Question & Answers

Many economists failed to predict the global financial crisis, and many policymakers mishandled it, because they were sticking to the following inconsistent model:

• Economy is driven by self-interest, i.e. the wish to get the maximum out of one's resources. Due to a one-dimensional definition of “maximum,” this generally implies an opposition of interests, so that the success of one party is to the disadvantage of the other party.
• Prices are essentially determined by the perceptions of market participants rather than by the reality underlying these perceptions.
• Example: Financial markets, where money is supposedly looking for maximum return.

Some saw it all coming, because they were using a different model:

• Economy is basically an exchange system in which every exchange (or deal) has to be to the advantage of both sides (supply and demand).
• Price determination is grounded in reality, as defined by market participants’ inner wish to get involved, or to make use of their resources, be that money, skills or something else.
• Example: Buying bread at the bakery, paying a doctor or a teacher for his services.

Pessimism is so unpopular with modern people! Yes it is dull, yes it is gloomy, yes it is unpleasent, and no it does not make you popular, nor makes you money. There were quite a few clever economists who could clearly see it coming, but not too many business people wanted to listen to them. I remember I was called a "stopped clock" back in 2007. "Stop talking about all that gloomy stuff! - was another popular response that I heard from managers. - We have enough of our own problems to think about all that! Let's think positive! Life is beautiful, isn't it?"

Once at the interview that I had in January 2008 I was asked what was the value of my education. Among other thigs I said that most people in the industry do not seem to appreciate completely how serious the current recession can be. A lot of anaylists were talking about a "Shallow" recession and a "V-shaped" recovery. I said that due to my education I could very well see that in fact this can be as bad as the Great Depression if governments do not act promptly. The interviewer only said: "Everyone is talking about recession today. You do not really need education for that."

Perhapse lack of education and treatment of education as an unnacessary accessory among business people is one of the factors too. As one of the big brokers has proudly said back at the end of 2007: "Bear Stearns was not made by people with MBA, Bear Stearns was made by people with PsD i.e. "poor, smart, with desire to succeed"." Whatever happened to Bear Stearns in 2008 proves, that sometimes PsD just isn't enough.

Just before the crisis of 2008 most brokers and analysts were giving BUY recommendation on most of the stocks, except for Tim Hortons, and I was just wondering what was going on. How come they could not see what was coming? I could not understand if the world was insane or if it was me loosing my mind. Well, everything was normal in the world. Those brokers and analysts were there to make money. They were there to say what their clients, shareholders and bosses wanted to hear. Whoever would diverge significantly from the mainstream opinion would most likely have to look for another job, and who would want to at the time when crisis is approaching?

Also in democratic society and market economy majority rules. He who goes against majority is lost, and who wants to be a looser? It is good to remember that the majority is not often made of the most educated or the most honest people, but it rules nevertheless. Majority likes rosy pictures and majority likes profits by all means and groupthink. This is why when things go well everyone is optimistic, everyone follows the trend and bubbles emerge. Once the bubble bursts everyone panics and everything goes down the drain. Disagreement is unpopular. Pessimism is unpopular. Long live the groupthink, cause it is so convenient for everybody and for business people on the first place! On the positive side I believe Canadian authorities have long anticipated crisis. Industry regulations were becoming tougher and tougher and the crisis was not as much felt.

I heard one sentence from David Morgan “If all are thinking same then perhaps no one is thinking really”.

That's exactly what happens in balloon. It's a win win win Situation. Landowners are getting huge amount for land, builders are building they are getting huge profits, Banks are getting customers, even buyers are getting appreciation. Who is loosing here. Those who are not in mania are also entering in it looking at "Success Stories". so whole system become part of balloon. Economists who warn of balloon also over the time start thinking "It may be different this time due to globalization / something else"

So real smart people who understand macroeconomic picture or people who have background of History and deep study like George Soros, Jim Rogers, Mark Faber, Peter Schiff understand and speak openly about it. Balloon has another phenomena that people become arrogant due to quick success. They laugh on these people till they realize that ... Yes it was balloon. Generally it's too late by then.

Thanks - Amaresh Gangal

The problem had little to do with economic theory. The problem is the sociology of the economics profession. It is dominated by a small credentialed elite who largely repeat what each other says and do very little independent thinking. They have little or no incentive to consider ideas raised by others, since there is no cost to being wrong along with everyone else.

This is easily shown by the fact there are probably no economists who have lost their job over a blunder of ungodly proportions. Missing the housing bubble is the equivalent of a school bus driver drunkenly swerving into the lane of oncoming traffic, killing all aboard, and then showing up for work the next day as if nothing had happened.

Of course stepping out of bounds did involve risks to one's career. No one could be certain that they were right. And, saying that the economy is going to collapse when all the top experts say that everything is just fine invites ridicule. Being wrong in this case is likely to have a very serious negative impact on one's career.

It also didn't help that the bubble (by the way, the crisis is the collapse of the housing bubble. The financial fireworks were entertaining, but they are not the reason that we have 9.5 percent unemployment right now) was actually very easy to see. The existence of the bubble in the U.S. could be easily shown by an unprecedented divergence of house prices from a 100-year long trend with no basis in the fundamentals of the housing market. There was no remotely comparable increase in rents and housing vacancy rates were hitting record levels as early as 2002.

If uncovering the bubble required complex mathematics then it might have been possible to interest key economists in the issue. As it was, the problem could be demonstrated with simple arithmetic, which put it largely outside of the purview of serious economists. Even now there is remarkably little interest in the simple arithmetic of the housing market as many economists are still expecting house prices to recover. They are also expecting consumption to recover to its bubble levels, even though this absurd given the loss of $6-$8 trillion in housing bubble wealth. Unfortunately, coherence is valued much less in economics that complexity, so few economists even now seem able to comprehend the nature of the downturn.