Mind Over Money on PBS

[jkjsooner]

Did anyone watch "Mind Over Money" on PBS last night? It was really interesting. It basically discussed the rift in economics between the behaviorists who believe that people sometimes act irrational and therefore the markets can in turn be irrational and those who believe in that markets can be modeled by assuming that the people act rationally.

I'm actually surprised there is any debate left. In my eyes the real estate bubble is plenty proof that people (even cumulatively) can act irrational and do so for a long period of time. The Wall Street firms who bet the bank on the idea that consumers would act rationally paid the price (or at least would have without bailouts).

Ironically, the guys from the Chicago School of Economics seemed to display their own irrational bias when it came to their own theories. They seem so attached to these theories that they couldn't see what was obviously in front of them.

Anyway, if you saw it what did you think of it. Even if you didn't, what do you think of this debate?

[jkjsooner]

As a side issue, I couldn't believe that economists still argue that 2006 home buyers in bubble areas were largely acting rationally.

There was an assumption of ever increasing home values. In one study most home owners expected that their homes would continue to increase in value 15% per year for the next 10 to 15 years. It doesn't take a PhD in mathematics to figure out that this is quite simply impossible (without extreme inflation in both prices and incomes).

Even if you assumed that most buyers could afford their house, this was predicated in many cases on extremely low interest rates. Even if those rates were fixed, it is irrational to ignore the risk that rising interest rates would negatively impact a home's values.

[cleller]

Hopefully I can find it online to see. Investor behavior/psychology is interesting stuff.

Someday some brain-child will find a way to keep a running gauge of exactly what the average citizen is doing with their money. One could then do the opposite, and be rich. Timing is the only missing link.

[pphilfran]

I am a contrarian....when everybody is buying the end is near and I tend to sell....and when everyone is selling the bottom is near and I tend to buy more...

[TUSooner]

How long til someone accuses "liberal" PBS of trying to punk the Chicago School? (Call me a pessimist.) :-/


Wish I had seen the show; I will look for a rerun. Thanks.

[pphilfran]

Here it is....

http://video.pbs.org/video/1479100777/

[jkjsooner]

I watched it again last night. I forced my wife to watch. On the second watch I noticed they it kind of wanders a little bit. I don't think the production value matches a good Frontline documentary but the topic was interesting.

[cleller]

Pretty good show. Think I may have seen parts of it before.

I was disappointed that it did not explore the possibility that 50 years ago, this "rational" approach was valid. Now, with the rise of government dependent idiots populating the land, and novices taking part in the equity markets, thing are much more "irrational". Seems obvious; to me. Is that rational?

I do think the old "ivory tower" idea is still a consideration. These academics just don't get out into the vast regions of idiocracy enough. If someone will spend their cash on goofy clothes, car rims, and man-caves, they'll definitely spend more than they should for a house.

[AlboSooner]

Thank for the heads up.

I was contemplating on getting the new iPad, and that show killed that desire.


I do think Keynes had it more right than wrong. Not totally right, but mostly right.

[Chuck Bao]

I didn't see the documentary, but judging from the comments in this thread I'd have to say that I agree.

I haven't kept up with what universities are teaching these days, either. When I told my old economics professor a few years ago that the textbooks in the 80s need to be re-written, he agreed.

In the history of mankind, markets have always tended to over-react, driven by alternating bouts of greed and fear. Is that rational? I guess so given an ever-changing risk/return perspective. Can market performance be broken down into individual participant rational choices? I'm skeptical on that. But I also have to admit that examining the psychology of the market versus the psychology of the individual could be a very useful tool.

Global markets have changed a lot in the last 25 years. The first key change is technology, particularly communication, which allows huge sums of money to be instantaneously transferred around the world. This coupled with the systematic lowering of international trade barriers has substantially shortened the investment cycle. The third component is the huge amount of money sloshing around the global system created by the massive retirement funds in the developed economies and the growing popularity of the non-regulated and aggressive hedge funds.

I was taught that more participants in a particular market would make it more efficient. But that seems to be a wrong assumption at the present, in my opinion. In the short haul, the weight of money betting on one side is the real driver and that is more about the rational choices of Wall Street rather than rational choices of individual participants.

[jkjsooner]

Chuck, I'm glad you commented on this. I was hoping to hear your insight since I know you know a lot more about this than I do.

[cleller]

When they would describe rational economic theory, I was thinking, "yep, that's how I would operate" in a given scenario. So, if Keynes had a nation full of people like me, he'd be right on the money. 50 years ago, that would be the way to go. (I consider myself stuck at the year I was born, 1962.)

People today are much more irrational with their buying habits and decisions, I think. Whether this means Keynesian Theory is now compomised, I have no idea. I think it should at least suggest that present day economics be open to concept of a change in people's behavior from Keyne's day.

There. Me, the conservative espousing an attitude of change. Funny how academics usually are thought of as liberal progressives, and many economists still cling to the "invisible hand", Keynes, etc.

[jkjsooner]

When they would describe rational economic theory, I was thinking, "yep, that's how I would operate" in a given scenario.

Same here. I'm pretty analytical and conservative when it comes to finances - unless women are involved and then I become pretty darn stupid. I'm sure deep down I fall into some of the traps but I don't think I would follow the typical patterns.

For example in the $20 game I would never have bet more than $15 or so. I would have seen ahead of time how it would play out. I suppose I could get stuck owing $15 with a $16 winning bet but that's unlikely.

As for the trader game where the stocks were going to be worth nothing at the end, I would have bailed very early knowing that there was going to be a sharp decline somewhere. The only way I would have stayed on is if there was only one winner who gets to keep some money. In that case it makes sense to gamble that you might be the last person to sell high as jumping out early would guarantee that you don't win either.

I will tell you one way where I find myself being somewhat irrational. I was a big believer in the real estate bubble. I simply couldn't believe what people were paying for houses and I couldn't believe how illogical their arguments were when attempting to justify the runup in housing prices. (I mean, c'mon, you really trust the national association of realtors chief economist?)

Anyway, fast forward to a year ago. I moved to a cheaper area and we decided it was time to buy a house. I knew there is still significant downside risk but after buying the house I find myself looking for reasons to believe the housing market might turn around. It's just human nature to look for reasons to validate the decisions you've made. I have to bring myself back to reality from time to time.

[cleller]

How about this new "insurance" they are advertising on the radio: Home value insurance. Now that the housing market is slogging around the bottom, they want people to pay money to insure the value of their house doesn't fall further.

[Chuck Bao]

I'm sorry, but either I am missing the point of the documentary or you guys are. Or, maybe the film makers left it intentionally ambiguous.

Are we talking about market theory, whether efficient or inefficient based on rational or irrational behavior of market participants? Obviously, if the market is inefficient then behavior of the market participants would be a secondary matter. This is what I am arguing.

It appears you guys are trying to tie it down to irrational behavior of participants and the inability of market forecast models to anticipate it. Then, you are just talking about inputs or the quality of the forecast models.

[cleller]

To me, the whole point of the show was whether or not people behave in a rational manor when it comes to investing, and spending their money. The show seemed tilted to suggest that people often behave irrationally, when the market theorems are supposing they behave in a rational manner.

That's what I got, anyway. Maybe different people take different things from. The focus seemed more on individuals....

[Frozen Sooner]

There seems to be a whole lot of misunderstanding of what "rationality" in the economic context means going on here.

[jkjsooner]

It appears you guys are trying to tie it down to irrational behavior of participants and the inability of market forecast models to anticipate it. Then, you are just talking about inputs or the quality of the forecast models.

I think this is in essence what we're talking about. Maybe this helps:


NARRATOR: The main model of consumer behavior assumes that we never buy anything until we've calculated the impact on, for example, our retirement fund, and we're so good at math we use interest rates to compute our pleasure, over time, after buying something.

ROBERT SHILLER: What are you talking about? What interest rate do I have in my head? That's the kind of thing that the models require that everyone is consistent about.

NARRATOR: Rational economists concede that people don't actually do these calculations, but they have a well-known defense: "as if."

EUGENE FAMA (University of Chicago): The way economics textbooks are written, they don't say people behave this way, they say people behave "as if" they were doing this.

[jkjsooner]

There seems to be a whole lot of misunderstanding of what "rationality" in the economic context means going on here.

Please explain.

[Chuck Bao]

Please explain.

Froze is far smarter than I am, but I want to say that the economic models are always a work in progress and very poor in actually predicting the future. In this case, the introduction of complex market derivatives, the weight of money, Wall Street greed and the spend-now mentality of American consumers were not forecast by any economic forecast models. For example, I didn't realize before the crisis that Americans were refinancing their mortgages to get money upfront. Do you consider that to be rational behavior? I don't. But, I guess that some others who did so successfully would disagree.

[Bourbon St Sooner]

I haven't seen the show but I wouldn't mind seeing it. I think you almost have to look at the housing market in the largest bubble markets as almost 2 different housing markets. There was a lot of speculation in these markets and a lot of short term investors buying up property and holding it for 3,6,9 months and turning it over for, at the time, tidy profits. That draws in more investors and you have a cycle of ever increasing property values. Is that rational behavior by the investors? Well when you're looking at a short term holding period and looking at the profits being generated at the time, it may have seemed rational.

Then you have the folks that just wanted to buy a house. Why do you buy a house? You move. You're a first time home buyer. These people are looking for a house and looking at what they can afford at least on a monthly basis. You have to pay what the market will bear. Is there any thought that the market is over-value? Well it's never happened before that home prices decline in value, so these folks aren't really considering that as a possibility. So did these folks act irrationally?

[jkjsooner]

Then you have the folks that just wanted to buy a house. Why do you buy a house? You move. You're a first time home buyer. These people are looking for a house and looking at what they can afford at least on a monthly basis.

First, many people could not afford the monthly payment. They assumed inflation would bail them out. Secondly, looking at only the monthly bill is a mistake in my opinion as you should always consider the risk that interest rates will not stay at historic lows forever. That's not even talking about people who took teaser rates, etc.


You have to pay what the market will bear.

Renting was always an option and many smart people did just that. It became far cheaper to rent vs owning. Unless you assumed some kind of absurd return on investment, any type of time valued analysis would have led anyone to conclude that renting was the most financially responsible decision.


Is there any thought that the market is over-value? Well it's never happened before that home prices decline in value, so these folks aren't really considering that as a possibility. So did these folks act irrationally?

Just looking at that cost to rent / cost to own ratio should have been a warning sign. And that ratio was out of whack even with low interest rates. That should have been an even larger warning sign. Or just looking at the unprecedented runup in housing prices should have been a warning sign.

We may have never had a national decline in housing but we've had a lot of very severe regional declines. Florida and California have both had their share of them.