by Guest Author Tim Iacono, TimIacono.com
After reading through some of the recently released transcripts from the 2006 Federal Reserve policy meetings, it occurred to me for about the thousandth time that economists are particularly ill-suited to oversee an economy where the financial system is, from time to time, run by psychopaths each trying to one-up the other.
During normal times, economists’ models of how the world works seem to function reasonably well, but when a multi-decade orgy of money and credit creation came to a head a few years back, they were completely unaware of how badly some people were acting and how contagious this was.
The central bank meets this week and is expected to revamp how they communicate their thinking about monetary policy to the world, but, maybe they should spend more time figuring out how to better observe what’s going on in the world – looking beyond the charts, tables, and models that they had their noses buried in back in 2006, oblivious to the looming crisis in housing and credit markets.
It was all there to see for anyone willing to make a modest effort to get out into the real world and look around.
Wild-eyed buyers lined up for blocks to buy new condos and mortgage brokers with barely a high school education were raking in hundreds of thousands of dollars a year in commissions by peddling all kinds of “exotic” mortgages to borrowers who, in many cases, didn’t really understand what they were signing.
As we’ve come to find out, there was a good deal of fraud involved here by both lenders and borrowers as few seemed to care about how their individual actions might affect others in the fullness of time.
You might say that a good asset bubble brings out the psychopath in many of us.
Everyone was swept up in a financial bubble of the largest magnitude and, with only a few exceptions, economists were content to look at their models – models that ignored the “shadow banking system” and failed to reflect how a rapidly inflating asset bubble was affecting behavior – while predicting clear sailing ahead and patting each other on the back for having done such a good job.
The worst of the psychopaths were on Wall Street and those tales of excess came to light in the years that followed.
A pattern of disregard for others was at the core of what Wall Street did with mortgage backed securities and related derivatives, a point that became clear as internal emails were released in the years that followed. Investment banks made boatloads of money – both in selling securities and then betting against them – and this behavior became standard operating procedure for some firms.
One could argue that the 20-something mortgage brokers really didn’t understand the bigger picture, but that can’t be said for those peddling mortgage products on Wall Street.
They have no such excuse.
These were some of the nation’s best educated and brightest minds and they took their cues from top management, yet they exhibited all the characteristics of the fellow to the right – shallow emotions, the lack of a conscience, selfishness, and lack of remorse.
Meanwhile, economists, particularly those at the central bank, were blissfully unaware that anyone was doing anything wrong in the financial system and that it could all come tumbling down around them in just another year or two.
Former Fed Chief Alan Greenspan famously “ found a flaw” in his theory of how the world works and that flaw was, basically, that the world is loaded with psychopaths, particularly on Wall Street.
But, psychopaths don’t exist within economists’ models.
In fact, I’m not sure if your run-of-the-mill economist acknowledges the existence of psychopaths in the financial system at all.
While trying not to paint with too broad a brush here (oh, what the hell), economists are an insular lot prone to group think and that much should be clear from the 2006 Fed transcripts. Some would say the dismal set is naive about how the world really works and not much interested in learning (in many cases a result of being scarred by bullying in grade school) and that they’ll continue to just keep trying to fit their square peg models into a world full of round holes.
Maybe they should pay a little bit more attention to what’s happening in the real world rather than relying on their models where only “rational actors” exist.
Either that, or they should get out of the business of stewarding the economy.
About the Author
Tim Iacono is the creator of his own blog, TimIacono.com and is the founder of the investment website Iacono Research. He rediscovered his passion and curiosity for macroeconomics, economic theory and finance after witnessing the economic bubble and bust. Tim Iacono’s purpose for writing is to uncover the secrets and shed light on today’s economic situations and problems. Tim Iacono hopes to help his readers “look past the headlines”.