For the ragged remnants of economic methodologists, it was a sorry sight to watch a few older economists rummaging around in the vague recesses of memories of undergraduate courses criticizing Milton Friedman’s little 1953 benediction for believing whatever you pleased as long as it was neoclassical, and coming up with nothing better than badly garbled versions of Popper and Kuhn.23 Of course, quite a few had premonitions that something had gone very wrong, but the sad truth was that they were clueless when it came to analytical deployment of abstract philosophical argument in isolating just where the flaws in professional practice could be traced, and assessing the extent that they were susceptible to methodological remedies. Mired in banality, the best they could manage to prescribe was more of the same. No wonder almost every economist instead took their philosophical perplexity as an opportune occasion to settle internecine scores within the narrow confines of the orthodox neoclassical profession: MIT vs. Chicago, Walras vs. Marshall, mindless econometrics vs. mindless axiomatics, New Keynesians vs. New Classicals, Pareto sub-optima vs. rational bubbles, efficient markets vs. informationally challenged markets . . . In May 2010, Dominique Strauss-Kahn, still chief at that point of the IMF, insisted that “the crisis is an opportunity”; perhaps even he didn’t quite grasp back then that the main opportunity was for revenge (both personal and intellectual).
Lesson 2: Economists lost control of the discussion
of the shape of the crisis early on
Exhibit #1 demonstrating that the economics profession was caught unawares by the meltdown in 2008 was the fact that it rapidly lost any control over how the crisis was discussed in public that year. From the failure of Bear Stearns forward, journalists scrambled to understand how it could be that problems in one sector would ramify and amplify into other sectors, such that the entire financial system seemed poised on the brink of utter failure. There had been bankruptcies and dodgy financial deals before: What was so different this time around? Reporters started out by interviewing the usual suspects (Alan Greenspan, and Ben Bernanke—himself prophet of the Great Moderation), and overwhelmingly, neoliberal economists from gold-plated schools (Martin Feldstein, Gregory Mankiw, Matthew Slaughter, Robert Barro, Glenn Hubbard, Larry Summers, Allan Meltzer, Ken Rogoff), but you could tell that all the tendering of lame reassurances was not holding up against the tsunami of bad news. Of course, the keening public just wanted simple answers and quick fixes, but the economists didn’t seem to provide any answers whatsoever. So the journalists, with a little help from the chattering classes, came up with the metaphors which ultimately rose to dominate initial discussions of the crisis in 2008–9.
Upon reflection, it was perhaps not unexpected that the concepts which came to dominate “explanation” in the generalist press were a mélange of biological and religious metaphors: Nature and God usually trump the market in America. Although the actual array of metaphors bandied about back then pose all sorts of interesting questions from a rhetorical point of view (and someday should attract its very own Derrida), the main lesson we shall draw here from our superficial survey is that none of them had anything whatsoever to do with economic theory. They were the flimsiest of jerry-built constructs, improvised on the fly to make someone disoriented by panic believe we could make some instant sense of the crisis.
The first, and most persistent, explanation of the nature of the crisis involved repeated reference to “toxic assets.” A quick content search reveals the term first surfacing in the Wall Street Journal in January 2004. What started out as a mere figure of speech suddenly blossomed in 2008 to constitute Finance for Dummies in the heat of the crisis—and even seems to have influenced the shape (and title) of the original three-page TARP plan sent to Congress. People liked it because it embodied both a notion of the problem and the cure—if you “ingest/invest” too many “toxic assets” you die, but the way to get rid of poison is to flush it out of your system. Hence the entire crisis was not so different from an outbreak of E. coli infesting your spinach: dangerous, to be sure, but definitely not a system pathology. All we had to do was detox and everything would return to health. The beauty of the metaphor was it elided all the hard work of explaining ABSs, CDOs, CDSs, SIVs and nearly everything else that actually caused the crisis. The assets were toxic; we didn’t need to know how or why; we didn’t stop to think that the financial system might have intentionally produced them—raising the prospect that therefore the entire metaphor was wonky at base. (It would be as if a snake naturally produced venom, only to kill itself.)
But more to the point, the metaphor had no basis whatsoever in the orthodox theory of finance, such as it existed in 2008. In that theory, efficient markets are arbitrage-free, and any contingent claim can be reduced to any other contingent claim through some stochastic wizardry (chapter 5 goes into some greater detail on these issues). Hence risk itself can always be commodified and traded away—that is the service the financial sector performs for the rest of the economy. That’s just Intro Finance 101, from CAPM to Black-Scholes. In academic doctrine, the system as a whole simply cannot fail to price and allocate risks; hence there is no such thing as virulently “toxic” assets. Crappy assets, junk bonds, dogs with fleas, yes; but inherently “toxic,” never.
The other dominant metaphor was the biblical “Day of Reckoning.”24 Americans love a good apocalypse, and journalists found some figures who were willing to deliver it, from Naseem Taleb and his “Black Swan” to Nouriel Roubini as Dr. Doom. The evil will be punished, the last shall be made first, the moneychangers will be ejected from the temple, and the righteous shall triumph. I hope I need not expound upon the fact that there is nowhere to be found such Old Testament reckoning in orthodox economic theory: the market correctly evaluates everything in real time, and no one is really punished, but rather experiences depreciation of their human capital (or something like that). This metaphor lacked staying power, however, once it started to become clear that the putative sinners, the investment bankers, never had to face the music at all. Instead, they were bailed out by the taxpayers, and went on to enjoy their most profitable year in history in 2009. Notoriously, bankers raked in record bonuses. Indeed, profits per employee in all privately held U.S. companies more than recovered by 2011, as revealed in Table 4.1 and Figure 4.1, while employment itself languished. Apparently all boats were not raised by the profit gusher. Socialism for the rich seems blatantly antithetical to the Great Reckoning, so we just stopped hearing about that by roughly mid-2009.
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Table 4.1: Average Profits per Employee, U.S. Firms
* * *
Year
Profit per employee (Privately held companies)
2001
$9,998.21
* * *
2002
$10,716.71
* * *
2003
$10,813.91
* * *
2004
$11,663.59
* * *
2005
$13,026.41
* * *
2006
$13,428.02
* * *
2007
$13,638.99
* * *
2008
$12,533.96
* * *
2009
$10,045.56
* * *
2010
$12,488.02
* * *
2011
$15,278.72
* * *
Figure 4.1: Corporate Profits U.S. by GDP
* * *
* * *
Source: St. Louis Federal Reserve
The last dominant metaphor of desperate resort was the myth of Eternal Return—usually phrased as the question “Is this another Great Depression?” This was not an attempt to channel Nietzsche as much as it was a quest to normalize threatening events by suggesting that however bad things got, it had all happened once before. The economists Barry Eichengreen and Kevin O’Rourke did some serious work attempting quantitative comparisons
(see Figures 4.2, 4.3),25 but the truth was, after a short interval, the most this trope demonstrated was that no one really had cared very much about the specifics of history. The underlying motivation of journalists had been to recast system breakdown as repetition, and therefore unremarkable, something partaking of a modicum of reassurance. Yet the figures revealed that, while the initial contraction was, if anything, sharper than 1929–30, around year two of the crisis, both equity markets and world trade began to turn around in a way they had not in the Great Depression. While both divergences could be traced to specific neoliberal triumphs in the teeth of the crisis—namely, the direct bailouts of large financial firms and their financialized counterparts in other sectors, combined with a ferocious resistance to any controls imposed upon capital flows and international trade—and as such might betoken further weakness down the line, journalists instead rapidly lost interest in the ways in which the current crisis might be “different” than the Great Depression. Indeed, they were rescued from having to seriously confront history by the intervention of a famous Harvard professor, and thus endorsed the convenient Kenneth Rogoff mantra that we could ignore anyone who insisted upon structural specificity in history, because every financial crisis was essentially the same.26 At that juncture, journalists just lost all interest in the Great Depression.
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Figure 4.2: Index of World Equity Market Prices, Great Depression and Current Crisis
* * *
* * *
Figure 4.3: Index Volume of World Trade, Great Depression and Current Crisis
* * *
* * *
Source: voxeu.org
This blasé line emanating from Harvard and the National Bureau of Economic Research committed the ultimate historical solecism by lumping together two centuries of credit crises as somehow “the same,” attempting to reduce them all to a few implausible quantitative indicators of sovereign debt to GNP and a “capital mobility index.” Thus was this particular journalists’ trope tamed and recaptured by the economics profession, indirectly revealing neoclassical economists’ contempt for history. Conveniently, this recapture of crisis discourse turned out also to be the opening salvo of the neoliberal offensive that all attention concerning crisis debilities should be refocused away from the private sector and toward the debt obligations of the state. But economists could not bring themselves to begin to discuss the major structural difference between 1929 and 2008: this time around, professional economists had played a much larger role in producing the conditions leading to systemic breakdown, from theorizing the financial innovations and staffing the financial institutions to justifying the deconstruction of regulatory structures held over from the last Great Depression. The profession did not entirely succeed in distracting public attention from that fact, but history was never a strong suit for Americans, and luckily for the economists, flighty attention spans quickly moved elsewhere.
What is significant in hindsight is that all of this hastily improvised analysis and metaphorical effusion by journalists and bloggers had essentially evaporated by 2010. A net search of Google Trends, inscribed in Figure 4.4, shows just to what extent mentions of “toxic assets” turned out to be just a flash in the pan. The “explanations” concocted by the journalists tended to melt away like the late winter snow as the crisis lengthened, and there exposed were the economists, same as they’d always been, ready to resume their role as high priests of the economy.
* * *
Figure 4.4: Google Trends, Search Term “Toxic Assets”
* * *
* * *
Somehow, the public managed to forget that economists had been caught clueless in the initial downdraft, and began to play along with the pretence that economists had been on top of things all along.
Lesson 3: Science is part of the problem, not obviously the solution
Whenever economists hit a bad patch, it is inevitable that outsiders will begin to sneer about how economics is not a science, and proceed to prognosticate how “real science” would make short work of the crisis. This is such a tired Western obsession, threadbare and careworn, it is astounding that it has not occurred to critics that such proleptic emotions must have occurred before, and are thus themselves part of a chronic debility in our understanding of economic history. Without going into the issue here, the current author has shown elsewhere in detail how neoclassical economics was born of a crude attempt to directly imitate physics in the 1870s, and that the American orthodoxy was the product of further waves of physicists cascading over into economics in the Great Depression and World War II. It is thus not such a stretch that, for instance, Paul Krugman became an economist because he had fallen in love with science fiction as a child.27 So, if anything, economics has suffered a surfeit of saviors (and their theories) transported from the natural sciences: the real question should be, why should we expect things to work out any better this time around?
Actually, it is known among the cognoscenti that physicists have again been tumbling head over heels into economics since the 1980s, as their own field experienced severe contraction at the cessation of the Cold War. And where did most of them end up? Why, in the banks, of course, inventing all those ultracomplex models for estimating and parceling out risk. Some of these Exiles on Wall Street bothered to attain some formal degree in economics, while others felt it superfluous to their career paths. In any event, the exodus of natural scientists into economics was one of the (minor) determinants of the crisis itself—without “rocket scientists” and “quants,” it would have been a whole lot harder for banks and hedge funds to bamboozle all those gullible investors, not to mention turning privatized trading into a robot operation (Patterson, Dark Pools). Everyone since the eighteenth century has sought to leverage their credibility in the history of economics with “science,” most frequently through appropriation of mathematical models and/or methods; alas, never has it turned out to be the Philosopher’s Stone. So much for the bracing regimen of a background in the natural sciences.
If anything, responses to disparagements of the contemporary profession that tended to pontificate upon the nature of “science” were even more baffling than the original calls for deliverance through natural science in the first place. Economists were poorly placed to lecture others on the scientific method; although they trafficked in mathematical models, statistics, and even “experimentation,” their practices and standards barely resembled those found in physics or biology or astronomy. Fundamental constants or structural invariants were notable by their absence. Indeed, one would be hard pressed to find an experimental refutation of any orthodox neoclassical proposition in the last four decades, so appeals to Karl Popper were more ceremonial than substantial. Of course, sometimes the natural sciences themselves encountered something commensurable to a crisis in their own fields of endeavor—think of dark matter and dark energy, or the breakdown of causality in the 1920s—but they didn’t respond by evasive maneuvers and suppressing its consideration, as did the economists.
In retrospect, appeals to science will be seen to have proven a bit of a red herring in coming to terms with the current crisis. Physical complexity theory or neuromysticism or dark matter won’t save us now. In the heat of battle, economists purported to be defending “science’”when, in fact, they were only defending themselves and their minions.
Lesson 4: The failure of the economics profession is a saga of social disfunction
The completeness of the [orthodox] victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an in
evitable incident in the scheme of progress, [with] the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted the support of the dominant social authority. But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, over the course of time, the prestige of its practitioners. For professional economists . . . were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation; a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists.
Never Let a Serious Crisis Go to Waste Page 23