The Failure of Academic and
Professional Economists
Research Questions:
- Why did the world's top economists fail to predict the financial
crisis? Others who missed the crisis, include government leaders,
award-winning scientists, market analysts and investors.
- Was the crisis predictable or was it a Black Swan (unpredictable)
event?
- Are government policy makers competent enough to manage the nation's
financial freedom and security?
- Are economists and their policies helping or hurting our economic
growth?
- Do we need to re-define the education of economic science and the
role that economists play in our financial markets, government
policies and business regulations?
Research Findings:
The most current views on the subject are illustrated by the
following news media quotes and research conclusions.
Media Statement I
In an interview (dated Jan 9, 2009) with the Associated Press’s Deb Reichmann,
Vice
President Cheney repeatedly insisted that no one anticipated the
looming U.S. financial crisis. “I don’t think anybody saw it
coming,” he said.
REICHMANN: But why, why didn’t you see such a huge downfall in
the economy coming?
CHENEY: I suppose because nobody anywhere was smart enough to figure
that out. - (Source:
Think Progress)
Media Statement II
In an article on Seeking Alpha (July 7, 2009), Cullen Roche,
an opinion leader, asks "Why did economist fail
to predict the crisis?" He writes: In hindsight, it seems like the crisis was so obvious. The now
infamous credit market debt to GDP chart, the parabolic Case/Shiller
housing chart, the 40:1 leverage ratios, the subprime problems, etc.
Weren't they telltale signs that something was profoundly wrong with
the economy? Perhaps not, but it's still astounding that
we can count the "experts" who actually predicted the crisis on two
hands. And many are even skeptical of this small sampling of
prescient economists and analysts. Statistically speaking you could
easily make the argument that most of these "experts" who got it
right were anomalies or lucky. So why were so few investors prepared for the
declines in the markets? (Source:
Seeking Alpha)
Research Conclusions:
Financial Crisis Inquiry Commission
In May of 2009, the Financial Crisis Inquiry Commission was created to "examine
the causes, domestic and global, of the current financial and
economic crisis in the United States." The Commission was
established as part of the Fraud Enforcement and Recovery Act
(Public Law 111-21) passed by Congress and signed by the President.
This independent committee released its conclusion as follows:
"The
Commission concluded that this crisis was avoidable—the result
of human actions, inactions, and misjudgments. Warnings
were ignored. The greatest tragedy would be to accept the
refrain that no one could have seen this coming and thus nothing
could have been done. If we accept this notion, it will happen again.” -
(Source:
FCIC.GOV )
Our research findings confirm FCIC conclusion.
U.S. Vice
President, Dick Cheney was
incorrect when he said "I suppose because nobody anywhere was smart
enough to figure that out." As you will later see, our research
found at least three people,
who were
smart enough to predict the economic crisis, and more importantly, they
issued public warnings, but were ignored by the government, Wall Street and
most of the financial media.
Mr. Cullen Roche is partially correct in writing that "statistically" speaking you could easily make the
argument that most of these "experts" who got it right were
anomalies or lucky. We agree with Mr Roche that statistically the number of experts
who predicted the
crisis appear to be incredibly small when compared to the rest of
the the global financial and academic communities. They do qualify as
anomalies. However, our research findings concluded that those few experts who
predicted the financial crisis were not lucky and knew exactly what they were
talking about. Their conclusions were based on data sets that were
ignored or dismissed by the rest of the world.
In order to overcome the luck factor and ensure credibility, we had to eliminate generic
predictive statements and we looked
for specific statements linking the subprime, the housing bubble and
the economic crisis together; This eliminated hundreds of experts; some of
them are prominent economists who saw risks of recessions based on other
reasons or insiders who saw troubles in housing sector but did not foresee
their
impact on the financial markets and the economy.
The date of the
prediction statements were also taken into consideration. We only considered
statements that pre-dated the public warning made on September 18,
2007 by former Federal Reserve Chairman, Alan Greenspan in which he warned about
the housing bubble and reversed his long-held position on the issue
(Source:
PBS ). Unfortunately, even after Greenspan's warning most investors
and economists did not take necessary actions to protect their investments
or the economy. It is safe to say that
the whole world, except for a few were taken by surprise by the banking crash
on Wall Street in September of 2008 and the impact it had on the US
economy.
Conspiracy Theory
Like everyone else, we wondered how could the world's leading
economy and its top economists, including the Federal Reserve
Chairman, Ben Bernanke - a man who is surrounded by a network of
smartest investors, scientists, and think tanks - miss the financial
crisis and its impact on the US Economy?
Was it a conspiracy? Contrary to the suggestions by
some, we believe that it was not a conspiracy. Our research revealed that
government officials and many of the top Wall Street banks did miss the signs and ignore
the warnings until it was
too late. We also believe that if they foresaw the crisis they would
have profited from it financially or by way of reputation.
We found no
evidence that the financial crisis was designed by a consorted
effort of a group of people who profited from it. On the other hand,
we cannot say the same thing about deregulations, the bailout and
the protection of the culprits on Wall Street. We believe that these
actions were, in fact, a
consorted effort by a group of the top investment banks and their lobbyists in
Washington. However, that is not the subject of our research and
we are confident that more researchers will investigate their
actions and reveal the truth about the bailout. (See section:
Who is to blame for the financial crisis?
Why did the government, financial institutions, and academia
ignore these early warnings? The following analysis by
academic research institutions and economic think tanks were the best
answers we found on the subject:
International Institute of Management
According to Med Jones, the president of IIM, and one of
three think tanks that warned about the crisis, there are two main
reasons that caused mainstream economists and Wall Street media to
miss the financial crisis of 2008.
The first is the NIH (Not
Invented Here) bias, which is an organizational phenomenon
manifested as an unwillingness to adopt an idea because it
originates from unknown outsiders. It is a form of social cognition
bias that leads to errors in group judgments, such as missing out on new
opportunities or risks.
The second reason is a cognition bias known
as the Confirmation Bias, which is the tendency to search for, filter, or interpret information in a way that confirms existing
preconceptions. The Confirmation Bias is recognized as an individual
cognition bias, but when met with NIH bias it appears to develop
into a social bias very similar to the Groupthink syndrome. - (Source:
CEO Quarterly).
What is surprising is the persistence of this counterproductive
psychological and social phenomena in government institutions, the
academic community and Wall Street. Many of the investors who lost
money because they ignored the previous housing bubble warnings,
continue to ignore other warnings about national debt, trade
deficit,
inflation and currency risks. As for the academia and government, the policy
makers rationalize their ideological decisions in
ways to continue to ignore the warnings rather than engaging the
experts who predicted the crisis in objective policy debates.
Research Comment:
It can be seen why those who failed in their jobs to warn their
investors and their governments would be quick to discredit those
who predicted the financial crisis as lucky. It is difficult on the
ego of the person in charge to acknowledge that there are other people who could be that smart.
This also demonstrates how rare the intellectual honesty is among
the policy makers. We would like to see more academic and research
papers that either give credit to these warnings from the experts or present credible
arguments against them. If you have access to such papers, please
email us at research {at} economicpredictions.org . We will
cite your paper and provide a web link to it.
Keil Institute for the World Economy
In a paper titled The Financial Crisis and the Systemic Failure
of Academic Economics
A group of researches wrote: "While we did not think the crisis could have been predicted, we
did severely fault the economics profession for failing to develop
and analyze models that, at least, had the possibility of such a
failure occurring...The economics profession appears to have been
unaware of the long build-up to the current worldwide financial
crisis and to have significantly underestimated its dimensions once
it started to unfold. In our view, this lack of understanding is due
to a misallocation of research efforts in economics. We trace the
deeper roots of this failure to the profession’s insistence on
constructing models that, by design, disregard the key elements
driving outcomes in real-world markets. The economics profession has
failed in communicating the limitations, weaknesses, and even
dangers of its preferred models to the public. This state of affairs
makes clear the need for a major reorientation of focus in the
research economists undertake, as well as for the establishment of
an ethical code that would ask economists to understand and
communicate the limitations and potential misuses of their models." -
Researchers - David Colander, Hans Föllmer, Armin Haas, Michael
Goldberg, Katarina Juselius, Alan Kirman, Thomas Lux, and Brigitte
Sloth - (Source -
The Failure of Academic Economics)
Research Comment:
The researchers' statement: "While we did not think the crisis could
have been predicted" is clearly wrong. Could this be an example of
Groupthink bias and NIH bias?
Wharton School
On May 13, 2009, a panel of Wharton Economists published a paper
titled Why Economists Failed to Predict the Financial Crisis.
The paper concluded:
"There is a long list of professions that
failed to see the financial crisis brewing. Wall Street bankers and
deal-makers top it, but banking regulators are on it as well, along
with the Federal Reserve. Politicians and journalists have shared
the blame, as have mortgage lenders and even real estate agents. But
what about economists? Of all the experts, weren't they the best
equipped to see around the corners and warn of impending disaster?
Indeed, a sense that they missed the call has led to soul searching
among many economists.
Although many economists did spot the housing bubble, they failed
to fully understand the implications, says Richard J. Herring,
professor of international banking at Wharton
It's not just that they missed it, they positively denied that it
would happen," says Wharton finance professor Franklin Allen.
Wharton management professor Stephen J. Kobrin said he
believes many academics share "an ideological fixation with free
markets and lack of regulation" that should be reexamined.
"Obviously, people missed the boat on a lot of the risks that a lot
of financial instruments entailed," he says. "We need to think about
what changes are needed in the curriculum."
Research Comment:
We believe this is an honest intellectual assessment of the
problem. We hope to find more high quality research work and
researchers.
The Chronicles of Higher Education
On October 3, 2010, Charles Ferguson wrote an article on Larry Summers and the Subversion of
Economics, describing the role of lobbying and how few people with powerful connections
can bring down the US financial system. He wrote: The Obama administration recently announced that
Larry Summers is resigning as director of the National Economic
Council and will return to Harvard early next year. His imminent
departure raises several questions: Who will replace him? What will
he do next? But more important, it's a chance to consider the hugely
damaging conflicts of interest of the senior academic economists who
move among universities, government, and banking. Summers is
unquestionably brilliant, as all who have dealt with him, including
myself, quickly realize. And yet rarely has one individual embodied
so much of what is wrong with economics, with academe, and indeed
with the American economy. For the past two years, I have immersed
myself in those worlds in order to make a film, Inside Job, that
takes a sweeping look at the financial crisis. And I found Summers
everywhere I turned.
Over the past decade, Summers continued to advocate financial
deregulation, both as president of Harvard and as a University
Professor after being forced out of the presidency...After the
resulting outcry forced him to resign, Summers remained at Harvard
as a faculty member, and he accelerated his financial-sector
activities, receiving $135,000 for one speech at Goldman
Sachs....During this time, Summers became wealthy through consulting
and speaking engagements with financial firms. Between 2001 and his
entry into the Obama administration, he made more than $20-million
from the financial-services industry. (His 2009 federal
financial-disclosure form listed his networth as $17-million to
$39-million.). Summers remained close to (Robert) Rubin and to
Alan
Greenspan, a former chairman of the Federal Reserve. (Source:
The
Chronicle Review)
On
July 8, 2009, Christopher Westley blogged a paper titled The
Financial Crisis and the Systemic Failure of the Economics
Profession published in Critical Review, by Colander, Goldberg,
Haas, Juselius, Kirman, Lux, and Sloth with the following
abstract: Economists not only failed
to anticipate the financial crisis; they may have contributed to
it–with risk and derivatives models that, through spurious precision
and untested theoretical assumptions, encouraged policy makers and
market participants to see more stability and risk sharing than was
actually present. Moreover, once the crisis occurred, it was met
with incomprehension by most economists because of models that, on
the one hand, downplay the possibility that economic actors may
exhibit highly interactive behavior; and, on the other, assume that
any homogeneity will involve economic actors sharing the economist’s
own putatively correct model of the economy, so that error can stem
only from an exogenous shock. The financial crisis presents both an
ethical and an intellectual challenge to economics, and an
opportunity to reform its study by grounding it more solidly in
reality. (Source:
Ludwig von Mises Institute)
On Marginal Revolution, a blog entry by CK on November 3, 2008
stated:
Dating from the publication of “Freakonomics,” economics has had
a star turn, “15 minutes of fame,” if you will. Nowadays, any talk
of money or assets or securities leaves people with a bad taste in
their mouths. Economists, with their images as eminently logical,
semi-Spock types who cut to the core of problems, are out of favor.
Now it seems like sophistry and false wisdom. The pendulum probably
swung to far in favor of economists before, now it’s going to go too
far in the other direction. In other words, the bursting of the
world economic bubble will NOT lead to the inflation of a bubble in
academic economics.
Other research questions and findings:
-
Why did the world's top economists fail to predict the financial
crisis? (Others who missed the crisis, include government
leaders, award-winning scientists, market analysts and
investors). Was the crisis predictable or was it a Black Swan
(unpredictable) event? Are government policy makers competent
enough to manage the nation's financial freedom and security?
Are economists and their policies helping or hurting our
economic growth? Do we need to re-define the education of
economic science and the role that economists play in our
financial markets, government policies and business regulations?
-
Who is to
blame for the financial crisis? Who contributed to the
creation of the crisis? Can they be held responsible
for their actions or inactions? Was there a conspiracy by some
Wall Street executives and government officials? Do investors
have legal cause to seek compensation for damages caused by Wall
Street firms?
- Who predicted
the financial crisis and the ensuing economic crisis?
Is there a documented evidence supporting their claims? Were those who warned about the crisis lucky or did they have a clear logic behind their
predictions? Can we use their knowledge to predict future crises?
What are their future predictions? How do their predictions
compare with each other? Where do the experts agree and where do they
disagree? How accurate are their economic predictions? Can they
be relied on for investment decisions?
- Who are the
top winners and losers of the financial crisis? Top
investors, economists, intellectuals, government officials,
think tanks, and universities that lost or won because of the
crisis.
- What are the lessons we can learn to
avoid future
crises? What the the economic policy lessons? What are the
investor's lessons? Do we need more or less financial regulations?
|
Economic
predictions from the world's top experts on the financial crisis
Dean Baker's
Predictions
Med Jones
Predictions
Nouriel Roubini's
Predictions
Peter Schiff's
Predictions
The Rise & Fall of Financial Assets
Knowledge
@
Wharton
University
Wall Street
Economic
&
Financial
Research
London
School of Economics
Financial Journalism Ethics
City
University
London
Challenges of Financial
Journalism
|
