animal spirits, financial literacy, and the housing crisis/media/documents/cd/... · the future....
TRANSCRIPT
![Page 1: Animal Spirits, Financial Literacy, and the Housing Crisis/media/documents/cd/... · the future. Behavioral economics provides specific suggestions not just for mortgages, but also](https://reader034.vdocument.in/reader034/viewer/2022050506/5f976382b7bd7135a851b756/html5/thumbnails/1.jpg)
Animal Spirits, Financial Literacy,and the Housing Crisis
Chris Foote
Federal Reserve Bank of BostonDepartment of Research
Dallas Fed Conference
Foote (Boston Fed) Housing Market Dallas Fed Conference 1 / 31
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Foote (Boston Fed) Housing Market Dallas Fed Conference 2 / 31
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Outline
1 Behavioral Economics and the Housing Crisis
Foote (Boston Fed) Housing Market Dallas Fed Conference 3 / 31
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Outline
1 Behavioral Economics and the Housing Crisis
2 Supplementary Slides: “Economics” and “Behavioral Economics”
Foote (Boston Fed) Housing Market Dallas Fed Conference 3 / 31
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Behavioral Economics and the Housing Crisis
Outline
1 Behavioral Economics and the Housing Crisis
2 Supplementary Slides: “Economics” and “Behavioral Economics”
Foote (Boston Fed) Housing Market Dallas Fed Conference 4 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal Spirits
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscycles
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychology
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial Literacy
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial LiteracyHow do real-world people understand the economy and makefinancial decisions?
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial LiteracyHow do real-world people understand the economy and makefinancial decisions?What can policymakers do to improve financial decision-making?
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial LiteracyHow do real-world people understand the economy and makefinancial decisions?What can policymakers do to improve financial decision-making?
Education
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial LiteracyHow do real-world people understand the economy and makefinancial decisions?What can policymakers do to improve financial decision-making?
EducationOptimal defaults
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Two Behavioral Themes
1 Animal SpiritsWaves of optimism/pessmism about the future matter for businesscyclesPotential for “multiple equilibria” influenced by psychologyHow do people form expectations about the future?How are these expectations ratified or rejected by experience?
2 Financial LiteracyHow do real-world people understand the economy and makefinancial decisions?What can policymakers do to improve financial decision-making?
EducationOptimal defaultsRegulation
Foote (Boston Fed) Housing Market Dallas Fed Conference 5 / 31
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Behavioral Economics and the Housing Crisis
Thaler and Sunstein on the Housing Crisis
A main cause of the mortgage crisis is that borrowers did notunderstand the terms of their loans. Even those who tried toread the fine print felt their eyes glazing over, especially aftertheir mortgage broker assured them they had an amazingdeal.
Richard Thaler and Cass Sunstein“Human Frailty Caused the Crisis”
Financial TimesNovember 11, 2008
Foote (Boston Fed) Housing Market Dallas Fed Conference 6 / 31
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Behavioral Economics and the Housing Crisis
Thaler and Sunstein on Policy PrescriptionsFar more important [than concentrating on today’s crisis], it iscrucial to design policies that will prevent similar problems inthe future. Behavioral economics provides specificsuggestions not just for mortgages, but also for credit cards,cellphone plans, prescription drugs, and student loans. Thebasic idea is that for complex financial instruments, thegovernment should strive for what might be called “simplifiedtransparency.”
Richard Thaler and Cass Sunstein“Economic Policy for Humans”
Boston GlobeApril 17, 2008
(insertion added)
Foote (Boston Fed) Housing Market Dallas Fed Conference 7 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans4 Prime mortgages have been defaulting as well
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans4 Prime mortgages have been defaulting as well
A type of “financial illiteracy” played a role in the crisis, but thisilliteracy ...
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans4 Prime mortgages have been defaulting as well
A type of “financial illiteracy” played a role in the crisis, but thisilliteracy ...
... is very widely shared,
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans4 Prime mortgages have been defaulting as well
A type of “financial illiteracy” played a role in the crisis, but thisilliteracy ...
... is very widely shared,
... concerns the ability to understand house prices,
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
What Caused the Housing Crisis?
It is very hard to tell a consistent story that “unaffordable” or“complex” mortgages caused the housing crisis.
1 “Teaser” rates on subprime mortgages did not exist2 Interest-rate resets played a very minor role in the crisis3 Little evidence that prime borrowers were “steered” into subprime
loans4 Prime mortgages have been defaulting as well
A type of “financial illiteracy” played a role in the crisis, but thisilliteracy ...
... is very widely shared,
... concerns the ability to understand house prices,
... and is closely related to the concept of “animal spirits”
Foote (Boston Fed) Housing Market Dallas Fed Conference 8 / 31
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Behavioral Economics and the Housing Crisis
Foote (Boston Fed) Housing Market Dallas Fed Conference 9 / 31
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Behavioral Economics and the Housing Crisis
22 East 71st StreetNew York, NY
(between 5th & Madison Avenues)
Foote (Boston Fed) Housing Market Dallas Fed Conference 9 / 31
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Behavioral Economics and the Housing Crisis
22 East 71st StreetNew York, NY
(between 5th & Madison Avenues)
7506 Norfolk CircleWichita, KS
(near Towne East Square)
Foote (Boston Fed) Housing Market Dallas Fed Conference 9 / 31
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Behavioral Economics and the Housing Crisis
22 East 71st StreetNew York, NY
(between 5th & Madison Avenues)
7506 Norfolk CircleWichita, KS
(near Towne East Square)
Which house was moreexpensive to live in during thepast 30 years?
Foote (Boston Fed) Housing Market Dallas Fed Conference 9 / 31
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Behavioral Economics and the Housing Crisis
22 East 71st StreetNew York, NY
(between 5th & Madison Avenues)
7506 Norfolk CircleWichita, KS
(near Towne East Square)
Which house was moreexpensive to live in during thepast 30 years?
The Wichita house
Foote (Boston Fed) Housing Market Dallas Fed Conference 9 / 31
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Behavioral Economics and the Housing Crisis
150
200
250
300
350
Index
(1976:Q4
=
100)
Real Housing Prices in New York, NY and Wichita, KS
Wichita, KS New York, NY
0
50
100
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: Federal Housing Finance Authority; Bureau of Labor Statistics
Foote (Boston Fed) Housing Market Dallas Fed Conference 10 / 31
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Behavioral Economics and the Housing Crisis
Wichita Amenities
Foote (Boston Fed) Housing Market Dallas Fed Conference 11 / 31
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Behavioral Economics and the Housing Crisis
Wichita Amenities
Foote (Boston Fed) Housing Market Dallas Fed Conference 11 / 31
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Behavioral Economics and the Housing Crisis
New York Amenities
Foote (Boston Fed) Housing Market Dallas Fed Conference 12 / 31
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Behavioral Economics and the Housing Crisis
150
200
250
300
350rice
Index
(1980=100)
House Price Indexes in Five MSAs
Bakersfield, CA
New York, NY
Las Vegas, NV
Phoenix, AZ
Wichita, KS
0
50
100
150
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
House
P
Foote (Boston Fed) Housing Market Dallas Fed Conference 13 / 31
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Behavioral Economics and the Housing Crisis
Location of Mortgage DistressMortgages 90+ days delinquent or in foreclosure, by county
Foote (Boston Fed) Housing Market Dallas Fed Conference 14 / 31
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Behavioral Economics and the Housing Crisis
New York Post, October 30, 1975
Foote (Boston Fed) Housing Market Dallas Fed Conference 15 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
The price of an asset today should depend on “fundamentals” (e.g.,future income generated)
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
The price of an asset today should depend on “fundamentals” (e.g.,future income generated)But how can we predict these fundamentals?
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
The price of an asset today should depend on “fundamentals” (e.g.,future income generated)But how can we predict these fundamentals?
The lack of this model underpins a lot of what Akerlof-Shiller call“animal spirits”
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
The price of an asset today should depend on “fundamentals” (e.g.,future income generated)But how can we predict these fundamentals?
The lack of this model underpins a lot of what Akerlof-Shiller call“animal spirits”
We do have models of how asset prices should behave, given“rational” expectations
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Expectations, Multiple Equilibria and Bubbles
Economists lack a tractable and empirically validated model toexplain asset prices
The price of an asset today should depend on “fundamentals” (e.g.,future income generated)But how can we predict these fundamentals?
The lack of this model underpins a lot of what Akerlof-Shiller call“animal spirits”
We do have models of how asset prices should behave, given“rational” expectationsBut “irrationally” optimistic expectations can give rise to eithermultiple equilibria (good) or asset bubbles (bad)
Foote (Boston Fed) Housing Market Dallas Fed Conference 16 / 31
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Behavioral Economics and the Housing Crisis
Famous Bubbles in History
Tulipmania South Sea Bubble Florida Real Estate(1630s) (1710s) (1920s)
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Behavioral Economics and the Housing Crisis
Famous Bubbles in Recent History
Beanie Babies Internet Stocks U.S. Housing Market(mid-1990s) (late 1990s) (early 2000s)
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Behavioral Economics and the Housing Crisis
Financial Illiteracy
We were on the March 22 [2007] call with Fitch regarding thesubprime securitization market’s difficulties. In their talk, theywere highly confident regarding their models and their ratings.My associate asked several questions. “What are the keydrivers of your models?”’ They responded, FICO scores andhome-price appreciation (HPA) of low single-digit ormid-single-digit [rates], as HPA has been for the past 50years.
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Behavioral Economics and the Housing Crisis
Financial Illiteracy (con’t)
My associate then asked, “What if HPA was flat for anextended period of time?” They responded that their modelwould start to break down. He then asked, “What if HPA wereto decline 1% to 2% for an extended period of time?” Theyresponded that their models would break down completely.
Robert L. Rodriguez, CFA“Absense of Fear”
CFA Society of Chicago SpeechJune 28, 2007
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loans
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%Loans that were made performed much better
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%Loans that were made performed much betterMany foreclosures were prevented
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%Loans that were made performed much betterMany foreclosures were prevented
Borrowers and would-be borrowers must have been verygrateful...
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%Loans that were made performed much betterMany foreclosures were prevented
Borrowers and would-be borrowers must have been verygrateful...
Residents in the target areas passionately hated the program
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Behavioral Economics and the Housing Crisis
When “Financial Illiteracy” Meets “Animal Spirits”
At the end of 2006, the city of Chicago passed a law requiringcounseling for at-risk borrowers — targeting subprime loansAmromin et al. (Chicago Fed, 2009) show that the program wasquite effective:
Targeted lending types declined by 73%Loans that were made performed much betterMany foreclosures were prevented
Borrowers and would-be borrowers must have been verygrateful...
Residents in the target areas passionately hated the programIt was suspended after only 4 months
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset Prices
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?How should imperfectly informed regulators behave?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?How should imperfectly informed regulators behave?
Micro: Self Control
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?How should imperfectly informed regulators behave?
Micro: Self ControlTo what extent are “time preferences” genetically determined?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?How should imperfectly informed regulators behave?
Micro: Self ControlTo what extent are “time preferences” genetically determined?What methods are most effective in promoting patience?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics
Macro: Expectations and Asset PricesWhen does “sunny optimism” become “crippling asset bubble”?What role does human psychology play in this transformation?How should imperfectly informed regulators behave?
Micro: Self ControlTo what extent are “time preferences” genetically determined?What methods are most effective in promoting patience?Likely to be a tough problem to solve, given numerous examples ofpoor self-control in many non-economic aspects of life
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial Literacy
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocations
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index funds
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
Other problems may not be
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
Other problems may not be
How can we prevent poor investment choices when returns to variousassets are so unpredictable?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
Other problems may not be
How can we prevent poor investment choices when returns to variousassets are so unpredictable?... and even professionals do very dumb things?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
Other problems may not be
How can we prevent poor investment choices when returns to variousassets are so unpredictable?... and even professionals do very dumb things?
Should we teach rank-and-file folks that markets are irrational?
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Behavioral Economics and the Housing Crisis
Three Hard Problems in Behavioral Economics (con’t)
Micro: Financial LiteracySome issues can be fixed with optimally chosen defaults,education, or the simple passage of time
Automatic enrollment in retirement plans with appropriate size/typefor asset allocationsDiscouraging payment of high investment fees for index fundsInadequate diversification in company 401(k) plans
Other problems may not be
How can we prevent poor investment choices when returns to variousassets are so unpredictable?... and even professionals do very dumb things?
Should we teach rank-and-file folks that markets are irrational?Homo Economicus would not have given a dime to Bernie Madoff
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Supplementary Slides: “Economics” and “Behavioral Economics”
Outline
1 Behavioral Economics and the Housing Crisis
2 Supplementary Slides: “Economics” and “Behavioral Economics”
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Supplementary Slides: “Economics” and “Behavioral Economics”
What is Economics (in three words)?
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Supplementary Slides: “Economics” and “Behavioral Economics”
What is Economics (in three words)?
Individual maximization
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Supplementary Slides: “Economics” and “Behavioral Economics”
What is Economics (in three words)?
Individual maximization
Equilibrium
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Supplementary Slides: “Economics” and “Behavioral Economics”
In the Beginning: Supply and Demand
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Supplementary Slides: “Economics” and “Behavioral Economics”
In the Beginning: Supply and Demand
Individual maximization: As price rises ...
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Supplementary Slides: “Economics” and “Behavioral Economics”
In the Beginning: Supply and Demand
Individual maximization: As price rises ...Producers have incentive to deliver more goods to the market
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Supplementary Slides: “Economics” and “Behavioral Economics”
In the Beginning: Supply and Demand
Individual maximization: As price rises ...Producers have incentive to deliver more goods to the marketConsumers have incentive to consume less (can enjoy more “othergoods” if they reduce consumption by one unit)
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Supplementary Slides: “Economics” and “Behavioral Economics”
In the Beginning: Supply and Demand
Individual maximization: As price rises ...Producers have incentive to deliver more goods to the marketConsumers have incentive to consume less (can enjoy more “othergoods” if they reduce consumption by one unit)
Equilibrium: Unique price results
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciences
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciencesEconomists are applying their tools to a wide variety of socialissues
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciencesEconomists are applying their tools to a wide variety of socialissues
Poverty and income inequality
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciencesEconomists are applying their tools to a wide variety of socialissues
Poverty and income inequalityCrime
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciencesEconomists are applying their tools to a wide variety of socialissues
Poverty and income inequalityCrimeMarriage and child-rearing
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Supplementary Slides: “Economics” and “Behavioral Economics”
Economics as a Social Science
Individual maximization and equilibrium impose discipline oneconomics
This discipline separates economics from other social sciencesEconomists are applying their tools to a wide variety of socialissues
Poverty and income inequalityCrimeMarriage and child-rearingIssues of race and gender
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Supplementary Slides: “Economics” and “Behavioral Economics”
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Supplementary Slides: “Economics” and “Behavioral Economics”
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Supplementary Slides: “Economics” and “Behavioral Economics”
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Supplementary Slides: “Economics” and “Behavioral Economics”
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Supplementary Slides: “Economics” and “Behavioral Economics”
The Development of Homo Economicus
Concepts of individual maximization and equilibrium usually allowideas to be expressed mathematically
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Supplementary Slides: “Economics” and “Behavioral Economics”
The Development of Homo Economicus
Concepts of individual maximization and equilibrium usually allowideas to be expressed mathematically
Example of consumer choice: PriceAPriceB
=MUAMUB
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Supplementary Slides: “Economics” and “Behavioral Economics”
The Development of Homo Economicus
Concepts of individual maximization and equilibrium usually allowideas to be expressed mathematically
Example of consumer choice: PriceAPriceB
=MUAMUB
Before long: Homo Economicus!
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences3 He has no “self control” problems
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences3 He has no “self control” problems
He will not deviate from previous plans unless he receives newinformation or constraints
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences3 He has no “self control” problems
He will not deviate from previous plans unless he receives newinformation or constraintsIf it is optimal for him to go on a no-cookie diet, then this dietremains optimal even after someone places a plate of cookies infront of him
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences3 He has no “self control” problems
He will not deviate from previous plans unless he receives newinformation or constraintsIf it is optimal for him to go on a no-cookie diet, then this dietremains optimal even after someone places a plate of cookies infront of him
Are these assumptions realistic?
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Supplementary Slides: “Economics” and “Behavioral Economics”
Homo Economicus (“Economic Man”) described
1 He is “financially literate” — good at translating problems intomathematical terms, then solving them
2 He has a stable “utility function” that determines his preferences3 He has no “self control” problems
He will not deviate from previous plans unless he receives newinformation or constraintsIf it is optimal for him to go on a no-cookie diet, then this dietremains optimal even after someone places a plate of cookies infront of him
Are these assumptions realistic?Behavioral economics says no
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