Developing a New Paradigm

The focus of paradigm revision, or developing a new paradigm, is upon markets. Here are a couple of excerpts from the two essays appearing in the Fall 2007 Newsletter Supplement, the issue reporting on the research roundtable launching the HHI Subprime Crisis Research Program and the Subprime Crisis Research Council, the principle coalition implementing the program. Fall 2007 contains lead story of roundtable, Fall 2007: Don't Panic Yet contains two essays.

“Don’t panic yet! Strategies are emerging to deal with the subprime mortgage crisis. A broad spectrum of options was discussed at a research roundtable sponsored by the Homer Hoyt Institute in conjunction with the Hudson Institute, the Institute for Urban Research at the University of Pennsylvania, and the Institute for Public Policy at George Washington University….The roundtable included presentations and discussions ranging from the causes of the crisis, a variety of proposals to deal with it and prevent it from recurring in the future, and the outlook for the mortgage markets and the US economy. In convening the conference, the sponsoring institutes noted that the subprime mortgage crisis has two aspects: (1)the problems confronting homeowners who are unable to meet their mortgage payments, notably those with subprime ARMs that will automatically reset to higher interest rates and payments after two or three years; (2) the appropriate policies and actions to prevent or minimize the risk of a repetition in the foreseeable future. Current policy attention is directed largely toward the first of these issues, but it is reasonable to anticipate that the second will attract more attention over time.” This is from the lead story “Don’t Panic Yet: Strategies Emerging to Deal with Subprime Crisis.” Fall 2007

“A Strategy for Averting Housing Bubbles The strategy is to mitigate the possibility of a downward spiral in housing prices and the side effect of bringing on a recession. This paper is not focusing on the policies for dealing with the financial crisis as a whole, including preventive measures. That is for parallel work. Rather, the focus is on the avoidance of the financial crisis generating excessive impact on the housing market and the housing market generating an excessive impact on the rest of the economy including the capital market. Housing markets are generally local. The strategy is to focus on those housing markets that have the greatest risk of an addition to supply of available housing because of foreclosures or threats of foreclosures. The idea is to keep people in their houses whenever possible… The whole idea is to reduce the risk of a cascading price level that would reverberate throughout the local economy and perhaps the national economy in addition to helping homeowners that are in over their heads because they were led astray by aggressive marketing techniques and didn’t realize the risks.” This is from the first essay, “Don’t Panic Yet: A Strategy for Dealing with the Risk of the Emergence of a Housing Bubble Resulting from the Interdependence of Space and Capital Markets.” Fall 2007:Don't Panic Yet

The second essay, in the same insert, is “The Market as an Icon: The Case of the Subprime Mortgage Debacle.” The quotes are “The current subprime mortgage debacle is a failure of the market. The institutional arrangements need to be modified if we are to buttress our faith in the system in which the market represents a good way to induce production and provide distribution using price as a vehicle. Perfect market systems have sets of conditions such as a level playing field with symmetric rather than asymmetric information and equal bargaining power among players. In the absence of some of these conditions, or with some shortfall, governments intervene with regulation in order to make the system work better…A major failing of the market in the subprime case emerged from a mismatch of the distribution of risks and rewards. Great rewards went to originators, packagers and distributors of the mortgages and investment instruments derived from their packaging and slicing-an’-dicing. The great risks were borne by borrowers and by investors who wound up holding the long term instruments… A major failing of the market in the subprime case emerged from a mismatch of the distribution of risks and rewards. Great rewards went to originators, packagers and distributors of the mortgages and investment instruments derived from their packaging and slicing-an’-dicing. The great risks were borne by borrowers and by investors who wound up holding the long term instruments.”

See my notes on reviewing three books for the seminar at ASPEC. Maury's Notes on Three Books Related to the Subprime Crisis

The comment, again from the ASPEC seminar essays, is as follows:

Complex Systems - By Jack Lillibridge

This is a follow-up to our discussion in the Seminar on Strategic Decision Making and my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein. However, in the follow-up presentation I tied the discussion to complex systems which you mentioned in your main essay, Subprime Crisis Strategic Decision-Making: A Discussion of What Went Wrong and Strategies to Deal with It and which Paul Carr discussed in his presentation which included Complexity, Risk, and Financial Markets by Edgar Peters.

The theory of complex adaptive systems identifies component processes that undergird these two aspects of nature, such as positive and negative feedback. A notable instance of a complex adaptive system is a living organism, which includes elements of interaction with the environment and of memory.

This view of nature is characterized by two interrelated aspects. One is characterized by equilibrium, balance, continuity, renewal, etc., resulting in maintaining the existing order. I call this first aspect stability. Nature is also characterized by creativity, learning, exploration, risking, etc., resulting in a new, more complex, order. I call this second aspect growth. These aspects are both complementary and mutually interacting, relating to a dynamic ongoing overall process.

There is a dynamic process described as part of the theory that perhaps will contribute to an understanding of the current economic crisis, especially how it could occur as it did. This dynamic process is the time course from a persisting, stable order, through a transition or threshold, to a new, persisting stable order that is more complex. There are at least three things to understand: what could cause a transition, how could the transition occur, and what might the new order look like. For instance, what triggered the transition and what will influence the kind of new order that results?