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ETpro's avatar

How Did Economists Get It So Wrong?

Asked by ETpro (34469points) April 18th, 2010

Back in 2006 and 2007 as we were closing in on the worst financial disaster since the Great Depression, economists were united in self congratulation. They were certain their theories of economy had been so finely honed that nothing could possible go wrong. Markets were prefect in setting the value of investments so long as they were left completely free of regulation. Pure laissez-faire capitalism had put an end to the cycle of boom and bust, ensuring perpetual prosperity.

Check out Pall Krugman’s op-ed piece, where he asks “How did economists get it so wrong?” What do you think?

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30 Answers

marinelife's avatar

They left out the human factor and greed. Investment banks, like Goldman Sachs, out together trashy investments opportunities that they knew would fail with no consideration fro what that would do to the greater economy as long as they came out on top.

Captain_Fantasy's avatar

Economic theory all too often fails to account for corruption.

tranquilsea's avatar

Will-full ignorance

zophu's avatar

The value of economy is not in stability, but in control. From the point of view of those that control it, anyway. It is foolish to view it as a natural system reacting only to the visible players.

Judi's avatar

@marinelife ; How could they leave out greed? I’m not overly educated and I have at least known that Capitalism=Greed.
I had a really good social studies teacher in Jr High that explained Capitalism, Communism, Socialism, and Totalitarianism, (probably more hut it was 100 years ago) in very neutral terms. He explained them all from an ideal perspective and we discussed the pitfalls of all the systems.
The conclusion I came to from the discussion is that all systems are corruptible, and none are perfect, because of exactly what you said @marinelife, greed and human fallibility.
I thought at the time that an ideal society would be a blend of the best of all the political systems, with plenty of checks and balances and an educated responsible voter pool. I still realized that corruption will find a way in any system, and I was only 12. I can’t figure out where these highly educated people were in Social Studies classes.

filmfann's avatar

Back in 2005 there were lots of newspaper stories about how the housing bubble was about to burst. Up to that point, no one thought house values could drop so significantly.
Really, leave to to a Bush to tank the economy so bad.

gorillapaws's avatar

It’s because they weren’t listening to the mathematicians who were warning against the credit-default swaps. Here’s an EXCELLET article that explains what happened.

phillis's avatar

I don’t think they got it wrong at all. They said exactly what they were told to say.

stranger_in_a_strange_land's avatar

The regulatory bodies, that were supposed to keep everything honest and transparent, had been systematically trashed ever since the Reagan years. Without strict oversight, the bankers began hiding bad loans in “bundles”, the rating services were in bed with the bankers and rated these bundled packages higher than their actual performance. These packages were then peddled as “safe” investments. A house of cards ready to collapse at the slightest bump.

We’re still playing that game with the national debt. The largest Ponzi scheme ever. Bond holders continue to buy more, knowing that if they stop the bonds they already hold will be made worthless by a default. The debt is so large that it can never be repaid, short of hyperinflation erasing it. This current financial crisis is nothing compared to the inevitable US default on the national debt. Gold is at $1000 an ounce and the dollar is steadily declining vs Euro and Sterling. The big boys know what’s going to happen and have been steadily getting out of dollar assets for the past decade.

bob_'s avatar

We’re sorry.

janbb's avatar

Paul Krugman, in the New York Times was predicting the collapse of the housing bubble and the dangers of subprime lending years before the recession. Not all economists march to the same step.

jerv's avatar

Misinterpretation of ”On Default Correlation: A Copula Function Approach and ignoring David X. Li’s warnings about the limitations of the Gaussian Copula as pertains to economics (a field with too many intangible variables for reliable mathematical analysis) for the sake of a quick buck.

gorillapaws's avatar

@jerv that’s what the article I linked above explains.

jerv's avatar

@gorillapaws I don’t always follow links, especially when I have errands to run in a few minutes ;)

ETpro's avatar

@marinelife & @Captain_Fantasy How could a buinch of PHDs be so naive as to think a group of greedy, corrupt, imperfect people, when taken en masse will equate to free-market perfection? You have to wonder if @tranquilsea hasn’t given us the right answer.

@Judi I guess somewhere in the paper chase these PHDs lost sight of what they learned back in Jr. High. :-)

@gorillapaws Excellent link. I read it through. Fascinating.

@janbb My respect for Paul Krugman has gone way up. He was far ahead of the Milton Friedman Chicago school of economics that came to dominate everything over the past 20 years. But geez—what do bubbles always do? Even hack newspaper columnists were calling it the housing bubble by 2005. It really didn’t take a rocket scientist to see a bubble will eventually burst.

YARNLADY's avatar

There were many economists and loan officers issuing warnings – they were ignored.

ETpro's avatar

@YARNLADY Upton Sinclair wisely noted, “It is difficult to get a man to understand something when his salary depends on his not understanding it.” They were making so much money on those leveraged CDOs and CDO squared instruments. $62 trillion in total.

JeffVader's avatar

They got it wrong because no-one listened to Liberal Democrat Vince Cable!!!

janbb's avatar

So what many of us are saying is that not all the voices got it wrong; it’s just that we as a society listened to the ones that fed our greed. And probably will continue to do so. “When will they ever learn; oh, when will they ever learn.” – Pete Seeger

JeffVader's avatar

@janbb Brilliantly put!

The_Idler's avatar

They didn’t, they lied, it was a scam.

Finance.

ETpro's avatar

@The_Idler That was no small part of the problem

The_Idler's avatar

@ETpro
Deceitful economics and financial scams are probably no small part of all our biggest problems.

ETpro's avatar

@The_Idler Two big problems. The derivatives market is open only to players with millions to invest. It can yield profits that would make a Ferengi blush, but the rules are it’s all predator and prey. There is absolutely zero sense of business ethics. Whatever you can pull over on someone else is fine. Not a good way to build a firm foundation for business. And 2—the derivatives market produces nothing of any worth. It doesn’t dfund business investment, provide jobs, help grow crops build houses or hotels or anything but huge profits—and it does that because the leverage is so enormous and this the risks if anything goes wrong are also staggeringly huge. The derivatives market in the US when the collapse came was $62 trillion dollars. That’s almost 5 times our entire Gross Domestic Product.

Ron_C's avatar

Look, and economist is no more a scientist than a psychologist. Both professions build statistics about what happened with no real insight into what will happen in the future. At best, they are college educated bookies.

Ironically the more involved in their particular economic model, the less they are able to see and understand what is happening around them.

ETpro's avatar

@Ron_C That certainly was true in spades of David X. Li.

Ron_C's avatar

@ETpro Li is a perfect example of economists today. He has this theory about risk, publishes it and somehow it becomes a standard. Then people do something that he failed to consider and the whole proposition falls apart.

I suggest that information from economists be weighed against ethics. If we had ethical traders, these problems probably wouldn’t have started. Another thing I would do is forbid “day trading”. These guys, mostly kids with gambling addiction, spend a few hours on line or at a trading office and make quick profits but add nothing to the economy. I believe that if they want that lifestyle, they should go to licensed casinos instead of messing with people’‘s lives.

jerv's avatar

@Ron_C As I recall, he actually warned against using it in the manner that people were using it. It wasn’t that he failed to consider it; he did and considered it a bad idea in certain contexts.

Ron_C's avatar

@jerv you are right about Li saying that his theory shouldn’t be used as a basis for risk control. The point is that the bankers were intent on making ever higher profits and are willing to select any sliver of logic to do what they were going to do any way. I blame the regulatory agencies and I blame the presidents, everyone since Reagen, for the results.

Anybody that uses an economists theory to run an economy is inherently dishonest.

jerv's avatar

@Ron_C That is why I take my financial advice from a 20-sided die. It’s at least as reliable as most financial adviser’s advice yet crazy enough that when it fails I can just shrug and say, “What the fuck did you expect?!”.

I include Reagan in the blame game. While I agree that the taxes on the rich were way too high at the time, I think he overdid it and set us up for a financial disparity normally only seen in a banana republic.

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