Economists Make Astrologers Look Good: Why They Failed To Predict The Great Recession
The first of a two-part series on why economists failed to predict the 2008 Crisis
I owe the title to the late Harvard professor John Kenneth Galbraith who was realistic about his fellow economists. One of his most famous quips in the 1970s was: “The only function of economic forecasting is to make astrology look respectable.”
On the brink of the collapse of our entire economic system in 1929, economists were predicting boom times ahead. Until one minute after the near total financial system collapse in 2008, all economists of influence were doing the same.
By 2006, many hedge fund managers had clearly seen the cracks in our financial system. While they began betting with the banks that the housing market would collapse, recently appointed Fed chair Ben Bernanke famously said he was, “moderately optimistic” about the future of the US economy which he described as being in “good shape” with steady growth for the last six or seven years.
In 2009, a self-deprecating economist with a sense of humor drew a meme based on that iconic scene of Wiley Coyote, who, while chasing Road Runner, discovers that he has run out of road and is treading air — depicting the moment when economists realize that a financial bubble has burst.
It was early in the 21st century. An unforeseen calamity had already happened. What next? The US Senate was so perplexed by this continuing failure of America’s greatest economic thinkers, it held a special inquiry into this recurring phenomena.
They summoned the teacher of economic teachers, Professor David Colander, who has so many achievements in the economic field that it would bore you to list them. Among his 35 books and over 100 articles are two textbooks dedicated to the education of economists. Colander could give little comfort to the distraught Senators. He said maybe there was too much reliance on mathematical formulas or, perhaps economic students should be taught common sense.
However, there are several reasons why the economists, who the government always puts in positions of power and who become the media talking heads, always miss when it comes to understanding the role of Wall Street. In 1975, Galbraith had warned that economists were intentionally not taught the truth about essential concepts of banking.
“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it.”
Two years after the 2008 Crisis, Lord Adair Turner, a former head of the UK Financial Services Commission, repeated that unfortunate fact: economic textbooks still presented false concepts about banking. Let’s explore several obvious and not so obvious reasons why economists have failed to understand the basic concepts of banking.
In Bankers They Trust
First I must qualify: while lambasting ‘economists’ in this article, I am directing my criticism at those who specialize in the financial system, and who are the main consultants to government and the media darlings. There are others, some who gave insightful warnings of the impending doom but were made non-persons with a thoroughness Stalin would admire.
Here are a few Cassandras of the crisis in the time leading up to the meltdown; there were undoubtedly more. You may not have heard of these names and it’s highly probable you never will. They have committed the unforgivable crime of being right when the economists who dominate the media were wrong.
- In 2003 at the Jackson Hole Conference that year, economist Bill White of the Bank of International Settlements vehemently warned US Fed Chair Alan Greenspan that his data was dangerously defective. White worried about the quality of loans, the honesty of the rating agencies, and the impenetrable complexity of derivatives that he contended were hazardous. In short, he gave a precise summary of all the causes of the coming crisis. Greenspan, then revered as the Maestro, summarily dismissed White.
- In 2003, economist Ann Pettifor began a series of public articles predicting a coming financial doom for the poor and richness for the already rich.
- At the 2005 Jackson Hole Conference, economist Raguram Rajan gave the same warning of an imminent and serious meltdown. US Treasury Secretary Larry Summers then called Rajan a Luddite.
Now, the failed economists I am targeting, whose predictive ability proves them no better than financial tea leaf readers, are undoubtedly brilliant. In all probability, they were identified as exceptional at an early age, knocked off academic award after academic award, and easily grabbed an early Ph.D. or two. They probably had little real life experience working in the outside world, the purest distillations of the academic library nerd.
The only contacts they have with bankers are being invited to give a short seminar on one of their brainy insights at about $10,000 a pop — to appreciative banker applause — and then, if they appear to have influence on the government, a position on a Board of Directors or two and dinners at five-star restaurants. They see bankers on their best behavior and have no idea of the bankers’ true character.
Brooksley Born was one of the people who could have helped us avert the 2008 mortgage crisis. Brooksley, then head of the Commodity Futures Trading Commission (CFTC) could have assumed jurisdiction over the dark derivative market. She warned Alan Greenspan that it was open season for banker fraud in that mushrooming market. Born was a danger to the “government-is-not-the-solution-government-is-the-problem” ethic of the mainstream economists like Greenspan.
Recall that it was in this very market that subprime mortgages were fraudulently passed off as if they had met Fannie Mae conforming mortgage standards. If Born’s warning had been taken seriously, the 2008 collapse may have been prevented or at least held to a minor recession.
Making Recessions Great Again: The Many Myths — And Frauds — Of The 2008 Financial Crisis
This is the last in a four part series on the Financial CHOICE Act.
Born recalls a meeting with Greenspan, a man the government trusted with leadership of its economy.
“Well, Brooksley, I guess you and I will never agree about fraud,” Born remembers Greenspan saying.
“What is there not to agree on?” Born says she replied.
“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls.
Greenspan, Born says, believed the market would take care of itself.
Not deterred by the credulous comment by Greenspan, Born circulated a concept paper on regulating derivatives. Because she was a lawyer and not an economist, economists like Greenspan rationalized that she needed to be stopped.
Shortly afterward, Greenspan, Larry Summers, and Robert Rubin (an ex Goldman Sachs CEO) influenced Congress to block Born. Even though it was the time of the Clinton Democrats, Congress passed an extreme deregulation statute called the Commodity Futures Modernization Act of 2000 (CFMA).
A banker’s deregulation wet dream, it absolutely prohibited the upstart Born and her CFTC from regulating what had become the new sacred cow of finance, the derivative. It didn’t stop there. It also took away any potential jurisdiction on the part of the SEC and forbade nosey state regulators from interfering with the derivative market. In other words, it exempted the up-surging derivative market from all government oversight from every possible source. Bankers could do what they wanted in the new and great shadow market — now a highway with no speed limits, no white divider lines, and no traffic cops.
An Insider’s Take On Bankers’ Ethics
The Spectator has dubbed Michael Lewis “by a long way, the most important financial writer alive today — not just in his native America, but worldwide.” Lewis’ greatest strength lies in the fact that he is not an academic economist but spent four years as a stockbroker at Salomon Brothers. His breakthrough novel, Liar’s Poker, exposed the narcissistic banker culture intent on making profit for itself — often at the expense of their clients’ interest whenever that got in the way.
He described his initiation into banker ethics with his first personal client, a European banker who asked Lewis for Salomon’s recommendation for a safe investment for a pension fund. Lewis looked at the recommended list and suggested the number one item. The banker bought. Instantly, his boss thanked Lewis over the loudspeaker for selling $20 million of “our” shares in that recommended corporation.
The announcement struck Lewis like a lightning flash. He had no idea that he was selling Solomon’s shares; but he knew that if Salomon was selling, that company was about to tank. And within a few days, tank it did.
The banker was apoplectic, pleading for help. He had recently married, had a new baby and a mortgage. He would lose his job. Lewis went to his boss, but was met with a blunt retort, “Who do you work for, him or Salomon?” Lewis tried enlightened self-interest. This guy would bring in future business. Why lose him? There must be a way to help him out. His boss told him not to worry. Some other stock broker was burning someone somewhere as they spoke.
Lewis got the message and tried to alert the public to the banker charismatic sociopathic personality in Liars Poker to no avail. Certainly, his exposé has had little effect on most economists and their theories. Many readers mistakenly thought this culture was unique to Salomon.
It wasn’t and isn’t— it pervades all investment banks. This knowledge that some of the most intelligent graduates of the universities across America are dedicated daily to gaming the system should be the starting point, the very foundation, for any economic policy regarding banks. But major economists remain deaf and blind to the true nature of the highly paid banker.
Financial journalist Bethany McLean kept tabs on the mounting massiveness of banking criminal behavior that economists usually ignored. On a day in 2013, she assembled headlines from various/scattered sources in one place about banker illegal activities that had occurred in that week alone:
“Ex Goldman Trader Found Guilty for Misleading Investors.”
“Bond Deal Draws Fine for UBS.”
“JPMorgan Settles Electricity Manipulation Case for $410 million.”
“Deutsche Bank Net Profit Halves on Charge For Potential Legal Costs.”
“US Sues Bank of America Over Mortgage Securities.”
“Senate Opens Probe of Banks’ Commodities Businesses.”
“US Regulators Find Evidence of Banks Fixing Derivatives Rates.”
“Goldman Sachs Sued for Allegedly Inflating Aluminum Prices.”
Soul-searching economists wanted to reread J. K. Galbriaith’s analysis of the crash of 1929 for clues about the meltdown of 2008. In preparing a new edition, his son, James K. Galbraith, a respected economist in his own right, commented in the introduction that banker conduct was so unethical in the 2008 Crisis, that economists should move into the background and criminologists to the forefront. Dead on and equally ignored by trusting economists.
We’ve discussed a few possible innocent explanations of why economists miss the warnings of impending financial crises. In the next part of our series, we’ll take a look at some other explanations, which imply a much more corrupt system and darker forecast for our economic future.
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