Bernanke and the Search for a Narrative Continues

25 Jun 2018

I can truly appreciate how uncomfortable it must be for macroeconomists not to have either an understanding of how the global financial system is designed or a theory explaining financial crises. Lacking both, they know when they open their mouth about a financial crisis all that could possibly come forth is BS.

Naturally, this makes them very defensive. But being PhDs, this doesn’t stop them from anointing themselves experts and talking about financial crises. A decade after the acute phase of the most recent financial crisis and their BS is piling up higher and deeper (PhD…) at an astonishing rate.

Not surprisingly, leading the charge is Ben Bernanke. While Ben has made himself incredibly wealthy, none of the BS he has generated since leaving the Fed Chairman job masks the fact his policies could not have been worse. It is almost as if he took it upon himself to undermine capitalism and US democracy. However, this implies he had any idea of what he was doing. After a decade, he has convinced me he was and still is totally clueless.

But why did I expect more from him or any macroeconomist? Could it be because he is a self-proclaimed expert on the Great Depression? Could it be because it should have been unavoidable to learn something about how the global financial system is designed when the acute phase of the financial crisis hit? Could it be in the years since he has had plenty of time to develop a theory a 6-year old could understand that explains financial crises (see here for my financial crisis theory)?

As he and other macro economists continue to barf forth BS, I have come to realize there is something systemic which prevents their understanding either the global financial system or financial crises. This systemic issue reveals itself in the terrible job they do even trying to accurately describe a financial crisis.

At the Nobel Symposium on Money and Banking, Olivier Blanchard reviewed papers by Ben Bernanke and Barry Eichengreen. He talked about these papers using a 5-level scale from mild to acute for financial crises.

Start from an initial adverse shock to some asset price, housing (US, Spain, Ireland)

Please notice the starting point: an adverse shock. Could Mr. Blanchard have provided a less insightful description?

I don’t know, but his description harks back to the Diamond/Dybvig’s model of bank runs I debunked (the authors provided 5 reasons for bank runs including sunspots; this suggests presence of a single factor that actually explains what is happening that can co-exist with all of their reasons; single factor is opacity of bank which makes it impossible to tell if bank is solvent; hence, prudent to run when solvency of bank called into doubt).

Mr. Blanchard’s starting point obscures more than it illuminates. But he goes on to make an important observation.

Level 3. Runs on liabilities, sudden stops, rollover crises, interbank market freeze

Uncertainty (Knightian in part): Solvency or liquidity?

Run on liabilities, fire sale of assets or worse, less lending

Mr. Blanchard noticed runs on liabilities including the interbank market freezing. However, like Diamond and Dybvig, he stops short of asking the question is there a single unifying factor behind where the runs occurred and the interbank funding market froze.

Had he done so, he would have found opacity.

As regular readers know, the acute phase of the financial crisis in 2008 was the equivalent of an earthquake across the opacity fault line in the global financial system. The story behind the valuation of every opaque security was called into doubt. Investors know when this story is called into doubt there is no logical stopping point in the decline of the value of the opaque security other than zero. Hence, they have an incentive to run and get their money back/out of the opaque security they are invested in.

As Mr. Blanchard points out, Mr. Bernanke doesn’t ask why is there uncertainty about the banks. After all, doing so would lead to discovering opacity creates liquidity problems for banks as it prevents market participants from assessing their solvency.

Ben stops at level 3 (OK for the US Great Recession).

By not accurately describing what happened during the recent financial crisis, macroeconomists give themselves no chance of offering up anything other than BS.