The cult of the PhD Economists managed to do what no other country has been able to do:  undermine America.  Not only did the PhD Economists provide the necessary narrative, but when put into positions of authority, they implemented policies that were knowably highly detrimental to America.

Of course, the cult of the PhD Economists would deny all of this.

Regular readers know I cite the US adopting Japan’s Model for responding to the Great Financial Crisis as a prime example of implementing policies that were knowably bad for America prior to their implementation.  But that didn’t stop PhD Economists like Ben Bernanke leading the charge to save the banks.  The cost of unnecessarily saving the banks included destruction of the social contract.

Fortunately, there are now other writers pointing out the role of the PhD Economists in undermining America.  Sebastian Mallaby wrote a very interesting review of two books that reflect a change in the analytical perspective about the Great Financial Crisis as these books set about

searching out larger political and intellectual wrong turns, an expansion that reflects the morphing of the 2008 crash into a general populist surge.

I want to focus on one part of his review.

Contrary to common presumption, the economics establishment in the 1990s and 2000s did not believe that markets were perfectly efficient. Rather, influential economists took the pragmatic view that markets would discipline financiers more effectively than regulators could. Alan Greenspan, the Fed chairman who is often painted as the embodiment of the pro-market age, had been preoccupied with the destabilizing inefficiencies in finance since the 1950s. Lawrence Summers, the Harvard economist who became Treasury secretary under Bill Clinton, had contributed to the academic literature on the limits of market efficiency. The fact that such sophisticated people presided over a dangerous buildup in financial risk suggests that something larger was at work than a naive faith in markets.

Please reread this passage focusing on “influential economists took the pragmatic view that markets would discipline financiers more effectively than regulators could.”

What is the necessary condition for this pragmatic view of the markets to be true?

There must be transparency so investors know what they own.  

It is only when investors have access to this information that they are able to perform the fundamental risk/return assessment and then use this assessment to determine how much, if any, exposure they want to a specific investment.  Market discipline is the result of investors changing their exposure based on their updated assessment when new information is disclosed.

An example of market discipline would be investors selling stock in a bank as management increases the risk of the loan portfolio.  The falling stock price exerts discipline on management to stop increasing risk.

PhD Economists didn’t and still don’t know this.  They championed ideas like the Efficient Market Hypothesis (EMH).  The strong form of this hypothesis says all information, whether disclosed or not, is reflected in the price for a security.  It never occurred to them Wall Street might design and sell a security where nobody had inside information.  Examples of this type of security include private label mortgage-backed securities and collateralized debt obligations that were built using the private label mortgage-backed deals.  It also didn’t occur to them the insiders in the opaque banks might not want to properly reflect the risk of the banks’ securities in the price for these securities.

PhD Economists like to blame a failure of imagination by a bunch of bright people for these shortcomings.

The NY Times’ Binyamin Appelbaum doesn’t buy this excuse.

Economists have repeatedly made excessive claims for their discipline.

In the ’60s, Kennedy’s and Johnson’s advisers thought they had the business cycle tamed. They believed they could prevent recessions by “fine-tuning” tax and spending policies. When this expectation was exposed as hubris, Milton Friedman urged central banks to focus exclusively on the supply of money circulating in the economy. This too was soon discredited. From the ’90s onward, economists oversold the benefits of targeting inflation, forgetting that other perils—the human cost of unemployment, the destabilization wrought by financial bubbles—might well be worse than rising prices. Meanwhile, Greenspan and Summers ducked the political challenge of buffering new kinds of financial trading with regulatory safeguards. To be fair, the Wall Street lobbies presented more of an obstacle to regulation than critics acknowledge. Still, Greenspan and Summers miscalculated.

Why would an Economist take on Wall Street’s lobbying when they believed in ideas like EMH and markets were better at exerting discipline than regulators?

Of course an Economist wouldn’t.

The result was the breaking of America.

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Thanks to John Furlan (@jfurlan14) who provided the title to this post.