Friday, October 18, 2013

Fox on What We’ve Learned from the Financial Crisis

Really great piece by Justin Fox on “What We’ve Learned from the Financial Crisis” over at the Harvard Business Review.  What follows is a brief excerpt, but you'll want to go read the whole thing.

Five years ago the global financial system seemed on the verge of collapse. So did prevailing notions about how the economic and financial worlds are supposed to function. The basic idea that had governed economic thinking for decades was that markets work…. In the summer of 2007, though, the markets for some mortgage securities stopped functioning…. [T]he economic downturn was definitely worse than any other since the Great Depression, and the world economy is still struggling to recover…. Five years after the crash of 2008 is still early to be trying to determine its intellectual consequences. Still, one can see signs of change…. To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world—the corporation—may be loosening.

Fox goes on to dissect each of these shifts, putting them in historical perspective.  As I said, I think it is well worth your time to read his entire piece.  A couple of additional noteworthy quotes from his analysis of item (3) above follow:

  • [M]ost economic theories also build upon a common foundation of self-interested individuals or companies seeking to maximize something or other (utility, profit) …. Still, one narrow way of looking at the world can’t be the only valid path toward understanding its workings. There’s also a risk that emphasizing individual self-interest above all else may even discourage some of the behaviors and attitudes that make markets work in the first place—because markets need norms and limits to function smoothly.
  • I don’t think the shareholder value critics have come up with a coherent alternative. We’re all still waiting for some other framework with which to understand the corporation—and economists may not be able to deliver it. Who will? Sociologists have probably been the most persistent critics of shareholder value, and of the atomized way in which economists view the world. Some, such as Neil Fligstein, of UC Berkeley, and Gerald Davis, of the University of Michigan, have proposed alternative models of the corporation that emphasize stability and cohesion over transaction and value.

Agency, Business Associations, Corporate Governance, Corporations, Financial Markets, Stefan J. Padfield | Permalink


Utility-maximizing rational actor theory has crested and is receding in light of multiple confirmations from behavioral economics that people make decisions based on multiple factors, including many outside our conscious awareness. Becker gives way to Kahneman. But it seems that rational actor theory became a self-fulfilling prophesy in financial services, where institutional and individual short-term profit was culturally instantiated as the dominant value and reinforced by single-factor bonus systems with enormous rewards. Which leads us to Lynn Stout's observation that "Not to put too fine a point on it, but homo economicus is a psychopath."

Posted by: Scott Killingsworth | Oct 19, 2013 7:31:37 AM

If behavioral economists wanted to do something useful (aside from highlighting anomalies in theories that they are unable to replace), they could turn their attention to the question of "systemic risk," which seems to be primarily a psychological problem and not an economic problem. That is, the problem is panic and its causes, and it is far from clear that the numerical indicia used by regulators to measure "systemic risk" have anything to do with explaining or predicting the causes of a financial panic.

Posted by: Douglas Levene | Oct 21, 2013 7:21:36 AM

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