Charles Wheelan Has an Epiphany

Charles Wheelan has written an insightful column over at Yahoo!Finance, in which he addresses the appearance and consequences of false market signals:

This isn't just a bad job market - it's the popping of a "human capital bubble." Wall Street and its assorted reckless offshoots didn't just squander much of our capital; the financial industry also sucked up human talent for the better part of a decade that should have gone somewhere else. It's the human equivalent of those empty subdivisions in foreclosure that never should have been built.

That's what happens with bubbles. Resources -- including people -- are allocated poorly because the market sends faulty signals.

Does "allocated poorly" in response to "faulty signals" sound familiar? Sounds hauntingly like he is articulating the basic idea behind "malinvestment" if you ask me. Why a market would systematically give false signals, which is precisely what markets are not supposed to do and is generally cited as the reason that market economies outperform command economies, appears to have concerned him, as it should:

After all, the whole point of a market, whether it is real estate or labor, is that prices send meaningful signals. Graduates take jobs with high salaries because that is where their skills will be most productive. Developers build new units where prices are high because that is where there is the most demand relative to supply.

To his credit, he doesn't fall for the old saw of blaming "greed:"

The problem was NOT greed; self-interest is and always will be at the heart of market behavior. The problem was that self-interest is a disaster when the market signals are wrong. It's like giving someone a bad map and then criticizing their driving when they show up in the wrong place.

This is precisely correct. Greed has always been around. It is an integral part of any market, and is precisely the reason that price signals work to allocate resources efficiently. Greed responds to pricing differentials; it doesn't create them. Actually, it destroys them by sending increased supply to meet demand, or for the more rapacious, by selling short on evidence of overpricing. Blaming greed is putting the cart before the horse. Or indicting rainfall for drought. Likewise, blaming the crisis on the dishonest behavior of characters like Bernie Madoff also does not make any sense, with one notable exception familiar to regular readers. Wall Street, and for that matter, Planet Earth, has always been full of greedy, dishonest con-men. To my knowledge, they have never managed to bring down the entire global economy with their evil deeds. Most commenters have focused on lax oversight by the government and less than rigorous regulation. But seriously, the long arm of the law has never been as reliable at keeping this type of behavior in check as a competitive and efficient marketplace. Even the commies couldn't keep an eye on everyone. These people have always been around, and always will. How is it that they managed to take us all in all at once? How did they last so long without getting caught by Mr. Marketplace? On top of that, far more losses have been chalked up to stupid behavior, and stupid is not criminal. How did it come to pass that so many patently stupid mortgage notes got written? How is it that so many actors, both criminal and stupid alike, managed to get away with such awful "investment" strategies for so long without the market tearing them to shreds? In an efficient market, none of these guys would have lasted five minutes. Yet this stuff has gone on for years. As I have said before, the operative question is not how they were allowed to get away with this stuff for so long, but how they were able to in a competitive marketplace. Why wasn't inefficient pricing corrected? Why weren't losses sustained earlier? Where were these false signals coming from, and how did they manage to persist for so long? Kudos to Dr. Wheelan on making some insightful observations and using his intuition to connect some of the dots, but unfortunately, he fails to come up with a plausible explanation for where the signals were coming from, so he doesn't have the complete answer for us. Of course, those who visit this site regularly already know quite well what the culprit is, and ought to be able to give a fairly complete description of how it all works at this point. I hope Dr. Wheelan continues with his line of inquiry and finds his answer. Perhaps we'll soon have another Austrian convert.