information cascades

How a Bubble Stayed Under the Radar

The New York Times

Well, as an engineer, I have to wonder if this can be modelled as a case of Positive Feedback?

Now I don’t mean modelling the actual market ie supply versus demand, cost of interest, inflation etc. - half the folks on here seem to have economics degrees or are wannabees, so are very familiar with these. What I am talking about is the madness, the frenzy, the denial of all logic.

Alas many precise engineering terms have become used and abused by the ahem soft sciences ie non-sciences like psychology and by lazy journalists so Positive feedback is now used to mean praising someone who finally gets off their arse and does something useful etc.

In ‘our’ terms Positive feedback is feeding part of the output of a system back round into the input in such a way as to reinforce the input. Usually this is a bad idea as systems (eg audio amplifiers) soon go unstable and will self-destruct in some cases. In the property area such feedback would be anecdotal (someone your brother-in-law knows is retiring at 35 'cos he now has 5 properties each paying for the other…) or “real” in that the house you paid 100k for is 10 years ago now “worth” 500k so you somehow feel you have 400k free money with which to gamble (sorry invest) and it’s burning a hole in your pocket.

Negative feedback (despite the untrendy appearance of the “N” word) is feeding part of the output back round into the input in such a way as to diminish the input. When this was first proposed it for electronic circuits it was rubbished for 20 years after it was shown to work. In this discussion such feedback would be say pinsters pointing out that what goes up must come down or just pouring cold water on some irrational exhuberance… Alas the Pinsters are usually only heard by other Pinsters.

Getting back to the point: I have 2 examples from personal experience:
When I worked for a huge technology company - no names of course but they invented the transistor - their production system was driven by the sales forecast which relied on a piece of crap DOS based code (in the mid 90’s! - was supplied by the VP of Marketing’s husband or something). When we would input our considered opinion on customer requirements for the next 4 quarters, invariably the word would come down from on high later on for us to adjust our forecast 25% to 50% higher - because the CEO had told the stock market that we would grow by that amount, or our competitiors had forecast their growth to be 100% and so It Had To Be. So we adjusted - and later in the year got dumped on 'cos we didn’t meet “our” targets. We supplied chips we knew our customers would never use 'cos their own forecasting was optimistic… Sometimes we were supplying the same unique chips to 3 or 4 customers chasing the same market each of whom confidently told us they expected 50% to 75% share of the market - and we believed them all and forecasted like they all would succeed, and added another 25% on top 'cos the marketing director got his bonus based on his forecasts meeting the forecast of his forecast, not the actual chips shipped or payments received. Bloody madness - no wonder it all went tits up (and genius here had all his spare cash invested in some of these companies).

Another example is Market Intelligence. Oh dear. We used to get requests from IDC or Gartner and so on for forecasts. We had a rough idea of what we would ship but our responses to these guys was more what we hoped would happen eg our tame customers would increase market share, our own sales would year on year same as last year but with a 20% added for luck, nothing EVER decreased and so on. If in any doubt about a figure, we would look up some recent Market Intelligence report, and use that figure, with a bit added on top.

In both of these cases negative thoughts were not to be tolerated. If you couldn’t see everything as Onward and Upward you were in the wrong job (ie you might have No Job). Graphs always go from bottom left to top right, don’t they?

db.

I think ye are over-analysing the situation. Noone could have not noticed the American housing boom of the last few years unless they were deliberately not noticing it for their own self-serving purposes. I mean people in positions of power, supposedly trained and advised, not ordinary Americans here.

As someone pointed out in another forum, Stephen Roach, chief economist with Morgan Stanley wrote an open letter to the Fed in 2004, begging them to raise interest rates from 1 to 3 % immediately and restore normalcy to the credit market. All he got for his troubles was to be send to the farthest East.

I remember reading stuff at this time, that developers were ‘donating’ house deposits to poor people via charities, so they could get outsize mortgages and give the money to the developer. This was openly reported on in mainstream media.

Not to mention all the internet spam and banner ads… those people would have to convince us they were completely isolated from the real world to have not noticed the bubble…
In which case they didn’t deserve their highpaid jobs then… or now.

Did they not? They are in the business of making money, by selling fiat money debt to people. They did that with expert understanding of how to manipulate people financially (those who have far less understanding of debt and financing, securitization, etc., ).

As far as I can tell, the Fed definitely did listen to him back then, because around 2005 (I think) the Fed stopped reporting on M3 money to prevent exactly that sort of useful information to trickle down to the mortgage broker or bank mortgage salesperson, local banks, etc., .

I’m not a psychologist, but it’s quite funny that you refer to psychology as a “non-science” and then go on to analyse the “frenzy”, etc., by using engineering references.

The whole basis of the frenzy, the marketing, the relentless debt manipulation was based on psychological manipulation and it’s exactly why it all happened.

For example:
hbs.edu/mba/academics/coursecatalog/1490.html

  • that’s Harvard University’s MBA Program Behavioural Finance course.

I think you’ll find the “non-science” of psychology is used in virtually all areas of business, from basis personal interaction to marketing, investment and other aspects.

What was the purpose of it all? To make money, but not for you. Morgan Stanley wants to make money for Morgan Stanley; they sell a product and have a profit from it. That’s how a Centra works and that’s how international banks work.

But banks can sell you a burger, allow yo to look at it but not eat it, and they want you to give it back as a quarter pounder later on. These are the smartest psychologists as far as I am aware. Sell nothing for something.

Great post Pete. Bankers make money by inflating the money supply which does cause prices to go up.
They make money off the interest. And they make money off the seignoraige.

Down through history the most powerful people have been those who control the money supply. They consider themselves to be the “masters of the universe”.

The most expensive and prestigious buildings in Ireland, apart from government buildings are -

I admire Shiller and enjoy reading his books and articles usually, but this is awful shite. Greed drove this bubble and the supposed regulators either through stupidity or greed allowed what came to pass.