20071015 nobel economics winners 18
Winners of the 2007 Nobel Prize in Economics, from left, Leonid Hurwicz of the University of Minnesota; Eric S. Maskin of the Institute for Advanced Study at Princeton University; and Roger Myerson of the University of Chicago. - 


KAI RYSSDAL: It was just happenstance, but the Nobel Memorial Prize in Economics that was announced this morning fits right in with what Jill and I were just talking about.

From Washington, Marketplace's John Dimsdale has that story.

JOHN DIMSDALE: The prize winners are Americans Leonid Hurwicz, Eric Maskin and Roger Myerson for their work on "mechanism design theory." The theory is a set of calculations to help create the ideal, most efficient financial markets for buyers and sellers.

How do you make sure sellers get the highest price for their product or service, while the buyer gets the cheapest possible price? It's a complex theory, because people sometimes make financial decisions with imperfect information, or they allow emotion to color their choices.

And that's what happened in the subprime mortgage market, says University of Texas economist James Galbraith.

James Galbraith: What we have in the subprime crisis is the innovation of particular types of mortgages that are meant to basically trap people into loans, which look good for the first few years, but then when interest rates rise and suddenly they become unpayable. That's a question of the rules not having been developed, not having been enforced that would protect vulnerable low-income people from what essentially were fraudulent practices.

Galbraith and other economists, like Stanford University's Kenneth Arrow, say the mathematical formulas in the financial design theory have become a part of the DNA of economics.

Kenneth Arrow: The value of these formulas is it forces people to ask the right empirical questions -- how to study the past data to make the best use of it.

Arrow says the prize-winning design theory can help bankers, lenders and government regulators think up more efficient and stable mortgage markets.

In Washington, I'm John Dimsdale for Marketplace.