Ten year after the start of the acute phase of the Great Financial Crisis and the Economics profession is still defensive about its failure to see the crisis coming.  Nowhere is this more easily observed than in the profession’s response to criticism or, gasp, new ideas.  Both are treated with dismissive disdain.

Of course this dismissive disdain should be directed at the Economics profession as a whole.  The profession could be forgiven for not seeing the financial crisis coming IF it acknowledged this failure calls into doubt any policy recommendations Economists made and are still making to respond to the crisis.

But the profession doesn’t acknowledge this legitimately calls their “expertise” into doubt.  The profession doesn’t realize it is like the Wizard of Oz saying “ignore that man behind the curtain”.  The profession has been exposed as being the man behind the curtain and its mathematical models not a powerful wizard.

Of course, those of us who did predict the financial crisis weren’t constrained by existing Economic theory and its mathematical models.  In my case, I understood exactly why the existing Economic theory and its mathematical models cannot be used to predict a financial crisis.

All of Economics is built on an assumption about the information the buyer and seller have when they transact.  Since I was first taught about the Lemon Problem in my freshman Econ 101 class, the Economics profession has not moved past information asymmetry.

The Information Matrix moves the Economics profession past information asymmetry.  It introduces the idea transactions occur where neither the buyer or seller has access to the information they need to know what they own or are buying (examples of this include subprime mortgage-backed and unsecured bank debt securities).  These transactions occur in the Blind Betting quadrant.

Information Matrix

Recognition of the Blind Betting quadrant’s existence has profound ramifications for Economics.  For example, it embraces rather than wrestles with the simple fact people are both rational and enjoy a good story.  Rational behavior is embodied in Neoclassical Economics.  The lover of a good story is embodied in Behavioral Economics.  If you look at the Information Matrix, you will realize the Neoclassical Economics’ rational behavior occurs in the Perfect Information quadrant.  The Behavioral Economics’ lover of a good story falls in the Blind Betting quadrant.

The Information Matrix can also be used to explain where financial crises come from, why our financial system is designed the way it is, how to respond to a financial crisis and how to prevent future financial crises.

And what has been the Economics profession reaction to the Information Matrix since it failed to see the Great Financial Crisis coming?

Dismissive disdain.

I should note, not everyone in the Economics profession is treating the Information Matrix with dismissive disdain.  I am aware of an article that has been submitted to a peer review journal featuring the Information Matrix, but without attribution.