I’ve been really disappointed in economists taking the Robert Lucas / Bill Easterly approach in answering the Queen of England’s perfectly good question, “Why didn’t you economists see the financial crisis coming?”
To refresh your memory, here is what Easterly (a big-name economist at NYU who has done some cool work on development) said:
First, Your Majesty, economists did something even better than predict the crisis. We correctly predicted that we would not be able to predict it. The most important part of the much-maligned Efficient Markets Hypothesis (EMH) is that nobody can systematically beat the stock market. Which implies nobody can predict a market crash, because if you could, then you would obviously beat the market.
In other posts, I have pointed out that this reasoning is only true if you frame investing the way an economist using a rational expectations model would frame it. It’s analogous to game theorists concluding that the only “rationalizable” strategy is to immediately defect in a 3000-round prisoner’s dilemma, even though “irrational” players in the real world will end up making a lot more money following their ad hoc strategies.
But in this post, let’s take Easterly’s response at face value. The Queen could and should come back and say:
Yes, gentlemen, very well. So I’m asking you, why didn’t you forecast these things back in 2004, so that housing prices would have popped back then? You wouldn’t have beaten the market; you would have spared the market trillions in losses.
Everyone with me? If you’re still not seeing it, let’s switch examples. Let’s suppose that George Bush was taken utterly surprise by the attacks on 9/11. (I realize there are some who would dispute that, but go with me on this–I’m just making a point.) Bush is furious and calls in all the intelligence gurus. He takes them out to the woodshed, demanding to know why they get funded billions per year if they can’t even see an attack on US soil coming that takes out the Twin Towers and hits the Pentagon, for crying out loud!!
Now can you imagine if somebody said, “Well Mr. President, we all feel awful about this, but it really wasn’t our fault. By its very nature, an attack like 9/11 couldn’t have been forecasted. If any of us had predicted it–even as late as 9/10–then we would have foiled the plot–we’re all patriots, after all.”
Now wouldn’t the above excuse have been worthy of an Atomic Wedgie? Well that’s what Easterly said to the Queen. But by dressing it up with fancy terms like “efficient market hypothesis” Easterly’s answer sounds deep, rather than patently absurd as the above quote is.
One last way of putting it, to make sure you get my point here: If the gurus on CNBC and in the bowels of the ratings agencies had realized how fragile things were in, say, 2005, then history would have been averted. Things wouldn’t have gotten even more fragile in 2006. So in the alternate universe, it’s not the case that the housing bubble still would have been just as severe, except that Bill Easterly made billions shorting the market. No, the bubble wouldn’t have been pumped up as much.
In that alternative universe, it still would have been true that “no one beats the market” (in the tautologous sense that Chicago School economists use that incantation). But “the market” wouldn’t have lost trillions of dollars.
The mainstream economists screwed up big time during the housing bubble years. The people interviewed on CNBC, and advising the government, weren’t saying, “What are you coming to us for? We have no special insight on the stock market.” No, they were assuring investors that the boom would last. (And I regret to say that I contributed to this madness before seeing the light [.pdf] in the summer of 2007.)
Lucas and Easterly are saying nothing more profound than, “It’s true we economists didn’t predict the crash, but then again neither did most of the big-money people around the world.” This is true, and the Queen’s correct response should be, “Fine, so my question is, why not? What did you–and most of the rich people–do wrong, so that we can try to prevent this from happening again?”
People were already suspicious of economists before this crisis. Now it’s downright embarrassing.
* Mario Rizzo on the issue of whether economists should have predicted (forecast) the financial collapse.
* Paul Green offers practical tips for Internet privacy. I have been urging techie/security guys I know, to write up such an article. What do people think of Green’s suggestions? I would like a second (and fifth) opinion before I go changing my antivirus software.
A lot of people are emailing me about the controversy. What can I say? I run into some old timers telling me how great socialized medicine is, and I just lose it.
Or take the health care debate we’re presently having: members of Congress have recessed now so they can go home and “listen to their constituents.” An urge they should resist because their constituents don’t know anything. At a recent town-hall meeting in South Carolina, a man stood up and told his Congressman to “keep your government hands off my Medicare,” which is kind of like driving cross country to protest highways.
I’m the bad guy for saying it’s a stupid country, yet polls show that a majority of Americans cannot name a single branch of government, or explain what the Bill of Rights is….
Can Bill Maher explain what the Tenth Amendment to the Bill of Rights is?
That practice has bothered me for a while now. It’s true, I definitely fall into the “open borders libertarian” camp, but that’s not really the point in this post.
If someone says, “I am concerned that there are so many immigrants coming in, and I think that wouldn’t happen if the border lands and roads were all privately owned,” then OK let’s have that discussion. (Anthony Gregory does a great job laying out the view I endorse.)
What I’m complaining about is when a person says, “Our government no longer listens to the will of the people! We clearly told them we want border enforcement, and they don’t listen to us. Instead they let in these millions of illegals, and educate their kids for free.”
I’ve been trying to put my finger on it, and I think my problems are twofold. First, to call an entire group of people “illegals” is the same dehumanizing trick as to call others “birthers” or “truthers.”
Second, a lot of these people using the term don’t really care about the official statutes coming out of Washington. If the politicians suddenly voted to turn all the “illegals” into “legals,” the rabble rousers wouldn’t be placated. No, they would call back in to the talk shows going nuts because, “Those fools in DC gave amnesty to all the illegals!”
So it’s not really their illegal status per se that is at issue. I’ve never heard anyone call in to Sean Hannity and refer to the signers of the Declaration as “illegals.”
An unanticipated drawback to writing this unorthodox book review is that Amazon now suggests some very childish books when I visit the site. (When I wrote the review, I had to get the picture of the Smash! Crash! cover from Amazon.)
Picture this: An Iranian man finds himself washed ashore a California beach. He stands up, dusts himself off, and starts announcing to people that they are going to die because of their fornication. He delivers the message with such conviction and lack of sympathy that it just clicks and people actually believe him. He’s not trying to reform them; if he were, then they would think he was bluffing. But no, he’s just informing them that they are going to be wiped out for their iniquities. He actually convinces all of Hollywood to empty their liquor bottles down the drain. The Iranian man’s warnings were just that compelling.
The above scenario would be impossible, right? Well, it’s true, it would be impossible for any man we’ve ever encountered to pull off such a stunt. But what if it were a man, who had just spent three days inside a whale?
Jonah must have been terrified of what the Ninevites would do to him, if he actually carried out God’s instructions. But after realizing his predicament, and knowing that God had every right to punish him by making him die of thirst over the course of days inside a pool of whale bile, Jonah was no longer so afraid. It was only after experiencing his aquatic trauma that Jonah had the ability to execute God’s plan for him.
Even God’s rebukes are designed to improve us.
The government (including the Federal Reserve) has paralyzed the credit markets. It has attacked the markets in many ways, but one particularly insidious move was the inject a massive amount of new reserves, and then pay interest to keep them bottled up.
This is one of the most perverse outcomes of the Fed’s combination of decisions. Because nominal interest rates have been pushed so low, it is relatively cheap for the Fed to turn itself into the ideal place for banks to park reserves. In a booming economy with nominal interest rates at 7%, it would be very expensive for the Fed to bribe backs into restricting their loan portfolio. But not now, with the fed funds rate hovering at 0%.
In yet another case where the government creates the very problem it was (supposedly) trying to solve, check out this graph. Remember, the unprecedented actions were justified as a way to patch up the “credit crunch” and to unclog or unfreeze the credit lines on which businesses rely.
Isn’t it ironic, then, that–as the graph shows–bank lending didn’t go down until after Bernanke shot the moon? There was no “credit crunch” before that intervention.