Government Economic Leaders Surprised that Real World Isn't Responding to their Magic Pixie Dust

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Washington’s Blog

Fed chief Ben Bernanke told the financial crisis inquiry commission today:

If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved

 

***

 

Too-big-to-fail
financial institutions were both a source ... of the crisis and among
the primary impediments to policymakers' efforts to contain it ....

That's funny, given that Bernanke has been one of the biggest defenders of the too big to fail banks, arguing strenuously against breaking them up, throwing trillions of dollars their way, and begging the banks to play nice with one hand, while patting them on the back with the other hand and giving them a big wink.

And Christina Romer - Obama's outgoing chief economist and Chair of the Council of Economic Advisers - said in her outgoing speech yesterday, as summarized by Dana Milbank at the Washington Post:

She
had no idea how bad the economic collapse would be. She still doesn't
understand exactly why it was so bad. The response to the collapse was
inadequate. And she doesn't have much of an idea about how to fix
things.

Many have tried to explain
to the neoclassical economists running the show exactly how bad the
economic collapse would be, why it was so bad, and how to mount an
adequate response to fix things. But Bernanke, Romer and the rest of
the gang ignored them.

Who Knew?

 

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As I pointed out in March:

 

Greenspan's big defense is that the financial crisis was caused by a "once-in-a-century" event.

 

 

Forget about the fact that the "once-in-a-century event" couldn't have happened if Greenspan's Fed hadn't:

  • Acted as cheerleader in chief for unregulated use of derivatives at least as far back as 1999 (see this and this)
  • Allowed
    the giant banks to grow into mega-banks. For example, Citigroup's
    former chief executive says that when Citigroup was formed in 1998
    out of the merger of banking and insurance giants, Greenspan told him, “I have nothing against size. It doesn’t bother me at all”
  • Preached that a new bubble be blown every time the last one bursts
  • Kept interest rates too low
  • And did alot of other hinky things

More importantly, as Nassim Taleb repeatedly points out, financial experts who don't plan for rare events are like pilots who don't know about storms.

 

There are storms out there, Taleb says, and any pilot who doesn't know how to deal with storms shouldn't be flying. Similarly, no one should be in a position of financial leadership if they don't know about - and plan for - the infrequent event:

 

 

High Priests Shake their Magic Wands Even Harder

As Australian economist Steve Keen wrote last week, mainstream economists have been acting like religious fundamentalists, rather than scientists:

Bernanke’s
failure to realize this: it’s a failing that he shares in common
with the vast majority of economists. His problem is the theory he
learnt in high school and university that he thought was simply
“economics”—as if it was the only way one could think about how the
economy operated. In reality, it was “Neoclassical economics”, which is
just one of the many schools of thought within economics. In the
same way that Christianity is not the only religion in the world,
there are other schools of thought in economics. And just as
different religions have different beliefs, so too do schools of
thought within economics—only economists tend to call their beliefs
“assumptions” because this sounds more scientific than “beliefs”.

 

Let’s call a spade a spade: two of the key beliefs of
the Neoclassical school of thought are now coming to haunt
Bernanke—because they are false. These are that the economy is (almost)
always in equilibrium, and that private debt doesn’t matter.

Indeed, as I wrote in June:

Most economists don't exercise any independent thinking because economists are trained to ignore reality:

As
I have repeatedly noted, mainstream economists and financial
advisors have been using faulty and unrealistic models for years. See
this, this, this, this, this and this.

And I have pointed out numerous times that economists and advisors have a financial incentive to use faulty models. For example, I pointed out last month:

The decision to use faulty models was an economic and political choice, because it benefited the economists and those who hired them.

For
example, the elites get wealthy during booms and they get wealthy
during busts. Therefore, the boom-and-bust cycle benefits them
enormously, as they can trade both ways.

Specifically, as Simon Johnson, William K. Black and others point out,
the big boys make bucketloads of money during the booms using
fraudulent schemes and knowing that many borrowers will default. Then,
during the bust, they know the government will bail them out, and they will be able to buy up competitors for cheap and consolidate power. They may also bet against the same products they are selling during the boom (more here), knowing that they'll make a killing when it busts.

But economists have pretended there is no such thing as a bubble. Indeed, BIS slammed the Fed and other central banks for blowing bubbles and then using "gimmicks and palliatives" afterwards.

It
is not like economists weren't warning about booms and busts.
Nobel prize winner Hayek and others were, but were ignored because
it was "inconvenient" to discuss this "impolite" issue.

Likewise, the entire Federal Reserve model is faulty, benefiting the banks themselves but not the public.

However, as Huffington Post notes:

The
Federal Reserve, through its extensive network of consultants,
visiting scholars, alumni and staff economists, so thoroughly
dominates the field of economics that real criticism of the central
bank has become a career liability for members of the profession,
an investigation by the Huffington Post has found.

 

This
dominance helps explain how, even after the Fed failed to foresee
the greatest economic collapse since the Great Depression, the
central bank has largely escaped criticism from academic
economists. In the Fed's thrall, the economists missed it, too.

 

"The
Fed has a lock on the economics world," says Joshua Rosner, a Wall
Street analyst who correctly called the meltdown. "There is no
room for other views, which I guess is why economists got it so
wrong."

The
problems of a massive debt overhang were also thoroughly
documented by Minsky, but mainstream economists pretended that debt
doesn't matter.

And - even now - mainstream economists are STILL willfully ignoring things like massive leverage, hoping that the economy can be pumped back up to super-leveraged house-of-cards levels.

As the Wall Street Journal article notes:

As they did in the two revolutions in economic thought of the past century, economists are rediscovering relevant work.

It
is only "rediscovered" because it was out of favor, and it was
only out of favor because it was seen as unnecessarily crimping
profits by, for example, arguing for more moderation during boom
times.

The powers-that-be do not like economists
who say "Boys, if you don't slow down, that bubble is going to get
too big and pop right in your face". They don't want to
hear that they can't make endless money using crazy levels of
leverage and 30-to-1 levels of fractional reserve banking, and credit
derivatives. And of course, they don't want to hear that the Federal Reserve is a big part of the problem.

Indeed, the Journal and the economists it quotes seem to be in no hurry whatsoever to change things:

The
quest is bringing financial economists -- long viewed by some as a
curiosity mostly relevant to Wall Street -- together with
macroeconomists. Some believe a viable solution will emerge within a
couple of years; others say it could take decades.

Saturday, PhD economist Michael Hudson made the same point:

I
think that the question that needs to be asked is how the
discipline was untracked and trivialized from its classical
flowering? How did it become marginalized and trivialized, taking
for granted the social structures and dynamics that should be the
substance and focal point of its analysis?...

To
answer this question, my book describes the "intellectual
engineering" that has turned the economics discipline into a public
relations exercise for the rentier classes criticized by the
classical economists: landlords, bankers and monopolists. It was
largely to counter criticisms of their unearned income and wealth,
after all, that the post-classical reaction aimed to limit the
conceptual "toolbox" of economists to become so unrealistic,
narrow-minded and self-serving to the status quo. It has ended up as
an intellectual ploy to distract attention away from the financial
and property dynamics that are polarizing our world between debtors
and creditors, property owners and renters, while steering
politics from democracy to oligarchy...

[As one Nobel
prize winning economist stated,] "In pointing out the consequences
of a set of abstract assumptions, one need not be committed unduly
as to the relation between reality and these assumptions."

This
attitude did not deter him from drawing policy conclusions
affecting the material world in which real people live. These
conclusions are diametrically opposed to the empirically successful
protectionism by which Britain, the United States and Germany rose
to industrial supremacy.

Typical of this now
widespread attitude is the textbook Microeconomics by William
Vickery, winner of the 1997 Nobel Economics Prize:

"Economic
theory proper, indeed, is nothing more than a system of logical
relations between certain sets of assumptions and the conclusions
derived from them... The validity of a theory proper does not depend
on the correspondence or lack of it between the assumptions of the
theory or its conclusions and observations in the real world. A
theory as an internally consistent system is valid if the
conclusions follow logically from its premises, and the fact that
neither the premises nor the conclusions correspond to reality may
show that the theory is not very useful, but does not invalidate
it. In any pure theory, all propositions are essentially
tautological, in the sense that the results are implicit in the
assumptions made."

Such
disdain for empirical verification is not found in the physical
sciences. Its popularity in the social sciences is sponsored by vested
interests. There is always self-interest behind methodological
madness. That is because success requires heavy subsidies from special
interests, who benefit from an erroneous, misleading or deceptive
economic logic. Why promote unrealistic abstractions, after all, if
not to distract attention from reforms aimed at creating rules
that oblige people actually to earn their income rather than simply
extracting it from the rest of the economy?

***

Michael Rivero may have the hardest-hitting critique of all:

This
seems to be a return to the mindset of the middle ages where only
the clergy were allowed to read and interpret the bible and the
laity were presumed incapable of comprehending the intricacies and
subtle nuances of the faith.

 

And indeed there is a great deal of
similarity between economics and [fundamentalist version of]
religion in that both depend on the unquestioning faith of the
masses that those pretty printed pieces of paper represent
something real, albeit invisible.

 

But the advent of the
printing press led people to take a closer look at the actual
content of [fundamentalist version of] religion and it has been
revealed not as a complex and sophisticated system but as a
mish-mash of half-baked myths and legends often in contradiction with
itself and used to enrich the church ....

 

The same is true of
economics. the advent of the blog has led people to take a closer
look at the actual content of economics and it has been revealed
not as a complex and sophisticated system but as a mish-mash of
half-baked theories and math often in contradiction with itself and
used to enrich the bankers and conceal their fraud against the
public. Athreya is reacting to the blogs the way [fundamentalist]
priests reacted to Gutenberg's Printing Press.

 

The fraud
and danger of the Federal Reserve system of banking stands exposed
to the public eye, sans the "benefit" of correct interpretation by
the self-appointed priests of Mammon. The public now understands
that when a private bank issues the public currency at interest,
debt will always exceed the available money supply. The public now
understands that the Federal Reserve is no more Federal than
Federal Express. The public now understands that the Federal
Reserve is a legalized counterfeiting operation, that creates the
money they loan out out of thin air! The public now understands that
the Federal Reserve system of banking, since its creation in 1913,
has reduced the value of a dollar down to about four cents! The
public now understands that the Federal Reserve system is a pyramid
scam that only works when ever larger populations of borrowers can
be found, and that once an entire nation or planet has borrowed to
the max, the system must crash (which is what is happening now).

 

Just as the [fundamentalist] priests, stripped of the arcane
scriptures and rituals, stand exposed ... so too the economists,
stripped of their arcane equations and theories, stand exposed ....

Karthik Athreya doesn't like that fact that the public sees the Federal Reserve for what it really is.

What Could Possibly Go Wrong?

Not
only have our government "leaders" in the Fed, Treasury, Congress and
White House ignored the real world, they have taunted it - like
monkeys who pull the tail of the lion and then are surprised when the
lion attacks:

They have:
  • Given trillions in bailout or other emergency funds to private companies, but then refusing to disclose to either the media, the American people or even Congress where the money went
  • Failed to take any meaningful steps to stabilize - let alone fix - the economy (see this and this)

Under these conditions, it is impossible to have a decent economy. After pulling these kind of shenanigans, of course the lion of debt and depression is going to eat us alive.