Economical With The Truth – Christmas Naivety

It’s over 4 years since the financial crisis began, and by now you would have thought that we would understand all the factors that drove the building of, and since 2007, the destruction of the foundations of world economic growth. Over the last few weeks the events have been analysed by a series of economic programmes on the BBC.

Not surprisingly, many of the players, the mistakes, the events and the dramas were plain to see, especially with the benefit of hindsight. From a bond holder’s point of view, we knew that companies could be opportunistic, rating agencies conflicted, and regulators under-resourced. These themes played out through the course of this week’s programmes.

One programme, however, the Oscar winning Inside Job, brought to light my continued naivety with the help of some of their cleverly edited sound bites.

A particularly interesting section of the film was dedicated to examining the academic profession. I naively thought that the point of academia was to study, develop arguments, and search for the truth. George Soros (1hr 19mins into the film) sees things slightly differently – “Deregulation had tremendous financial and intellectual support because people argued it for their own benefit…..the economics profession was the main source of that illusion”.

You obviously expect some bias with economics and the study of the financial system, whether it’s the economic arguments leading the political arguments (or vice versa) from both the left and the right. However what I had missed was the conflict of interest that frames the whole economic and regulatory debate.

The carousel of regulators, politicians and academics was something that had previously passed me by. The intellectual framework for regulation was heavily influenced by sponsorship of academia by interested parties. An example of this was where a professor (and ex central banker) had been paid to write a financial report on the stability of the Icelandic financial system by the Icelandic Chamber of Commerce. The report that he was paid in excess of $100,000 to write came out favourably; unfortunately reality did not. Events always appear clearer with hindsight. Mind you, the CV of the economist who wrote the glowing report on Iceland may have benefitted from hindsight more than it really should have. A “typo” appears to have occurred at some point which changed its title from a report on stability to one examining the instability of the system (1hr 24mins in).

Now we as investors know the conflict that rating agencies may face when rating the firm that pays the fee, but had not spotted who else was conflicted.

Why should we care? Well sadly it means the system is weaker than we thought.  The politicians and regulators look for independent analysis from academia to drive us forward, however that analysis may well be severely conflicted. To get rich quick, the academics, central bankers and regulators have an interest to keep filling the punchbowl, as they too are drinking from it.

The supposed benefit of appointing professors to run central banks is the concept that we are getting independent, intelligent individuals who have the ‘general good’ as their goal – a type of benevolent dictator. Maybe, however, part of their rise through academia came through the money that Wall Street threw at themselves, their departments and their universities.

The thing that amused me most in the interviews with these potentially conflicted economists was that they had trouble understanding where the conflict of interest lay (1hr 22mins). If any profession should know how incentives work then surely it is the economists.

If the intellectual and political establishments are too beholden to the system they are meant to control then we have yet another new problem to add to the list. What else will we learn next year?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Discuss Article

  1. Sean Fernyhough says:

    There is also the PBS documentary “The Warning”, which is about the Brooksley Born episode touched on by “Inside Job”. 

    We should also take notice of William K Black on fraudulent activities at the base of the process – the liar loans.  Black – “Inside Job” and “The Warning” suggests to me that regulators were not just supine but at least negligent, and perhaps worse.

    On the subject of the state of economics today read Steve Keen’s book “Debunking Economics”, and is most recent paper “Debunking Macroeconomics” available online here:

    These sources also quash the view that it is only with the benefit of hindsight that the problems were clear. 

    Posted on: 12/12/11 | 5:05 pm
  2. Kevin Hill says:

    Absolutely spot on. This conflict of interest runs inherently through academic circles and is most damaging in economics and science alike. Unfortunately there is no benevolence found in either discipline and those that rise to the top of their professions do so by publishing material which supports the concensus and hypothesis of the paymasters. Why bite the hand that feeds?

    Posted on: 12/12/11 | 10:32 pm
  3. Jeremy Dufton says:

    I’ve just got round to reading Justin Fox’s The Myth of the Rational Market. Was part of the problem the fact that so many of these people were not just conflicted, it was that they saw no reason or need to control the system as they perceived the system to be perfect and, well, rational, efficient or whatever word you choose to use?

    Posted on: 13/12/11 | 9:03 am
  4. Anthony Rayner says:

    Fully agree. In both the City and mainstream academia, there is a notable lack of pluralism when considering viable economic systems. Unchallenged neo-liberalism is the only game in town.

    This still seems to be the case, despite the fact that the sub-prime crisis is a wonderful example of how inefficiently capital can be allocated by a ‘free-market’. This capital was allocated with such recklessness that, with the help of extremely globalised systems, it’s helping to bring the world economy to its knees.

    So, with this disaster still fresh in mind and likely to impact economic and government policy for years to come, why is there a lack of genuine debate as to alternatives? I think it’s structural, note:
    1. The predominance of the financial sector in key advisor roles to politicians
    2. The recent trend for unelected technocrat leaders Mario Monti (Italian prime minister – amongst other roles, Goldman Sachs advisor) and Lucas Papademos (Greek prime minister – ex ECB vice president, advisory roles with the IMF and head of Greek central bank when the country’s true deficit was being hidden),
    3. The power of lobbying (the hedge fund industry is now the largest contributor to the Conservative Party, with the City contributing to half of the party’s income).
    The market still rules and meaningful reform seems increasingly out of reach.
    Genuine debate as to how to best structure economic systems for the benefit of society at large is unlikely to be driven by politicians.

    Posted on: 16/12/11 | 12:22 pm

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