Monday, September 29, 2008

"Goldilocks Market" - Competition on the Edge of Chaos

What "philosophical" issue could justify posting this photo of me precariously negotiating the wet sands of Daytona Beach on a bicycle yesterday?


Well, it is the "Goldilocks Market" at the heart of the present financial mess.

As you'll recall, in the famous Goldilocks and the Three Bears fable the young home intruder finds three bowls of porridge, one too hot, the other too cold and the third "just right". Similarly, beds were too hard, too soft and "just right".

It seems we've slipped from too much regulation to too little and are now searching for what is "just right". How to navigate the narrow "just right" line between the "bulls" and the "bears"?

In the era of too much regulation, the economy was mired in the doldrums with a slow growth rate. Then, with less regulation, things picked up, competition increased, consumers found a wide variety of excellent products and services available at great prices, and house values continued to increase. Things were "just right".


However, the situation of a business in a competitive market may be thought of as like a surfer "catching a wave" and staying "on the edge of chaos". I watched some surfers at Daytona Beach. If they were not aggressive enough, they would slip behind the wave and end up in the doldrums of the flat ocean, waiting for the next wave. If they were too aggressive, they would fall off the sweet spot at the head of the wave and into the chaos of the churning waters. The waves at Daytona on Saturday were not big enough for most of the surfers and very few managed to catch the wave. (Too much "regulation"?)

Was it the lack of sufficient regulation that led many financial services executives to become too aggressive and ignore the risks, taking their companies into the abyss of failure? Or, was it the knowledge that their firms were "too big to fail" and that we US Government Taxpayers were bound to come to their rescue? I think it was a combination of both.

Over the past few decades, we taxpayers have bailed out: 1970-Penn Central RR $3.2B, 1971-Lockheed $1.4B, 1974-Franklin Natl. Bank $7.7B, 1975-New York City $9.4B, 1980-Chrysler $3.9B, 1984-Continental Illinois Bank & Trust $9.5B, 1989-Savings and Loans $294B, 2001-Airline Industry $18.6B, 2008-Bear Stearns $30B -Fannie/Freddie $200B -AIG $85B -Auto Industry $25B -Financial Industry $700B (proposed).

It seems to me we have established a pattern here of "Main Street" bailing out "Wall Street". Is it fair to force ordinary taxpayers, working hard for a living and making due in small homes and cars to "pay the piper" for the excessive parties of the rich and infamous business and financial elite?

I'd like to see them "stew in their own juices" - but we've been warned that if we don't agree to yet another bailout, there could be another depression and we could all lose our jobs and homes and savings and retirement incomes and so on.

I'm not sure what the correct answer is, but I think CONgress (the opposite of PROgress) needs to spend at least as much time coming up with the correct solution as they did, for example, considering the issue of drugs in professional sports.


But, back to something I do know, the photo above. Automobiles are allowed to drive on Daytona Beach. They pack the sand down along a couple of lanes extending from about twenty feet from the top of the beach to about fifty feet. On Saturday, as the tide went down, I was able to bicycle along the auto lanes from our beachfront hotel north for four miles, almost to Ormand Beach. The sand was "just right" - not too dry or wet and solidly packed down.

I had to stop when I came to an area of dryish sand that was marked "4-wheel drive vehicles only". Apparently that area, while wet from the tides, is not packed down enough to support a car or, as I found out, a bicycle.

Packed wet sand poses an interesting physics problem. When it gets too dry it is too fluffy to support a car or bicycle. On the other hand, when totally under water at high tide, even the packed down auto lanes are too unstable to drive on. Conditions need to be "just right".

Well, the above photo was taken early Sunday morning, just an hour or so after the highest of high tide. The auto lanes were intermittently under water. The tide had receded a bit and the sand near the top of the beach was dryish but not packed down and the packed down sand in the auto lanes was too wet. However, after experimenting a bit, I found a narrow "Goldilocks zone" where the tide was receding and conditions were "just right".

I hope Congress and the President and the Treasury Secretary and all can do the same.

Ira Glickstein


Howard Pattee said...


I think "edge of chaos" is more than an analogy. I think it is a good model of the economy. When you are riding the wave right your policy is to use the power of the wave "just right." When you lose it or wipe out you change policy completely and fight against the waves to reposition, at which point you change policy again.

I see the problem with most politicians is their ideologies don't allow such rational and abrupt changes of policy.

Surfing also requires great skill while riding the wave. Successful businessmen have it, but not many economists or politicians.

Ira Glickstein said...

Thanks Howard - but if we agree too much what value will this Blog have?

I read this from CNN and it makes quite a bit of sense to me. It is written by Jeffery Miron a Harvard University senior economics lecturer and says, in part:

"This bailout was a terrible idea. ... The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

"Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared. ...

"The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

"Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable."

What do you (and others on this Blog) think?

Ira Glickstein

Howard Pattee said...


I read the same article, and Miron’s argument make sense provided that those who made bad decisions are the ones who bear the costs of failures. This is currently not the case. The effects of failures have rapidly spread throughout the whole economic system. As you know, stocks, bonds, and even the value of currencies largely depend on the individual’s confidence in the whole system and ultimately in the stability of governments.

I agree that even without government intervention the system will eventually “correct itself” one way or another. However, I don’t see much evidence that the government’s doing nothing will result in the most painless correction.

For example, we all eventually would recover from disasters like earthquakes and hurricanes without government help, but it is easier with help. Also, such disasters would be less serious if the government enforced building codes. Financial “codes” are needed for the same reason.

Miron’s view seems to be an extreme position. The current disagreements are not about whether the government should do something. The disagreements are mostly about the details of how the help is distributed and how it is managed. Since apparently nobody can predict results, it is essential that regulators constantly evaluate the results objectively.

Unfortunately, most of the political arguments I hear are ideological. That is, they are faith-based economics (e.g., supply-side tax policy), which I think is one major cause of the mess.

Ira Glickstein said...

We agree again. As this comment is being written (9:30PM Wed), the Senate has passed the Bailout bill handily and the "talking heads" seem pretty sure the House will follow suit tomorrow or Friday with an identical bill, but by a closer margin. The original 3 pages have grown to 400, including a provision that helps a company that makes wooden arrows (no joke).

You raise an interesting point when you justify government intervention: "For example, we all eventually would recover from disasters like earthquakes and hurricanes without government help, but it is easier with help. Also, such disasters would be less serious if the government enforced building codes. Financial 'codes' are needed for the same reason."

I guess the government is obligated to rescue those foolish enough to have built their houses on well-known earthquake fault lines and on low-lying coastline in well-known hurricane zones. By allowing these houses to be legally built (building codes, certificates of occupancy, roads and other infrastructure, subsidized flood insurance, etc.) the government has, in essence, put its stamp of approval on this risky behavior.

OK, we need to rescue the victims and make them whole again. If private insurance is insufficient, public money must be used. However, why does government then allow people to rebuild on shaky ground, sometimes after multiple disasters?

Fannie/Freddie were quasi-governmental entities and politicos on both sides pressed them to make risky loans. Now we are going to obligate $700B to cover that govenment action.

Once the credit markets are stabilized, why can't we agree that, in the future, we will not put the government stamp of approval on well-known types of risky behavior. We should cut Fannie/Freddie loose, perhaps broken up into pieces and sold off.

The virtually unlimited government safety net encourages risky behavior. Bailout costs have increased to the point that that risky behavior has put our entire Country in peril.

I hope the next Administration and Congress has the guts to reform the situation and use government to regulate those things that are within its competence and make it clear that private interests are on their own in other areas.

Ira Glickstein