Democrats’ Diversionary Tactics
Washington Post
By John Boehner
March 5, 2009

^{In the first two months of 2009, the Democratic Congress and the White House have spent more money than the combined cost of the Iraq and Afghanistan wars and the response to Hurricane Katrina. After they doled out taxpayer dollars at such a blistering pace, the instinct of many inside the Beltway is to do what’s most convenient: desperately try to change the subject by creating straw men – called "the party of no" – to rally against. And in a carefully calculated campaign, operatives and allies of the Obama administration are seeking to divert attention toward radio host Rush Limbaugh, and away from a debate about our alternative solutions on the economy and the irresponsible spending binge they are presiding over. This diversionary tactic will not create a single job or help a single family struggling in today’s economic crisis. And that is where our focus should be.}

^{Make no mistake: This strategy did not develop out of thin air. Democratic pollsters began laying the groundwork for this effort last fall. What’s particularly regrettable is that all this is unfolding at a time our nation can least afford it. President Obama has said that we must change the way Washington operates in order to address the unprecedented challenges of today. I hope that those inside and close to the administration begin heeding his advice, because the change-the-subject campaign they are employing is the oldest trick in Washington’s book. This isn’t about the leadership of political party officials or the influence of radio hosts. It’s about the need for both parties to work together toward real solutions to end this recession and put Americans back to work.}

^{It’s no secret that middle-class families and small businesses across our nation are hurting. Their job security is diminishing, their budgets are tightening, and their 401(k)s and college savings are evaporating. During this recession, they are being forced to make difficult budget decisions; unfortunately, Congress and the administration do not feel the responsibility to do likewise. Instead, the profligate spending we’ve seen over the past two months is simply breathtaking – and it’s exactly why some here in Washington are scrambling to change the subject.}

^{Consider what Washington Democrats have "accomplished" since the beginning of the year: The administration requested $350 billion from the Troubled Assets Relief Program even though neither the Bush administration nor the Obama administration has adequately answered questions about where the first $350 billion went and what strategy Treasury officials have developed to get the government out of the private sector. President Obama signed "stimulus" legislation that costs twice as much as the House GOP’s alternative bill but that will create only half as many jobs.}

^{The president apparently plans to sign the $410 billion "omnibus" spending bill, even though it is loaded with some 9,000 unscrutinized earmarks and the largest increase in discretionary spending – save for a brief increase after the Sept. 11, 2001, terrorist attacks – since the Carter administration. And the Obama administration has proposed a budget blueprint that increases taxes on every American, to the total tune of $1.4 trillion. Each of these policy proposals is meant to lay the groundwork for a new era of big government – and neither Main Street nor Wall Street likes what it is seeing.}

^{Markets are plunging, businesses are cutting jobs and families are growing more anxious every day. Moments like this demand the kind of cooperation and new way of doing business that Obama has promised. Instead, those around him are taking to the airwaves and the pages of our nation’s newspapers to carry out a campaign intended to change the subject and divert attention from what matters most: finding a way to work together to get our economy moving again.}

^{Something is wrong when the discourse in Washington is more focused on a political sideshow than, say, the fact that Congress is attempting to terminate a school choice program that serves thousands of needy children in the District of Columbia, or the impact of a presidential budget that raises taxes on millions of Americans during a recession. When it comes to jobs, the budget, children’s health care and other issues, House Republicans have offered what we believe are better solutions to the problems facing middle-class families and small businesses. We will continue to do so in the coming months and hope that White House political operatives abandon their cynical "change the subject" strategy by joining us.}

Once a week, I buzz by the Rush Limbaugh web site – just to see what he’s up to. I started doing that a year ago during his Operation Chaos at the time of the Democratic Primaries. In case you missed it, Limbaugh declared a campaign to get Republicans to cross-over and vote in the Democratic Primaries for Hillary Clinton. This was a big deal – a part of every radio show and web page. In some States, it was even illegal, but he and his followers marched forward. His objectives were clearly stated on the tee shirts he sold on his web site [click the image for a larger, more readable version].

In addition to this ludicrous campaign, he jumped on [or lead] every attack on Obama – Ayres, Muslim, Wright, smoker, etc. No day was complete without some obnoxious, sarcastic "Barry" graphic and numerous slanderous articles. It was a "study in contempt," in which vague facts, innuendo, rumor, and just plain lies intermingled in a symphony of hatred and snarling devaluation reminiscent of a Ku Klux Klan rally.

After the election, there was no letup in Limbaugh’s sarcasm and contempt culminationg in his famous four words, "I hope he fails!" And the rhetoric has continued throughout the debates on the Stimulus Package and every cabinet pick. Finally, last week, Limbaugh appeared in Prime Time at CPAC as the featured speaker, rambling on endlessly spewing his venom. His speech was carried on CSPAN.

The Four Elephants

1. Rush has eaten his way into Elephantine proportions again.

The pictures on his web site were obviously taken after a diet of some sort, but it’s over now. He’s huge, looking like the fat, obnoxious bully I’m sure he’s always been.

2. There’s a story of the blind men and an Elephant.

Each blind man feels a different part of the animal and makes up a story from the part about the nature of the whole animal – all grossly inaccurate. Right now, that’s what’s happening in Washington. Limbaugh and the Republicans are poring over every proposal the Democrats make and finding the soft spots, blowing them up into huge issues, and ignoring the essence of the whole [Unfortunately, the Democrats are not immune to this same tactic].

3. There’s a saying in the recovery community, "… the Elephant in the Living Room."

It refers to what happens in a family where one member is an Alcoholic. Some such families never talk about the Alcoholic’s drinking [or the Rage-oholic’s abuse]. The biggest thing that’s happening with the family is avoided. Right now, in response to the largely Republican governance, this country is going to hell in a handbasket. This is the biggest emergency of our lifetimes, and it requires drastic action. The last Administration exhausted all other measures – tax cuts, interest rate drops, rebates – and now the only possibility is mammoth reform and mammoth spending. This financial crisis is the biggest Elephant of them all. Speaking of biggest Elephants, Rush Limbaugh has inserted himsef into the forefront of the Republican Campaign as a loud, unavoidable central figure. After he’s made an amazing amount of noise, Boehner’s asking why we’re listening.

4. And finally, Republicans:

Back in 1874, America’s famous cartoonist, Condé Nast drew this cartoon for Harper’s mocking the Democrats ["asses in a lion’s skin"] and the Republicans jumped on the Elephant as their symbol [not bad – lumbering, big, ugly]. Our fourth Elephant’s leader, John Boehner, tells us that, "… in a carefully calculated campaign, operatives and allies of the Obama administration are seeking to divert attention toward radio host Rush Limbaugh, and away from a debate about our alternative solutions on the economy and the irresponsible spending binge they are presiding over." For the Republicans to accuse the Democrats of "a carefully calculated campaign, operatives and allies of the Obama administration" is Rovian theater of the first kind – accuse your adversaries of doing exactly what you yourself are doing.

Breaking: Turdblossom and Harriet to Testify
By emptywheel

And, just as importantly, the notion of Absolute Immunity dies a well-deserved death (via email).

In an agreement reached today between the former Bush Administration and Congressman John Conyers, Jr. (D-Mich.), Chairman of the House Judiciary Committee, Karl Rove and former White House Counsel Harriet Miers will testify before the House Judiciary Committee in transcribed depositions under penalty of perjury. The Committee has also reserved the right to have public testimony from Rove and Miers. It was agreed that invocations of official privileges would be significantly limited.

In addition, if the Committee uncovers information necessitating his testimony, the Committee will also have the right to depose William Kelley, a former White House lawyer who played a role in the U.S. Attorney firings.

The Committee will also receive Bush White House documents relevant to this inquiry. Under the agreement, the landmark ruling by Judge John Bates rejecting key Bush White House claims of executive immunity and privilege will be preserved. If the agreement is breached, the Committee can resume the litigation.

Chairman Conyers issued the following statement:

"I have long said that I would see this matter through to the end and am encouraged that we have finally broken through the Bush Administration’s claims of absolute immunity. This is a victory for the separation of powers and congressional oversight. It is also a vindication of the search for truth. I am determined to have it known whether U.S. Attorneys in the Department of Justice were fired for political reasons, and if so, by whom."

Update on timing: The Committee is going to get the documents it had requested and read them before they do the interviews with Harriet and Karl. And the interviews will be done by staffers, with the option of doing a public hearing with questions from Congresspersons if that seems useful. So the timing for the moment seems to be driven by how quickly they get documents.

Update: Pelosi does a victory dance for the authority of Article I (via email):

The agreement for Karl Rove and Harriet Miers to testify upholds a fundamental principle: no one is above the law and Congressional subpoenas must be complied with.

As public officials, we take an oath of office to uphold the Constitution. It is the institutional duty of Congress — as an independent branch — to ensure against abuse of power through meaningful oversight over the Executive Branch. When there are credible allegations about the politicization of law enforcement, the need for Congressional oversight is at its greatest.

In upholding our oaths of office, the House of Representatives was determined to preserve checks and balances — the separation of powers that protects the rule of law. It brought action in court to enforce the Judiciary Committee’s subpoenas, and won a major ruling by U.S. District Judge John Bates dismissing the extreme position of absolute immunity from Congressional oversight advocated by the Bush Administration for former Administration officials. Under this agreement, the precedent established by Judge Bates’ historic ruling rejecting this extreme Bush Administration doctrine will be preserved.

Today’s agreement is a great victory for the Constitution, the rule of law, and the separation of powers. I appreciate the strong leadership of Chairman John Conyers and the assistance of the Obama Administration.

Congress now has the opportunity to uncover the truth and determine whether improper criteria were used by the Bush Administration to dismiss and retain U.S. Attorneys.

Update: One more detail on logistics. The documents and the transcripts will eventually be made public.

Top Bush Aides to Testify in U.S. Attorneys’ Firings
By DAVID JOHNSTON
New York Times
March 4, 2009

Karl Rove and Harriet E. Miers, top former aides to President George W. Bush, will testify under oath to a House committee investigating the firings of nine United States attorneys in 2007, under an agreement announced Wednesday by the panel. The agreement settled a rancorous dispute that began in mid-2007 when the House Judiciary Committee subpoenaed Mr. Rove and Ms. Miers, who, according to e-mail messages released by the Justice Department, played a role in the firings.

In a statement after the agreement was announced, Representative John Conyers Jr., a Michigan Democrat and chairman of the judiciary panel, declared victory and said the committee had finally succeeded in breaking through the Bush administration’s absolute immunity claims. Mr. Conyers called the agreement “a vindication of the search for truth.” He added, “I am determined to have it known whether U.S. attorneys in the Department of Justice were fired for political reasons, and if so, by whom.”

A key factor in ending the impasse appeared to be the pressure on both sides exerted by President Obama’s legal team, which had urged each side to reach the arrangement. Up until the deal, lawyers for Mr. Bush had stuck by their assertions that Mr. Rove, a senior Bush political adviser, and Ms. Miers, a former White House counsel, could not testify because they were protected by executive privilege. Bush lawyers had continued to invoke that legal claim even after Mr. Bush left office.

Under the agreement, Mr. Rove and Ms. Miers will provide depositions and sworn public testimony about the firings, but the scope of their testimony will be limited to the dismissals and closely related issues. Moreover, the two former Bush officials will not be asked about their conversations with Mr. Bush on the subject or their discussions with other members of the White House counsel’s office. The committee will also be able to ask questions about the case of former Gov. Don Siegelman of Alabama, a Democrat who has said he was victim of a politically motivated prosecution, possibly involving administration officials…

 

I feel a lot of ambivalence about these graphs. I love these places. I live in them, listen to their music, travel around their back roads, read their history. I’m proud of how they persist through times like these ,sometimes not even aware that things are different. But it’s also sad, because a lot of the people in these timeless pockets of America can’t really leave, even if they want to. And as things get worse, in this Recession/Depression, these will be the places that will take the hardest hits. The people here are as far from the world of Wall Street, Hedge Funds, and Credit Default Swaps as you can get in this country, and they’re going to feel the pinch more than anyone.

Old friend Carl has used this Pascal quote recently to remind me that mediocrity is the rule, and any attempts to transcend it are often resisted with a vengeance – an annoyingly regular truth much in evidence in today’s political scene. It’s from Blaise Pascal, an interesting character from the 17th Century – a mathematician who became a religious philosopher who died before he was 40. I remember Pascal’s Triangle from algebra – a device for calculating the coefficients of expanded binomials [funny what things stick in the mind]:

Sometimes I wish that things were as precise as Pascal’s Triangle instead of as muddy as the world of his quotes [but if that were the case, I’m sure I’d wish for more mud]. But I was thinking about Carl’s Pascal quote tonight for a reason.

I always liked mathematics. It was my talent and my college major. I went to medical school with an eye towards doing research, the kind that you do with mathematic precision. But I ended up in the most subjective of anything remotely medical – psychoanalysis. As imprecise and peculiar as it is, it felt like research to me of the best kind because I never had any idea what I’d find or where the journey was heading. I got to thinking about that dichotomy – the precision of mathematics and the endless complexity of human mental life – when I was reading about the failure of economists to predict the dreadful state of our economy [the  economic  economist’s crisis…]. Their own self critique was pretty insightful by my first reading [The Financial Crisis and the Systemic Failure of Academic Economics]. But, in retrospect, I think it was off the mark. Economics is an applied science. They treated it like it was Algebra.

They said that the economic models were designed to study stable systems and were constructed with assumptions weighted towards stability, leaving out the less precise, chaotic realities of financial institutions and investors. I guess the problems are more like Pascal’s Quotes than his Algebra.  I was thinking that’s what I liked about my final profession. No matter how hard I tried to nail things down and no matter how much literature I read, the endless purturbations of my patients’ mental currents always had a ripple or two that made my last model too simple, in need of revision. The story was in the person, not in the models.

What the economists failed to see were the entrepreneurs and speculators searching for loopholes, places between the cracks,  inefficiencies in the system where profits could be extracted. And over the last thirty years, those "holes" became wider and more numerous. Hedge funds bought long and short. The derivative markets became a casino. Speculators manipulated the futures markets, creating bubbles to exploit. Unsecured insurance in the form of credit default swaps were the source for outrageous bonuses while piling up future debt for unsuspecting taxpayers. There was even room for long term Ponzi schemes. What model would an economist use to mathematically recreate that kind of chaos? How does one put corruption into a spreadsheet?  What parameters would represent Hedge Funds when they weren’t even required to register, much less submit to regulation? In a system that couldn’t even detect that a fifty billion dollar semi Hedge Fund with only one accountant [in a shopping center store front] might be on the take, what good is a mathematical model?

I think that the economists let us down, sure enough. But I don’t think it was an inadequacy in their ability to make mathematic models. I think they let us down by failing to alert us that we had a system that could not be modeled, couldn’t even be defined. They could have told us that the findings of rising house prices indicated corruption from the agents, speculators, loan originators, mortgage brokers, CDO Traders, credit default swap sellers, etc. They let us down by staying in their offices looking at graphs, indices, and models, and not investigating the markets in person to actually see how they were working. They didn’t get their hands dirty and run down the truth about the systems they were pontificating about. Real scientists live in the interface between the world as it looks on paper and the world as it actually exists. It looks to me like the economists never really entered the reality of the financial world they were being paid to study…

In U.S. Visit, Brown To Urge ‘New Deal’
By Kevin Sullivan
Washington Post
March 3, 2009

LONDON, March 2 — British Prime Minister Gordon Brown arrives in Washington this week to press a "global new deal" that he hopes will shore up his sagging poll numbers at home and solidify his place as the international leader of efforts to surmount the deepening financial crisis. On Tuesday, Brown will become the first European leader to meet with Obama at the White House, and he will address a joint session of Congress on Wednesday.

"He is hoping to be seen as a genuine global leader," said Michael Cox, a professor of international relations at the London School of Economics. "He wants to show that he is the big man on the big stage when the big crisis hits." A month before Brown hosts President Obama and leaders of the world’s major economies in London on April 2, he will press his case for an overhaul of the world’s financial regulations and institutions.

"President Obama and I will discuss this week a global new deal, whose impact can stretch from the villages of Africa to reforming the financial institutions of London and New York," Brown wrote in the Sunday Times newspaper. Obama’s decision to meet with Brown before other European leaders such as French President Nicolas Sarkozy has been interpreted in Britain as a symbolic victory. But Peter Kellner, head of the British polling firm YouGov, said that although Brown’s meeting with Obama is important, it may not be as important as his address to Congress.

"These things are normally mostly ceremonial, but Brown’s speech to Congress is the biggest single event of the trip," Kellner said…

Global recession is fault of US, Brown to tell Congress
PM pinpoints poor regulation and sub-prime crisis in America as being at the root of economic crisis
By Patrick Wintour and Andrew Sparrow
guardian.co.uk
3 March 2009

Gordon Brown will reject the calls of cabinet colleagues to accept responsibility for the economic crisis when he makes a landmark speech to the US Congress tomorrow.

In the speech, the fifth by a serving British prime minister to both houses on Capitol Hill, Brown is in no mood to admit that the British government bears any responsibility for the crisis, insisting it is a banking failure caused by lack of regulation in the US and the rise of sub-prime mortgages. In an interview in the Daily Telegraph today, the chancellor, Alistair Darling, acknowledged there were "a lot of lessons" to be learnt from a "culture" of limited regulation that encouraged bankers to take risks. Ed Balls, the schools secretary and another close ally of Brown, also admitted "it is clear we were nowhere near tough enough". The comments chime with criticism by Lord Turner, chairman of the Financial Services Authority.

But Brown insists this is not a typical recession caused by a government allowing inflation to rear out of control, and is instead the product of the failure of an international regulatory system to stay abreast of globalisation.

In an interview with National Public Radio this morning, Brown said the global banking collapse needed a global solution. He called for the same standards in banking "of remuneration, accountability, transparency and disclosure all round the world", saying it would lead to a restoration of confidence in banking…

Criticisms "welcome" [make that "appreciated"]. I like Gordon Brown. He got out of Iraq and stopped making nice with Bush like Dapper Tony Blair. It’s interesting that the British commentators see him as grandstanding. I don’t know that about him. But we could use another "British Invasion" given the performance of our own economists [the  economic  economist’s crisis…]. We’ve made a rapid return to the economics of John Maynard Keynes since the recent failure of our free market models – the Monetarism of Milton Friedman. Maybe adding a British accent would smooth the transition.

On a more serious note, Gordon Brown’s advertised message is solid. It is our fault. And "PM pinpoints poor regulation and sub-prime crisis in America as being at the root of economic crisis" is spot on target. But it’s only a preface to the blame. Everything Bu$hCo did seems wrong. He cut taxes, not as an antedote to a recession but as a tool to get elected or help his rich friends. He increased spending by starting a massive, un-necessary war and kept it "off the books" much like the Enron method of burying debt in "other" accounts. He "leveraged" America to a record level foreign debt. He encouraged the "housing bubble" as policy. He took the term "free market economy" as meaning he didn’t have to think about the economy, so he didn’t. And he modeled corruption as a national pastime. But of all of that, perhaps his worst legacy was to actively nurture a partisan divide that seems impenetrable – diverting the whole energy of his Party into pointless bickering as a Party Platform, destroying the opportunity of Republicans to participate in our attempts to get things on an even keel.

In Free-Fall, Stocks Hit Lowest Mark Since ’97
Markets Sink Globally as Government Actions Fail to Reassure Investors
By Neil Irwin
Washington Post
March 3, 2009

The global financial rout worsened yesterday, driving U.S. stocks to their lowest level since 1997 amid deepening questions about whether governments around the world are being forceful enough in combating the economic crisis.

There was no single cause for yesterday’s sell-off, which sent each of the major indicators down at least 4 percent, with the Dow Jones industrial average closing below 7000 for the first time in 12 years. Investors were shaken by another government rescue of insurance giant American International Group, which said it would take on $30 billion more in public money after reporting the largest quarterly loss in U.S. history. The markets were also absorbing news from the weekend from famed investor Warren E. Buffett, who said the economy will be "in shambles" this year and who reported the worst investment returns in the 44 years he has run Berkshire Hathaway.

But more than any individual development, the continuing collapse in financial markets around the globe reflected an absence of faith that the trillions of dollars that governments have deployed to try to contain the damage will do the trick – and a realization that, from Europe to Japan to the Americas, the flow of goods and services is drying up.

"People are really coming to terms with the fact that we not only have a global slump, but one that’s going to be prolonged," said George Feiger, chief executive of Contango Capital Advisors. "And there’s a lack of coherence to the global response. In Japan, the government is paralyzed, in Europe the absence of a central government is crippling their ability to conduct coordinated policy, and the U.S. government has taken some dramatic actions, but always too little too late."

There, I read things like this Wikipedia article. There were names of researchers from a variety of disciplines who had worked in the area, but little about anything "General" in what they said except for Cybernetics, the study of regulatory systems and their feedback loops. That was pretty interesting stuff. It’s essentially how computer programs work – feedback loops where a change in some measurable parameter results in a change in what the program does. That was pretty interesting to me and got me started programming on the then embryonal PC’s.

Your car is a system. Most of the time, it’s like a Magic Carpet. This morning, most of you drug yourself out of bed, got dressed, and drank a cup of coffee. Then you walked out the door and after a time found yourself in another place – a lecture hall where some guy was talking about General Systems Theory. In the process, you had no thought about how your car works. It was just Magic. But for a few of you, it wasn’t like that. Your car sputtered and jerked [some hands went up and we all laughed], and you began to think about getting gasoline, or an oil change, or a tune up, or a new car, or going back to bed  [many hands went up to loud laughter]. The system "car" fragmented into parts in your mind as you went through the various causes of "car sputtering." A system is only composed of parts when it’s not working.

Some made-up lectures are better than others. That was one of my best – repeated year after year. Medical students are generally impoverished and still driving poorly maintained ckunkers left over from college [or their parents’ hand-me-down cars], so my opening gambit never failed to get a few hands in the air. I would go on:

There are two kinds of people when it comes to systems. People like most of you guys [and me] who do nothing until the car starts sputtering [or fails to start]. Then there are others like your parents [and my wife] who seem obsessed with auto maintenance, and rarely have to deal with sputtering cars. You’ll meet both types when you get into practice. Some patients will have you thinking, "How did you let yourself get into this bad a shape before you finally got hauled into my office?" With others, you’ll think, "You again. Everyone knows that Viral URI’s last a week or two. You’ve only had your cold for two days! "

Well, the system "our economy" started sputtering like crazy last September [Don’t we wish there had been more people obsessed with auto maintenance in the last Administration]. And our system has fragmented into parts which began to blame each other. Like the patient who arrives when they can no longer breathe, our frustration that they didn’t come in when they first noticed that they were having trouble getting up the stairs isn’t worth much. Most decent Doctors learn to deal with the patient in front of them rather than the patient they wish they had. So we’ve had almost six months of craziness as the klunker-ness of our economy becomes increasingly apparent. This article starts, "The global financial rout worsened yesterday." This just isn’t true. It didn’t worsen yesterday. Yesterday, a significant number of people woke up to how bad things already are.

But I hope this article is sort of a marker. Heretofore, our new President has tried like hell to get us to wake up to the size of this mess and come together to deal with it. On the left, he’s been criticized for not doing enough. From the right, everything he’s tried to do has been met with resistance and mockery. But, here we have the real business guys saying "… and the U.S. government has taken some dramatic actions, but always too little too late" and "… famed investor Warren E. Buffett, who said the economy will be ‘in shambles’ this year and who reported the worst investment returns in the 44 years he has run Berkshire Hathaway." We’re "chasing the problem" right now instead of putting together a new system to deal with the collapse of the old one, and replacing the old system with a fresh one. From 1929 until 1933, Herbert Hoover chased a similar problem into the depths of hell before F.D.R. was able to come up with a "New Deal." And George Feiger is correct when he says above, "… there’s a lack of coherence to the global response."

Economics Research on Systemic Risks
by eriposte

Via Lambert at Correntewire and Yves at Naked Capitalism, here’s an interesting opinion paper by a bunch of academics from the US and Europe:

The Financial Crisis and the Systemic Failure of Academic Economics

Here’s the abstract:

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

This paper is definitely worth reading. One of the most interesting aspects touched upon by the paper is this, and I have to say I agree with this:

Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models;⁴ even as they saw individuals and businesses build a financial system based on their work. There are a number of possible explanations for this failure to warn the public. One is a “lack of understanding” explanation – the researchers did not know the models were fragile. We find this explanation highly unlikely; financial engineers are extremely bright, and it is almost inconceivable that such bright individuals did not understand the limitations of the models. A second, more likely explanation, is that they did not consider it their job to warn the public. If that is the cause of their failure, we believe that it involves a misunderstanding of the role of the economist, and involves an ethical breakdown. In our view, economists, as with all scientists, have an ethical responsibility to communicate the limitations of their models and the potential misuses of their research. Currently, there is no ethical code for professional economic scientists. There should be one.

I’m highlighting the last point in bold primarily because I routinely see economists – especially of the conservative variety – talk authoritatively about stuff without bothering to acknowledge real world situations that run counter to their assumptions.

One point that came to mind upon reading the paper is this – what are the principal sources of funding for economics research? How much of it is funded by universities themselves versus government agencies versus the private sector [especially the financial sector]? How much of the research is dependent on the cooperation of entities [whether government or industry] that have a stake in the implications of the findings? I don’t have a good idea and am trying to find out – because the quality and depth of research is often dictated by who is funding it and what their expectations are. For example, if some research on derivatives, financial models and what not, is funded by companies in the private sector that have an interest in using the research or models, then it becomes more likely that the models might tend to gloss over realities.

"… this failure to warn the public. One is a “lack of understanding” explanation – the researchers did not know the models were fragile. We find this explanation highly unlikely; financial engineers are extremely bright, and it is almost inconceivable that such bright individuals did not understand the limitations of the models. A second, more likely explanation, is that they did not consider it their job to warn the public."

The most recent literature provides us with examples of blindness against the upcoming storm that seem odd in retrospect. For example, in their analysis of the risk management implications of CDOs, Krahnen [2005] and Krahnen and Wilde [2006] mention the possibility of an increase of ‘systemic risk.’ But, they conclude that this aspect should not be the concern of the banks engaged in the CDO market, because it is the governments’ responsibility to provide costless insurance against a system-wide crash. On the more theoretical side, a recent and prominent strand of literature essentially argues that consumers and investors are too risk averse because of their memory of the [improbable] event of the Great Depression [e.g., Cogley and Sargent, 2008]. Much of the motivation for economics as an academic discipline stems from the desire to explain phenomena like unemployment, boom and bust cycles, and financial crises, but the dominant theoretical model excludes many of the aspects of the economy that will likely lead to a crisis. Confining theoretical models to ‘normal’ times without consideration of such defects might seem contradictory to the focus that the average taxpayer would expect of the scientists on his payroll.

But it took people in the financial institutions to put these tools to use with such disastrous results. I spent my morning after returning from a vacation poring over the AIG-FP/Joseph Cassano story [see economic rape… below]. It’s a horrible story of a small business unit in an AAA rated Company finding a way to rake in billions selling insurance that was essentially unsecured, using the unregulated Derivatives Markets [created by the team of Gramm and Gramm, originally for Enron]. The CFTC chief that followed Wendy Gramm, Brooksley Born rattled sabres all over Washington trying to point out the dangers of these complex financial instruments called credit default swaps, but was opposed at every turn by Alan Greenspan and other government financial advisors. So, true enough that the government allowed these tools for fraud to continue, but the financial industry jumped at the chance to use them to create the largest insurance fraud ever conceived – one that created and plundered the housing bubble/sub-prime mortgage crisis. Nowhere did any of the academic economic models include projections for what would happen as this cancer grew and grew.  The economists stayed with the clean stuff – using models with unrealistic, built-in stability that made them useless in the nasty world of real-life economic practice. Even after the Enron people used these unregulated markets to create energy bubbles in California that almost bankrupted the State, no economists saw these same dynamics as part of the escalating gas prices that were [now obviously] part of an "oil bubble" – probably created by the very Enron Traders who had just moved on to lucrative jobs in new digs.

The implicit view behind standard models is that markets and economies are inherently stable and that they only temporarily get off track. The majority of economists thus failed to warn policy makers about the threatening system crisis and ignored the work of those who did. Ironically, as the crisis has unfolded, economists have had no choice but to abandon their standard models and to produce hand-waving common-sense remedies. Common-sense advice, although useful, is a poor substitute for an underlying model that can provide much-needed guidance for developing policy and regulation. It is not enough to put the existing model to one side, observing that one needs, “exceptional measures for exceptional times”. What we need are models capable of envisaging such “exceptional times”.

THIS IS WHERE THE DEAD TEACH THE LIVING HOW TO LIVE