Tuesday 2nd September 2008 01:15 GMT ..... Spoken like a vulnerable banker/investor, Kanhef. The Industry works like a Scam for it is predicated on Dreams which are tied to the supply of perceived wealth/printed paper/currency. Control the Flow rather than Supply the Flow of Global wealth has you sitting in Control of Dreams and Reality.

That is How IT Works in two Short Simple Sentences.

What would you like to do about IT? Ignore the Facts or Change the Rotten System for Something/Anything Altogether Beta, for of course, IT will be Registering and Monitoring its Live Rebuild with ITs CyberIntelAIgent Reaches into Virtually Instant Global Communications Networks InterNetworking Influence and Affluence to New and More Wwworthy Homes/Stores/Hubs/Safe Havens.

The Old Money System with Powers in Control is Dead .... Long Live the New Money System with IT Control of Powers instead.

The market is mostly just fine, thanks

This article goes on and on about markets but it's really just about hedging, which is certainly not the same thing as a market.

However, while creating a hedging mechanism (not a market) is an interesting idea, it is not a good one. There already are many hedges for the housing market. You can short housing stocks, buy put options etc etc.

Furthermore, consumers are particularly bad at insuring themselves adequately or even understanding risk. That's really why the housing bubble occurred. People like to hear "this market's gonna keep on risin', baby." Generally, they're also not very good at understanding financial instruments like options.

What's more, futures and the like are themselves very liquid, very risky instruments whereas a house is not. A homeowner could find themselves forced to sell the entire house at a discount in order to cover hedging losses.

Yet most homeowners don't even have access to such financial instruments simply because they are too risky and, although intrinsically simple, difficult to understand. Do I buy a call or sell a put?

We don't need another 'market' - ok, just a hedging mechanism. We also don't need a lot more intervention ie regulation in the existing market. However, there is a need for better monitoring of abidance of the rules of the market because this market failed due to lack of 'policing' not because of a lack of rules.

There is one major distortion in the UK housing market. Buy-to-let causes a shortage of housing supply and is also well-rewarded by HMRC. Unfortunately, rectifying something as simple as this is insufficiently dramatic or far-fetched. No one's going to print a story about a change in taxation when they can scare readers with the worst slump in 60 years.

Clearing the AIRwaves of Dross and Petrified Thoughts

"This article goes on and on about markets but it's really just about hedging, which is certainly not the same thing as a market." .... By Anonymous Coward Posted Tuesday 2nd September 2008 08:58 GMT

You can say that until you are blue in the face, AC, but the thread is about the dire straits need for wholly different markets, which dispenses with leads from the corrupted financial controls of the less than worthy. And if that should see their little ego empires collapse rather than flourish in their Unbridled Support of Virtualisation of the Great Game, then who would they have to Blame but themselves whenever they are Appraised of the Paradigm Shift in New World Order ProgramMIng. The Offer is there for them to Support IT with Global Wealth. After All, it is not as if it is their Money which is being Spent, is it, although too many are Stupid enough to tell themselves that Tall Tale and thus are Frightened to Spend IT Freely and Wisely for IT to come around to them again for their Philanthropy?

Take a Bow all those Pontificators a la Buffet/Gates/Soros to name but three, who promise a lot but do practically nothing.