Never Let a Serious Crisis Go to Waste
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Fed directors typically hold down a full-time job elsewhere, so in practice, most directors are officers of banks, or academics who are somehow connected to them. This level of private control of a central government regulatory agency is rather more extreme in the United States than in other developed countries, where directors are often paid civil servants; but what it accomplishes is an enhanced degree of “self-regulation” of the industry, covered over with a patina of plausible deniability. This is combined with a critical dynamic wherein the Fed has engineered greater concentration in the financial sector over time (through shotgun mergers of failing banks, plus other blandishments), such that there are fewer banks to provide and elect qualified directors, and therefore, the entire system is increasingly being “regulated” by the few oversized firms that conveniently dictate the staffing of the Fed. The most recent history of this unprecedented consolidation is depicted in Figure 4.6. This leads to those very same banks being bailed out in times of crisis, and, not insignificantly, something approaching the Bernanke doctrine. As Donald Westbrook has sagely observed, “Corporations may live globally, but they die—or are rescued—nationally.”68
The only wild cards that might potentially mitigate this built-in regulatory capture are the residual academic members of the boards, primarily economists. Yet most observers then miss how the Fed system facilitates repeated indelicate liaisons between financial executives and the economics profession, and brings about “cognitive capture” of the discipline. One way this happens is that large financial firms are induced to hire prominent academics, even to the extent of incorporating them onto their own boards, as we shall see below. It thus remains opaque exactly the constituency any given economist actually “represents” while nominally propounding the general welfare. Another significant way this occurs takes place by the Fed itself either hiring or providing contract funding for a substantial proportion of the economics profession concerned with macroeconomics and monetary economics. The following is the result of some underappreciated research by Auerbach, White, and Grim on this issue.69
In 1992, testimony provided directly by the Fed listed at least 493 economists employed as “officers, economists and statisticians” and an additional 237 as “support staff.”70 Since about 1,700 members of the American Economics Association listed “monetary and financial theory” as their primary or secondary fields in that year, the Fed was currently employing something like 43 percent of the field. White estimates that there are about 390 economists specializing in money, macro, or banking in the “top 50” graduate departments in the United States; so the Fed could easily have employed that totality, or engaged them in some consulting relationship over the course of their careers. White also reports that over a five-year horizon 80 percent of the papers in the Journal of Monetary Economics had at least one co-author with a Fed affiliation (not all disclosed in the article, however), whereas in the Journal of Money, Credit and Banking it was 75 percent.71
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Figure 4.6: American Bank Mergers, 1995–2009
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Source: Federal Reserve; GAO
The Fed is constructed to evade democratic accountability, and as such, short of a Supreme Court order, it abstains from documentation of its web of support of the modern economics profession. For instance, the Fed declined to report more recent totals of actual employment. Related agencies loom equally large. Depending on how one regards the International Monetary Fund in the financial constellation, that would add roughly another 1,100 economists employed in Washington, D.C., alone. The World Bank refuses to report any breakdown of employment statistics out of its aggregate 10,000 employees worldwide whatsoever. But that was not all. The Fed board plus the twelve regional Feds awarded 305 contracts to other external economists to the tune of $3 million—although some individual economists enjoyed multiple contracts. In 2009, contracts issued for external economic research totaled $433 million. Some high-profile economists are kept on paid retainer, without even having to produce actual reports. Printing your own money means you can afford to cover all relevant bases. It is safe to say that there are few orthodox American macroeconomists who have not enjoyed a subvention from the Fed (or the international agencies) at some time during their career.72
There is no doubt that that the Fed system and its international counterparts as a whole either employ or fund a substantial proportion of the economics profession concerned with monetary policy and macroeconomics, and have therefore had an enormous intellectual influence on the profession. Grim reports that every single member of the editorial board in 2009 of the Journal of Monetary Economics was or had been affiliated with the Fed, and 54 percent were on the payroll. Of the editorial boards of eight top-ranked economics journals, 84 out of 190 had been affiliated with the Fed at some point in their careers. Indeed, sometimes the connection is even more intimate, with the bulk of the offices of the economics department at the University of Minnesota essentially located to a large degree at the Minnesota Fed.73 Much of the early and intermediate stages of the “rational expectations revolution” were funded and promoted out of the Minnesota Fed, in a period when it was not yet conventional wisdom, or entirely welcome in some “saltwater” departments. A major pillar of support for the DSGE model (described in the next chapter) originally came from research staffs and contracts of the regional Feds. Moreover, the money, once bestowed, comes with strings. Employees and contractors must sign nondisclosure agreements, and published articles are often vetted by Fed bureaucrats. In the interests of needing to speak with one voice in monetary policy, the Fed regularly imposes the trappings of intellectual uniformity.
It is tempting to describe this situation as “symbiosis” but even that would not manage to capture the unholy alliance of banks, the Fed, and the economics profession. It is an open secret that junior Fed positions are considered consolation prizes within the economics discipline: what you get for a first job if you graduate with a PhD from a top-ranked department in the areas of macro/money, but fail to land an academic post at another top-tier department. The movers and shakers are, rather, given the plum consulting contracts, appointed visiting positions, and other perks. Both are entryways into subsequent work for the financial sector. Hence the Fed manages to curry favor with a number of strata of the profession simultaneously with forging links to the financial sector, building a deep bench for support of the kinds of positions exemplified by Bernanke in this chapter. The net result is an interlocking directorate of the self-defined “orthodoxy,” which has been able to recruit, sustain, and promote its members almost on a par with the neoliberal Russian doll itself. Indeed, the Fed and the doll have grown increasingly fond of each other. Since the 1980s, when Ronald Reagan was able to appoint all the Fed governors, the Fed has become an unapologetic openly neoliberal institution; and this has constituted one of the major channels through which the economics profession was shepherded in a more neoliberal direction. One Russian doll mated with another.
The slavish genuflection to the financial sector within modern economics is therefore quite easily understood once a little effort has been devoted to exploring the sociology of the profession. The cognitive capture of the profession by the bankster-regulator industrial complex helped set up the profession for its fall, and is indispensable for understanding the rituals of denial that ensued.
A Potemkin Consensus
The Fed, undeniably a powerful, pervasive patron of professional economists, has not yet ascended to the eminence of the Ministry of Truth, and thus cannot, by itself, fully account for the contours of the entire contemporary economics profession. The brute fact is that it has been unable to completely eradicate dissent concerning the macroeconomy, although it has wrought wonders banishing it to the margins of discourse. The mere fact that such a dissenting remnant persists has led in the aftermath of the crisis to yet another symptom of the paralyzing syndrome of denial: the incessant hand-wringing about the extent (or not) of “
consensus” within the “legitimate” orthodox economics profession. Famous neoclassical economists love to assure us that “everyone that matters” subscribes to their own favorite roster of shared truths in the profession, no matter how much this proposition has been besmirched by recent events. In their disarray, economists indulged their bad habit of confusing regression to the safe median with an unimpeachable badge of Truth. They seemed incapable of imagining that their glittering prizes (and Fed contracts) may not be much more than signifiers of abject capitulation to sanctioned ideas. Indeed, they often unconsciously channel neoliberal epistemology, as if putting the questions up to a vote (or a market) would somehow manage to extract the dependable “wisdom of crowds,” which would naturally endorse the validity of neoclassical economics. Journalists, having had to resort to their own devices in the early stages of the crisis, have also grown solicitous in searching out where that magic consensus might be located, since their own metaphorical flights have come to grief in the interim.
The explicit projects to codify orthodox “consensus” reveal just how difficult it has become for the profession to police its boundaries, and yet also the extent to which neoliberal presuppositions have become second nature in any arena one seeks to frame whatever economists are supposed to know. If one takes the simplest possible proposition—say, that the raising of the debt ceiling by an August 2011 deadline would serve to stave off a disastrous financial crisis and employment contraction pursuant to a technical default of the U.S. Treasury on part of its debt—then it was a snap to get 162 economists, including two Nobel winners, to sign a statement denying that proposition.74 Or take that larger and more contentious issue, the question of whether there was a bubble in housing prices by 2006, and why so few economists were willing to sound the alarm. There is retrospective evidence that a few prominent economists had warned the New York Fed of a housing bubble as early as 2004; in response to one such presentation, Timothy Geithner removed Robert Shiller from the Fed advisory board.75 But the orthodox profession seems loathe to ever admit knowledge is actively policed and purged according to a preset script. After the fact, some economists at the Boston Fed decided that, because one would encounter a range of opinions on that issue before the crisis, there is no justification in blaming the profession for missing the disaster. They wrote: “Economic theory provides little guidance as to what should be the ‘correct’ level of asset prices—including housing prices . . . While optimistic forecasts held by many market participants in 2005 turned out to be inaccurate” those projections were not “unreasonable” given what was understood about the economy and housing market dynamics in the years before housing prices crashed. “The pessimistic case was a distinctly minority view, especially among professional economists . . . The small number of economists who argued forcefully for a bubble often did so years before the housing market peak, and thus lost a fair amount of credibility” in the process. Others spotted a bubble with “arguments fundamentally at odds with the data” that became available after the fact. “Academic research available in 2006 was basically inconclusive and could not convincingly support or refute any hypothesis about the future path of asset prices.”76
The “dog ate my homework” level of self-exculpation here is quite extraordinary, especially coming as it did from within the Fed. It went: First off, you can’t blame us just because the neoclassical orthodoxy we actively help enforce is pathetically empty in its ability to discriminate such matters. Moreover, we assert those who were adamant in sounding the alarm were cranky Cassandras and perennial moaners, which means mostly pariahs exiled outside the orthodoxy, so we, the Fed, were fully justified in ignoring them. When in doubt, always err on the side of Pollyanna optimism. Finally, the supposed consensus enforced at the Fed was clearly not based on any demonstrable intellectual discernment, so much as herding behavior and the chairman’s visible iron hand, but not to worry, because it is eminently “rational” to stick with the herd. People whine about the parade of economists being unable to come to a conclusion, but soothing their anxieties concerning dissention and disputation is the main reason we were right to persist in our stubborn errors. We simply channel the cultural zeitgeist.
The chutzpah of economists in their hyperactive attempts at self-exculpation tended to backfire rather dramatically, but that didn’t stop them coming. One particularly embarrassing Aunt Sally appeared in the Financial Times:
But crises will happen and, even if there is a depressing periodicity to them, their timing, form and provenance will elude prognostication . . . So, if the value of economics in preventing crises will always be limited (although hopefully not nonexistent), perhaps a fairer and more realistic yardstick should be its value as a guide in responding to them. Here, one year on, we can say that economics stands vindicated.77
Here, three years on, we can observe that everything faulty with the predictive capacities of the profession became compounded with the exquisitely groundless pomposity that orthodox economics never made anything worse, and so should take credit before the fact for them getting better. The blogs, once again, broke out in an orgy of derision.
Panglossian exercises of this nature were ill-suited to reassure the keening populace, so the more proactive journalists went about seeking to construct a provisionary consensus. The Economist decided to ask roughly fifty handpicked economists to identify which economist had been most influential over the past decade, and which had proposed the most important ideas for a postcrisis world. The “most influential” list they compiled was Ben Bernanke, John Maynard Keynes, Jeffrey Sachs, Hyman Minsky, and Paul Krugman; the “most important ideas” roster was Raghuram Rajan, Robert Shiller, Kenneth Rogoff, Barry Eichengreen, and Nouriel Roubini.78 If you were a member of the orthodoxy back then, it is hard to see how these lists could be anything other than profoundly unsettling; if you are someone reading this book right now, then perhaps you will gaze upon them with existential nausea. That list counts at least three open neoliberals, Bernanke, Rajan, and Rogoff, and one maverick neoliberal, Shiller. Three are rather conventional defenders of the veracity of orthodox neoclassical economics: Sachs, Krugman, and Eichengreen. We have already mentioned the unbearable lightness of the Keynesian rehabilitation within the economics profession. Minsky is nowhere taught in any ranked economics department. Roubini is the odd man out, largely ignored by the profession because of his propensity to cry wolf. The angst comes with the utter void of anything that could charitably be designated “new ideas” in the second list, and the sheer deliquescence of influence of the middle three of the former list for the economics profession. But worse, other than fealty to the home team, there is nothing here which acknowledges that the individual candidates tend to contradict one another in the main. If this be consensus, then sound and fury may be our fate.
Thus recent conatus to make it appear as though there exists some sort of stable “consensus” among economists concerning what to do about the crisis and its aftermath reveals more about the “incentives” to misrepresent the real state of affairs in the postcrisis profession—making it appear to speak with one confident voice—than it has to do with serious reform and repair of the international financial system. Not that some organizations haven’t tried. One such attempt to render a motley collection of economic prescriptions seem issued from a professional consensus was Make Markets Be Markets (2010) by the Roosevelt Institute, and largely funded by George Soros.79 It was perhaps most noteworthy for demonstrating a lack of agreement about what “markets” should indeed be and do. Rather, most attention was focused squarely on the regulators, pointing out, for instance, that the United States was unique in having multiple agencies competing as bank regulators within the federal government (but ignoring the structural debilities of the Fed itself as any kind of “regulator” of the financial industry). Frank Partnoy did describe therein how bank balance sheets had become a tissue of lies due to the shadow banking sector; while Rob Johnson insisted that the “too big to fail” proble
m could not be solved independently of reigning in derivatives. Simon Johnson did mention the “intellectual capture of the economics profession,” but nothing further was done with the observation in the way of analysis or empirical confirmation (such as that found in this chapter). One of the more extreme failures of imagination found therein was a proposal to create an analogue of the FDA for new financial instruments; clearly none of the assembled worthies had bothered to dip into the literature concerning the utter abject failure of the pharmaceuticals industry to actually find really new drugs in the last two decades, in part due to capture and corruption of the entire research process overseen by the FDA.80 But this foray was rapidly overtaken by events, with the passage of the Dodd-Frank legislation.