Why did Economists, as a group, miss the warning signs of housing, credit and market crisis?

I don’t mean individuals — several professional Economists got it right; Academics like Nouriel Roubini of NYU and Robert Shiller of Yale, as well as a few Wall Streeters, such as David Rosenberg of Merrill Lynch and Paul Kasriel of Northern Trust. Too many bloggers to name also got it right. Meanwhile, the vast majority of professional economists, strategists and analysts — the “Herd” — totally missed it.

One explanation comes from Dean Baker, who channels Keynes, and says “incentives in the economics profession, just as in finance, strongly encourage a lack of original thinking.” (That’s a variation of Keynes: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally“). Paul Krugman wondered if it was a fear of going “against bubble denier Alan Greenspan.”

I find all these explanations wanting — and quite frankly, too generous by half.

My explanation is there were systemic failures in economics as a discipline, at least as it is employed in the real world. Note that these are not theoretical critiques (i.e., Keynesians versus Monetarists), but rather, these are broader inquiries as to why so many working economists were so utterly clueless about all of the red flags for so long. The inherent biases of working on Wall Street go along to explain why those economists were so awful — but I have less of an explanation as to why so many academic economists were so blind. Perhaps it is the profession itself.

As far as Central Bankers were concerned, they too missed the warning signs — but there were several notable exceptions to this to, including the Bank of England’s concerns about a credit crunch and a collapse in asset prices.

Ideas? I have a few. Here are my top 10 indictments as to why professional economists missed the crises until it was too late:

1. An inherent upward bias is built into ALL Wall Street research — including economic research;

2. Ideological rigidity prevented creative thinking;

3. Non-critical acceptance of official data from BEA, BLS, Commerce led to only a passing familiarity with reality;

4. Institutional rejection of negative analyses remains endemic;

5. Traditional (non-behavioral) economic analysis seems to have difficulty with human irrationality;

6. Political Bias; (Right wing during GOP Presidencies; Left Wing during DEM Presidencies);

7. Corporate bias — Stock option compensation — skewed views too optimistic;

8. “Timing” is very different from Analysis;

9. Factoring in excessive leverage and liquidity is exceedingly difficult from a traditional economic perspective (Derivatives especially);

10. Herding instinct is powerful;

Economics as a discipline does not seem to be particularly introspective. In my opinion, the sooner the profession develops some self doubt, recognizes its own failings and shortcomings, the faster they will be able to recognize the failing constructs of the profession and fix them. The Efficient Market Hypothesis, homo economicus, the deification of markets, all need an open public review and a good thrashing.

There were many professions that did not distinguish themselves in the lead up to the housing boom and bust, financial bust, the credit crisis, and the recession. Economics is near the very top of that list.


The Mystery of the Awful Economists
Barry Ritholtz
RealMoney.com, 3/2/2005 3:42 PM EST


(Free version at Investors Insight)

Bubble blindness
NYT December 23, 2008, 5:16 PM


Ezra Klein
The American Prospect, December 23, 2008 11:26 AM



Mystery of the Awful Economists, part II (April 8th, 2005)


Mystery of the Awful Economists (Part III) (April 13th, 2005)


More Sources:

‘City faces meltdown if debt crisis hits’
Edmund Conway, Economics Editor
UK Telegraph, 12 Jul 2006


Merrill’s Rosenberg Inspired by Farrell in Foreseeing Crash
Carlos Torres
Bloomberg, Dec. 30 2008


The Doomsayers Who Got It Right
More Bad News in Store for 2009? Last Year’s Cassandras Are Still Gloomy
WSJ, JANUARY 2, 2009


Category: Economy, Employment, Inflation, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

55 Responses to “Why Economists Missed the Crises”

  1. WaltFrench says:

    My recent favorite paper was about the S&L crisis of the early 80s. Came out in 1993, after the facts had been collected, bailout money wasted and careers shattered. Insightful, but hardly the sort of stuff of journalism. I think blogging leads us to believe that hair-trigger response is always more useful than in-depth research, the dimensions of which aren’t always obvious.

    For that matter, certainly the blogosphere, the MSM and Washington, DC, are all scrambling to understand What To Do. Not that Who/What Was To Blame isn’t a useful question, but the disorder of the latter, and the presumptive benefit from getting it righter than wronger, seems an order of magnitude more important.

    Finally, you are a victim of the same sort of selectivity biases that you rail against in economists. In February of 2003, 450 economists, including 10 of our surviving Nobel laureates, signed a full-page ad in the NYT that blasted the direction of the Bush tax-n-spend tax policy. While that ad hardly could have been expected to forecast a full-blown recession 5 years later, it DID predict a raft of problems such as weak employment, an exacerbated trade deficit, a weakening of the not-top of the income distribution, and a Federal deficit that would require expanded borrowing, all of which (a) came to pass, and (b) created a “who cares” environment by politicians and MOTUs.

    I think more of the problem sits with a society as a whole, which has been willing to believe in lies that make the Tooth Fairy story look rock-solid. I.e., “we have met the enemy and he is us.”

  2. Pravin says:

    The Austrian school clearly foresaw this. So there is no need to tarnish all economic schools as deficient. Though it can be said that even they were surprised by the warp speed of how things evolved (like you say,Timing is very difficult). Ideology: yes -the basic premise of the forecasting community of using math and stats to predict human behaviour (ie physics envy) is the differentiating factor that binds together Austrians and mainstreamers like Roubini. Both Austrians and Roubini didnt base their predictions on math models

  3. I would add:

    1. Ingrained belief that all economic growth is inherently good.

    2. Failure to identify, recognize and include externalities.

    3. Failure to consider law of unintended consequences.

    4. Failure to ask at every juncture, why?

    The rampant overdevelopment of the past decade reminds me of all those cars from the 1950s with those monstrous fins. Nobody asked for those giant fins. They just appeared. And then they got bigger. And bigger. And bigger. Until massive amounts of car real estate and steel and chrome was consumed to make giant fins a little bit bigger than the last set of fins.

    And then they disappeared.

  4. mlomker says:

    My favorite is the article from over the weekend, “Why don’t policymakers respond to rising markets?” It seems that very few economists consider a bubble to be a problem. There’s no doubt that the general public isn’t going to complain but don’t policymakers have a responsibility that goes beyond giving people what they (think) want?

  5. jonhendry says:

    This question echoes similar questions about the run-up to the war, and the errors of the “foreign policy establishment”.

  6. Jonathryn says:

    Try “In with the In Crowd.”

    Most economists on Wall Street and in Academia are baby boomers, a generation notable for its groupthink and ostracism of members who stray from “conventional wisdom.” Note also the curious effect in journalism: there are no old faces, and no young faces, just baby boomers. All thinking the same thing: Nobody could have seen this coming!

  7. Maseratij says:

    HHeh…. He said defecate…….That’s funny

    Not a spammer, just a reader trying to make a joke. Perhaps everyone was a little too serious about themselves as well.

    >>”The Efficient Market Hypothesis, homo economicus, the deification of markets, all need an open public review and a good thrashing.”<<

    They may be explanations but the reasons are always the same. It is just unusual when a group of people offend a majority of the Seven Sins. Greed, Pride, Gluttony, Envy, Wrath, Lust, and Sloth. http://tinyurl.com/7rvzp

  8. harold hecuba says:

    hey watts,

    WELL SAID!!!

    pravin… one of the reasons for the rapidity of the collapse was the stock markets denial for quite some time that there were any problems at all. remember oct 2007 the stock market was hitting ALL TIME HIGHS and the credit markets were in freefall. hell the stock market and shills believed everything was contained after BSC and the collapse of the auction rate security market. i still hold the belief that the stock market is no where near pricing in all the horrible news which continues to deteriorate.

  9. Mike in Nola says:

    I agree with Keynes. America as a whole follows that principle.

    Those who are skeptical of the comfortable present make almost everyone else uncomfortable and are shunned or derided. Look at Taleb, Roubini, etc. who were labelled cranks. Many cannot deal with that treatment emotionally. Others who were skeptics and didn’t already have a tenured position or “f-u” money like Taleb, would probably be concerned about promotion if they didn’t go with the flow. An example of what academics might fear is the story of Mandelbrot told by Taleb: he was set for a nice job somewhere, but the offer was yanked by George Shulz because he held unconventional beliefs.

  10. Schuler2 says:

    From my perspective at a Fortune 100 is many of the cheerleaders do not want capitulation and have a upward bias in all situations as that is linked to incentives, reputations and positions of power.

    I think the BP stated an interesting observation along the following “those that denied the recession, now state we have been in the recession for a year and now are at the bottom and recovering”. Bias such as groupthink from the previous comment and initial thread is a failure of rational driven discourse at the macro level to drive a better outcome on an macro basis.

    Taking a walk in a small town and observing what people are doing in conjunction with quantitative research is a combination many policy makers and economists can incorporate into the conclusion process to balance relative empirical cheerleaders with a dose of old fashion common sense. If you see a long line at the employment office, perhaps checking out the U-6 rate via BLS makes sense to see the Big Picture – no pun intended.

  11. danm says:

    11. Navel gazing or specialization.

    I find that most people who work long hours have limited knowledge of things happening outside their sphere of influence. How can you understand what is happening in the economy if all you are doing is reading economics books, Fed data, the Economist and shopping in expensive stores or staying in expensive hotels and boating?

    Most economist don’t know enough in other disciplines to be good economists.

  12. Lars39 says:

    OK, but my question is: will the “government” get the fix right? Will a bailout of everyone (banks, insurance, cars, states, etc.) help or hurt in the long run? What is the plan anyway, aside from throwing money around?

  13. MAL says:

    I use to make up stories for a living: I worked at the Federal Reserve Board in Washington, DC.

    At the Fed we had a preconceived “story” about the economy, and I would analyze economic data to make it fit the story. Or in our research we had no clear idea what the data “should” say, so we analyzed the data, but if the results were counter intuitive, we would make up a safe consensus view story to fit it. I thought, “if I am going to be a story-teller, I should get a PhD in philosophy.” Nothing against philosophy, as it is one of my passions, and I studied it as an undergrad.

    The problem with economics as a discipline is that many economists think it is a science, but it is not. The field is way to quantitative, and many use quantitative models to do their thinking. These models are too rigid and the underlying assumptions rest on rationality.

    Furthermore, the positive research bias leads “professional” economists to message the data using econometric techniques until there is statistical significance. Sometimes it is useful to know that the dog does not bark.

  14. AmenRa says:

    As Pravin said the Austrian school of thought recognized this would happen. Two quotes from Mises’ “Human Action”:

    What is needed for a sound expansion of production is additional
    capital goods, not money or fiduciary media. The credit
    boom is built on the sands of banknotes and deposits. It must
    collapse. Human Action, p. 559; p. 561

    If the credit expansion is not stopped in time, the boom
    turns into the crack-up boom; the flight into real values begins,
    and the whole monetary system founders. Human Action, p. 559; p. 562

  15. Dan Duncan says:

    Why did economists, asa group, miss the credit crisis?

    Because in the run up…to the dizzying heights of “Flip that House” and DOW 15,000, etc., etc….all arguments highlighting the insanity were met with, “Yeah, but it’s different this time”. The reasons given for it being “different this time” just happened to make the person offereing those reasons sound pretty damn intelligent.

    Greenspan was the perfect in this role of intellectual prophet. Listen to his turgid, opaque “analysis”. As an economist, you either “got it” or you didn’t. Too many economic lemings did not want to come across as being an intellectual lightweight…so all of us had to suffer through the nonsensical bullshit as if it made sense. “At the end of the day, the proliferation of nondeterminant economic models and innovative financial structuring mechanisms has resulted in an unprecedented dispersion of risk across uncorrelated asset classes…” BLAH, BLAH, BLAH….

    The beauty of it all is that no clear thinking economist could honestly even disagree with the above—because it has no structural coherence.

    “Sir, our model was created be a team of theoretical mathmeticians from MIT. This is cutting edge stuff! You, unfortunately are a dull, rusty blade. Back to Community College for you!”

    It’s no coincidence that the rogue economists who did call the crisis were contrarian thinkers who take a certain intellectual pride in going against the grain. Unfortunately for many of these economists—there’s a certain validity to the notion that they too often play the role of contrarian for the sake of being contrarian…and in the case of someone like Roubini, it’s too easy for his critics to simply say “There goes Nouriel again. Always has to be the Devil’s Advocate.” [And there's some truth to this---as over the long haul, Roubini has been far from perfect in his prognostications.]

    Economists just try too damn hard. Too many are physicist wannabes. Economics is not a science, and should not be treated as such. Any prediction given by an economist should be treated with the same weight as one given by an astrologer (sorry to all you astrologers out there). Economics departments should be permanantly removed from science departments and be made part of the Accounting Department at all schools. Upon graduation, in addition to their diplomas, economists should be given a simple Radio Shack Tandy calculator. The Dean, upon shaking their hands, should give each one of them 4 pencils along with the following advice: “Here stuff these in your shirt pocket. Get ready for a social scene filled with actuaries and accountants. Your down time will be filled with creating dynamic avatars in the 2nd Life Virtual World. Enjoy the Revenge of the Nerds (1-8)….Oh yeah, I almost forgot—Realize this: The opposite sex is not part of your future.”

  16. Bruce N Tennessee says:

    Economists would do a better job if they thought of themselves like many good mutual fund managers do…they have an inherent scepticism of what they are told, and get up off their heines and go check to see if the numbers from MSFT are really as good as they are told. I get the feeling most of these folks would rather push numbers around than go out and kick the tires….they are Dr. Watson and not Sherlock Holmes.

    And as others have stated…there seems to be a bias towards not rocking the predictive boat…

  17. Transor Z says:

    Keynes’ quote is one of those “it was ever thus” truisms that seems applicable to all walks of life, even art. Seems the Great Ones in every field are often “intellectually arrogant” enough to question conventional assumptions/revisit the data and methodology from “classic” experiments. Thank God they do.

    In a past life as a science writer I used to interview REAL scientists. Theoretical physicists were always my favorite. I had no clue what the hell they were talking about most of the time but most were surprisingly humble in describing the unknown. They used terms like “spooky,” “strange” and “weird” to give working names to poorly understood phenomena. Other than “black swan,” don’t see quite as much of that in economics.

  18. Economists are like so many other professions in these days of worshipping intellectual quantification of complex systems. We hardly understand and can predict weather beyond a few days for any particular locale, yet believe our scientific quantification of climate can predict the future climate for the entire planet a hundred years hence. Likewise, the VaR models used to assess risk failed to account for the fact that risk comes from many places in many ways, and as the saying goes, that past performance is not always indicative of future results.

    It is an irrational belief in the power of rational thinking. Every economic model, just like every risk model, just like every climate model, necessarily must assume certain things that are uncertain. There is no way to quantify the entire economy of a country as vast as the United States, or to quantify all the risks that inhere when borrowing short to lend long in a world-wide financial system, or to quantify every possible variable in the entire universe that might affect the earth’s climate. It is belief (bordering on hubristic worship) in the power of rational thinking to create these models and then follow them as truth when so much of the truth has necessarily been left out.

    Economists need, as do risk managers, climatologists and many others, to drink from the cup of humility, and admit that there are things no model can account for, and that the best that can be hoped is to use the model as a tool for understanding some limited aspect of the subject matter, keeping always in mind that a fancy model is no substitute for actual thinking.

  19. sailorman says:

    One very important reason is the incredibly inaccurate economic data compiled by the government. Particularly, as you have pointed out many times, the unbelievable inflation numbers.

    The artificially low inflation number made the economy look like it was growing when it was not.

  20. Thisson says:

    Economists spend too much time looking at the dashboard of the economy, and too little time looking under the hood.

  21. I forgot one, which is a distillation of the others:

    5. Failure to anticipate and adjust to emergence of negative feedback loops that arise from a growth bubble fueled by unstable positive feedback loops.

  22. VangelV says:

    I take it that Barry does not follow the Austrian school of economics. Frankly, I can’t think of a single Austrian economist who didn’t predict the collapse. The predictions were not based on mathematical models that depended on simplifications and false assumptions but on sound theoretical grounds that have been shown to work previously. If people started to pay more attention to such a logical approach they may find it easier to see things as they are rather than as the mainstream economists imagine them to be.

  23. whitespiral says:

    Barry – are you really looking around to see what the heck actually transpired, or is there some coherent “Big Picture” you’re saving for some big unveiling?

    I get the feeling that New York has become so festered with Neo-Keynesian, Krugmanite BS, that even sound minds like yours are beginning to get clouded.

    I’ve seen the absence of “Intellectual Rigidity” and its called Hank Paulson, our “pragmatic” Treasury Secretary-thankyouverymuch.

    It’s quite one thing to insist on something that’s right, and quite another to caress your beard while sprouting bullshit left and right.

    Its funny how surprised everyone is at Mises’ prescience when reading passages that looked like they came right out of the present crisis, yet somehow takes a step back when it comes time to actually implementing what should be done.

    Sure, let’s keep this Ponzi scheme a little longer-after all, pesky little Madoff’s lasted 30 years or so-why should ours last less than 100?

  24. Stuart says:

    I boil it down to: politics and money are joined at the hip. You say and report what you WANT people to hear, subject to all your biases, discriminations and agendas. Also, very very true. The Austrian school absolutely saw this coming, but their message was not part of the agenda of the financial oligarchy of the Western World.

  25. rww says:

    As a society and a species, we are so oblivious to so many truths, I am inclined to give economists a break.

  26. dwkunkel says:

    Doug Noland from Prudent Bear has been railing against the dangers of structured finance for at least the last 4 years.

  27. grumpyoldvet says:

    Whenever humans are involved predictions at best are just SWAGs. I’ll again say what I said on a previous post. When I was young and sent to a faraway jungle to “save some country from some evil force” we were told by the people in charge that they knew how to fight this conflict. Afterall they studied all the stuff in West Point, etc, Sun Tzu, Ceasar, Verdun, etc.But the funny thing was our opponents,a person we called “Victor Charlie” never did what they were supposed to. We learned after a while, but we paid for it with shattered limbs, broken bodies and a profund belief that TPTB have no Damn idea what the hell the are talking about.

  28. Todd says:

    It can be summed up in this:

    There is a total lack of critical thinking skills in all areas and aspects of our society. There are few original thinkers and doers every where. The few implement and then the herd maintains. This goes for most of corporate America, govt and higher education.

    The majority of all forecast are based on last years forecast with minor adjustments. Forecasts are rarely done based upon actual “real world” data. Real world data is too messy and doesn’t confirm to models.

  29. Andy Tabbo says:

    As a pure technical trader and Elliotician, I would suggest your #10 about herding instinct can account for much of what drives boom and bust cycles. Human emotions and herding behavior drive all cycles. All the misdeeds and mistaken policies are a symptom of the powerful underlying emotional content of the last cycle.

  30. Patrick Neid says:

    On a day to day basis Keynes got at least one thing right, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally“. IT guys knew this for years—when in doubt buy IBM computers.

    But for the real “big picture”, the majority no matter their personal disciplines, has to miss the rare great turns in the “market” as opposed to the run of the mill corrections of 10-35%. Great manias by definition sweep along virtually everyone despite any previous training.

    To now imagine that there will exist a “new” body of rules and regs that will prevent the next one is a gerbil running on his treadmill. The dirty little secret is we are hard wired for bubbles. We look forward to them. I don’t care what gloom is preached, we go looking for the next one, each in our own ways. In fact I would go so far as to say that way down deep it drives capitalism. The next big thing. Kill that part of human nature, that buzz, and you end up in the toxic waste dump of socialism/fascism/communism where all society dies.

    The markets will recover, lessons will be learned for a couple generations and with baited breath humanity will wait for the next big MANIA. Sure, go ahead and pick through the entrails trying to find a partisan reason why it was the other guy, a lax law or reg that got ignored. Knock yourself out, it will be to no avail. The rantings will be about things that will never happen again.

    Madoff always reinvents himself.

  31. Ken says:

    As a science, economics is somewhat limited by the difficulty of doing experiments. However, the same is true of astronomy, paleontology, and other sciences, which seem to manage well enough. I have to agree with many of the above posters, who note a strong “herd” or “conformance” mentality, especially as embodied in the Chicago, Austrian, and other schools. This seems (at least to me) to produce strong devotions to the theories, to the extent that when the data contradicts the theories, the data is ignored or denied.

    This extends not just to observational data, but even to the limited experimental results that are available. Experiments show that human beings are not rational maximizers of expectations, or even able to rationally evaluate future values and expectations. So any economic theory that is based on that as an axiom is not descriptive of reality. It may serve as an approximation in some limited contexts, or as a simplified basis for instruction – much as do the frictionless planes and perfect springs of an introductory physics course – but the science needs to recognize that. Especially, I might add, when policy-makers start trying to use these false-to-fact assumptions in domains where they do not apply.

  32. whitespiral says:

    Andy, ups and downs are different from the gigantic booms and busts modern “market” economies have been experiencing. When you have this much money sloshing around (courtesy of the Fed), all you need is a minor excuse for ALL that money to find a place to invest.

    What? Demand for petroleum moved 0.0001% about supply? Quick everyone-go long crude! The Internet is re-writing the rules of profit and loss and economics? Let’s make a nice leveraged play on tech stocks then shall we?

    Artificial credit infusion does not create herding instincts. It amplifies them to a level that is always catastrophic.

  33. debreuil says:

    11) Too much faith in the markets. If you have sites like Intrade in your bookmarks, and books like Freakonomics on your shelf, they will eventually wear away your (very important) nagging feeling that the herd might just be full of shit.

  34. whitespiral says:

    If you want, you can use cocaine as a metaphor. And what all these grand-sounding idiots are proposing is more of it.

  35. David in D says:

    Barry’s comment at the end of the post that the “deification of the markets” are one of the problems is spot on. My field is religion, and in the formal study of religion scholars basically spot sacred, absolute (and thus unchallengable) ideas. We need to face up to the reality that a certain type of capitalism is America’s secular religion, consumption is our sacrament, and Wall Street has been our temple.

    Unlike some of my personally religious counterparts (I am not particularly personally religious), the answer has nothing to do with “turning to God” or “turning to true religion;” but rather to deconstruct the type of mythology and symbol systems that lead us to believe the things we do about the markets. In doing so, we will be able to recognize our idolatry and regain a grip on reality.

  36. gordo365 says:

    Experts often discount/ignore data that contradicts their ideas/beliefs/hypothesis.

    As a highly paid professional – economists should be looking for data that contradicts their beliefs. Looking only for data that confirms beliefs is something us armchair economists have covered…

  37. wally says:

    I see the prediction failure as simply inexcusable. The ‘miss’ is too big and too broadly based and there is no cover for mainstream US economists to hide behind.
    Even if they, as a whole, do not accept theories of credit busts and debt deflations, the fact remains that they did not predict this as a business-cycle recession either. So even on their own grounds, on their own home field, they totally missed it. Reasonable people, when confronted with the reality that their basic understanding is incorrect, must rework their theories.
    I think we are looking at a couple of decades of revision to basic economic theory.

  38. mark mchugh says:

    “You can’t polish a turd”
    ~ Butthead

    When you take fundamentally flawed principles (like debt-based economic systems) and hold them up as sustainable models, the only people who are gonna pray at your altar are pseudo-scientists and pseudo-intellectuals (plus a few clever ones who realize it beats working for a living). The wisdom of Butthead is lost on these guys, who just can’t bring themselves to say, “it’s all just a bunch of crap”.

  39. TDL says:

    Two more points (one already mentioned several times.)

    1) Mathematical modeling replacing traditional social science modeling & inquiry. The economics profession became a slave to mathematics, despite the fact that all the other social sciences refused to go in the same direction.

    2) Economists are profoundly ignorant of history, let alone economic history. I believe that there are a number of winners of the Noble prize who basically “re-discovered” theories that they had no idea existed (I don’t have the source on this issue, however, I believe Nash’s work was one of those theories.)


  40. vic says:

    You mentioned the Keynesians and Moneterists, but you failed to mention the Austrian school, who picked this recession cold. Many warning about it in 2002 when the Fed became easy with their monetary policy. Notables from this school:

    Peter Schiff, Ron Paul, Mike Shedlock, Frank Shostak.

    As usual, no one pays any attention to the Austrian school, but rather focuses on the economics of the other two intellectually bankrupt schools of thought who like to pretend that economics is like the natural sciences where repeatable experiments can be performed under laboratory conditions. What a huge joke.

  41. ottovbvs says:

    This is all getting too complicated BR. The reason was very straightforward and it’s the same one that accounts for all the idiocy we get from economists at the NAR. You were likely to get fired if you told the truth. Pessimistic forecasts would have been as popular as pork chops in synagogues.

  42. gnomic says:

    Your premise is that the system isn’t working; mine is that it is working as designed.

    I suspect that the system is designed to occilate is such a way that some can make money off of others based on access to resources. The system is inherently designed to concentrate wealth to those with resources (information, access). Bubbles and instability are good, otherwise the whole thing would be…boring and predicable, with little opportunity to make bazillions.

    But I agree, much of the system has been built on a flawed theory, with failed controls, by people who are incented to act in opposition to thier intended function.

    But then, that is the point of the people that designed it.

  43. chacona says:

    I did not know whether to laugh or to cry when Bloomberg published today this:

    Bard College Had Losses of $3 Million Tied to Madoff (Update2)….


    Why? – Because it is precisely the circle of Post-Keynesian economists associated with the Levy Economics Institute of Bard College ( http://www.levy.org/ ) that has continued to develop Minskyan analyses of the capitalist finance system…Indeed, Minsky published many of his path-breaking later (i.e. written before his untimely death in 1996) articles under the Levy Economics Institute….

    But I guess Minsky would have laughed if he had seen the latest by Michael Lewis in Condé Nast Portfolio:
    After the Fall…


    Now that is a timely reminder that Madoff was not the solitary Ponzi financier: far from that, the whole system had become a giant Ponzi scheme…

    Enjoy the article if you can…

  44. patient renter says:

    To the extent that any group of economists can be formed and their performance can be measured, the only group that truly shined were the Austrians.

    The record of their performance leading up and into the crisis is on the internet for the world to see. They were all right while nearly everyone else was all wrong.

    At times economics seems a bit like a battle of ideas. If an economist’s record is worth anything, the battle is over, and the Austrians have won.

  45. Mark A. Sadowski says:

    As a group the Austrian Schoolers are a bunch of quacks. The Austrian School is inductive rather than deductive. As a result it does not believe in the scientific method. Consequently it lacks academic legitimacy. (In fact there’s only a couple of schools in the entire country that even teach it.) Thus it has become the province of amateurs, goldbugs, libertarians, anarchists and other cranks. (The Austrian School is less a school than a cult. You’ll have to take up Ayn Rand and Ludwig von Mises to join.)

    One glaring area where the Austrian cultists have been wrong is with respect to inflation. (And yes, inflation matters more than stock picks.) All were forecasting high inflation by this time last year. For example, here is what Peter Schiff was saying late last year:


    Here is a good rebuttal from about about the same time (with an exchange):


    On the other hand many New Keynesian economists were forecasting the possibility of deflation a year ago. Here is a January 2008 entry from Nouriel Roubini’s blog (you’ll need premium access to read the whole thing, but you’ll get the gist of it from the beginning):


    Use any index you want, CPI, PPI or PCE, we are experiencing deflation right now (even measures of core inflation are flat or declining). And although Peter Schiff had a relatively good year this year he got almost everything else wrong the past five years (with the exception of gold of course, which if you’re an Austrian it is always going to go up):


    Note that virtually all of the so called economists that got it wrong in the “Peter Schiff Was Right” video were Supply Siders and with the exception of Art Laffer they weren’t even academic economists. The only other person to actually have any degrees in economics was Ben Stein, and that includes Peter Schiff (accounting and finance). Note also that they appeared on Fox Noise. (Time to change the channel to MSNBC and see what Paul Krugman has to say.)

    “No, but I stayed at a Holiday Inn last night.”

  46. I find the substantive Delta, found on this thread, between the pro-Austrian School arguments and the pro-Keynes opinions, to be, in itself, instructive.

    Also, it seems, the answer to the central Q: “Why did Economists, as a group, miss the warning signs of housing, credit and market crisis?”–lies, in pieces, within this thread.

    It, to me, has been well worth reading..

  47. David Merkel says:

    As a fellow-traveler with the Austrians, I think the failure is more systemic in nature. The neoclassical school of economics is intellectually bankrupt, and most economists are interested in playing cute theoretical games with obscure bits of math, assuming that people are robots in the way they imagine we must be on average (or else the math with the twice-differentiable functions won’t work).

    Economics should never have been used to give detailed predictions. It is a social art (not a science). The math gives a false precision that could never be fulfilled. People are complex, and rational in ways that simple optimization models cannot comprehend.

    Economists get into trouble when they are forced to make detailed predictions. The economy is far too complex to be explained through the simplifying assumptions of economists. The best we can do is qualitatively look at things and say: “Here are the risks; here are the opportunities.” We won’t ever be right, but we can indicate the prevailing direction of future economic winds.

  48. Graphite says:

    Barry appears to me to be intentionally leaving out Austrian economists in his “why didn’t we see what was coming” threads because he disagrees with their economics or their politics.

    “As a group the Austrian Schoolers are a bunch of quacks. The Austrian School is inductive rather than deductive.”

    You can’t even get your recycled, hack criticisms straight. It’s deductive, not inductive, because induction is mostly impossible with a complex system like the modern economy.

    “As a result it does not believe in the scientific method.”

    How, exactly, would one apply the scientific method to analyzing the economy? How do you falsify your hypotheses? If you apply one Keynesian solution (e.g., in Japan), and the outcome is catastrophe, the apparent lesson Keynesians draw from this is that you just should have tried harder. They’re no more “scientific” than the Austrian’s, but they’re very good at cloaking themselves in the mantle of science.

    “Consequently it lacks academic legitimacy. (In fact there’s only a couple of schools in the entire country that even teach it.)”

    You’re trying to make arguments AGAINST the Austrian School, right?

    “Thus it has become the province of amateurs, goldbugs, libertarians, anarchists and other cranks. (The Austrian School is less a school than a cult. You’ll have to take up Ayn Rand and Ludwig von Mises to join.)”

    Blah blah blah blah blah ad hominem blah blah.

    “One glaring area where the Austrian cultists have been wrong is with respect to inflation. (And yes, inflation matters more than stock picks.) All were forecasting high inflation by this time last year. For example, here is what Peter Schiff was saying late last year:…”

    Peter Schiff is not the end-all and be-all of Austrian analysts. Others, including Mike Shedlock, Frank Shotak, and the Daily Reckoning guys highlighted the possibility of deflation starting in early ’08 or even earlier. And we’re not out of the woods yet. Schiff may yet be proved right if we go full steam ahead with deficit-spending solutions (such as Roubini favors) and wind up with a public debt that is unserviceable without using inflation or sovereign default.

    Reading the Austrians, especially Mish, has personally helped me save hundreds of thousands of dollars. As far as empirical evidence for the Austrian school goes, that’s not too bad.

  49. whitespiral says:

    Sadowski, positivisim, the premise of falsifiability, and all that great stuff that holds true for the physical sciences, can not, nor will ever be, applicable to economics.

    Tell me again why no other social science like history, geography, philosophy, political science, and sociology use the positivist method and mathematical modeling?

    Oh-I know some psychologists use it-it must be working out great for them.

    Human Action throws any physical absolutes on their head. Learn that well.

    BTW, as for the Austrian School lacking any academic legitimacy, its kinda funny how no mainstream economist will dare enter any debate with an austrian.

  50. DeDude says:

    The big problem is that a lot of them are more idealogogs than scientists. Its not that they were too stupid to see the problem; it was that in order to react to it they had to realize and admit that their ideology was wrong. Instead they convinced themselfves that what they were seeing was “anormalities” that would soon correct themselves and start behave according to their ideology. A lot of these people have huge overblown egos that simply cannot deal with realities that would require them to admit they were dead wrong. Its 3’rd grade math to understand that if 70% of our GDP is consumption, then all economic policy must center around the health and sustainability of the consumer class. The consumption based on dept is unsustainable, is no more complicated to understand. Don’t tell me that people with a university degree could fail to understand these things due to intellectual inadequacies – it was ideological deficiencies.

  51. Mark A. Sadowski says:


    Your right, I did get inductive and deductive backwards. My bad!

    Your also right that there were a few exceptions in the Austrian school with respect to deflation. But Mike “Mish” Shedlock and Frank Shostak (and Gary North for that matter) were in the extreme minority (and still are). Maybe you (and all the Austrians) should go figure out what they did (and are still doing) right. I have my own suspicions. In fact it seems to me that Mish in particular is much less a slave to monetary aggregates than the other Austrians (“credit destruction” etc.) In fact some of his analysis sounds an awful lot like the Keynesian aggregate demand thinking to me. And his predictions for the new year also sound an awful lot like the New Keynesian predictions (Could it be, for all his anti-Keynesian bluster, he is really a Keynesian in Austrian clothing?)

    As for investments, I followed my New Keynesian education, selling my stocks in August 2007 (just before peak) and selling my gold last month (buy low, sell high!) I notice that Mish isn’t committed to forecasting that gold will go up this year. Hmmm.

    P.S. Whitespiral, I’m an all but dissertation mainstream economist, and I love arguing with you guys!

  52. Pravin says:

    ““Consequently it lacks academic legitimacy. (In fact there’s only a couple of schools in the entire country that even teach it.)”

    LOL. Unbelievable. this guy is actually trying to sell consensus academics?. progress is made by dissent and not consensus. Galileo anyone?. geez, what sort of brainwashing a few years of university macroeconomics can do.

  53. Here is a little fact:

    “””For the fourth quarter of 2004, according to OECD, (source Employment
    Outlook 2005 ISBN 92-64-01045-9), normalized unemployment for men aged
    25 to 54 was 4.6% in the USA and 7.4% in France. At the same time and
    for the same population the employment rate (number of workers divided
    by population) was 86.3% in the U.S. and 86.7% in France.

    This example shows that the unemployment rate is 60% higher in France
    than in the USA, yet more people in this demographic are working in
    France than in the USA, which is counterintuitive if it is expected that
    the unemployment rate reflects the health of the labor market”””

    Number of economists using unemployment measure as is to prove
    superiority of X or Y policy/country: 100%
    Number of economists studying this discrepancy: 0% +/- 1% (1) (2)

    Raw economics data is also top secret: there is a big incentive
    for the profession to keep data out of the public eye to
    avoid embarassing debates (inflation comes to mind, why
    are hedonic adjustments not public for example?).

    (1) of the hundreds of economist I presented with this evidence
    only Dean Baker reacted positively, but he also predicted this crisis
    (correlation is not causation :)
    (2) it’s easy to disprove this affirmation: cite a paper

  54. Mark A. Sadowski says:


    How can you argue that there’s a consensus when evidently your own “school” lacks one. In fact in my own case I have the unfortunate fate of working within one of the most out of touch economic departments in the country. John Boehner recently posted a list of 34 economists who were against the economic stimulus. This was out of perhaps 30,000 PhDs in economics in the entire country. In that list were two members of my own department. One of those was my own disertation supervisor. Ironically he is an “expert” on the Great Depression. He is a seemingly rational guy but he has had a terrible year for investment advice. (For example, the very day Lehman Brothers went under he told me that AIG stock was cheap.) There was no consensus, but maybe there will be one soon, after the dust settles.

    P.S. Laurent Guerby, I love Dean Baker. I’ve been reading him for years. In fact, check out this:


  55. [...] few pixels on the same subject previously. Let’s do a quick search — hey, whattataknow: Why Economists Missed the Crises (January 5th, 2009) [...]