March 05, 2006

Maybe tulips don't fit in bubbles after all

More reading of this week's New York Times Magazine got me to look up the history of the Dutch tulip bubble. For those of you who aren't quite as into history, the Dutch tulip bubble was the first generally recognized economic "bubble", occurring in the mid-1600s when crazed investors bid up the price of tulip bulbs, of all things, to a ridiculous amount before the market crashed. People often draw analogies between the tulip bubble and the dotcom bubble or today's real estate prices.

Problem is, apparently there was no tulip bubble. A bit of reading in Wikipedia and Slate points out that what actually happened was that a slip in the tulip futures market -- yes, they had futures markets in the 17th century -- caused some well-connected investors to push through a law changing existing tulip futures contracts into tulip options contracts. This substantially reduced investors' risk, thereby pushing up prices dramatically as you'd expect in any normal market. The price increases started when the law took effect, but they didn't settle down until the law was announced a few months later. Investors who had inside knowledge therefore came out ahead, as you'd expect.

So the next time someone claims that modern markets are being irrational and points to the Dutch and their tulips, you might want to think about whether the new markets are as irrational as they sound. Maybe the markets are insane, but we can't blame that on anything that started with tulips.

Not quite so keen on that mortgage-interest deduction

As someone who's been thinking of buying a house for a while now and for whom a Bay Area mortgage would stretch the budget rather thin, I've been very interested in the mortgage-interest tax deduction. For anyone out there who isn't a homeowner or prospective homeowner, that's a part of the tax code that allows you to deduct interest on mortgages, which for the first few years of a mortgage is usually a significant portion of the payments.

Today's New York Times Magazine has a fascinating article about how the mortgage-interest deduction isn't all it's cracked up to be. Specifically, it overwhelmingly helps the rich, and it doesn't seem to boost homeownership at all. Given that, I'm suddenly a lot less enamored with it than I was an hour ago. In fact, I'm inclined to agree with the tax reform panel that unanimously decided that the mortgage-interest deduction should be scrapped as part of a plan to simplify the tax code and eliminate the AMT. Sadly, it looks like that plan was dead on arrival in Congress.