The fourth dimension is very interesting in architecture going back to Gideon’s Space Time and Architecture, one of the great modernist architecture books. But, the more conservative or tradtional strains in architecture see the house and all of its codes and memories, its references to survival lessons learned and its shaping to survival furntions like bathing, eating and sleeping as a defense (the Fence) against time. It tradtionally creates security with timelessness ( ironically the great modernist measure of a masterpiece.)

How can anyone feel anything other than alienation when they are afraid of putting a nail in a wall to hang a treasured picture because they are afraid of weakening the commodity value of their home? Ironically the result of the “free market” as many have noted is stupefying homogenaity in suburban tract developments. Everyone dreaming of a future when they can trade up this commodity for another.

An alternate that is interesting is Oregon Truckhomes

http://www.housetrucks.com/

Here, a modern take on chattle homes, for a completely mobile labor force, outside the artificial environment for making a home (no building code, no financing) yet totally personal, no boundary between the maker, the owner and the inhabitant. And existing in four dimensions, three-space and time(motion).

just some musings.

As for books by Thaler, skip Nudge, read The Winner’s Curse.

It’s also important to pause on that word “cynicism.” Economists and what-not do portray the market as a place free from romance or other non-pecuniary connections. The relentless force stamping out these systematic “failures” is arbitrage, something financial engineers were supposedly very good at. Assuming that arbitrage would enforce efficiency and efficiency would (most of the time) dictate rational behavior on average wasn’t that bad of a premise. What was even better (in my opinion), is starting from that assumption, observing data, and seeing where that assumption generated an anomalous result. That sentence sums up a good bit of behavioral finance from ~1970 on. Trouble is, we have difficulty determining where the anomaly lies; in the behavior, or our model of the behavior, or both. The REAL trouble comes from when we make a fundamental error in those assumptions.

Perhaps an example.

Felix Salmon (a smart cookie, BTW) has an article in the most recent Wired about a default risk correlation formula developed by a “quant” named David X. Li. Basically, the formula calculates the correlation in default risk on two collateralized debt obligation not by measuring default rates (there wasn’t a whole lot of data to go on, otherwise a simpler function would work) but by measuring prices on credit default swaps for those CDOs. CDS price goes higher, default appears more likely, if two bonds have similar movements in CDS prices, their default risk is expected to be positively correlated. Seems scary and complicated, but it isn’t that byzantine in comparison to some of the other stuff being used. The article revolved around the single number (the version of the correlation coefficient for that function) which expressed the relationship between those two CDOs–CDOs which were built from dozens of swaps, bonds, and other bits and pieces of financial architecture. Managers and financial analysts grew to rely on this function to determine how risky their portfolio was. Specifically, they relied on that single number without thinking about its underlying meaning or composition.

This reminded me of what happened in the 1990s with something called Value at risk. VaR was designed to be a measure of exposure to an entire portfolio. You took all the stocks and bonds in a portfolio, determined their volatility (by using past data…this will become important), and then just figured out how much a portfolio would lose if a 1 standard deviation from the mean loss occurred (or two or three, depending on your risk aversion). That loss equaled how much liquid capital those investment banks would have on hand to cover margin calls and such. If you (a trader) suddenly had a big loss or a big change in volatility that made your VaR go up too high, they would just tell you to cash your accounts out–cut your losses. Ostensibly this was a risk management tool. Banks, investment banks, mutual fund managers would use it to keep from exposing themselves to too much risk. But managers reified this number as a single all inclusive measurement for risk and exposure. And when volatility on exchanges increased (remembering that volatility in the model just used past data) and distributions on returns followed something other than the normal distribution, managers would see losses well exceeding their VaR and their funds went belly up. That’s part of the LTCM story.

In both cases, VaR and the Gaussian copula function, people replaced complex situations with a single number that could be compared across otherwise differentiated investments and could be grokked easily. We zero in on easy to read indicators. On Los Angeles class submarines, there are basically two depth gauges, an analog and a digital depth. The analog looks…well, like you would expect, a needle on a gauge face. The digital depth looks like the face of a big alarm clock. There are lots of incident reports about submarine crews “locking in” on digital depth and not checking that against other instruments–they would keep a certain depth on the digital depth meter, unaware that the meter was broken or frozen and that their real depth was changing. That’s not a good thing. Despite years of training (the guy sitting behind the helmsmen has probably been on submarines for over a decade) and multiple people (there are ~4 people in close proximity to that gauge and 4 people who are directly responsibly for ensuring that the submarine stays at depth XYZ), crews latch on to that measurement. Sometimes they have seen the analog depth and rejected it “incorrect” because it didn’t accord with the digital depth. There is a deep cognitive bias at work here, and it is the same one that causes otherwise trained and rational fund managers, whose whole job is to efficiently make money, to replace a complex system with a simple number.

He explains how mortgages are debts which are subject to interest rate risks–if you bought your house under a standard mortgage in 1981 (when the federal funds rate was about 20%), you might be pretty upset at the rate you are paying in 1994 (when the federal funds rate is about 5%). It would make sense at that point to refinance your mortgage, taking on a larger principal to pay at a lower rate. For Dunbar, this provided a teaching moment. A homeowner refinancing their home to negotiate a lower interest rate was exercising an option which they owned by virtue of owning the house itself. When interest rates dropped or the value of the home was expected to rise, homeowners would exercise this option more frequently. In one sense, this is hardly radical. Calling it an option is an interesting twist (and does actually provide some analytical traction for pricing it…but that is neither here nor there), but it isn’t exactly voodoo yet.

At the same time, this little peek at the way we visualized home ownership proved instructive. One of the early postulated causes (much dismissed by economists, though I give it some credence) for the Dutch Tulip mania was the shift in attitudes toward the Tulips themselves. They moved from craft goods, differentiated among growers and strains to commodities and their exchange moved from growers to dealers and middlemen. Part of the complaints about “middlemen” in those days have a whiff of Antisemitism to them–or at least a good old fashion Protestant disdain for dealmakers. But the fact remains that whatever sense we had of intrinsic value was abstracted away by warrants, futures and options. Likewise as we saw the house as an investment property rather than a home we obscured our ability to gauge changes in value. If a home is a home it is difficult to see how it could rise in value, uninterrupted by any fluctuation. If, instead, the house is a vehicle for investment driven by multiple hidden options whose spot prices move with the London Interbanking Offering Rate and expected trends in home value…well it is a little easier to convince someone that they can get a risk free return.

Not just time, really, and your further comments really underscore that. We can imagine time stretching on, but imagine as well so many things staying determinate or consistent across time frames that we can fool ourselves into positing structures or models for how things work that look authoritative when viewed from one angle, but which fall apart in the face of what time (at least in this universe) seems to entail: open-endedness, the contingent unfolding of circumstance. You do a great job of conveying just how skewed from the flow of experience economic models can become when confronted with incorporating time.

And then you cycle back to reliable expectations, which I think is the right thing to do. The brute contingency of the universe shouldn’t lead us to throw up our hands, or imagine that everyone must do so as they face their own circumstance. Rather, there are “reliable” expectations, good enough to bet on, sometimes to bet the house on (oop — sorry, bad example), but they’re never perfect. In a way we are all, as Holmes put it for himself, “bettabilitarians;” we make bets with the universe which may or may not pay off.

Which leads at last to the most interesting phrase of yours: “a rare (though not unheard of) failure in future expectations and an increased ability to trade on that failure.” That seems to be the notable thing here, from a broader historical context point of view. What are the conditions that make this kind of double-whammy of failure and compounded failure possible? One thinks of Schiller’s Irrational Exuberance, or Clifford Geertz’s Agricultural Involution — I’m guessing that Kal could add an argument about marketing and pharmaceuticals to the list. I suspect that technology, as it has for the financial markets, plays an important role in making these kinds of outcomes possible.

(Oh, and gentle chiding acknowledged, hotlinking removed. :-) )

All right. Oh, from the “science fiction” end of things, you might be interested in this: Paul Krugman, while doing his time in the dilithium mines as an assistant professor, wrote an article mocking the form and subject of most refereed papers in economics. The paper, titled The Theory of Interstellar Trade deals with exactly what you might expect it to. It’s fairly clever.

I’ve always found the treatment of time by most economists to be very interesting. From a pedagogical standpoint, time enters in to the instruction path very late in the game. Most textbooks begin with “one period” (that is to say, static) models of guns or butter or what-not, and only proceed to “multi-period” well into their coverage of a subject. When they do introduce the notion of time, the tropes of the discipline are marched out to give some structure to the thing: people are rational, they prefer an apple today to an apple tomorrow, they make reasonable decisions about the future based on information at hand. That aside (and it truly may be brushed aside at the cost of simplicity), time represents an interesting and somewhat unique situation.

Most economic decisions involve a sacrifice. I buy a coffee and I can’t spend that same dollar on a cookie. Nothing too difficult to grasp. But decisions made across time are unique in that (presumably) you cannot know your state of mind in the future. When I spend a dollar today I foreclose that same dollar’s purchases tomorrow. And when tomorrow comes, I have no means by which to undo yesterday’s decision. That dollar is taken from me as surely as if it had been robbed (Of course I still own the good I purchased yesterday, but I may not value it as much or it may not fetch as much on the market).

Add into this mix credit. We have some picture of what the lifetime earnings of a worker will be in society. It makes something of an inverted U shape. Lower in the early years, where the worker hasn’t developed the skills or seniority to command a higher wage, then peaking over the 40-50s and decreasing slightly as she ages. It differs from person to person and career to career–shallower for an anthropologist than a football player, perhaps. The idea is then that we borrow while we are young from our earnings at the peak of that profile. Presumably our borrowing is sensible and we invest in our education. Sometimes it is not. Either way, someone is expected to have a fairly decent idea of our future ability to pay (or willingness, for that matter).

Those elements, the necessity of expectations and the literal differences between choice over objects and choice over time, make me ponder the special nature of the fourth dimension in economics. Here it seems like we had a rare (though not unheard of) coincidence of failure in future expectations and an increased ability to trade on that failure.

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Had a longer post about houses as financial instruments in the 1990s and responses to low interest rates and what-not, but it didn’t seem too germane to the broader question at hand, so I snipped it.

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-Adam

This is a long-established point of view, but one that has been out of fashion for some time. I also confess to be surprised to be someone making the point, since I am temperamentally suspicious of institutions. But when it’s a choice between a free market mania, driven by greed and bolstered by ideology, and the imperfect benefits of the regulation of desire, I end up choosing the latter.

But you’re right – one of the problems that can arise is that excessive top-down protection from the vagaries of circumstance can run counter to innovation. On the other hand, mandates can also drive innovation (whether that be the Manhattan Project or the Apollo Space Program). I guess I tend to think that there is plenty of room for imagination even in the absence of privation – which I guess amounts to some version of the argument against the “starving artist.” :)