Props to Dean Baker. 

Short-selling can play a very important role in the market. If
informed investors recognize that a stock is over-valued they perform a
valuable service by selling it short and pushing down its stock price.
This can both deprive the company of capital and be a signal to other
actors in the market that the company might not be as healthy as is
generally believed.

The economy would have benefited enormously if large numbers of
traders had shorted Fannie and Freddie 4 years ago when they were
buying up hundreds of billions of mortgages issued to buyers who bought
homes at bubble-inflated prices. This would have stopped the bubble
years ago. Similarly, we could have prevented the financial chaos at
Merrill Lynch, Citigroup, Bear Stearns and the rest, if traders had
recognized their financial shenanigans and aggressively shorted their
stock. In the same vein, heavy shorting by informed investors could
have prevented the boom and bust of the tech bubble.

The decision to intervene against short-selling is completely
inconsistent with the belief in the wisdom of the markets. Of course
short-sellers can be wrong and depress stock prices more than is
justified by fundamentals, but so what? The government doesn’t
intervene when it thinks investors have exaggerated the true value of a
stock. The public has no more reason to fear under-valued stock prices
than over-valued stock prices. This one-sided intervention by SEC is
hard to justify on any grounds.

Wow, we usually think about U.S. bonds as being the "risk-free" asset but with a credit default swap you can buy insurance on a US default and the price of such insurance is way up.

The change in price is a shock but to put things in perspective do note that the price for insuring US debt is now higher than for German debt but similar to that for Japanese and British debt.  We are still far from Argentinian levels.

Hat tip to at, in the comments to my post on the peso problem.

In Nudge Thaler and Sunstein motivate their Save More Tomorrow plan with the following unfortunate illustration:

Consider, for example, the case of Tony Snow, the former White House press secretary, who resigned at age fifty-two in 2007 to return to the private sector.  He said his motivation for leaving was financial.  "I ran out of money," he told reporters…Before serving as press secretary, Snow worked a much more lucrative gig as a Fox News Channel anchor.  But he arrived at the White House not having learned Retirement 101 lessons.  "Snow conceded: ‘As a matter of fact, I was even too dopey to get in on a 401(k).’

Sadly, Snow’s choices now look optimal.  Ok, I know that may be in poor taste but let’s try to rescue this observation with some theorizing.  Are we more likely to commit the error of saving too much or too little?

There are people who don’t save much because they have very low incomes, their behavior does not seem to be in error, especially when we take into consideration the various welfare programs that will cover people in their old age.

So let’s focus on people with moderate to high incomes.  Thaler and Sunstein say that we are more likely to make errors when the benefits are upfront and the costs are delayed.  Eating too much chocolate being a classic example.  Ok, that suggests we may save too little.

T. and S. also argue that the less frequent a decision the more likely are errors.  Frequency, however, cuts both ways – we only die once – so that’s a wash.

Over confidence and in particular the idea that we are special and will live a long life suggests the error is saving too much.  Note that we also tend to think that our partner will be alive as well.  My wife once asked me whether we were saving enough for "our" retirement.  "Sure," I said, "don’t forget one of us will probably die before the other and I’m not saving for your future husband."  "Why," she replied with a sigh, "can’t economists be more human?"   

Availability bias probably also suggests we save too much – we see people who saved too little in the street but the ones who saved too much are dead and gone. 

In theory, optimal saving equalizes the marginal utility of income across one’s lifetime – some programs like Kotlikoff’s ESPlanner attempt to calculate such an eqi-marginal utility flow and Kotlikoff’s finding is that a large fraction of Americans, some 40%, are saving too much.  Kotlikoff’s program takes into account that we may need less wealth when we are old and retired (e.g. less transportation for work related reasons) but not that the marginal utility of wealth may be lower when we are old.  (e.g. Money’s not so valuable if you don’t need it to or can’t use it to attract a mate.)  Thus over-saving may be even more common than Kotlikoff suggests.

I do not know which error is more prevalent but if we are to be neither spendthrift nor miser we need to recognize both types of error.

A government bailout of the GSEs should not be a surprise.   After all, for a long time the markets have been predicting that sooner or later there will be a very expensive bailout.  What do I mean?  According to Freddie Mac (quoting the OMB)  "mortgage rates are 25 – 50 basis points lower because Fannie Mae and Freddie Mac exist in the form and size they do."  Now, that is almost certainly an exaggeration but to the extent that interest rates are lower due to the GSEs some significant part of that is due to the market valuing the government’s implicit guarantee.  In other words, interest rates are lower because the market is valuing the implied insurance.  Now, the whole point of insurance is that sometimes the insurer must pay.  Thus the market has been telling us all along that sooner or later the taxpayer was going to pay.

Maybe the taxpayers will have to pay today or maybe in some future tomorrow but the benefits of the GSEs are intimately tied to the costs – there is no such thing as a free lunch.  The lunch may look free for a long time – as in the classic peso problem – but what that means is that when the bill comes due it will be big. 

There are none.

The bulbous root is the only commodity for which futures trading is
banned. Back in 1958, onion growers convinced themselves that futures
traders (and not the new farms sprouting up in Wisconsin) were
responsible for falling onion prices, so they lobbied an up-and-coming
Michigan Congressman named Gerald Ford to push through a law banning
all futures trading in onions. The law still stands.

And yet
even with no traders to blame, the volatility in onion prices makes the
swings in oil and corn look tame, reinforcing academics’ belief that
futures trading diminishes extreme price swings.

Amazing, onion farmers and Congress panic in 1958 with the Senate Committee arguing that

…speculative activity in the futures markets causes such severe and unwarranted fluctuations in the price of cash onions…[that a] complete prohibition of onion futures trading [is necessary] in order to assure the orderly flow of onions in interstate commerce…

and for going on fifty years onion futures are banned.  Makes me want to cry.

More here on the banning of futures markets .  (A report from 1956 indicates that the fluctuations at that time were due to an attempted swindle.)

Hat tip to Newmark’s Door

On oil I will make one point adding and one point detracting from Tyler’s analysis.  First, on speculation remember that demand and supply are both very inelastic so relatively small changes in either can make a big differrence.  That means that speculation, if that is what you want to call it, can shift prices a lot without being very significant in total demand.  Because of this point Krugman’s analysis is quite right for iron ore but a little off for oil – indeed Krugman’s analysis of oil is difficult to square with his analysis of the California electricity crisis.

My disagreement with Tyler is an agreement with Caplan. 

Bryan Caplan notes that commodity prices always have fallen back down in the past and argues that is likely to happen again in the future.  I say no, the current price is your best (rough) estimate of scarcity (adjusting for storage costs), don’t expect mean-reversion, future returns (but not prices) are a random walk, and extrapolation is a dangerous method to apply to financial time series.   

No, two points.  First, commodities are not stocks and nothing need be a random walk.  Imagine, for example, that you can produce 10 units of commodity X but no more (fixed production).  Thus you produce 10, 10, 10…. Now you know that a big technological innovation is about to increase production possibilities to 20, 20. 20…..   Does the price today necessarily fall?  No.  Price today is determined by supply and demand, supply is fixed and if substitution across time isn’t very easy (you still have to get to work today, right?) then demand doesn’t have to fall much with expectations of future supply.  Thus the price is high until it drops, even if everyone expects the drop.

Finally, on oil – who really cares what the price is?  The issue is energy, not oil.  I am confident that the long run price of energy will fall.