Must reading

"Second, the capital regulations also allowed banks to reduce the amount of capital they held against assets that remained on their balance sheets—if those assets took the form of AAA-rated tranches of securitized mortgages."

Thus the incentive for the rating agencies to rate everything AAA.

I read Jeffrey Friedman's paper; it was very good. There was a interesting dicussion about it over on the "The Austrian Economists" blog. Perhaps you knew that already.

Looks like Peter J. Wallison knows what he's talking about.

After reading all those abstracts, I conclude that economists are mostly tools.

Russ, I have been trying to access ungated versions of the papers in this issue for some time (Arnold Kling recommended it as well), with no success.

It's remarkable that the eminent economists reading this blog (including, of course, myself), can trash the papers by Nobel and Bates medalists by just looking at the abstracts.

Indiana Jim, I don't think I am spinning things, but will let the readers of this blog decide. But oh yes it is "amazing is that SOME with medals have written such.", and that is not prejudging.

Just out of curiosity: Do you teach Economics, or serve as an economist in some professional capacity? Have you read any academic paper by Daron Acemoglu? Do you have a formal training in Economics? I am asking because, although Austrian economists are a very respectable bunch, I'd say that some people quoting the Austrians don't seem versed in the otherwise arcane black art of Macro.

This one is notable:

"Daron Acemoglu

ABSTRACT: The financial crisis is, in part, an embarrassment for economic theory. Economists tended to think that severe business cycles had been conquered; that free markets require no regulations to constrain self-interest; and that large, established companies could be trusted to monitor their own behavior so as to preserve their reputational capital. These three beliefs have proved to be inaccurate."

Just this much of Acemoglu's abstract suggest things such as:

1) That Acemoglu either knows nothing of Austrians (who have consistently warned of Fed induced credit subsidy cycles), or that Acemoglu wants to do what has been done for years in economics: Ignore the Austrians. On second thought, maybe Acemoglu doesn't think the Austrian theory is an economic theory (it doesn't have any fancy mathematics complex enough to invoke the theorem, lemma, proof mantra invoke in "real" theories in economics).

2) That setting up straw men may be Acemoglu's bag. His statement that "free markets require no regulations to constrain self-interest" is silly because as Milton Friedman explained operating within the law and customs of society and "without fraud or deception" are necessary caveats that must constrain the pursuit of profit. Furthermore, the idea that "regulators" are choir boys and captains of industry are Madoff clones is dangerous as well as ignorant.

3) That Acemoglu fails to see and/or appreciate the maze of regulations and moral hazards that led SOME employees of SOME "large established firms" to take actions that roiled the reputations of their firms. Acemoglu reminds one of Krugman who laudes Keynes for having freed us all from having to worry about causes of recessions and depressions; just send in the elites and politicians (the genius choir boys) to fix things. Just trust them; they KNOW better, just ask them. Does reputational capital constrain managers of for-profit firms? Of course. Does reputational capital perfectly constrain the managers of for-profit firms? Of course not. But how does the reputation of, say, the IRS constrain its managers relative to the reputational concerns that constrain the manager of your local Wal-Mart (which is now sending out "sustainability surveys" etc. to try to improve their image to the public)?

I really hope the article (which I haven't read yet) is better than the Abstract.

Stiglitz is also notable for the following in his abstract:

"Others can be blamed: the ratings agencies that judged subprime securities as investment grade; the Fed, which contributed low interest rates; the Bush administration, whose Iraq war and tax cuts for the rich made low interest rates necessary. But low interest rates can be a boon; it was the financial institutions that turned them into a bust."

So, according to Joe: the Bush "tax cuts for the rich" and the "Iraq war" forced the Fed to loan too much money into existence, but the root cause was really the greedy capitalists running financial institutions? Really? Say in ain't so!

gappy,

I'm not trashing anyone, merely commenting on what THEY wrote. What is amazing is that SOME with medals have written such.

But as I said, "I hope the article is better than the Abstract". HINT for gappy: this means that I withhold final judgement pending careful reading. Psst Gappy: Stop spinning things into things they are not.

What I found interesting --

"A high-grade CDO could produce a triple-A tranche constituting 93 percent of the

bond." (page 11)

"Mistakes simply don’t fit into standard economic and political models, because standard economic and political models take ignorance out of the human equation. Instead of mistakes—caused by ignorance—the standard models focus on motives, i.e., 'incentives.' The effect is to model economic and political agents as if they automatically get what they want (unless they are blocked by agents with contrary desires, as in game theory), which sidesteps

the question that actual human beings constantly confront: How do I get what I want? Desires are not self-actualizing, and to assume that they are might be called magical thinking to emphasize how unscientific it is." (page 25)

"It must surely be true that, as among the bankers, there was disagreement among the regulators about the wisdom of placing so much power in the hands of the rating agencies, or about the capital risk weights assigned to their ratings. But heterogeneous opinions among regulators do not matter. Only one regulation becomes the law in any jurisdiction (regarding any given activity), regardless of whatever dissent occurs among regulators before the decree is issued. This renders heterogeneous

opinions among regulators fundamentally different from heterogeneous opinions among capitalists, for when capitalists disagree,


they can (in effect) test their discordant theories against each other through market competition." (page 29)

"Ideally, of course, [predicting a rules unintended interactions with other rules] would mean predicting the new rule’s unintended interactions with rules that have yet to be promulgated — rules that will be crafted as solutions to problems that have yet to arise. That being impossible, the most we can realistically hope for in the way of systemic regulation is that when a new rule is being designed, possible interactions with previously enacted rules are fully considered. As time passes, however, that gets increasingly difficult, as the number of rules that have been enacted goes up. Currently, after more than a hundred years of social democracy, it is literally impossible for a real world regulator to gain a synoptic perspective on possible interactions with previously enacted regulations, let alone for anyone do so fully (i.e., accurately). No human being can master the contents of the Federal

Register, which grows by tens of thousands of pages a year—let alone also master the state, local, and international equivalents of the Federal Register. And no human being has anything close to a detailed, accurate grasp of the workings of the modern societies that all these regulations are


designed to improve." (page 37)

Who the hell is Jeffrey Friedman? His is one of the best articles in economics (on any topic) that I've read in a long time. It's like he took Alchian, Hayek, (the other) Friedman, Friedman (the other's son), Demsetz, and every other insightful writer in economics, and wrapped them all up in a neat little coherent theory/narrative about spontaneous order. Wow.

gappy,

I'm not a plumber.