Albert Edwards is back and it probably won’t surprise you to learn that he’s got some thoughts on central bank hubris on the tenth anniversary of the financial crisis.
The financial media has been awash this week in retrospectives on Lehman’s collapse and we’ve heard from some of the policymakers who in 2008 found themselves in the rather awkward position of having to rescue the world from a bubble that formed right under their noses and, arguably, with their consent (see the Op-Ed by Bernanke, Geithner and Paulson in the New York Times, for instance).
One of the points I try to drive home when it comes to assigning blame for burst bubbles in a world governed by an inherently “soft” science (economics), is that economists aren’t as oblivious to the shortcomings of their methods as critics often insist. Or at least the economists I know aren’t.
To be clear, my defense of economics (and of “soft” sciences and “pseudo-experts”, to quote the insufferable Nassim Taleb) isn’t based on extensive personal interactions with the economists who are actually in charge of making policy at the highest levels. As with any other profession, it’s unquestionably true that the higher one climbs on the ladder, the more arrogant one gets, and that arrogance undoubtedly served to blind the likes of Bernanke to what was happening in the lead up to the crisis.
But what I lack in face-to-face interactions with the handful of high-level policymakers who run the show, I like to think I make up for by the extensive personal interactions I’ve had over the years with dozens upon dozens of people you’ve never heard of but who practice the same “science” (or non-science, if you like) as that espoused by the Greenspans and Draghis and Bernankes and Yellens of the world. Believe it or not, these aren’t evil people and in my extensive experience, the “average” university-trained economist is acutely aware that he/she is not a physicist or a dentist (to use one of Taleb’s examples). I don’t know what Ben Bernanke would say after three beers, but I know what “regular” economists say when tipsy, and my experience isn’t that they think they’re masters of the universe with a complete command of the business cycle (even when inebriated to the point where most people think they can fly).
Ok, so with that obligatory defense of academia out of the way, let me excerpt Albert’s latest note because as ever, it’s worth highlighting. Here’s Edwards on Lehman and the extent to which things were already deteriorating prior to its collapse:
Without doubt, Lehmans bankruptcy caused the financial system to seize up and for many this was the cause of the ensuing deep downturn and hence the focus on this one high profile event. But I have always found this explanation disingenuous and often an expost justification for those who had drunk the kool-aid and never foresaw the financial crisis and economic slump and that includes policymakers.
For even before the Sept 15 Lehman bankruptcy, the US economy had already collapsed into deep recession. In September 2008 we now know US payrolls declined 443,000 after a fall of 277,000 in August, and an average 190,000 decline in Q2. Although these numbers have been revised down, even at that time the Sept 2008 was reported as a fall of 159,000 having already lost 600,000 jobs that year (Septembers 2008 survey was taken the week before the Lehmans bankruptcy, so was unaffected by the fallout).
And here he is on central banker hubris:
I was amused to read the NY Times op-ed, co-authored by the three leading US policy makers at the time of the crisis (Ben Bernanke, Tim Geithner and Henry Paulson). In a piece entitled “What We Need to Fight the Next Financial Crisis” they lament the fact that Congress has taken away some of the tools that were crucial to us during the 2008 panic. Its time to bring them back.
Tools! Apparently, they always need more tools. Rubbish, they had all the tools necessary. They just never recognised beforehand that the economy was a massive credit bubble just like it is now. It was worse than that. In 2005 Bernanke had even derided an interviewer who asked him about the possibility that the housing bubble could burst. And I also remember Shelia Bair, who headed up the FDIC (the Federal bank liquidator) at the time, and had successfully seized and closed many banks during that period, including the massive Washington Mutual, lamenting that she had not even been consulted about Lehman.
He also cites comments from Peter Fisher, delivered last year at a conference held by Jim Grant. The full comments are embedded below, but this is the passage that Edwards alludes to:
Let’s agree that in the desperate conditions in which we found ourselves ten years ago, the Fed had a duty to be effective – to do no harm and preferably to do some good. How do we know that an action is reasonably likely to produce good outcomes? The second claim, that the central banks had a duty to experiment, is a stronger one and suggests a way of knowing whether an action may produce good outcomes. But simply invoking the scientific method is not enough. A duty to experiment, particularly when making guinea pigs of the rest of us, presumably carried with it a corresponding duty to scrutinize rigorously the results of their experiments – to apply what the late, great physicist Richard Feynman called “scientific integrity” requiring “a kind of utter honesty” – so as to learn from their failures and shortcomings.
Curiously, the Fed has acknowledged no failures. All the experiments have been successful, every one: no failures, no negative side effects, no perverse consequences, only diminishing returns.
Peter is in a far better position to make that latter claim than I’ll ever be, but do note that it is almost by definition a bit disingenuous. Implicit (and very nearly explicit) there, is the notion that no Fed officials have ever, in any context, admitted to screwing up at anything, ever.
Obviously, that’s not true. In fact, Peter is himself proof that it isn’t true because he’s a former Fed official.
In any event, Albert’s points excerpted above are duly noted. In fact, they’ve been duly noted by all kinds of people (economists included) since the crisis. There is no question that central banks, in their efforts to tame the business cycle, have created a kind of rolling, boom-bust dynamic. We’ve written voluminously about this. Here are two examples for anyone interested in exploring further:
Ultimately, though, it’s important to remember that hubris isn’t the sole purview of economists and central bankers.
The idea that excessive pride comes before an inevitable humbling fall is a concept as old as Ovid and everyone would do well to bear it in mind – not just economists.