Arnold Kling  

Emperor, Clothes, etc.

Letter of Law, Spirit of Law... Thanksgiving Thoughts...

Richard Dale writes,

thousands of finance research papers are published each year, and yet there have been few if any warnings from the academic community of the incendiary potential of global financial markets. Is it too harsh to conclude that despite the considerable academic resources that go into finance research our understanding of the behaviour of financial markets is no greater than it was in 1929/33 or indeed 1720?

As usual, pointer from Mark Thoma.

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COMMENTS (12 to date)
Bill Woolsey writes:

The ratings agencies used sophisticated quantitative models to assess the risk of securities. Clearly, academic financial research was very valuable!

shayne writes:

Something of this seems a bit fatalistic to me. I'd say we've learned a great deal of financial markets, risk modeling and the like - a great deal of which has been learned in the preceding century. I suspect much of the current situation is due to ignoring some very important lessons of the past, rather than generally being ignorant of the workings if financial markets. Dr. Kling's (and my) preference for more 'conventional' mortgage lending practices going forward is a case in point.

But I would suggest one possible 'learning aid' with regard improving understanding of financial markets. I would recommend required undergraduate and graduate level course[s] in 'Financial Humility'. We currently tend to teach students how to succeed in financial markets by 'pushing the envelope', and it might be a good idea to teach them that no one has ever had a successful formula for predicting, causing or dealing with the collapse of the envelope.

Of course, everything I've said might be wrong.

Justin Ross writes:

I see little reason to compare our understanding of financial markets in 1929/33 or 1720 to our understanding today, given the ever increasing complexity of these markets. Research publications take years, and the data even comes with a lag, so forecasting is difficult no matter how much we understand. Furthermore, since these markets are pushed by the whims of politicians with little to no understanding of financial markets, how much blame can be laid at the feet of researchers who could not foresee the unintended consequences of so much complicated regulation?

"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." ~ Friedrich Hayek

Mike McCartney writes:

I beg to differ. Not many academics saw this coming, but I believe Roubini (NYU), Schiller (Yale) and Krugman (Princeton) all saw this coming in advance. In addition, non-academic PhDs who saw this coming include Stephen Roach of Morgan Stanley and Paul Kasriel of Northern Trust. My question is why didn't more people listen to their warnings?

Mercutio.Mont writes:

"Not many academics saw this coming, but I believe... Krugman (Princeton)... saw this coming in advance."

*spits coffee on keyboard*


Ray G writes:

Taleb, as most avid readers know, rails on economic experts in academia and the media, and even mentions in a footnote that Fannie Mae is - at the time of his writing - sitting on a barrel of dynamite, ready to blow with the slightest hiccup.

Likewise, but at a more pedestrian level, everyone here in the Phx metro area knew that the housing prices couldn't last. The institutional blow up wasn't foreseen or even thought of for that matter. But even under-educated, blue-collar types that had just recently discovered what an ARM was understood that we were living in a bubble.

I think what most people are feeling along these lines isn't so much surprise at this vague notion of academia, but they're coming to grips with just how foolish "experts" in general are.

Because of a lack of accurate news coverage, many still do not understand the government's role in instigating the entire mess, but that still doesn't excuse the so called financial professionals from continuing the practices that got us here.

I've recently reread The Black Swan precisely because of these circumstances, and I thought it was a nice touch that he makes a very clear picture of how interconnected modern banking is now days, and how our failures are more rare, but when they come. . . watch out.

I'll look it up again for accuracy's sake, but he makes one statement that just nails it: Something to the effect of "When one goes, they all go."

Krugman, Roach, et al, proof needs to be linked of their warnings, and they need to be dated pre-2007 to be valid as warnings, and not just "me too-ism." I worked as a lowly advisor at Morgan Stanley and read Roach's work - and others quite often as we had access to a lot of writing not even available to the general public, and while I haven't followed Roach lately, I will be mildly surprised if I find out he was predicting this kind blow up pre-2007.

MattYoung writes:

Economists may have missed the change if the change was cased by external shock, say, unanticipated technology change.

My chain of causality:
Minimize scarcity -> Measure the distribution of valuable goods -> ,,,

Stop there, and think of measuring the distribution of goods. The consumer today can see the entire supply chain, including shipping and associated products, so he acts as the system manager for his own purchase of valuable goods.

Hence, as classical change, an intermediary is no longer. The affect is to attempt to demonetize the defunct intermediary.

To anticipate how the consumer expectations change because of technology the economist must be a marketer and study anticipated changes in individuals; product testing.

I would look at marketing persons from the indutries like, digital phones, web interfaces, ihandhelds; and see what they knew and when.

Ray G writes:

More thoughts on predictive powers:

I wouldn't expect anyone to predict with great accuracy the kind of mess that the financial institutions have themselves in now, but a blowup of general magnitude can be predicted.

This is for the academics as a possible course of research.

There should be more of a focus on dialouge with certain professionals in the real working world. Not CEO's or CFO's or anyone that might be in a position to give a biased or self-serving answer.

An anonymous and ongoing survey of supply chain managers, production schedulers, buyers, and engineering managers (among others) would give a view of the working side of the data that the academics seem to be missing.

I suspect someone is already doing something like this, but whatever effort might be in existence is not enough, or not done correctly since we're even having this conversation, and not discussing their predictive data.

Greg C. writes:

@Ray G

RE: et al sources.

Shiller wrote a book called Irrational Exuberance. Surely you must have heard of it. It was updated in 2005 to include the housing bubble and other info (before that the book was published before the tech bubble and crash, which he predicted as well).

In fact, I'd say Shiller has been the most consistent out of all the people on Mike McCartney's list. He's also an economist, which would probably irk the gadfly Taleb, and his anti-economist fanboys, to no end. OMG an economist is consistently right! And no one listens to him, what will we do!

MattYoung writes:

I ditched Thanksgiving, don't hang me.

The message is the media, like Marshall McLuhan.

By 1924, radio markets were established, and goods could be announced prior to arrival to customers. Hence, with personal transportation for the costumer, a step in the warehousing of goods was gone.

The pinch in 1924 was the lack of infrastructure for automobile, and need to build up oil delivery capacity. But economists could not keep up, for the cost of the new radio transmitter was a fraction of the cost of a warehouse, events moved too fast. The result was the department store, the chain store, and the great depression.

Today, the customer is again dropping a level in the supply chain, and the force on the transportation grid is to separate goods flow from personal transportation.

In both cases, we have the McLuhan mechanism, the Kalman filter model in our heads wants to match the information flow about goods, information technology leads transportation technology. Hence we get the instability problem, I think.

With the new medium, when customers look for particular goods, they do so collectively, hits are announced almost immediately; collective buying is automatic. The customers effectively synchronize the supply chain and therefore can run the delivery of goods closer to home, geographically. This changes the transportation system.

Causality would be bi-directional, in this theory, because the cost of transportation drives the information technolgy and visa versa.

Mike McCartney writes:

Ray G, see below. It was early 2007. He wrote many similar pieces. Also, Rick Bookstaber warned of this in his book Demon of Our Own Design, as did Michael Panzer.

The World Drops Its Guard
February 26, 2007

By Stephen S. Roach | New York

"The odds have shifted back toward a more bearish endgame. I have a gnawing feeling we’ll look back on the current period with great regret."

Read the whole thing here.

Jack writes:

Thousands of medical research papers are published each year, and yet illness and disease remain an important problem. Is it too harsh to conclude that despite the considerable academic resources that go into medical research our understanding of the behavior of the human body is no greater than it was in 1796 [Jenner, vaccination]?

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