Tim Price On One Of The Most Overlooked Aspects Of The Financial Crisis

Tyler Durden's picture

Submitted by Tim Price, Director of Investment at PFP Wealth Management, courtesy of Sovereign Man

One Of The Most Overlooked Aspects Of The Financial Crisis...

An engineer, a biologist and an economist are washed ashore on a desert island. After a few days without food they are starving. Eventually, they stumble on a can of beans on the beach.

They spend a few minutes considering how they might feed themselves. The engineer is the first to speak: "We could hit the can with a rock until it opens."

The biologist counters, "We could suspend the can in a seawater solution and wait for erosion to work its magic." The economist is last to contribute: "Let's just assume we have a can-opener."

OK, so it's not the funniest joke in the universe. But it has the ring of truth.

For example, one colossal presumption of mainstream economic theory holds that the economic mean reverts to some form of stable equilibrium; all that is required from our enlightened monetary leaders, we are told, is a gentle nudge of this policy lever or that, and the path back to stability is assured.

But what if the presumption is fundamentally wrong at its core? What if the economy is never destined to reach a stable equilibrium- a state in any case analogous in its cold sterility to the dynamism of air molecules in a perfect vacuum?

Judging by recent market action (on the part of equities and euro zone government bond yields), investors would appear to believe that the euro zone debt crisis has been largely resolved.

The market's supposed saviour has been the European Central Bank, benignly tipping half a trillion euros of liquidity onto the continent's banks. More pertinently, a crisis of overmuch credit provision seems to have been resolved through the medium of... more credit provision.

Computer scientists coined the phrase "garbage in, garbage out" to describe the vulnerability of computers to process meaningless input data and produce comparably meaningless output. One could drawn similar conclusions about the modern financial system and all the economic garbage going into it.

It was Nobel laureate William Sharpe, for example, who devised the capital asset pricing model in the 1970s in an attempt to establish the sort of risks that can be reduced by diversification.

But the CAPM (as it became known) also contains a number of assumptions about financial markets that can variously be described as either quaint or ridiculous, including:

  • Financial markets are perfectly competitive
  • Tax does not exist; nor do transaction costs
  • All investors have the same time horizon
  • All investors have the same expectations of returns and volatility
  • All investors can borrow and lend at one risk-free rate
  • Investors can go short any asset and hold any asset fractionally

Clearly the natural world we actually inhabit simply does not behave according to the sort of models that economists use.

In "The Origin of Wealth," Eric Beinhocker makes a convincing case that the rot set in to field of economics when serial French loser Leon Walras, having failed as engineer, novelist, journalist and banker, set his mind to this exciting new discipline. Beinhocker writes:

"Prior to Walras, economics was not a mathematical field. Walras and his compatriots were convinced that if the equations of differential calculus could capture the motions of planets and atoms in the universe, these same mathematical techniques could also capture the motion of human minds in the economy."

And so erroneous, inappropriate, and flawed models were lifted wholesale from the world of physics, and made to fit, somehow, jammed and crammed, no matter what pieces broke or flew off, into the unstable and probably unforecastably wild world of the economy.

This matters. And it may be one of the most overlooked aspects of the financial crisis: widely accepted economic wisdom may be fundamentally inappropriate in "the real economy", and the scope for potential losses in "the real economy" driven by such fundamentally inappropriate economic wisdom is almost infinite.

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macholatte's picture

Mr. Price has overlooked one simple truth which alters the equation; government intervention to the point where the concept of a "market" is illusory.

q99x2's picture

We can balance it by assuming the illusion is a market.

The Big Ching-aso's picture



Three arrogant assholes with Ivy League PhD's in Economics are washed ashore on a deserted island.  This is a good start.

Stuck on Zero's picture

It's a market.  We are always in a market.  Everything is s market in the business of life and we all operate in it with our own business models. 

CompassionateFascist's picture

Economist brains engineer w can of beans. Economist and biologist cannibalize dead engineer. Economist brains biologist w can of beans. Economist cannibalizes dead biologist. Finally, economist dies of starvation.

Stack Trace's picture

Yes we do. Thank you. Remember: Engineers add to GDP in a tangible way. I guess economists try to add to GDP by doing it with better models. Problem is those models are pretty much garbage because economists are just lap-dogs of TPTB.

sgt_doom's picture

I concur, ServingMyKing!!!

This post, no offense, is kind of silly, the purpose of chaos it to "earn" money for the money masters, the senior capital pool doods, etc.

Same as the purpose for war, which is no doubt why America always seems to support both or all sides in every war!

(During an ambush many years ago in Vietnam, the NVA patrol we hit just happened to be carrying the latest American-made weapons system, something completely new to the 3-man squad I was part of.

When I got back to the 'states, I looked into it, and found out that the company, a subsidiary of Xerox Systems, routinely sold their government-contracted-and-developed weapons systems on the black market, or actually sold it to the NVA and other supposedly enemy nations.  That was an eye-opener to this young fellow!)

Markets must be manipulated to roil, otherwise thieving profits won't go to the JPMorgan Chases, Goldman Sachs, Morgan Stanleys, Credit Suisses, Deutsche Banksters, and UBSers.

And that screws with the rest of us.  This is simply, prhased at it's most elegant, yet another ultra-leveraged bankster run, quite similar, but differing only in the details, to the run back in the 1920s leading up to the Great Crash of 1929.

That time, the Securities Act of 1933 was passed to put a halt to their securitizations (in stock form back then), while this time around, nothing was done (certainly the Dodd-Frank act was the typical faux legislation, or predatory legislation -- for an outstanding article deconstructing Dodd-Frank, please see link below).



BigJim's picture

I hope you feel proud to have helped Xerox's subsidiary - an American company! - field-test their new weapons system.

That's got to be worth a Purple Heart, at least.

The trend is your friend's picture

CIMA, CFA, CFP...worthless titles based on BS

Bull and Co.'s picture

it's called " Physics Envy"


GeneMarchbanks's picture

The methodological model of physics first was misapplied to psychology as the great Dr. Otto Rank of Freud's inner circle first observed. The same now holds true for economics and finance.

Goldman can collateralize the claim of a photo of water vapor and stick an X price on it through sheer obscurantism and criminal forgery and get an entire industry to share in the psychosis. This is the biggest cult in the history of mankind.

5880's picture

replace "economist" with "Steve Liesman"

NOW it's funny

Stack Trace's picture

Perfectly equal subsitution. Thanks. Now I have an image for each time I hear the word "economist". Too bad Liesman is so fugly. Is there an equally disreputable economist that is cuter?

optimator's picture

Steve Liesman, Reggie Middleton, and Tom Knight are washed up on an island with nothing but coconut trees!  Tom says, "I'm gonna start cutting down a few trees so we have some shelter".  Reggie says, "I'm gonna write a survival book about this".  They both turn to Steve Liesman and ask what he's going to do.  Steve thinks a second and says, "I'm gonna open up a coconut store".

EmileLargo's picture

Most economists make really lousy investors/traders. Why is that? 

5880's picture

They're a guy who knows 50 ways to fuck a girl...

but he's a virgin

sgt_doom's picture

Because, and I'm being serious now (a rarity w/me, I admit), they really aren't familiar with shorting, financially manipulative speculation, etc.

It's takes a highway robber/financier to understand the synergistic effect of naked swaps (uncovered credit default swaps), the potential of an unlimited number of commodity futures contracts purchased, using the Stock Borrow Program of DTCC on the shorting side, and that an unlimited number of investors are permitted per hedge fund --- this is how the banksters rule in their world of fictitious capital and phantom wealth!

Inspector Bird's picture

Prove it.  Keynes was actually a very good investor.  So was Schumpeter.


I think what you're trying to say is that if economists "know so much, why aren't they rich as Midas?"  And the answer is simple.

Some actually are very wealthy and quite good investors.  Others are not.  Like anyone else, we are prone to human bias.  I can tell you today that I knew the housing bubble was happening, and I had some ideas on how to profit from it.  My wife, however, didn't believe me and insisted she get a new home in 2007.  Ever try to fight your wife?

Well, had we stayed in our last home and waited only 2 more years, I'd have been able to buy our current home for many thousands less than we paid, our down payment would've been much larger, and our original home (which could either be a starter or step-up home due to its size it was a cross-market opportunity) wouldn't have lost much value at all.  Instead, I had to take money I wanted to use to short the market and buy a house which is worth less than when I bought it.

Add to this that economists are also subject to political bias.  Basically, Austrian Economists are sunk on inflation hedges now and doing well.  I had a conversation with a cousin (financial planner/money manager) 2 years ago and told him to keep an eye on gold.  He tossed back the 'barbaric relic' line to me.  I saw him a few months ago and asked again - he merely shrugged.  He's not an economist, I am.  I'm sure Krugman has done well since 2008, but is about to get a comeuppance when his world melts down.  He's a true believer.  Many economists are.  Austrians are truly flexible, however.  There is no guarantee, and so we seek general trends rather than specific concepts to be compelling.

Economists are also not usually well connected in the crony capital markets.  As academics, they usually try to stick to what they teach.

I've lost money in the market.  I've made money in the market.  I would say I'm a good investor, though, because I've made far more than I've lost.  In fact, were it not for my wife and her needs, I'd still own Apple, which I bought at 15 some years ago when I heard Michael Dell say they'd be better off selling everything and giving investors cash back.  I looked into it, saw he was right, and bought the shares.  When it hit 90, I wanted to keep hanging on.  She wanted a new kitchen.

So...it's all what you want to see.

Inspector Bird's picture

I forgot to mention - regarding bias - this is what drives markets.  Economists recognize that when they buy (or sell, or short, or option) something, they are doing the opposite of what someone else is doing.  That someone else could be another economist.  This is how markets are made.  Were we all uber-intelligent and all knew exactly what the market would do each and every time, ther would be no market, there would be no risk, and there would be nobody getting rich because everyone would do exactly the same thing.

When I buy a stock, I believe and hope many others will agree with me and do the same thing, but that a few people will not agree and do the opposite.  We need those other people to keep the market healthy.

Yes, that means there are losers.  But that's true in everything.  The idea being that there can and should be many more winners than losers, if a market works properly.

aleph0's picture



IMO ... Today's best fitting Law of Economic Theory is .... Criminal Law.

GeneMarchbanks's picture

'Clearly the natural world we actually inhabit simply does not behave according to the sort of models that economists use.'

'And so erroneous, inappropriate, and flawed models were lifted wholesale from the world of physics, and made to fit, somehow, jammed and crammed, no matter what pieces broke or flew off, into the unstable and probably unforecastably wild world of the economy.'

Once again, physicists and biologists observe the 'natural' world.

Economists, anthropologists, sociologists and psychologists observe the 'man made' world. These are all disciplines in the study of relationships. Who needs help understanding this simple concept?

exi1ed0ne's picture

Ding. People posses the capability for malicious intent. Nature may be a mother, but it's not personal.

disabledvet's picture

Economics without common sense is Physics without Newton. Of course "you try and make sense of the field vis a via investing" in the 1970's. The theory of "less is more" is pretty straightforward..."and it has the added value of being true" as Wall Street discovered (for most on a permanent basis) in 2008. The irony of course is that it's the Greeks who give us this word...which when translated means "household management." It still does in my book. "If I manage my household correctly what do I care what governments or businesses do?" And of course the answer is "I don't." that's why I start with divorce rates and proceed from there when measuring "how the economy is doing."

thatonekid13's picture

Complicated garbage in, polished and complicated garbage out. Mathematics is to economics what the Titanic is(was?) to sailing. 

Joe Davola's picture

As an electrical engineer, we learned that circuit theory worked real well under it's assumptions.  When the assumptions are increasingly violated, you don't fall off a cliff - you just get progressively worse results.  Economics seems to have the "progressively worse results" aspect when assumptions are violated, as well as the "fall off a cliff" capability.  All that without even considering the inherent biases the various practitioners build into their models.

ZippyBananaPants's picture

As a metallurgical engineer we learned on the atomic level why a paper clip finally breaks after you bend it back and forth, dislocations build up and then snap.  Like an airplane wing.  Or a greek bond bailout!

BandGap's picture

As PhD Chemists we learn that making stuff and selling stuff leads to a very stable, and lucrative, career path.

I learned a long time ago that the more variables that are introduced, the less predictable the model becomes.  There is no greater variable than the human being, and the human being is defining the variables here.


bbq on whitehouse lawn's picture

As Geologists we learned to think in millions of years. With great extintions come great rebirth as new life never before seen or imagioned is born.

Think Venice of 1300 leads to the CDS we have today or the mice like ancestors leading to the people creating the Greece default we have now.

In one million years will there be a new financial product created that destroys the world once more.

My bet is still on the bugs, in nature or machine who will prosper most.

Humans, even if we win we lose.

hannah's picture

the gov states that the paperclip can be bent back and forth forever without breaking.....economic theory would work if the assumptions were reasonable.


NotApplicable's picture

They would just redefine breaking until it becomes impossible to achieve. Just like they do with any other word  that still has any meaning left.

geekgrrl's picture

I don't think economic models are producing "progressively worse results," they are producing exactly the outcomes desired by the Fed in their Jekyll Island meeting a hundred years ago. If you "fall off a cliff," that's not a concern of theirs; their goal is to ensure that they get to keep all their ill-gotten gains and hole-up in a gated community with plenty of armed guards around.

CuttingEdge's picture

An interesting slant on potential armag€ddon (for the Germans) here in one of their own papers:


jimijon's picture

As I have always maintained Mr. Charles Ponzi was the true architect of modern economic theory and more importantly - practice.

He should be awarded a nobel posthumously.


VulpisVulpis's picture

"...widely accepted economic wisdom may be fundamentally inappropriate in "the real economy", and the scope for potential losses in "the real economy" driven by such fundamentally inappropriate economic wisdom is almost infinite."


Ok. I'm just going to file this one away in the "No Shit, Sherlock" file.

bankonzhongguo's picture

I have yet to meet an economist that actually ran a business for profit, met a single payroll or otherwise negotiated one contract with another private party.

In terms of pure utility, when I'm Team Captain I would pick the Girl Scout who sets up shop at your local grocer to sell Thin Mints over any stuffed shirt ivy league loser with PhD attached to their econ major.

They couldn't even cut my lawn much less anything else.

Go play with your own money, if you could actually earn some legitimately.



GreenPlease's picture

The species you describe does exist but is extremely rare.

adr's picture

An economist will be the first to die on a deserted island because while the others are complaining how thirsty they are, the economist is saying, "fools there is water everywhere", as he slurps seawater with reckless abandon.

GreenPlease's picture

Two economists are walking down the street together. One is a believer in the efficient market hypothesis and the other is not. The later spots a $100 bill on the ground and exclaims "Look at that! There's a $100 bill on the ground!" The other economist, the one who believes in the EMH, says "No, there's not. If there was a $100 bill on the ground someone would have already picked it up."

Yeah, I know. Pretty dry. But that's the world we economists live in.

zebrasquid's picture

Bernanke thinks he is an engineer, of course.

Uber Vandal's picture

Yes, just like this engineer:


The results should be about the same, but on a larger scale.

BadKiTTy's picture

The human mind is a pattern recognition belief engine. Once it locks on to a particular way of explaining/understanding the world it is hard to shift. True for all of us. Zero hedgers as well as fanciful, delusory, sociopathic douch mainstream economists....

Just my 2 C


exi1ed0ne's picture

Understanding where your own bullshit lives it the first path to wisdom.

sessinpo's picture

Dang. I would have killed the other two and eaten them already.

Zero Govt's picture

".. the rot set in to field of economics when serial French loser Leon Walras, having failed as engineer, novelist, journalist and banker, set his mind to this exciting new discipline.."

Chuckle ;)

Physics/science is the understanding of the Universe. Economics, if it has a role, should be about measuring markets, not trying to understand it

Because you cannot understand markets, that is best left entirely to the enterprises and consumers in each of the hundreds of market sectors who know far better their market than any academic trying veinly to 'average man' what cannot be averaged

So you cannot 'Lord it' over markets (as economists try) or pretend you're some wise, all-knowing God (as those cretins, politicians and central bwankers, believe) and tamper a few nobs here, twist a lever there, as if you can fine-tune a Goldilocks economy

The ebb and flow of human productivity, like music or fashion, is a creative beast and not to be messed with: you're just going to botch it, fuck up and vandalise it (see all Govt intervention throughout human history)

Free Markets (no rules, no Regs, no Govt) is best served untouched and left well the fuck alone

PS. Eric Beinhocker is also an idiot/economist

bbq on whitehouse lawn's picture

Proper science has always been and ever will be, counting.  You count and record the result. Its not about thinking or even explaining its just about the number, you leave the thinking to those foolish enough to believe that they have wisdom or understanding.