Never heard of that myth…..please explain. I think that people’s behaviour is a rational response to the incentives they are given. The problem is that the incentives, which amount to macro moral hazard, are not sustainable.

the US v foreign flow spreakdown on spread products would be interesting, but it will also be distorted by all the SIV activity/ hedge fund activity offshore. There was a huge surge in foreign demand for spread product from the UK from 03- mid 07, but it looks to me to have been artificial, meaning that entities in the uk borrowed from the us (via the money market) to buy long-term us debt, and were only offshore in the tax and legal sense. they weren’t intermediating foreign savings.

When I noted that Americans hold a lot more Agencies than foreigners, Brad pointed out that flow was more important. I’m glad to see the US/foreign flow breakdown on spread product.

Sound like the myth of the irrational voter to me. You know the guy is not irrational, right?

I agree that people are not stupid. On the contrary, they have learned that if enough other people are taking the same financial risks as them, their downside will be limited by the political imperative to bail them out.

The meltdown of Agencies is only the begining, the Treasuries will be next.

Come to think of it, the idea of displacement inspires another argument against the theory that central banks played an active role (as opposed to a passive role through their currency pegs) in creating the US debt bubble. That is that the volume of spread product created exceeds the growth of foreign exchange reserves. From the beginning of 2003 to mid-2007 when the credit crisis struck, global dollar foreign exchange reserves grew by about $2tn, whereas US non-government debt grew by about $8tn. The outstanding stock of CDOs alone grew from very little to about $2tn in the same period.

Perhaps dollar-pegging central banks can be blamed for not raising the level of the overflow outlet as they entered the bath, but the US borrower kept the taps fully open.

In my view, the facts are more consistent with a story in which the irresistible force of a US credit boom ran into the immovable object of dollar currency pegs.

Your second para hits the nail right on the head. But why are people so stupid to believe all those snake oil salesmen offering low borrowing costs and high investment yields? Because they do not believe, realize, have not been taught, etc that lunches have to be paid by someone. I do not think people a stupid, they are just optimistic about their own ability to avoid paying. They expect that everyone else (the community that pays tax) will pay.
And they are right up to a point. I believe that the US taxpayer should be not too concerned about bail-outs (there is of course the moral issue that reckless equity investors and crooked managers took on risks voluntarily that were so transparent that they do not deserve a bail-out. But Joe taxpayer might expect that next to warfare, the gvt may also spend a little on his more specific welfare. And over time, that is what has happened, and then bracket creep bailed out the government, and even more lately, an even less painful process took care of things, greater fools from abroad.

I think our only disagreement is how broad my “market conditions” clause was. No question, this is a possibility and perhaps a probability.

Thanks for flagging the tax change. I’m luckily too young to have been financially aware back then. It’s a serious mistake — amongst many made — that would’ve been even more consequential if our IRS were sufficiently staffed to even do its job. The more I learn about history and the world, the more inspired and awed I am that we’ve made such amazing progress despite ourselves.

But, ndk is missing the psychological component. Usually when a bubble bursts, prices end up falling too far. Lots of people who bought houses during the bubble and lost their life savings will not likely take the plunge again. I’m betting that housing prices will decline much farther than 30%, even if easy credit is available.

And let’s not forget that it was President Clinton’s 1997 change in the capital gains tax treatment for housing that may have gotten this bubble started. Bad economics policies can be extremely destructive.

Clinton replaced President Truman’s sensible capital gains deferment when homeowners sell one home to buy another with a new treatment that encouraged speculation. See our Enter Stage Right commentary: ( http://www.enterstageright.com/archive/articles/0808/0808ecgrowth.htm ) or our blog posting about the congressional attempt to finally close the barn door that Clinton opened ( http://tradeandtaxes.blogspot.com/2008/08/clintons-1997-tax-cut-contributed-to.html )

Howard Richman