Monday, January 12, 2009

Utter Batshit Insanity

There's really no other words I can use to describe the complete drivel that these two Stanford economists are flogging over at VoxEU.  And this after I've promised myself to try to be less breathlessly antagonistic when writing.  I moused over there because I read the abstract, and it sounded like a view quite different from my own, which is always useful -- the title of the article is The Recession Will Be Over Sooner Than You Think.  The abstract:

A key source of the today's economic weakness is uncertainty that led firms to postpone investment and hiring decisions. This column, by the authors whose model forecast the recession as far back as June 2008, report that the key measures of uncertainty have dropped so rapidly that they believe growth will resume by mid-2009. This means any additional economic stimulus has to be enacted quickly. Delaying to the summer may mean the economic medicine is administered just as the patient is leave the hospital.

Sounds okay, ¿no?  Then you read the article, and you realize that the entire thing is based on the neo-classically idiotic notion that you can use the VIX (an index of option implied volatility often cited as a measure of fear and uncertainty) not only to predict the depth of a recession, but in fact to time the whole thing as well. 

This is the sort of thing that gives economists a bad name, and it's hard to no where to begin when one sets out to enunciate just how dumb this idea is.  Let's start with the fact that the whole thing implies that both the economy and markets were cruising along in equilibrium before the recent volatility spike.  What husing bubble?  Then let's move on to what the VIX actually measures, namely, a number inferred from an equation that we know is wrong, and is any any case completely backward looking and based on a tiny, specialized subsegment of the market where a few traders go to bet on horses when they're not in Vegas.

Finally, let's go to how useful this actually is a macro-economic predictor, even if it didn't suffer from other problems.  What happens if the pricing of options begins to change again tomorrow?  For example, they trumpet how their model predicted a recession as far back as ... June ... as if this were a tremendous feat of sooth-saying daring.  Wow, I definitely needed a sophisticated model like this to tell me there might be problems as I watched Freddie and Fannie and their $6 trillion in quasi-governmental obligations go under.  Thanks.  And now of course, it's comforting to know that everything is fine again because the VIX is falling.  Oh god wait ... what if it goes back up again?  The recession will get deeper again!  We cannot afford to have this sort of output gap!  We need to put all the options traders on federally mandated prozac and fill the canyons of Wall St. with subsidized low-rider-jeans-sporting fomer strippers in order to save the economy!

These guys need to be taken out back along with VaR, the Laffer Curve, and Tier 1 capital ratios ... and shot.  We are surrounded by chimps.

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