Never Let a Serious Crisis Go to Waste

by Philip Mirowski

  44 Westbrook, Out of the Crisis, p. 60; D. MacKenzie, An Engine, Not a Camera and “The Credit Crisis as a Problem in the Sociology of Knowledge”; Mehrling, Fischer Black and the Revolutionary Idea of Finance.

  45 MacKenzie, An Engine; O’Neill, “Black Scholes and the Normal Distribution”; Sherman, “Revolver.”

  46 Bullock, “Friedman Economics”; Khademian, “The Pracademic and the Fed,” p. 142; Bernanke, congressional testimony, 2006.

  47 The phrase was actually first coined by the Harvard economists James Stock and Mark Watson in 2002.

  48 Bernanke, “The Great Moderation.”

  49 Bernanke, congressional testimony, 2007; Leonard, “Alan Greenspan’s Housing Bubble Coffee Break”; Olivier Coibion and Yuri Gorodnichenko, “Did the Great Recession Mean the End of the Great Moderation?” at www.voxeu.org/index.php?q=node/4496.

  50 Khademian, “The Pracademic and the Fed”; Lowenstein, “The Villain.”

  51 Although one might want to insist upon the doctrinal differences between Randian libertarians and the Chicago School for some conceptual purposes, it is noteworthy that Milton Friedman was a vocal supporter of the Greenspan record in the press (Auerbach, Deception and Abuse at the Fed, p. 246n54).

  52 Khademian, “The Pracademic and the Fed,” p. 146.

  53 Bullock, “Friedman Economics.”

  54 Partnoy, “Sunlight Shows Cracks in Crisis Rescue Story”; Chan and Protess, “Cross Section of Rich Invested with Fed”; Ivry, Keoun, and Kuntz, “Secret Fed Loans Helped Banks Net $13 Billion.”

  55 Bernanke has changed his tune a few times over just why the Fed had to let Lehman fail. See John Cassidy, “Bernanke Changes Story on Lehman Collapse,” September 2, 2010, at www.newyorker.com/online/blogs/johncassidy/2010/09.

  56 “Christy [Mack] and her pal Susan [Karches] launched their investment initiative called Waterfall TALF. Neither seems to have any experience whatsoever in finance, beyond Susan’s penchant for dabbling in thoroughbred racehorses. But with an upfront investment of $15 million, they quickly received $220 million in cash from the Fed, most of which they used to purchase student loans and commercial mortgages. The loans were set up so that Christy and Susan would keep 100 percent of any gains on the deals, while the Fed and the Treasury (read: the taxpayer) would eat 90 percent of the losses. Given out as part of a bailout program ostensibly designed to help ordinary people by kick-starting consumer lending, the deals were a classic heads-I-win, tails-you-lose investment.” (Taibbi, “The Real Housewives of Wall Street”). TARP and TALF are further discussed in chapter 5.

  57 Lowenstein, “The Villain”; Krugman, “Return of Depression Economics.”

  58 U.S. Government Accounting Office, “Opportunities Exist to Strengthen Policiesand Processes for Managing Emergency Assistance.”

  59 Johnson, “An Institutional Flaw”; Sanders, “Jamie Dimon Is Not Alone.”

  60 Bernanke, congressional testimony, 2007.

  61 Bernanke, “On the Implications of the Financial Crisis for Economics.”

  62 Bernanke, “Global Imbalances.”

  63 This has been seconded by Yves Smith (“New York Fed Brownshirt”): “The prestigious staff roles relate to the central banking functions: economic research, macro modeling, and of course, monetary policy. PhD monetary economists rule the roost. And there is considerable group think. The organization is very vertical, with little lateral hiring except at the very top levels. The result is intellectual inbreeding. I’m told the public rejection of perspectives that ruffled the Fed’s world view, such as Robert Shiller being pushed off the New York Fed’s economic advisory board after he suggested that there was a housing bubble pre crisis and the dressing down of Raghuram Rajan at Jackson Hole in 2005 is consistent with an internal posture of ignoring people who don’t fall in with the party line.”

  64 Baker, The End of Loser Liberalism, p. 59.

  65 “The Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.” At www.federalreserve.gov/faqs/about_14986.htm.

  66 There are some further stipulations of three “classes” of governors, one-third of whom are supposed to represent the public interest; but given that most are economists or bankers, that is mostly window dressing. There is some rotation of regional bank presidents on the Federal Reserve Open Market Committee, which votes every six weeks on monetary policy; but the details are moot for our current purposes.

  67 The ability to act subservient to the banking sector while posing as a regulator has been a major factor in the trajectory of the current crisis. For instance, the Fed dictated to AIG that it must keep all details of the bailout secret, even from the SEC (Walsh, “Fed Advice to AIG Scrutinized”). This was done to hide what was arguably one of the most corrupt aspects of Fed behavior in the early phases of the crisis, namely, pretending the system of credit default swaps had any integrity whatsoever. Moreover, the Fed has persistently used underhanded tactics, like having the private banking lobby block most scrutiny of Fed actions, to consolidate its lack of political accountability (Auerbach, 2008, pp. 5, 157–59). It fought the Freedom of Information Act request of Bloomberg to disclose its actions during the crisis retrospectively all the way to the Supreme Court through surrogates from the banking industry.

  68 Adams, “Who Directs the Fed?” Duchin and Sosyura (“The Politics of Government Investments”) find that banks with Fed directorships were more likely to receive TARP funds during the crisis. Someone needs to do a similar study with the Bloomberg release of Fed data on previously secret loans. Westbrook, Out of the Crisis, p. 134.

  69 Auerbach, Deception and Abuse at the Fed; White, “The Federal Reserve System’s Influence on Research in Monetary Economics”; Grim, “Priceless.”

  70 Auerbach, Deception and Abuse, p. 141. This made the Fed one of the largest employers of economists within the federal government, above the Department of Agriculture (525) and below the Department of Labor (1,076) in the year 2000. White (p. 325) gives a figure of 495 full-time staff, which for a decade later is suspiciously too close to the 1992 figure to be entirely credible. In another attempt to gauge Fed employment, but relying solely on BLS data, DeMartino (The Economist’s Oath, p. 25) estimates only 310 economists working there in 2008. This, most likely, is an undercount. DeMartino gives a rough estimate of 28,000 persons employed as economists in the United States in 2008.

  71 White, “The Federal Reserve System’s Influence,” pp. 325–26.

  72 Grim, “Priceless”; DeMartino, The Economist’s Oath, p. 25; Auerbach, Deception and Abuse, p. 145.

  73 Information provided in a presentation by Warren Young at a talk delivered in Tel Aviv in December 2010.

  74 See http://netrightdaily.com/2011/06/150-economists-call-for-spending-cuts-that-exceed-debt-limit-hike/. The Nobelists were Robert Mundell and Vernon Smith. Not unexpectedly, the petition was arranged by a neoliberal think tank. “The absence of a clear mainstream is one underappreciated reason for the standoff between the Obama administration and Congressional Republicans over raising the debt limit” (Appelbaum, 2011).

  75 Suskind, Confidence Men, pp. 56–57.

  76 Gerardi, Foote, and Willen, “Reasonable People Did Disagree.”

  77 Subramanian, “How Economics Managed to Make Amends.”

  78 Economist, “Influential Economists.”

  79 http://makemarketsbemarkets.org/. It was one of the earliest programs of finance reform from the center-left.

  80 Johnson and Kwak, 13 Bankers, p. 51; For some documentation of the failure of the FDA, see Mirowski, ScienceMart; Angell, The Truth About the Drug ­Companies; Washington, Deadly Monopolies; and Murray and Johnston, Trust and Integrity in Biomedical Research.<
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  81 Available at www.cfr.org/publication/19540/reforming_global_finance.html and published as French et al., The Squam Lake Report.

  82 The Squam Lake papers are archived on the Greenberg website, www.cfr.org/thinktank/cgs/index.html. Of course, where the money for the exercise really came from remains unreported. However, the financial backgrounds of the individual Squam Lake members is covered in Epstein and Carrick-Hagenbarth, “Financial Economists, Financial Interests and the Dark Corners of the Meltdown,” and below. The Council on Foreign Relations is chaired by Robert Rubin, which further cements the behind-the-scenes Wall Street influence, not to mention the Rubin effect on the Democratic Party administrations (Suskind, Confidence Men).

  83 This is the interpretation found in many reviews not emitted from the economics journals controlled by the Squam Lake cabal: see Goodhart, “The Squam Lake Report,” and Mike Konczal at http://rortybomb.wordpress.com/2011/05/13/darrell-duffie-on-regulating-foreign-exchange-swap-moderate-1990s-republican-­style-financial-reform/. The latter writes: “You can take the Squam Lake report on what financial reform should look like as a kind of moderate Right/moderate Republican view of financial reform post–financial crisis. Dodd-Frank is conceptually similar in theory and very similar in practice to the Squam Lake report . . . when it is compared to Dodd-Frank, Squam Lake was weaker on consumer protection, conceptually stronger on derivatives (with a purposeful eye towards eliminating regulation arbitrage, hence Duffie’s no exemptions for foreign-exchange and little emphasis on end-user exemptions), and focused on coco bonds as the major companion piece to resolution authority.”

  84 Independent Commission on Banking, Vickers Report. As Sir John Vickers is reported to have said in the rollout news conference: “The too big to fail problem must not be recast as a too delicate to reform problem.” This itself was a sharp departure from the Squam Lake document. But eventually, the Tory government could not bring itself to implement the recommendations.

  85 Dash, “Feasting on Paperwork.”

  86 Mirowski, The Effortless Economy of Science?

  87 See, for instance, the discussion on Paul Krugman’s blog, March 19, 2011, http://krugman.blogs.nytimes.com/2011/03/19/disagreement-among-economists/; or that of Peter Dorman, http://econospeak.blogspot.com/2011/08/its-political-economy-stupid.html.

  88 Blinder, Hard Heads, Soft Hearts, p. 1.

  89 Orthodox economists are simply incapable of admitting that the crisis impugns their microeconomics as drastically as their macroeconomics. “There is a sense in which times like these are what economists are for, just as wars are what career military officers are for. OK, maybe I can let microeconomists off the hook” (Krugman, “The Profession and the Crisis,” p. 307).

  90 The preliminary SEC report can be consulted at www.sec.gov/sec-cftc-prelimreport.pdf. The final attempt at imposing consensus came out five months later as U.S. SEC, Findings Regarding the Market Events of May 6, 2010, but the dispute nevertheless continues. See Kirilenko et al., “The Flash Crash”; Easley et al., “The Microstructure of the Flash Crash”.

  91 This attitude is almost too ubiquitous to document properly. For selected examples, see Coyle, “The Public Responsibilities of the Economist”; Krugman, End This Depression Now!; and Quiggin, Zombie Economics.

  92 One rather unapologetic example is Eric Maskin at http://thebrowser.com/interviews/eric-maskin-on-economic-theory-and-financial-crisis. Maskin is domiciled at the Institute for Advanced Study, and is a specialist in game theory, which may go some distance in explaining the intellectual bubble he inhabits. Another is Sargent, “Modern Macroeconomics Under Attack.”

  93 See Zeleny, “Financial Industry Paid Millions to Obama Aide”; Skomarovsky, “Evidence of an American Plutocracy”; Ferguson, “Larry Summers and the Subversion of Economics”; Cohan, “Endless Summers”; and Story, “A Rich Education for Summers.”

  94 Schmitt, “Prophet and Loss”; Skomarovsky, “Evidence of an American Plutocracy”; Mirowski, ScienceMart, pp. 343–49.

  95 David Warsh suggested there may have been a conflict of interest, even this early: “Summers had consulted for a hedge fund, Taconic Capital Advisors, from 2004 until 2006, while president of Harvard. Its founders, Kenneth Brody and Frank P. Brosens, had earlier been Goldman Sachs partners. . . . Professors report their outside consulting income to their deans, and deans report theirs to the president. Presumably the president reports his outside earnings to the Harvard Corporation, of which he is a member. Summers is going to have some explaining to do to his Harvard colleagues when he returns” (www.economicprincipals.com/issues/tag/lawrence-summers).

  96 Suskind, Confidence Men.

  97 ‘Inside Job had essentially all its facts wrong,’ replies Summers, unbelievably, resorting to an argument based on timing: because he didn’t work in financial services before he was Treasury secretary, and because he waited a few years before taking that job at DE Shaw, Summers says it’s ‘absurd’ to blame the revolving door for any of his actions. It’s weird that Summers, who loves debate, generally refuses to sit down in some public forum and answer serious, informed questions about the legacy of his tenure at Treasury; it might well be that this single interview is the closest we’ll ever get. And on the basis of this interview, it’s clear that, far from apologizing for his actions, Summers is going Full Bluster, denying any culpability, and choosing instead to violently reject and belittle any suggestion that he holds any responsibility for the crisis at all.” www.cjr.org/the_audit/summers_inside_job_had_essenti.php?page=all. Summers’s assertions here have been challenged (Ferguson, Predator Nation, p. 252).

  98 Summers, “The Great Liberator.”

  99 The role of government spending and borrowing in the full-spectrum neoliberal response to the economic crisis is described in chapter 6.

  100 Summers, Interview, 2011.

  101 Ferguson, Predator Nation, chapter 8.

  102 Henderson, “AIG Scandal Could Hurt Official’s Chances.”

  103 Ferguson, Predator Nation, p. 260.

  104 In Mollenkamp et al., “Behind AIG’s Fall, Risk Models Failed to Pass Real World Test.”

  105 “Mr. Gorton’s work helped convince [Joe] Cassano that these things were only gold . . . because AIG would never have to make payments to cover actual defaults . . . However, Mr. Gorton’s work didn’t address the potential write-downs or collateral payments to trading partners.” (Mollenkamp et al., “Behind AIG’s Fall”)

  106 Corkery, “Ben Bernanke’s Labor Day Reading List”; Gorton, Interview, 2010, p. 1; Suskind, Confidence Men, pp. 86–91.

  107 Gorton and Metrick, “Getting Up to Speed”; Rogoff and Reinhart, This Time is Different.

  108 I have to enter the demurrer that I think the claims of Rogoff and Bernanke are essentially wrong, and that Gorton misportrays the nature and role of the shadow banking sector. He is especially dense on the causes of the financialization of the economy as a whole. The role of the Federal Crisis Inquiry Commission as explanatory cover-up is dealt with in the next chapter.

  109 Gorton and Metrick, “Getting Up to Speed,” p. 150.

  110 Gorton, Interview, 2010, p. 16.

  111 The trope of natural financial innovation, shared by many other economists of similar inclination, such as Robert Shiller, is discussed in chapter 6.

  112 Lo, “Reading About the Financial Crisis.”

  113 See the NSF’s Science360: “Are Mathematical Models the Cause for Financial Crisis in the Global Economy?” at http://science360.gov/obj/tkn-video/ 86c73a5e-4710-4c7d-ac76-ff635dc93937.

  114 Lo, “Reading About the Financial Crisis.”

  115 See Epstein and Carrick-Hagenbarth, “Dangerous Interconnectedness.” The incident gained notoriety because Duffie’s belated admission was captured on YouTube: www.youtube.com/watch?=OSBgfYrL9fs.

  116 Johnson, “Predators and Professors.”

  117 Ibid.

  118 Taibbi, “Glenn Hubbard Leading Academic.”

  119 Chan, “Academ
ic Economists to Consider Ethics Code.”

  120 Ferguson, Predator Nation, chapter 8; kapur “Academics Have More to Declare.”

  121 The membership of the Pew Group can be examined at www.pewfr.org; its major publications at www.financialreformtaskforce.org.

  122 Carrick-Hagenbarth and Epstein, “Dangerous Interconnectedness,” p. 59.

  123 Out of the nineteen academic economists chosen, thirteen had identifiable ties to some private financial firm, while eight served on boards of directors, and two were co-founders. When writing for the public (with the interesting partial exception of business advice proffered on Bloomberg), very rarely did any of these figures self-report their financial affiliations; rather, they did identify their affiliation with the NBER or the Fed. In academic papers published from January 2005 through October 2009, with one exception, the financial affiliations were never mentioned. They also noted “the stronger the economists’ alliance with the private sector the weaker would be their calls for regulation.”

  124 Carrick-Hagenbarth and Epstein, “Dangerous Interconnectedness.”

  125 Lohmann, “The Endless Algebra of Climate Markets.”

  126 Mirowski, ScienceMart.

  127 Of course, many of these particular economists have subsequently been succeeded by noneconomist presidents. But having just concluded numerous interviews with technology transfer officers recently, it seems clear to me that economists have successfully seeded their vision of the purpose of the university throughout its administrative structures.

  128 Bradley, Harvard Rules, p. 67.

  129 Hersch and Viscusi, “Law and Economics as a Pillar of Legal Education”; Frank and Gabler, Reconstructing the University, pp. 202–3; Fourcade, “The Construction of a Global Profession.”

  130 Khurana, “Why Are There Business Schools in Universities?”

  131 Some representative samples: Cook et al., “Reporting Science and Conflicts of Interest in the Lay Press”; Bekelman et al., “Scope and Impacts of Financial Conflicts of Interest in Biomedical Research”; Sismondo, “Pharmaceutical Company Funding and Its Consequences”; Slaughter et al., “U.S. Research Universities’ Institutional Conflict of Interest Policies”; Murray and Johnston, Trust and Integrity in Biomedical Research; Moore et al., Conflicts of Interest; Mirowski, ScienceMart, pp. 233–39; M. Epstein, “How Will the Economic Downturn Affect Academic Bioethics?”