Economists don’t understand the financial system
Cross posted from Naked Capitalism.
A bit more than a week ago I went to a panel discussion at the Met about the global financial crisis. The panel consisted of Paul Krugman, Edmund Phelps, Jeffrey Sachs, and George Soros. They were each given 15 minutes to talk about what they thought about the Eurocrisis, especially Greece, the U.S., and whatever else they felt like.
It was well worth the $25 admission fee, but maybe not for the reason I would have thought when I went. I ended up deciding something I’ve suspected before. Namely, economists don’t understand the financial system, and moreover they don’t get that they don’t get it. Let me explain my reasoning.
The panelists all are pretty left-leaning guys, and each of them basically talked about how the U.S. government should stimulate the economy in one way or another. Krugman kept saying that hey, this isn’t too hard, we’ve seen financial crises before, and this is no different: we should immediately pass a massive stimulus package, that’s the one and only thing that we should be discussing. Sachs was very consistently saying we should do something else: namely, start planning long-term for the future. He focused on the percent of tax dollars going into infrastructure and basic education and research. Phelps also wanted stimulus, but he consistently referred to his own economic models in how exactly it should work. I didn’t completely follow his train of thought.
Soros was the most interesting of the four, in my opinion. He started by saying that we should all acknowledge that, as nice as it would be to think we can model the economy and feel control over the situation, this is a pipe dream and we should get used to not really knowing what will happen when we do one thing versus another. He suggested that we should instead work together to develop a theory, or perhaps even an philosophy, that assumes uncertainty itself. He ended by saying that, even with the three colleagues on the panel with him, who are essentially all united in thinking we need to be proactive, his ideas are essentially being ignored.
The rest of the evening essentially consisted of everyone ignoring Soros and arguing about how Keynesian they all were and how exactly different kinds of stimulus would work and which way they should use 2% of GDP to jumpstart the world’s economy. So basically exactly what Soros said would happen.
It got me more and more riled up. Here are these expert economists, two of whom have Nobel Prizes and the third who runs the Earth Institute at Columbia and is considered a huge swinging dick in his own right, and they don’t seem to acknowledge how much power they actually have over the situation (specifically, not much). For that matter, they clearly don’t know the nitty gritty of the financial system. To listen to them, all you need to do is spread a thick paste of money on the system and it would revive whole cloth. Soros is the exception, probably for the reason that he actually traded and made money inside the system.
At the end I asked a question, since they allowed a few questions, and as you know I’m not shy. I asked how we are going to make the system simple enough to actually make it possible to regulate it. Krugman basically said that Dodd-Frank is going to do it. My conclusion from that is that Krugman must really have only an outline in his head of how this stuff works- the devil, as we know, is really in the detail, and I’m too acquainted with the Volcker Rule’s list of exemptions to have a lot of hope on this score. To be fair, Phelps mentioned Amar Bhide’s book A Call for Judgment, which I’m reading and seems pretty good and at least addresses this exact issue head-on.
Overall, the evening brought me back to the credit crisis, and working at D.E. Shaw, when Larry Summers was consistently quoted at the firm as saying that the “magical liquidity fairy” needed to come and “spread some magical liquidity dust” in the markets to make everything better. No, I’m not kidding.
What I felt then and what I still feel is that these super influential economists are so high on their clean, simple economic models of the world (about the only variables of which are GDP, stimulus, and tax rates) that they focus on the model to the exclusion of the secondary issues. Sometimes you get important results this way: simplifying models can be really useful. But sometimes it’s really truly misleading to do so, and I believe this is one of those cases.
I’m left thinking that they (the economists) are so entranced with their simplified world view that still don’t understand what actually fucked up the world in 2007 and 2008, namely the CDO market’s implosion. Message to Krugman: this is not exactly like other financial crises, because it’s partly caused by complexity, and nobody seems to have the balls to fix it. The problem is that the financial system has been allowed to get so complicated and so rigged in favor of the people with information, that normal people, including homeowners, credit card users, politicians, and regulators have been left in the dark, and many of the little guys are still stuck in ludicrous contracts left over from the outrageous securitizations that took place in the CDO market.
What is especially enraging is how these same economists are still the experts that people turn to to help figure out how to get out of this mess, when they don’t actually understand the mess itself. Why else would a large audience be willing to pay $25 a piece to hear them talk about this? Why else would Obama be considering Larry Summers to lead the World Bank?
As an aside: please, Mr. President, do not let Summers lead the world bank. He does not understand the system well enough to lead it. And he is too arrogant to admit what he doesn’t know. I can introduce you to a bunch of people that may be less imposing but are more informed, more ethical, and wiser. Give me a call any time and we can chat and form a short list of candidates.
By the way, I’m not saying we shouldn’t have a major stimulus, or that we shouldn’t do longer term planning and invest more in infrastructure. I think we should do both. But I also think those efforts will be futile unless we enforce a basic system that is simple enough to be regulated. Otherwise we will be reliving this entire ordeal in another 15 years.
mathbabe 
Based on your last paragraph, which seems to support the Keynesian view, isn’t it perhaps fairer to say that nobody (except possibly Soros) seems to have a complete understanding of all aspects of world’s financial and economic system? I fully agree that economists don’t really understand finance properly. But isn’t it possible that finance people don’t fully understand economics properly, too? Especially macroeconomics? It all reminds me of the blind men studying an elephant.
I do strongly agree with the need for much better regulation of the financial system.
But I think the significance of financial regulation for the economy also depends on the form of the stimulus. I believe that if we had found a way to do it via, say, greater government spending on infrastructure, then its effectiveness would not have been so dependent on financial regulation. However, this approach has not been possible, and most of the economic stimulus has had to be done by purchasing financial securities and offering cheap loans to financial institutions. That approach combined with weak financial regulation is simply a recipe for another even worse disaster.
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Absolutely true: finance people don’t generally “understand” economics. But that may be a good thing in some sense, since economists disagree on so many fundamental issues. In any case we urgently need to dumb down this whole system so we can all have a conversation about it.
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“we urgently need to dumb down this whole system”: Absolutely! Years ago, after I saw what was going on with investment bankers and quants conspiring to create more and more complex financial products, I came up with the motto: “if you need someone with a math Ph.D. to explain a product and how much it’s worth, then stay away from that product”. Warren Buffett said it much better than me: “Derivatives are toxic waste”. And, to me, this was also the essential message that Nassim Taleb tried to broadcast a long time ago, well before the mortgage bubble and collapse. By now, everyone has forgotten that we had already suffered more than one major and very scary crises in the financial system before the latest and worst one.
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We urgently need to ‘smarten up’ perception about the reality of our human nature and move to correct our deeply soiled moral code of conduct — our now scam hijacked rule of law — the foundation of our national alliance that is supposed to bind us as one and allow us to rise above our baser instincts.
This is not a financial crisis this is a moral crisis. We have all been sucked into a destructive complicity with the aberrant sick <1%. You pay the piper twenty five bucks for the music that entices you over the cliff.
Deception is the strongest political force on the planet.
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Mathbabe – your observation is fair but relies on a limited sample of 3 (if we exclude Soros).
Many economists are thinking very deeply about macro-economics, uncertainty, modelling and the need for greater humility in the “profession”. For an example of some of the debates that are ongoing, consider this post by Diane Coyle http://www.enlightenmenteconomics.com/blog/index.php/2012/02/the-problem-of-macroeconomics/ .
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Last week, I read Tyler Cowen’s “The Great Stagnation”. It offered an interesting perspective on Krugman and the Keynesian view.
I consider myself ‘left-leaning’ and believe the ‘Right’s’ traditional “government is the problem” thesis, is a dramatic ideological oversimplification. However, Cowen’s thesis about not finding new ‘low hanging fruit’ fits in with my experience as a software entrepreneur.
It’s very tough to come up with products that don’t already exist, and if you do, you will get copied very very quickly. In internet app. businesses, the shelf-life of advertising revenue is short and hard to predict. Facebook will make money, but the profit curve falls off steeply.
Most apps. loose money.
Krugman and Keynesian’s in general believe that stimulus will either ‘uncover new low hanging fruit’ or that R&D investment will lead to future growth. In our current globalized, overpopulated world, with state capitalism competing with free market capitalism, where the internet is free and companies sit on trillions of dollar of cash, finding growth
and revenue is very hard. Perhaps this is why the capital stays in the ‘casino’ part of casino capitalism, with investment horizons in micro-seconds, instead of going into R&D, infrastructure, VC, and longer term investments.
Do the economists get this?
Finally, AI has matured to the level of a self driving car which can drive 160,000 miles throughout California. When I asked 10 of the worlds leading economists how this dramatic event will affect their employment models, the ‘Luddite Fallacy’, etc., none gave me a satisfactory answer.
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Here’s a discussion of the best and brightest ‘not finding’ the ‘low-hanging fruit’ in alternative energy production:
http://www.technologyreview.com/business/39600/?p1=BI
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I enjoyed your post and agree with most of what you observed. Soros seems to really grasp the challenges the world faces (and the dark side of not confronting those challenges) better than most. A few other comments/critiques.
The CDO issue was certainly part of the cause of the 2007-2008 meltdown, but underlying all of that was global liquidity and an asset class – housing – that had steadily inflated itself well beyond reason but seemed an ideal place to store those dollars. The CDOs were really just the vehicle to grab that liquidity and re-use an asset class that was thought to be bullet proof.
I think expecting the banks to get more simple as the world gets more complex is as realistic as Tea Partiers expecting the government to shrink while the country gets bigger and the world more complex. I would suggest that 30 years ago, Citibank’s business was more complicated than even its CEO then could understand completely. In my view, the only way to really address the inherent risk in the banking sector, is to regulate it like the utility that it is. Shrink the leverage to a normal company level. I worked for a major bank for 15 years, and I never had a really good explanation as to why banks were allowed to be significantly more levered than any non bank we would ever lend to.
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re: PB #8
I think the CDOs pumped more money into housing than you seem to be giving them credit for. The ease of directing capital there, and the alleged safety in the good tranches, seems to have been a factor in driving those prices up.
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“What is especially enraging is how these same economists are still the experts that people turn to to help figure out how to get out of this mess…”
In Krugman’s blog he’s pretty clear that no one in power pays any attention to him. (And he regards Dodd-Frank as a step toward a solution, not a solution itself.)
“Why else would a large audience be willing to pay $25 a piece to hear them talk about this?”
General interest is an adequate explanation at that price level. (linkpause) And it came with a free copy of Soros’s book? Make that a more-than-adequate explanation. $2500 a pop might mean something.
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There are two problems to solve: How do we get out of the mess we are in, and how do we avoid getting into again? In fairness to Krugman (and probably also Sachs and Phelps), he happens to be more focused on the first question than the second. Your post seems to be claiming that macroeconomics alone is insufficient to answer the first question, and that an intricate understanding of our financial system is necessary to figure out how to fix the economy. But what is your basis for this position?
You say that this crisis is very different from other crises, because it was caused by complexity. But to say that the *cause* of the recession is unique is very different from saying that the recession itself is unique. In other words, I suspect Krugman would say that the problems with banking are important for the second problem I described above, but mostly irrelevant to the first. But if you think they are relevant, tell us why.
Finally, I’m not so impressed by Soros’s suggestion “that we should instead work together to develop a theory, or perhaps even an philosophy, that assumes uncertainty itself.” Those are just empty words to me.
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I apologize that I have only scanned previous comments. My comment on your text is simply: Of course, Soros is most attractive. He is a realist and a nice guy and a player in battlefields far from those (somewhat emasculated) ones in Academia. It gets down to the “Belling the Cat” fable. It’s all in the execution, stupid! Which is political. I’m thankful for all these folks with good hearts.
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I’ve just now gone to your post on Naked Capitalism. It’s great for the response it’s engendered! Thank god I got my little comment in here. I’m a secret admirer of Yves. Better than I ever could, G M Hopkins put it into words — “My heart in hiding/Stirred for a bird.”
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Cathy,
You are so correct, most economist that receive national play do not understand the financial system. It has always amazed me how ignorant most economists and Wall Street professionals are of something as real as the Federal Reserve and yet they are so voracious about discussing theory. Keep doing what you are doing.
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Dear Cathy,
You raise crucial points, which come up often in many places lately.
I think there is a revolution taking place in economics (taken broadly, including such considerations as physical energy sources, engineering, technology). We are starting to model our limitations on controlling social dynamics with a view to applying that to policy-making. For example we may (try to) determine whether asset regulation is better than institution regulation (regulator licenses).
http://johnhcochrane.blogspot.com/2012/01/romer-on-regulation.html
http://johnhcochrane.blogspot.com/2012/01/three-kinds-of-regulation.html
What we are starting to understand and model (partly justify) is that there are limitations on the efficiency of _any_ policy, which arise because the system we try to control, if we include regulators themselves, is chaotic. That is, we may be able to control some process only investing commensurate amounts of resources to what is gained, and different policies at best only decide where the burden falls, they cannot increase expected utility for the whole society.
“simplifying models can be really useful. But sometimes it’s really truly misleading to do so”
I think your general opposition to models in this post is actually mistaken: current developments in economics (by Romer, Cochrane, and many more) are about creating new models, because intuitive thinking is not enough, it gives free reins to bias, ultimately it does not satisfy us (we are aware all sides of a given argument are reacting emotionally without being able to pinpoint what pushes who). I think we need more models and then models to properly weight and combine various (economic, financial, political) models. 🙂
And I believe those efforts will be recognized in a few decades as revolutionary in our thinking (with leading figures receiving recompenses), basic to policy-making, institution design.
Similar issues and ideas are relevant in other aspects of engineering, like the comparison of various energy sources (vaious nuclear, carbon-based, etc.), or of various computing technologies (digital serial, parallel, custom vs. all-purpose chips, analog, quantum, biological, etc.).
Who knows what those models being created will tell, perhaps that shouting at each other, expressing basic emotions, a common realization of democracy, is optimal decision-making.
PS: I do not think the math involved in those new models will be much different from what is already used in economics (game theory, optimization, differential/difference equations).
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People like P Krugman have a great gig: since they are math heavy, almost no one can criticize them (out of total us pop) and they get a lot of respect
They have decent salarys, and a lot of the things that psychologists tell us are important for job satisfaction: power over working conditions (and undergrads and grads dependent on letters of rec) and autonomy
And, if they write a textbook, they can rape their students: the list on Krugman’s book is well north of 100 dollars – and he is, by any statistical measure, wealthy.
On the other hand, I don’t fell that you, mathbabe, really put a lot of specific concrete details into your complaint; the first few paragraphs of your post are generic and detail light.
further, i think you are dead wrong when you say (quote below) – do you really think that a guy as smart as krugman doesn’t understand what caused the present crisis ?
and your saying that krugman doesn’t understand that no one has the balls to fix it is dead nuts wrong – have you actually read any of his columns ?????
“I’m left thinking that they (the economists) are so entranced with their simplified world view that still don’t understand what actually fucked up the world in 2007 and 2008, namely the CDO market’s implosion. Message to Krugman: this is not exactly like other financial crises, because it’s partly caused by complexity, and nobody seems to have the balls to fix it. The problem is that the financial system has been allowed to get so complicated and so rigged in favor of the people with information, that normal people, including homeowners, credit card users, politicians, and regulators have been left in the dark, and many of the little guys are still stuck in ludicrous contracts left over from the outrageous securitizations that took place in the CDO market.”
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umm… yeah, I really think someone as smart as Krugman doesn’t understand what caused the present crisis. That’s why I wrote the post, and that’s what I’m upset about. I’ve read quite a few of his columns, and I haven’t been impressed with his financial knowledge. Can you point to a specific column where he exposes deep understanding?
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I’m confused by this. What exactly does it mean to “understand what caused the present crisis?” In broad brushstrokes, everyone (including Krugman) knows about the CDO market implosion.
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Agreed. What I want to see is deeper than broad strokes. For example, I’d like to see an understanding of why the current mortgage settlement has no chance of working, as HAMP had no chance of working. Devil in the detail stuff.
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Actually, I don’t think it’s so easy to say exactly what caused the crisis. I think it’s easy to identify many significant contributing causes but I think it’s difficult to say which things were critical factors and which just made the crisis even worse than it had to be.
And I don’t think it’s Krugman’s job to figure out what caused the economic crisis or how to fix the conditions in the financial system that either caused or exacerbated them. His job is to understand the economy, which is a much larger thing than just the financial system, and understand what needs to be done to get it into better shape. I think that’s a larger task of which fixing the financial system is only a piece. I definitely do not want economists playing any role in designing financial regulation, but I’m not sure finance people would be the right people to make macroeconomic decisions. Krugman himself has made this point vis-a-vis Bill Gross. You don’t want Krugman making your fixed income investment decisions, and you don’t want Bill Gross setting macroeconomic policy decisions.
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1) I am the first to admit I don’t understand economics.
2) I also don’t understand everything about the finance system.
3) But I don’t pretend to.
Here’s a related question. How can we choose a World Bank leader if the only people considered for the job overestimate their understanding and influence?
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Cathy, that’s exactly why I’m extremely pessimistic about the situation. I don’t see anyone with any real power and influence over the financial regulatory system who really has the expertise or just the clarity of sight to cut through all the bullshit. Volcker probably comes closest of anyone, but nobody seems to want to put him in charge. And macroeconomics has become a total morass poisoned by politics. And the politicians don’t really care about doing what’s right, especially when it means political suicide. So we do things only half-heartedly and half-assedly. It’s big mess.
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😦
True! Let’s complain loudly and articulately and see if anything changes.
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Cathy, yes. I must thank you and your working group for working so hard on this, especially your efforts on the Volcker Rule. It does create at least some hope in me.
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I said it before —
“It gets down to the “Belling the Cat” fable. It’s all in the execution, stupid! Which is political.”
“Working hard” is commendable. “Working effectively” is even better. I have my fingers crossed.
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Certainly, Krugman claims to understand finance to some degree, but is he really claiming that he’s an expert on finance? I’m still trying to figure out what it is you’re mad about. Reading between the lines, I think it has something to do with the idea that serious expertise in finance should be an important part of macroeconomics. I’m genuinely curious as to why one might believe this.
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Two comments:
1. Perhaps consider limiting reply depth to one, like on Tim Gowers’ blog. 🙂
2. I think the solution is more models. There is no omniscient politician or economist (not Volcker, not Soros), but scientists recognize and respect the power of models, which is why Krugman, Phelps, and all other economists I can think of got their Nobel prizes (and Cochrane will have his). Unfortunately I really think they are the best we will have, formalizing our intuition and separating them from bias and explaining that to others, that is how we humans come to think the same, agree, how we satisfy ourselves, become happy. It’s constant work for us to be complex enough to match reality. We can face the challenge or bail out and be content with whatever happens -which I cannot do but I think is fine too. I personally feel confident that we will overcome the simplicity of our models with more modeling, especially modeling of our limitations -as I expressed above.
(3. Like Deane, thank you, for your OWS work and for teaching me many things through blog posts.)
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Talking of global financial leaders, I saw a profile (puff piece?) on BBC news site about Christine Lagarde today. Her opinion seems to be that a good starting point for avoiding global financial crises would be for the finance ministers in each country to stop thinking that economic crises in other countries are somebody else’s problem. I am comforted by the fact that she doesn’t seem to pretend to have a complete analysis nor a complete solution.
http://www.bbc.co.uk/news/world-us-canada-17216160
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Isn’t it most important to fix what’s broken?? I don’t mean in the “economic sense,” which is what everyone argues about.
Here are the main problems,
1. The people who are being tasked to “fix” the problem all have jobs in which they earn money from the PRESENT system–universities, the govt, the financial system itself. Ask a person who needs work what HE needs, and he’ll say, “a job like yours.”
2. There is simply no reward (other than altruism) to fix what’s broken.
3. The problems are not really as much economic/financial as psychological. “Who’s ox is gored.”
consider the debate over principal reductions on mortgages:
“It’s a moral hazard.” (Isn’t it a moral hazard to give banks trillions of dollars in advantage at the taxpayer expense? But you see, that supports the PRESENT system).
“Other people will want principal reductions, who have equity, and you are punishing THEM if you give reductions to people who need them…” (really? So?? I don’t have cancer, and you do. You smoked. I don’t think you should get the cure…”)
“If we give principal reductions to homeowners, we encourage bad behavior.” (BANKS’ bad behavior is why I BEGGED the congressional representatives in my area not to approve the original bailout–or at least to wait until the appropriate number of teeth could be put into it). How is it better to make the taxpayers liable for the banks’ bad behavior than it is to make the banks responsible for the homeowners’ mistakes (I am distinguishing here because I assume the bankers had access to the knowledge not available to the owners of the homes)?? And here, we are not even discussing losses. Investors inevitably lose more from foreclosures than from paying loans even if there’s a haircut. Yet the entire system stands against the idea of any principal reduction and rate reduction–“homeowners must pay back what they borrowed,” we say, forgetting that their own store of value was destroyed by the real estate downturn.
So while all of you are discussing math and models (no reflection on you, mathbabe, I really like your stuff), the entire “peasant economy” is going to hell–higher prices, lower wages, loss of employment–human suffering; except YOU are not suffering. Economists have jobs. Put all the economists out their jobs, and make them unable to pay their mortgages, and see how perspectives change….same for university professors, govt employees and so forth.
the point is, I think, that the “little guy” is still getting screwed by the big guy; as long as the economists really do represent the big guys, and the finance people represent the big guys, and the government represents the big guys (YES, they do!!!), and the universities represent the big guys, and the __________ (fill in the blank) represent the big guys, this will not change.
I am convinced that the solutions are much simpler than the complex equations might suggest (i. e., psychological), and that if things get too complex to work, we have to simplify them until they DO work.
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Sorry for doing this twice, but Mish (Mike Shedlock) makes my point rather elegantly today, in fact:
http://globaleconomicanalysis.blogspot.com/2012/03/unbelievable-stress-of-making-only.html
If you find yourself identifying with the subjects of this article, you need to give up your job for a year, and live like the folks who make $7-$8 per hour.
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“Isn’t it important to fix what’s broken?”
Yes indeed. Many of us recognize a common enemy (the Cat). In a meeting, a young mouse comes up with a great solution (a Bell). An old mouse says — “Fine idea, but who will do it?”
“It is one thing to say that something should be done, but quite a different matter to do it.”
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Krugman’s field of expertise is in trade economics, and “economic geography” as well as more broadly macroeconomics. Financial economics is a special field within itself. As another poster has suggested there are two questions. 1.) How did we get into this mess and 2.) How do we get out of it. The answers two both questions are not as related as you might think. Somebody with knowledge of Macroeconomics can answer question 2.) fairly well. Question 1.) and the extension of that (how do we avoid this sort of problem in the future?) are best left to a ketchup economist. I don’t believe there were any on the panel. Krugman will have some basic knowledge of financial economics of course, but that is not to say he is a financial economist. Does that mean his knowledge is useless? No, not really. Did he answer the question you specifically wanted to hear? Well no, not really. He can hardly be blamed for that though.
Now the real question is: What makes this financial crisis different from others? You like details, so it could be said, yes the details. There is some benefit however to looking at the bigger picture, and in the bigger picture this is exactly like all of the other financial crises we’ve had that follow a Fischer/Minsky cycle. Complexity did not cause the mess, it aided it.
Certainly if we want well designed financial regulation we should look for a financial economist. (Preferably not one with a ridiculous libertarian tilt…) Of course financial instability isn’t the only problem we are trying to solve. We have other fish to fry you know.
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Hi Mikestu,
I’m really not complaining that one guy doesn’t know everything. I’m actually complaining that people should know what they don’t know and should realize that, because they don’t understand the whole picture, their expertise and suggestions may not be relevant. It’s the not knowing combined with arrogance that gets me.
Thanks,
Cathy
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I’m a dog trainer who uses positive, gentle techniques that are very effective and practical. There is a large group of positive trainers that I find to be ineffective who base all of their trainer on the behavior theories developed by BF Skinner. After much thought I’ve come to the same conclusion about theories of behaviorism that you have about economics. There is nothing wrong with the theories themselves but theories boil a subject down to it’s essence taking away any variables often making it impractical or just unworkable in the real world.
In training, I call this the nature of the beast. When working in the real world, I have to understand the animals I’m working with- their motivation, their rewards, their needs. Just using simple theories doesn’t get the job done.
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In reading Krugman day to day, especially his blog, I can tell you he agrees with, and expounds on, a lot of what you complain about. For one, he agrees with you about the use and misuse of models, including his own. Given that, one of his chief claims to fame is his recognized ability to boil a lot of complicated phenomenon even experts don’t understand down to ‘back of the envelope’ charts, graphs and formulas that shines bright lights on how macro, in a broad way, actually works.
He is also well known for his progressive views about regulation, including consumer protections you list, including simplifying clamping down on the casino mentality. It’s not his, or your, fault that the political situation today lets a minority filibuster away the cleaning up of the financial system.
He is also a proponent of the role of complexity and unpredictability in markets, as opposed to the ‘Freshwater economists’ whose belief in ‘perfect, self-correcting markets.’
You might do well to glance at his blog entries as they come and go and get the gist of them. You can especially stop and read those where he explains via his theoretically oriented graphs.
The fact is (as he indeed is plenty gratified to point out — no one’s saying he or any of these other birds don’t have a healthy ego — has a very high batting average in his forecasting of macro conditions as a result of the policies he criticized. He was an early canary concerning the housing bust (not hardly the first, but early nonetheless).
Yes, I am a ‘fan’. But that’s because he has a very sensible and down-to-earth way of explaining the theories (he is very familiar with that of his detractors) and the politics. In any case, I wanted to point our that your complaints about him are largely misplaced. I’m sure it’s hard to cover the full range of anyone’s ideas in a panel discussion.
I would add that regulators regulate. That is, everyone knows the complexities of modern life and that steering corrections of policy, law, and regulation are constantly needed.
I myself think that part of the problem here is that you’re talking about ‘finance’ as if it is the same thing as ‘the economy.’ And of course our regulators and, more and more, our law-makers, have been bought and paid for by people with a short-term ‘financial market’ view of the world which is centered on how to multiply their earnings-to-cost-of-bribes ratios.
– Ted, NY
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Thank you so much for this post. As a lawyer who served in the financial world in various capacities for 10 years, what frightened me so much during the crisis and even now is how little many many influential people (policy makers, politicians, pundits – even CFOs!) understood these products and, more important, how many there were and are. The scale is absolutely enormous and I haven’t read anything to date about how to deal with that from a policy perspective or, as you eloquently point out, how we will incorporate it in economics going forward. (See for example the data on TRSs on just corporate debt in America – I have seen some numbers that say the amount of those and other similar derivatives total something like four times the amount of corporate debt actually outstanding.)
While Dodd-Frank has some decent starting points (making many derivative trades be more transparent to at least regulators), it barely scratches the surface. And even with that, it is being eviscerated by banks, funds and other interested institutions in the rule-making phase, with others just trying to scrap it period. It’s hard to understand ideologically how trying to make the system more transparent and information more available to the market is anti-capitalistic- except when that isn’t really the point but maximized unfair advantage is.
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The answer isn’t in the math or any quants. The answer lies in policy. Go back to the end of WWII (you may have to read up on it). Europe got The Marshall Plan, and the US got Bretton-Woods. What that means: we gave Europe money, they let us control international finance. Domestically, we operated (due to the residual bonhomme of WWII) on a “we’re all in this together” kumbaya mode. Unions created a blue collar middle class, domestic output was consumed domestically, and income was about as equitable as it’s ever been in the history of the country.
Then came Israel and 1973 oil embargo. Bretton-Woods was scrapped, and eventually Reagan was appointed. He then led the charge of the 1% (long before they were identified as such) against the 99%. Since then, save for Clinton’s years, median income has stagnated, demand has collapsed, manufacturing emasculated (and would have been worse if the Right Wing had gotten its way with autos), and the ascendence of financialistic economy.
Finance is, in fact, merely a broker between savers and borrowers. Finance produces nothing, yet in the lead up to 2007, accounted for as much as 40% of corporate profits. Those profits exist only by extracting moolah from the saver borrower stream: finance creates no value on its own, it only extracts from the existing stream.
The CDO mess happened because Greenspan crashed interest rates in order to push the collapse past Dubya’s reign. Almost got away with it. With “risk free” returns (which is an oxymoron) collapsing, housing (which is risk free historically, right) became the place to get unearned income. Look at any plot of median house price (or median house price / median income), and the divergence was clear by 2002. The “wealth effect” kept consumption up in the face of declining middle class incomes. With global “saving” outstripping “risk free” vehicles, the banks, etc. found ever more clever ways to soak up that cash. Thus Liar Loans, which, by the way were created by mortgage companies, not banks.
The moral of the story: the macro policies will guide the economy, whether one likes it or not. The Right Wing tends to adorn its policies with rhetoric about returning to the days of the Founding Fathers and such. We’re getting the kind of inequity that existed then. The difference is that in 1800 there was a whole continent of land and resources which a few million white Americans could exploit unfettered. We no longer have that luxury.
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