http://www.thedailybeast.com/blogs-and-stories/2009-01-08/how-the-entire-economics-profession-failed/p/
How the Entire Economics Profession Failed
by Jeff Madrick
January 8, 2009 | 6:40am
At the annual meeting of American Economists, most everyone refused to
admit their failures to prepare or warn about the second worst crisis of
the century.
I could find no shame in the halls of the San Francisco Hilton, the
location at the annual meeting of American economists that just
finished. Mainstream economists from major universities dominate the
meetings, and some of them are the anointed cream of the crop, including
former Clinton, Bush and even Reagan advisers.
There was no session on the schedule about how the vast majority of
economists should deal with their failure to anticipate or even
seriously warn about the possibility that the second worst economic
crisis of the last hundred years was imminent.
“No one questioned their contribution to the current frightening state
of affairs, no one humbled by events.”
I heard no calls to reform educational curricula because of a crisis so
threatening and surprising that it undermines, at least if the
academicians were honest, the key assumptions of the economic theory
currently being taught.
There were no sessions about why the profession was not up in arms about
the deregulation of so sensitive a sector as finance. They are quick to
oppose anything that undermines free trade, by contrast, and have had
substantial influence doing just that.
The sessions dedicated to what caused the crisis were filled, even those
few sessions led by radical economists, who never saw turnouts for their
events like the ones they just got. But no one was accepting any
responsibility.
I found no one fundamentally changing his or her mind about the value of
economics, economists, or their own work. No one questioned their
contribution to the current frightening state of affairs, no one humbled
by events.
Maybe I missed it all. There were hundreds of sessions. I asked others.
They hadn’t heard any mea culpas, either.
Here’s what mainstream economists overwhelmingly—with only a few
exceptions—ignored or believed was acceptable and even healthy economic
behavior that contributed rather than detracted from prosperity:
• Wall Streeters paid themselves enormous bonuses based on rising market
values of investments, not on revenues actually made. The bonus system
has been based on the preposterous assumption that the value of an
investment set by traders in financial markets rationally reflects the
true future value of that asset almost all the time.
• Investment banks took on $25 to $40 of debt for every dollar of
capital in order to maximize their returns. It was assumed that these
smart people wouldn’t do this if they didn’t know how to manage their risk.
• Financial firms that were not regulated or overseen by the Federal
Reserve or any other Washington watchdog agency lent four out of five
dollars of lending to business and consumers. Economists as a group
raised no concern and in truth went along without serious questioning.
• Average Americans took on record amounts of debt compared to incomes,
which was said to be just fine because it was supported by high stock
prices and, when that bubble burst, by high house prices.
• The earnings of financial institutions rose to more than one-third of
all American profits. This only proved how valuable finance was to the
economy and that manufacturing was simply old hat.
• Hedge funds could justifiably charge two percent of assets each year
and take 10 to 20 percent of profits because they were excellent at
finding anomalies in the otherwise efficient market. Meanwhile,
economists assumed there was no manipulation or inside information
involved, of course—or undue risk taking. Furthermore, economists
believed this sector required no special regulation because it only had
sophisticated and rich people as investors like those who participated
in Bernard Madoff’s funds.
• House prices reached record levels compared to incomes. But this was
because of innovations in finance that reduced interest rates
substantially. That, after all, is why the Wall Street MBAs who made
these innovations, like complex mortgage-backed obligations and credit
default swaps, supposedly deserved all that money.
• Financial deregulation freed MBAs to make the brilliant technical
innovations. I could find no single mainstream academic economist who
criticized financial deregulation in a systematic way since the 1990s
until only very recently. Two veteran Wall Street economists, Henry
Kaufman and Al Wojnilower, were partial exceptions.
• A key economic price like the oil price, which rose to $145 a barrel
in August and has reached about $40 today, was supposedly not unduly
influenced by speculators. Markets are usually fair and, to repeat,
correctly anticipate the future, right?
• A high dollar, as long as it is set freely in the currency markets, is
just fine. It merely reflects the strength of the U.S. economy. No mere
human mechanism could set a more economically efficient price.
• The record trade deficit, caused by the high dollar, was tolerable
because overseas investors invested in America with their excess funds.
Their confidence in America was again further indication the economy was
strong, despite the ever-shrinking manufacturing sector.
• Low rates of unemployment were proof the American economic model was
working. In light of this, stagnant or falling wages in the 2000s was
not an indication of economic failure—just a reflection of American
competitiveness.
• The Federal Reserve can always save the day, as Milton Friedman taught
us. Just add more reserves and believe in Ben Bernanke, whose mentor was
Friedman. So now Bernanke is adding reserves far beyond anyone’s
imagination, just like Friedman said he should do, and the economy is in
ever-deeper trouble.
Of course, there were objections to these trends by some academic
economists. Robert Shiller of Yale was upset both about high stock
prices and then high housing prices. Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, was long
vociferous about over-speculation in housing. Nouriel Roubini of the NYU
Business School warned about financial collapse, as did Jim Crotty of
the University of Massachusetts at Amherst, who insisted, correctly,
that Wall Street traders and bankers mispriced risk. There were a
handful of Wall Street analysts who were concerned and some made money
by betting the other way.
But the exceptions were partial at best, and they prove the rule. What
most economists can't seem to acknowledge is that they have been
overcome by free market ideology over the past thirty years. Such
ideology is especially beneficial to wealthy vested interests. But
economists are purportedly dedicated to objective empirical and
statistical analysis. Ideology has little part in the work of these
serious empiricists, but surely there was no buttering up of the rich
and powerful that provide jobs and grants.
Only with the near collapse of the economy are economists changing their
tunes slightly, accepting the need for regulation and Keynesian
stimulus. But they will probably not change their deepest assumptions
about how markets work, or about when they should and should not be
given free reign. They will make no bigger place for government than to
adjust a little more for “market failures.” They will go back to
tinkering with those models, not transforming them, and even make them
fit the current crisis without blinking an eye.
As I say, at least they now believe in Keynesian stimulus and are a
little more skeptical of Friedmanism. Be thankful for small changes, I
suppose. A few will fight for a larger shift. Among mainstreamers
Shiller and George Akerlof at Berkeley are leading the charge. A lot of
pertinent and important ideas are percolating among the liberal fringe.
If there were some humility at the San Francisco gathering I’d be more
optimistic these voices could prevail. Government has a central place in
the economy, after all, as the Obama administration is about to
demonstrate. It is not merely an option of last resort. In general—and I
think the above examples of dereliction of duty make it just fine to
generalize—mainstream economists are a long way from getting that
fundamental idea.
Jeff Madrick is a contributor to The New York Review of Books and a
former economics columnist for The New York Times. He is editor of
Challenge Magazine, visiting professor of humanities at The Cooper
Union, and senior fellow at the Schwartz Center for Economic Policy
Analysis, The New School. He is the author of several books including
Taking America (Bantam), and The End of Affluence (Random House). His
latest book is The Case for Big Government (Princeton University Press).
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