A Renegade's Wise Lessons

The economist Charles Kindleberger died the other day at 92, just when the world most needs his panoramic vision. Kindleberger was a cheerful skeptic of all the mathematical models that define modern economics and have, not incidentally, disconnected it from the real world. He believed that history also matters, meaning all those messy forces that cause people, businesses and governments to behave as they do. The long list includes wars, harvests, new technologies, revolutions, intellectual fads and popular psychology--among others.

The boast of modern economics is that it has broken from the past by providing businesses and government new tools to reduce risk and manage the business cycle: everything from central banks (the Federal Reserve) to sophisticated hedging techniques. The obsolescence of the past makes history irrelevant except as a curiosity. Kindleberger's dissent rendered him an intellectual renegade whose revenge was that events kept proving him correct.

His best-known book, "Manias, Panics, and Crashes: A History of Financial Crises," appeared in 1978 and was widely regarded as a charming account of an extinct problem. Government macroeconomic policies and deposit insurance, as well as professional investment advice, had essentially outlawed banking panics and financial crises. So held conventional wisdom. Kindleberger objected.

"Speculation often develops in two stages," he wrote--first as a reasonable reaction to genuine investment opportunities, then as a frantic scramble for quick profits. So it was during the English railroad boom of the 1830s. Before 1835, projects were sensible; later, they were scams. "Professional promoters... [targeted] a different class of investors, including ladies and clergymen." A similar pattern applied to U.S. farmland sales in the South in the 1830s and later; early price increases reflected better prospects for cotton, but speculation soon dominated. Sound unfamiliar? Not after the Internet bubble.

Before his death, Kindleberger suspected a housing bubble. Most economists discount the danger. Houses aren't bought and sold like stocks, it's said; price increases pale beside the stock bubble. All true. In the late 1990s, stock indexes rose 20 percent or more annually. By contrast, median home prices rose 7.1 percent in 2002.

But some other things are also true, as Kindleberger might have noted: (a) before a "bubble" pops, most people deny it exists; (b) some home-price increases have been huge (from 1998 to 2002, median prices rose 57 percent in Boston, 50 percent in Denver, 48 percent in Los Angeles and 65 percent in New York), and (c) cheap credit--a.k.a. low mortgage rates--has propelled the price rise. There are vulnerabilities. Even slightly higher interest rates could cause home prices to stagnate or fall.