A new Stanford University paper by Monika Piazzesi and Martin Schneider that examines the housing bubble provides an offhand observation – and rationalization – of the efforts of GS and other large Wall Street establishments to push stock prices higher:

The second part of the paper considers the role of a small number of optimistic traders on house prices. For the stock market, there is a standard argument for why even a small number of optimists can push up prices in the presence of short-sales constraints (Edward Miller 1977*.) Indeed, if investors are risk neutral and have unlimited wealth, and if stock cannot be sold short, then the competitive equilibrium price reflects the subjective valuation of the most optimistic investors in the market. Those investors use their wealth to buy up all stocks in equilibrium. Less optimistic investors would like to short stock, but are constrained from doing so. As a result, they simply sell all stock to optimists at inflated prices.

While the standard argument is plausible for segments of the stock market where shorting is difficult (such as recent IPO financial company shares), it does not work for the housing market: we do not observe a small number of optimistic speculators buying up all houses.

Why didn’t I think of that?

Recent observations by Zero Hedge and others of liquidity constraints and the predominance in computerized program trading by a small number of major players such as Morgan- Stanley and Goldman- Sachs are of a piece with this analysis. Certainly these last are ‘optimists’ and possess limitless (Treasury/Federal Reserve) wealth.

The rest of the paper is an analysis of some of the forces that propelled the rise in housing prices prior to 2007. Some assumptions I disagree with;

“Housing services are derived from indivisible housing units that must be bought in a search market. Households may own at most one house. Utility is quasilinear in housing and other consumption, and households discount the future at the constant rate r. “

How housing was marketed is never addressed; investors and speculators were an indivisible part of the housing market with some speculators owning twenty or more units and this compound ownership would shift the utility discount in proportion to the number of units owned. Nevertheless, the overall observations are useful and the insight on Wall Street’s ‘majah playahs’ strategy is very apt.

* Cited in paper: Miller, Edwards. “Risk, Uncertainty, and Divergence of Opinion.” Journal of Finance 1977, 32(4), pp. 1151-68.