Arnold Kling  

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Megan McArdle brings up two. First, she writes,


Probably the best way to avoid the problem is to keep financial professionals in the game longer. The money and stress of banking means that its titans tend to retire early. Bubbles seem to be a natural feature of asset markets, from tulips to houses, and the only known cure is repeated experience of them.

She is trying to answer the question about what sort of regulation, in hindsight, would have averted the bubble in housing and subprime lending, without other adverse consequences.

It is interesting that both at Freddie Mac and Fannie Mae, a lot of institutional memory got lost several years ago due to turnover at the top. When I worked at Freddie in the late 1980's and early 1990's, we had to dig out of some losses from bad regional housing markets--Texas fell during an oil price bust and California and Massachusetts both suffered local busts. So we knew a thing or two about home price declines. But my friends who remained at Freddie tell me that when Richard Syron became CEO a few years ago, he made it clear to the incumbent staff his contempt for them. He certainly cleaned house one layer below him.

But even if you don't lose institutional memory in one firm, what a bubble does is create an aura of "it's a new world" that the old folks don't understand. So brand new firms become the darlings of the industry, and the older firms either watch their market shares decline or hire a bunch of younger folks and give them lots of authority as a way to try to stay with the trend.

I think that trying to prevent bubbles is harder than it looks. One of my favorite lines is that you can't make something idiot-proof, because they'll just build a better idiot.

I think that the best thing to do is try to ensure that most of the pain of financial mistakes is born by mistake-makers, preferably those who can afford it and should know better. It's ok to try to socialize some of the risk for really poor, naive market participants, but let the big boys take their lumps. In that sense, the subprime thing played out pretty well, all things considered.

Next, Megan talks about graduate student swagger.

She writes,


I was relating an exchange I'd had with an interviewer, a PhD economist, who'd asked me about my MBA. "Well, while I was getting it, I thought I knew everything," I told him. "Sadly, that turned out not to be the case."

The interviewer laughed. "Everyone thinks they know everything when they're in graduate school." He paused. "You're lucky you got over it. A lot of people never do."

Read the whole post.

I think of the arrogance of graduate school as somewhat age-related. I thought I could put down anybody--Fischer Black, Robert Lucas, Stanley Fischer. Thirty years later, I'm still not afraid to disagree with an eminent economist, but I am less likely to do so with as much attitude.

Most new Ph.D's are subjected to very strong adverse jolts to their egos. Prestigious job offers fail to materialize, papers get rejected by journals, and so on. I would think that this would drive their egos back down to earth pretty hard--it certainly did for me.

But real-world experiences may yield a more profound humility. I got chewed out by co-workers a number of times when I was at Freddie Mac, particularly when I thought I knew more than I did about computer systems, and I learned a lot as a result. My law-student daughter is in a summer legal-aid program where law students actually represent their clients in court (under a supervisor's watch), and she is finding that experience quite humbling. I don't think she is going to come out of law school with a swagger.

Maybe somebody should make a movie of relatively uneducated people doing skilled work that a typical graduate student could not do. Then show that to graduate students as they are about to finish their degrees, so that they appreciate that while they know some things, they do not know everything.


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Gary Rogers writes:

Let me throw some random thoughts and maybe someone can add more information to either prove or disprove this. Bubbles are the result of too much liquidity added to an economy, generally after an incident of some type. This happened in 1987, 2001 and is happening today. The excess liquidity looks for a place to go and will find the weakest point, just like when you blow up a long balloon. Once the economy starts expanding at that point more money follows and you end up with the classic bubble. Two things are certain. First, the expansion will happen somewhere and, second, if you stop it one place it will start somewhere else. For this reason regulation is futile. The best solution is not to add excess liquidity. There is some possibility that bubbles can be detected early and fixed with a controlled deflation, but I sure would not trust the government to do that.

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