PhD Economist Derp: Seeds for Next Financial Crisis being Planted
Having had the Queen of England point out they missed seeing the Great Financial Crisis coming, PhD Economists aren’t taking any chances this will happen again. Their new strategy is to offer up the refrain “seeds for next financial crisis are being planted”.
For example,
Professor Douglas Diamond of the University of Chicago is the author of a canonical theoretical model of bank runs and last week was awarded the triennial Onassis prize in finance….
[I debunked this paper in earlier posts: see here.]
“We’ve certainly had a lots of liquidity injected recently. One thing you see is this huge increase in what’s called leveraged loans – high-yield, syndicated loans. And very few covenants in those loans,” he said. “That’s an indicator to us that we could be planting the seeds of the next crisis.”
Could be? Either the increase in liquidity and/or the covenant-lite leverage loans are seeds of the next crisis or they aren’t.
The waffle by the professor indicates he has no idea. This wasn’t missed by Ben Chu, the Independent’s Economics Editor who wrote the article. He pushed for an explanation for why increased liquidity and/or covenant-lite leverage loans might be a future problem.
Professor Diamond refused to be drawn on when, or where in the financial system, the next crisis could break out, saying “if you think crises are about fear and panic they’re almost by definition unpredictable. [And] they may come up in a place that’s different from where they came in the past.”
Please re-read Professor Diamond’s response again recalling he co-authored what the Economics profession considers to be the seminal paper on bank runs and financial crises. When you write the seminal paper in an area, there is a very high probability you are familiar with the current state of the art in this area. His response demonstrates the Economics profession is no further along in understanding financial crises than when he wrote the paper in the early 1980s.
Regular readers know financial crises are not about fear and panic in the sense fear and panic cause the crises. Fear and panic are the result of the emergence of doubt about the valuation story Wall Street tells about the securities in the Blind Betting quadrant of the Information Matrix. The opacity of these securities eliminates any logical stopping point in their downward valuation. Investors know this and “run” to get their money out as soon as doubts about the valuation story emerge. Predictably, this “run” spreads along the opacity fault line in the global financial system. It becomes a financial crisis when this doubt spreads to the opaque banking system.
However, the Economics profession doesn’t know what regular readers know.
As Professor Diamond showed, the profession still doesn’t have a working theory for why financial crises occur. But this doesn’t stop the members of the profession from offering up a refrain suggesting they do know. If PhD Economists have identified what causes financial crises, it would be nice if like myself they would share the causes. Ann Pettifor explained why sharing this knowledge is important:
We believe, perhaps vainly, that with a better understanding … we may, as a society, be able to prepare for a collapse. We might be able to protect ourselves, our families and firms from economic failure, job losses, collapses in living standards, housing insecurity and the impact of these failures on social life: divorce, depression and in some cases, suicide. Not to mention the disastrous political impact of economic failure.
On the other hand, perhaps their refrain is yet another example of PhD Economist Derp. Given Professor Diamond’s comments, PhD Economists appear as clueless about the causes of a financial crisis today as they were ten years ago. This is probably what Ann Pettifor was getting at when she observed:
The public instinctively knows this to be the case – that economics and the design of the economic system is driven by the class interests of the few, the ‘elite’. Which is why the profession is now held in low regard, and why so many have turned to populists and populism – for protection from the fragility of an unequal, polarising and unstable economy – whose underlying forces economists still do not seem to understand; are not inclined to explore, and are unwilling to explain.
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