Stephen Karlson (shkarlson) wrote in 50bookchallenge,
Stephen Karlson
shkarlson
50bookchallenge

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MUGGED BY REALITY.

We fall short of the fifty, completing this year with Book Review No. 43. Richard Posner, one of the leading lights of law and economics, and a scholar prone to look for efficiency explanations of social phenomena, concludes that the incentives to allocate resources efficiently were insufficiently strong in financial markets. Thus A Failure of Capitalism: The Crisis of '08 and the Descent into Depression. Strong words in the subtitle, but defensible as a characterization of the reluctance of individuals and corporations to borrow money for capital investments after the housing bubble burst and the glamour drained away from the clever financial products. His thesis, however, is that the bubble and its bursting were consequences of excessive confidence in the Invisible Hand (turn to page xii):
The movement to deregulate the financial industry went too far by exaggerating the resilience -- the self-healing powers -- of laissez-faire capitalism.
Although the crash was forseeable, nobody knows the day or the hour, and Judge Posner notes that the usual corrective to inefficiently high asset prices -- short selling -- didn't work, in part because the bubble kept inflating long enough to break several waves of short seller. Toss in the short-term gains to many people on the long side of the market, from the owner of a starter house to the highest-rolling hedge fund manager, and expect few tears to be shed for the killjoys being wiped out. Much responsibility must also rest with economists, whether in the professoriate or practicing business economics (pp. 258-9).

[P]rofessors of finance, who are found mainly in business schools rather than in economics departments, and whose field overlaps macroeconomics in regard to recessions and depressions, tend to be deeply involved in the real world of financial markets. They are not only armchair theoreticians; they are consultants, investors, and sometimes money managers; many of them ... have worked for the Federal Reserve, the International Monetary Fund, or other nonacademic institutions. Their students typically have worked in business for several years before starting business school and so bring with them up-to-date knowledge of business practices.

The entwinement of finance professors with the financial industry has a dark side. If they criticize the industry and suggest tighter regulation, they may become black sheep and lose lucrative consultantships. This conflict of interest may have caused some economists to pull their punches. More important, few theorists spend their time poring over or digging behind banks' balance sheets. Business economists -- consultants, and employees of business firms or trade associations -- emphasize economic forecasting, and often have industry-specific knowledge and data, but many are compromised by their business status. One does not expect economists employed by real estate companies or by banks to be talking about housing and credit bubbles.

The spat among adherents of various approaches to macroeconomics (Keynesian, monetarist, rational expectations - representative agent, New Keynesian, Marxist, Austrian) doesn't help. Judge Posner points to the presence of these schools of thought, often motivated more by ideology than by confidence in their transversality conditions as evidence of the field's weakness. His work is primarily an evaluation of the causes of the financial depression and the failures of business, of policy, of academic thought, and his conclusion recapitulates that message, rather than issuing a call for action.

(Cross-posted to Cold Spring Shops.)
Tags: academic, business, current events, economics, politics, scholarly
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