Regular readers are well aware that Barbara and I really hate assigning deep meanings to daily stock market movements, and when we are pressed into doing so by our editors we usually respond by writing about volatility.

But today's 889-point rise in the Dow really takes the cake. There is no plausible explanation for why the market just did that, other than that everybody is extremely confused right now, so pretty much anything can happen.

The new S&P/Case-Shiller house-price numbers came out today. They're for August, so the onset of full-on financial panic in September isn't reflected, but the news was bad enough: The pace of decline had slowed sharply in April and May and stayed low through July, but now appears to be on the rise again. That may just be a seasonal issue (home sales, and thus prices, are usually strongest in the summer), but it's not encouraging.

One of the few genuinely encouraging signs in the data is that Cleveland may be done with its housing bust, with prices in the Cleveland area rising in August for the third month in a row. Cleveland's housing bust is very different from the one playing out along the country's coasts: House prices never rose all that much in there, and they stopped rising there a year before the bust went national (summer 2005 vs. summer 2006). Here's the chart, going back to January 2000:

Cleveland's house price decline was the product of a regional recession, not the bursting of a housing bubble. It's possible that the declines will return there if the national recession gets much worse. And while one really can't extrapolate Cleveland's experience to the national picture, it's interesting to note that Cleveland is now back to bottomed out at the house price levels of February 2002. To bring prices nationally (or at least in the big metro areas represented in the Case-Shiller 20-city index) back to February 2002 levels, we'd need another 26% price drop (on top of the 20% we've had so far). And I called the news from Cleveland encouraging?

Since I've become something of a volatility junky, let me point you to this interesting FT article that describes how volatility is wreaking havoc on the way financial firms value their assets. An excerpt:

The second, more tangible implication of the return of volatility relates to the models that banks and hedge funds use to measure their assets. When banks extend credit to hedge funds, they often use so-called “value at risk” models (VAR) to measure the risks attached to such loans. These models typically assess the riskiness of an asset by measuring how its market price has moved in the past.

During the Great Moderation, this approach cast a fabulously flattering light on the investment world, creating the impression that it was safe for banks to extend massive volumes of credit to hedge funds. Moreover, since banks typically use VAR to measure the risk attached to their own assets too, these models also seduced banks into feeling complacent about their own risks.

Now, this process has gone violently into reverse: as volatility surges, VAR models are showing that the risk attached to almost any transaction has exploded upwards. Thus banks are selling assets and slashing loans to the funds – in turn sparking more fire sales and increasing volatility in all asset classes. It is a vicious trap that does much to explain why the market upheavals have infected so many asset classes, ranging from subprime to sterling to Shanghai shares.

I've been feverishly working on a magazine piece about risk, and yesterday I happened to have a conversation about the VAR models that were used to value mortgage-related structured products. The guys I was talking to kept saying that a big problem was that VAR models used during an asset boom make the future seem extra-rosy since the model extrapolates from that historical data. I asked why firms didn't use more historical data, maybe going back 30 years instead of--what?--ten years?

Um, no. Try two or three. So we were deriving values for things like CDOs from just a few years of historical data. It's not that the VAR models captured the boom—it's that they only captured the boom. Brilliant. And then plenty of firms either weren't stress testing those models, or they were, and deciding to ignore the results. But more about that in a week or so.

Barbara!

I have a brief quote in my new column on the Keynes comeback from the University of Chicago's Robert Lucas, who in 1980 declared Keynesianism not just dead but laughable ("At research seminars, people don't take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another.") and later won a Nobel for his efforts. Here's his fuller response, from an e-mail:

Well I guess everyone is a Keynesian in a foxhole, but I don't think we are there yet. Explicitly temporary tax cuts do nothing: people just bank them. Supply side tax cuts are fine with me, but they take time to work and at some point we need the revenue to run the government.

I feel the current situation requires a lender of last resort but not a fine tuner.

First came the Great TIME.com Blog Crash of 2008. Then I spent Monday as the Nauseous Capitalist, and really didn't feel up to posting. I still don't feel great but here, finally, is a perfunctory post linking to my latest column. It begins:

We are all Keynesians now. It's a phrase that entered public discourse as the headline of a TIME cover story in 1965. Now it's coming back into fashion.

This does not signify that we are all--as was Englishman John Maynard Keynes--Cambridge University economists with lucrative side jobs as investment managers, spectacular art collections, lots of famous friends and Russian-ballerina wives. At least I don't fit that description. Do you?

The resurgence of interest in Keynes also doesn't represent a full return to 1960s-style Keynesianism--the belief, shared by many economists and politicians in those days, that government could tame the business cycle and guarantee good economic times indefinitely.

Instead, what we are seeing now in Washington and other world capitals is fear we might be headed for an economic collapse caused by a collapse of demand caused by a collapse of credit. Confronted with that threat, governments seemingly cannot help turning to the remedy formulated by Keynes during the dark years of the early 1930s: stimulating demand by spending much more than they take in, preferably but not necessarily on useful public works like highways and schools. "I guess everyone is a Keynesian in a foxhole," jokes Robert Lucas, a University of Chicago economist who won a Nobel Prize in 1995 for theories that criticized Keynes. Read more.