Never Let a Serious Crisis Go to Waste

by Philip Mirowski

  82 The Hearing Charter (quoted above) of the House Committee on Science and Technology and sworn testimony of the economists Sidney Winter, Scott Page, Robert Solow, David Colander, and V. V.Chari can be found at http://democrats.science.house.gov/publications/hearings_markups_details.aspx?NewsID=2876. David Colander (e-mail dated 12/21/2010) informs me his connections to the committee staff member Ken Jacobson may have played a role in the idea of convening a session devoted to the DSGE.

  83 This is not the place to run through the tortured history of orthodox neoclassical macroeconomics, from the “neoclassical synthesis” through Friedman’s monetarism to “New Classical” to “real business cycles” to “New Keynesians,” and thus finally to DSGE. Two good sources on this massive literature are Quiggin, Zombie Economics, and Mehrling, “A Tale of Two Cities.” As usual, the history is frequently accompanied by utterly naïve methodological statements: “the field looked like a battlefield. Researchers split in different directions, mostly ignoring each other, or else engaging in bitter fights or controversies. Over time however, largely because facts have a way of not going away, a largely shared vision of fluctuations and of methodology has emerged” (Blanchard, “The State of Macro,” p. 2).

  84 Blanchard, “The State of Macro,” pp. 2, 26, 24.

  85 V. V. Chari, testimony before the Committee on Science and Technology, Subcommittee on Investigations and Oversight, U.S. House of Representatives, July 20, 2010. For a similar argument, see Kocherlakota, Modern Macroeconomic Models as Tools for Economic Policy.

  86 Sargent, “Modern Macroeconomics Under Attack,” p. 29.

  87 Kirman, “The Economic Entomologist,” p. 63.

  88 S. D. Williamson, “A Defense of Contemporary Economics.”

  89 Lucas, “Econometric Policy Evaluation.”

  90 Stiglitz, “Rethinking Macroeconomics,” pp. 606–7, p. 597n7.

  91 Colander et al., “Beyond DSGE Models”; Kirman, “Economic Theory and the Crisis.”

  92 For the curious, he was referencing the Sonnenschein-Mantel-Debreu theorems in microeconomics. See Kirman, “Whom or What Does the Representative Agent Represent?”; Rizvi, “The Sonnenschein-Mantel-Debreu Results After 30 Years.”

  93 Brunnermeier et al., “Macroeconomics with Financial Frictions,” p. 38.

  94 Kirman, “Economic Theory and the Crisis.”

  95 This position is almost exactly repeated in the Chari testimony, and in Kocherlakota, Modern Macroeconomic Models as Tools for Economic Policy; De Grauwe, “The Scientific Foundation of DSGE Models”; Maskin, “Economic Theory and the Financial Crisis”; Caballero, “Macroeconomics After the Crisis”; S. D. Williamson, “A Defense of Contemporary Economics”; and Sargent, “Modern Macroeconomics Under Attack.” All reactions in this paragraph are paraphrases of DSGE defenses found in these sources.

  96 See, for instance, Brunnermeier et al., “Macroeconomics with Financial Frictions.” We shall indulge in just one example of how such protests were so misleading as to border on misrepresentation. The notion that DSGE models, which rarely incorporated money, much less a banking sector, could indeed handle a financial crisis, is often motivated by citation of the Diamond and Dybvig model (1983), which is a model of a run on a solvent bank (Krugman, “The Profession and the Crisis,” p. 309). Since most of the main institutions in the current crisis were insolvent, and not merely illiquid, this model turns out to be utterly irrelevant. Furthermore, since most DSGE models encompass a presumption of the EMH at base, and accept the Modigliani-Miller theorem, there are no functions for finance to perform in the models.

  97 Although he does not fully concur with the points made here, one example could be Ricardo Caballero (“Macroeconomics After the Crisis,” p. 90): “We are digging ourselves, one step at a time, deeper and deeper into Fantasyland, with economic agents who can solve richer and richer stochastic general equilibrium problems containing all sorts of frictions.”

  98 See, for instance, Mirowski, “The Cowles Anti-Keynesians” for American hostility to Keynes. Robert Skidelsky is the most prominent prophet of the Old-Time Religion when it comes to Keynes.

  99 Clark, “Where’s My Money, Idiot?”

  100 Quoted in Scheiding and Mata, “National Science Foundation Patronage.”

  101 Buckley, Financial Crisis; “Financial Plumbing,” Journal of Economic Perspectives, Winter 2010; Brunnermeier et al., “Macroeconomics with Financial Frictions.”

  102 For the 22nd Jerusalem Summer School in Economic Theory, table of contents, see http://iasmac31.as.huji.ac.il:8080/groups/economics_school_22/search/; See the roundtable video at www.youtube.com/watch?v=6NkBODcJSX4. David Warsh’s summary of the conference (“Last Week in Jerusalem”) provides a short precis of events there.

  103 Warsh, “Last Week in Jerusalem.”

  104 Geanakoplos, “Managing the Leverage Cycle.”

  105 Whitehouse, “Crisis Compels Economists to Reach for New Paradigm”; Geanakoplos, “Managing the Leverage Cycle,” p. 90; Thurner et al., “Leverage Causes Fat Tails and Clustered Volatility.”

  106 Geanakoplos collapses the concept of “collateral” and the concept of “leverage” in his models by assuming “no-recourse collateral”: the borrower must put up a percentage of the asset value as collateral, and lose the entire amount if payments are reneged upon. Abstractly, no-recourse collateral is portrayed as a plain put option for the borrower.

  107 Geanakoplos, “Managing the Leverage Cycle,” p. 90.

  108 Geanakoplos and Fostel, “Leverage Cycles and the Anxious Economy,” p. 1239.

  109 Geanakoplos, “Managing the Leverage Cycle,” p. 97.

  110 Brunnermeier quoted in Whitehouse, “Crisis Compels Economists.”

  111 From an unpublished address of Paul Krugman to the European Association for Evolutionary Political Economy, November 1996, at www.mit.edu/~krugman/evolute.html. He rather touchingly concedes there: “As you probably know, I am not exactly an evolutionary economist.” I owe a debt to Steve Keen (“Like a Dog Walking on Its Hind Legs”) for this, and some other ideas covered in this section.

  112 See Krugman, “The Return of Depression Economics.” This talk has disappeared from its original site, and was never published; it can be found at www.youtube.com/watch?v=5N35mq4_gIw.

  113 Eggertsson and Krugman, “Debt, Deleveraging, and the Liquidity Trap,” p. 3.

  114 Nocera, “The Big Lie.”

  115 Paul Krugman blog, December 24, 2011, at http://krugman.blogs.nytimes.com/2011/12/24/joe-nocera-gets-mad/#postComment.

  116 For the original claim, see Mooney, The Republican War on Science. The misguided tendency of blaming “Republicans” for the transformation of academic science in the United States is covered in Mirowski, ScienceMart, pp. 35 et seq.)

  117 Interview with Josh Rosner, PBS NewsHour, August 1, 2011; “Fannie was shrewd enough to understand that in order to push their agenda on Capitol Hill they needed to be supported by economists as well and so they started a series of papers where they would hire notable Conservative economists like Glenn Hubbard or progressive economists like Joe Stiglitz and Peter Orszag to justify various aspects of Fannie and Freddie’s mission, or dispel concerns about their safety and soundness, and really used those as lobbying points on Capitol Hill,” said Rosner. For Stiglitz’s response see www.pbs.org/newshour/rundown/2011/07/-rep-barney-frank-d-mass.html. This issue is parsed in the next section. We might note in passing that both Morgenson and Nocera reign over the financial pages of the New York Times, and yet seem perched on opposite sides of the agnotological divide.

  118 See, for instance, Litan, “In Defense of Much, but Not All, Financial Innovation” and The Derivatives Dealer’s Club and Derivates Markets Reform. This is discussed further in chapter 6. The Kauffman Foundation website opens with a quote from Hayek: www.kauffman.org. They have also funded their own Hayekian critiques of the economics profession: see Frydman and Goldberg, Beyond Mechanical Markets, which was distributed gratis to participants at the
2011 meeting of INET at Bretton Woods.

  119 This section is joint work with Edward Nik-Khah.

  120 Swagel, “The Financial Crisis”; Sorkin, Too Big to Fail; “Break the Glass Bank Recapitalization Plan,” dated 4/15/2008, available at www.scribd.com/doc/21266810/Too-Big-To-Fail-Confidential-Break-the-Glass-Plan-from-Treasury (accessed 2/21/2012).

  121 “Secretary Paulson’s intent to use TARP to purchase assets reflected a philosophical concern with having the government buy equity stakes in banks: he saw it as fundamentally a bad idea to have the government involved in bank ownership” (Swagel, “The Financial Crisis,” p. 50).

  122 Oliver Armantier and James Vickery of the N.Y. Fed delivered the baseline auction proposal on September 20; during the following week, the Treasury and the N.Y. and Washington Feds reached out to the academic market designers Lawrence Ausubel, Peter Cramton, Jacob Goeree, Charles Holt, Paul Milgrom, Jeremy Bulow, and Jonathan Levin. See Armantier et al., “A Procurement Auction for Toxic Assets with Asymmetric Information”; Klemperer, “The Product-Mix Auction.”

  123 Ferguson and Johnson, “Too Big to Bail,” pp. 28–29; Prasch, “After the Crash of 2008.” See “Bernanke’s Comments on Asset Auction Process,” dated 9/23/2008, available at www.reuters.com/article/2008/09/23/financial-bailout-bernanke-auctions-idUSN2338396920080923. The concern was with “mark to market” accounting rules, under which low prices might make banks (incorrectly) appear insolvent.

  124 For example: “Treasury is talking with the experts you would expect—prominent academics who have designed auctions. . . . Treasury is committed to get the market price as best it can.” Swagel, quoted on Greg Mankiw’s blog, dated 9/25/2008, http://gregmankiw.blogspot.com/2008/09/defense-of-paulson-plan.html (accessed 2/20/12). Whereas the quote is unattributed on this blog entry, Swagel has subsequently made clear that he was its author (Swagel, “The Financial Crisis,” p. 47).

  125 For an example of the latter, see Tim Ryan, “Lesson from Saving and Loan Rescue,” Financial Times, September 24, 2008, available at www.ft.com/cms/s/0/8e19c058-8a35-11dd-a76a-0000779fd18c.html#axzz1oOrqY4OO. Tim Ryan wasthe president and CEO of the Securities Industry and Financial Markets Association, a lobbying group.

  126 Ausubel and Cramton, “Auction Design Critical for Rescue Plan.” Cramton makes clear in an NPR interview with David Kestenbaum that he shared Bernanke’s concern: “If the price [for a toxic asset] was too low then the banks would collapse and we would still have a mess.” See “Complicated Reverse Auction May Aid In Bailout,” October 10, 2008, available at www.npr.org/templates/story/story.php?storyId=95591129.

  127 Swagel, “The Financial Crisis,” p. 56.

  128 Promoting confusion about what markets are supposed to be has become standard operating procedure among market designers. To wit: “In addition to markets, there is also the market, an abstraction as in ‘the market economy’ or ‘the free market’ or ‘the market system.’ The abstract market arises from the interaction of many actual markets” (McMillan, Reinventing the Bazaar, p. 6).

  129 The fact they were academic economists was significant. Swagel noted that Wall Street economists were also in favor of the TARP, but acknowledged that people would be suspicious of their judgments. (Swagel, quoted on Mankiw’s blog, September 25, 2008, at http://gregmankiw.blogspot.com/ 2008/09/defense-of-paulson-plan.html).

  130 Ausubel and Cramton, “Auctions for Injecting Bank Capital,” p. 2.

  131 Armantier et al., “A Procurement Auction for Toxic Assets with Asymmetric Information,” p. 6.

  132 Ausubel and Cramton, “Auctions for Injecting Bank Capital”; Klemperer, “The Product-Mix Auction”; Armantier et al., “A Procurement Auction”; Swagel, “The Financial Crisis”; Armantier et al., “A Procurement Auction.”

  133 Ausubel and Cromtom, “Auctions for Injecting Bank Capital,” p. 4. More specifically, Ausubel et al. have since acknowledged, “there is no Bayesian Nash equilibrium bidding strategy for a similar auction that we can use as a benchmark. The reference price auction is beyond current theory” (“Common-Value Auctions with Liquidity Needs”).

  134 Paulson, On the Brink, pp. 258, 264, 334, 363–68, 389; see also Swagel, “The Financial Crisis,” pp. 50–52, 58.

  135 Ausubel and Cramton, “Auctions for Injecting Bank Capital.”

  136 “Study Suggests Buying Toxic Assets Could Work,” NPR, November 18, 2008, available at www.npr.org/templates/story/story.php?storyId=97161786. Ausubel and Cramton (“No Substitute for the ‘P’-Word in Financial Rescue,” p. 1) repeat the “suitcase approach” charge.

  137 “Complicated Reverse Auction May Aid in Bailout,” NPR, October 10, 2008.

  138 Ausubel and Cramton, “A Troubled Asset Reverse Auction,” p. 10.

  139 And, indeed, the studies that Ausubel and Cramton draw upon to get their 97 percent figure (Kagel and Levin, “Implementing Efficient Multi-Object Auction Institutions”) provided experimental treatments of private value auctions.

  140 Matthew Philips, “Gaming the Financial System,” Newsweek, November 18, 2008, available at www.thedailybeast.com/newsweek/2008/11/17/gaming-the-financial-system.html.

  141 Lawrence Ausubel and Peter Cramton, “Auction Design for the Rescue Plan,” presentation dated October 5, 2008, available at www.cramton.umd.edu/papers2005-2009/ausubel-cramton-auction-for-rescue-plan-slides.pdf (accessed March 6, 2012).

  142 Nik-Khah, “A Tale of Two Auctions.”

  143 Cramton, “Auctioning the Digital Dividend,” p. 1.

  144 “The Credit Crisis and Market Design,” Alvin Roth’s Market Design Blog, January 3, 2009, at http://marketdesigner.blogspot.com/2009/01/credit-crisis-and-market-design.html.

  145 Cramton, “Market Design,” p. 2.

  146 Session on “Research Funding for Economists.” See www.etnpconferences.net/sea/seaarchive/sea2011/User/Program.php?TimeSlot=4#Session11.

  147 Prasch, “After the Crash of 2008,” p. 161.

  148 Sorkin, Too Big to Fail, pp. 227–29; Calomiris and Wallison, “Blame Fannie Mae and Congress for the Credit Mess.”

  149 Krugman, “Fannie, Freddie and You.”

  150 White, “The Federal Reserve System’s Influence on Research in Monetary Economics”; Wallison, see all; Congleton, “On the Political Economy of the Financial Crisis and Bailout 2008–9”; Calabria, “Fannie, Freddie and the Subprime Mortgage Market”; Pinto, “ACORN and the Housing Bubble”; Paybarah, “Bloomberg: Plain and Simple.”

  151 Nocera, “The Big Lie.”

  152 For the best examples, consult Engel and McCoy, The Subprime Virus; Muolo and Padilla, Chain of Blame; Fligstein and Goldstein, “A Long Strange Trip”; Avery and Brevoort, “The Subprime Crisis”; Madrick and Partnoy, “Did Fannie Cause the Disaster?”; and Levitin and Wachter, “The Commercial Real Estate Bubble.” See also http://motherjones.com/kevin-drum/2011/12/housingbubble-and-big-lie.

  153 Morgenson and Rosner, Reckless Endangerment, p. 121.

  154 Bernanke, congressional testimony, 2007.

  155 www.freddiemac.com/investors/pdffiles/fm2006_moodys.pdf. This evidence also calls into question the curious claims by Morgenson and Rosner that in 1993 “the new Fannie and Freddie [Alternative Qualifying] program institutionalized the endorsement of untested underwriting criteria [for mortgages]” (Reckless Endangerment, p. 53). This and similar locutions attempt to bypass or evade the fact that Fannie and Freddie neither pioneered nor engineered the spread of subprime practices; and that the timing of events is off for them to bear responsibility.

  156 Engel and McCoy, The Subprime Virus, p. 17, 40; Muolo and Padilla, Chain of Blame; Roubini and Mihm, Crisis Economics.

  157 See, for instance, Levitin and Wachter, “The Commercial Real Estate Bubble” and “Explaining the Housing Bubble”; Palley, From Financial Crisis to Stagnation, pp. 83–85.

  158 Fligstein and Goldstein, “A Long Strange Trip.”

  159 These disappeared suspiciously soon from the Web after the FCIC was wound up, but were
then archived at http://fcic.law.stanford.edu/hearings.

  160 Financial Crisis Inquiry Commission, Final Report, pp. xxvi, xxxvi, 414, 427. Wallison’s dissent reprised this point: “Wall Street was not a significant participant in the subprime PMBS market between 2004 and 2007, or at any time before” (p. 504). This does border on Orwellian doublethink.

  161 Final Report, p. 443.

  162 See the work by David Min at www.americanprogress.org/issues/2011/07/wallison.html. These are the basis for the complaints of Nocera, Barry Ritholtz, and Paul Krugman. The short version is that Wallison and Edward Pinto have played fast and loose with what counts as “subprime” in the GSE balance sheets. This complaint is then extended to Morgenson & Rossner, Reckless Endangerment.

  163 Weil, “Wall Street’s Collapse to Be Mystery Forever.”

  164 This comes from a posting by Yves Smith on Nakedcapitalism.com of January 26, 2011: www.americanprogress.org/issues/2011/07/wallison.html.

  165 Room for Debate, New York Times: www.nytimes.com/roomfordebate/2011/01/30/was-the-financial-crisis-avoidable/address-excessive-leverage.

  166 Room for Debate, New York Times, www.nytimes.com/roomfordebate/2011/01/30/was-the-financial-crisis-avoidable/more-than-just-greed.

  167 U.S. House Committee on Oversight, An Examination of Attacks Against the Financial Crisis Inquiry Commission.

  168 Lo, “Reading About the Financial Crisis.”

  6. The Red Guide to the Neoliberal Playbook

  1 De Soto, “The Destruction of Economic Facts.”

  2 While one can readily endorse Corey Robin’s insistence that the historical common denominator of conservatism has been that “the conservative favored liberty for the higher orders and constraint for the lower orders” (The Reactionary Mind, p. 8), there is indeed something more that sets the neoliberals apart, and helps explain their successes in the face of economic circumstances that should have shredded their credibility.

  3 Robin, The Reactionary Mind, p. 24.

  4 Sorkin, “Volcker Rule Stirs Up Opposition Overseas.”

  5 Fleming, “Adbusters Sparks Wall Street Protest”; Lasn quote in Motavalli, “Cultural Jammin’”; Adbusters website at adbusters.org. It is full of upbeat slogans such as: “As the #S17 anniversary of Occupy Wall Street nears, an art war against capitalism grows.”