Thursday, March 11, 2010

John Cassidy of the New Yorker "How Markets Fail" Difficulty of Determining Truth from Press/Media

Tags: John Cassidy, How Markets Fail, Snopes, Our Unconscious Brain Thinks?, Economic Theories,

Joel might be interested in the book by John Cassidy of the New Yorker "How Markets Fail" It had lots of excellent reviews and an excellent review is below my comments. I have it in my Kindle but have not read it yet, but he might watch the C-Span Video first.

I forgot to ask you whether you had a specific question of fact you verified with Snopes? |

Apr 10, 2009 ... Q: Is run by "very Democratic" proprietors? Did they lie to discredit a State Farm insurance agent who attacked Obama? - Cached - Similar

Because of the Internet and conscious or unconscious parts of our brain, we tend to accept certain conclusions which occurs even in science and especially in areas such as politics and medical research. But scientists, if they follow the scientific method where we question our biases or theories, should try to prove their theories wrong as you know. In practice, we often do not and look chiefly for supporting results.

That is why conservatives and liberals absorb different information by reading or remembering what they agree with and forgetting contradictions to their thinking. Americans seem to have this problem to a much greater extent than Asians or Europeans according to psychological research by many researchers.

I have been very independent all my life in contrast to my brothers and parents and Japanese-Americans in general. I am also someone who is interested in views opposite to my own and read their views to see if they have a good point.

I also know that very smart doctors and scientists and professors and politicians have problems with flawed thinking. For example, engineers tend to be too conservative while among scientists, physicists tend to be the most independent and liberal and non-religious with about 90 percent not having a religion.

Collins who headed the government genome project, for example, was picked more for his managing ability which is superb than his genetics credential. He is Catholic and goes to church every week. In fact about a third of members belonging to the club of most distinguished scientists, The Academy of Science, are regular church goers, many Catholic as you are.

Ignorant comments such as Larry Summers saying while President of Harvard that women do not have the mathematical brain to be a scientist! What most people do not realize is that successful scientists are largely very aggressive because any new idea is opposed by the Establishment and many women until recently did not like that. Now women are becoming along with Jews and South and East Asians, formidable scientists with many ground-breaking results and are doing better academically in college than boys.

Just in the early 1990s, Summers did not agree with the current Milton Friedman and Becker school of economics, but obviously changed because both got Nobel Prizes to push their disastrous theory that humans are only concerned about profit! At the University of Chicago which heavily influenced Obama when he was teaching Constitutional Law, he picked economists from that school to be his advisors.

Obama was not completely fooled since he seemed to agree with Volker's approach to financial regulation, but he has Rahm Emanuel who made hundreds of millions on Wall Street who decides who Obama meets with except Hillary has free access, a deal she reached with Obama before accepting the Secretary of State. Hillary and Obama have scheduled a long meeting to discuss foreign policy and surely Netanyahu's settlements policy on Peace Talks.

Hillary was kept out of the loop during Clinton's 8 years to minimize her influence on Bill which led to some very bad decisions including Welfare Reform and changes in financial regulation such as the elimination of the Glass-Steagall Act and banking deregulation which allowed the current scandal.

GlassSteagall Act - Wikipedia, the free encyclopedia

The Banking Act of 1933 was a law that established the Federal Deposit Insurance Corporation (FDIC) in the United States and introduced banking reforms, ... - 10 hours ago - Cached

People forget that the Republicans controlled both the Senate and House after the November 1993 election and Wall Street mavens including Rubin, Greenspan, and Summers were Bill's advisors! After Bill lost his first re-election as governor, Hillary actually ran Bill's governorship and did most of the campaigning in Arkansas, a state that gave McCain 20 percent more votes than Obama! Experience and flexibility really helps in the enormously tough job of President so I supported Hillary first. She is proving to be a top-notch Secretary of State where she has enormous influence and is considerably more popular than Obama. I think she was responsible for the break-through in Pakistan. Israel's Tea Bag government will be a tougher nut to crack.

Most people pretend that they read the 1200 page "Wealth of Nations" so they can selectively quote from the book to support their views, especially the Republications. The truth is that Adam Smith said we must regulate banks!

Because television, except for MSNBC's Rachel Maddow and Keith Olbermann, do not provide much context (history) to really understand current events so reading good books is the only alternative. But Americans are distracted and unable to concentrate well enough to productively read serious novels and non-fiction.

44 of 52 people found the following review helpful:
5.0 out of 5 stars A must read critique of economic theory, December 10, 2009
Cassidy analyzes how orthodox economic theory (he calls Utopian economics) went astray. While Adam Smith advanced the merits of market competition and free trade in "Wealth of Nations" in 1776; He warned against unregulated credit creation and ensuing speculative excesses. But, economists focused solely on Smith's benefit of free markets. The field of economics became increasingly quantitative based on flawed assumptions including Cassidy's four basic Utopian illusions:
1) the illusion of harmony (free markets always generate good outcomes);
2) the illusion of stability (free market economy is sturdy);
3) the illusion of predictability (distribution of returns can be foreseen); and
4) the illusion of Homo Economicus (individuals are rational and act on perfect information).

This idealized framework allowed economists to develop overreaching math models increasingly disconnected from reality. This trend started with
Friedrich Hayek, leading Austrian economics, who stated in late 1930s that prices communicate near perfect information that determined underlying demand and supply. This was a brilliant insight if not taken too far.

In the 1970s, Eugene Fama builds upon Hayek's insight with the Efficient Market Hypothesis (EMH) that stated stock prices captured all available information. Thus, stock prices move randomly and both technical and fundamental analysis do not add value. The theory was popularized by Burton Malkiel in A Random Walk Down Wall Street: Completely Revised and Updated Edition.

The EMH was a brilliant insight backed by data (the majority of mutual fund managers do not beat the index to this day). But, it lead to Robert Lucas Rational Expectation Hypothesis (REH) in the 1980s. The REH stated that all markets (goods, labor, etc...) are efficient not just securities. It also stated that individuals act upon their anticipating of future events. This entailed that fiscal or monetary policies have no effect since the public counters them.

Cassidy states REH was the most hubristic Utopian economics theory as it was completely disconnected from reality. The next Utopian manifestation was the General Equilibrium Theory (GBT). The latter represents more than century long effort (Leon Walras, French economist, first pronounced it in 1870s) to demonstrate that all markets affect each other and each has a single interdependent equilibrium price. The underlying math is forbidding; yet GBT utility and accuracy is null.

Cassidy discredits Milton Friedman and Alan Greenspan the most. Friedman is "The Evangelist" libertarian who broadcasted his anti-government views in two manifestos
Free to Choose: A Personal Statement and Capitalism and Freedom: Fortieth Anniversary Edition. His anti-Keynesian theory of monetarism is completely obsolete. It was shortly tried in the early 1970s in the U.S. and the U.K. and was a dismal failure (source: Paul Krugman).

Cassidy states Greenspan was the main culprit of the housing bubble and ensuing financial crisis on two grounds. First, he kept interest rates too low for too long in the first half of this decade. This contributed to skyrocketing home prices. Second, his Utopian view that financial markets better self-regulate their risks than regulators promoted egregious mortgage underwriting (the Subprime mess). It also facilitated unregulated collateral debt obligations (CDOs) and credit default swaps (CDS) that spread the financial crisis worldwide.

Cassidy provides rebuttals to Utopian economics from many fields he lumps into "reality-based economics." The latter includes Game Theorists John von Neumann and John Nash. Game Theory contradicts economic theory as individuals respond strategically to each others' actions (Prisoner's Dilemma) instead of economic incentives. Reality-based economists also include Daniel Kahneman and Amos Tversky, psychologists, who demonstrated individuals are irrational as we are more sensitive to losses than gains. We overweight our firsthand experience and events that occurred recently. Richard Thaler, an economist, will apply their ideas thereby creating behavioral economics.

The most successful reality-based economist is Hyman Minsky. His theories pervade Cassidy section on the current financial crisis. Minsky is an American economist (1919-1996) ignored during his lifetime; but, is now experiencing a resurgent posterity. This is because the first decade of the 21st century with the and housing bubbles confirmed the relevance of his model.

The later entails that free market economies are inherently unstable prone to booms and busts caused by asset bubbles. This is because the credit cycle exacerbates the business cycle. Bankers lend too much when collateral values go up (causing bubbles) and not enough when collateral values flatten (credit freeze). Minsky's model is scalable from homeowners defaulting on their mortgages to countries defaulting on sovereign debt. Charles Kindleberger leveraged Minsky's model to explain 400 years of financial crisis in his formidable Manias, Panics, and Crashes: A History of Financial Crises (Wiley Investment Classics).

Minsky success also reinforces the greatness of both Adam Smith and John Maynard Keynes. Smith fully anticipated the relevance of Minsky's model and the resulting need for tightly regulating credit. Keynes fully understood free market economies are inherently unstable and occasionally need a fiscal push (Keynesianism). Additionally, both Smith and Keynes were behavioral economists before it was cool as they fully grasped the irrationality of speculators.

Cassidy is by no means a socialist. He just thinks the dogmatic choice between free markets and socialism is wrong. He adheres to what Smith/Keynes/Minsky suggest. And, that is
the credit market is a social utility that needs tight regulation to prevent the type of economic calamities we just experienced. And, his preventive recommendations are more stringent but in line with the proposals from the Obama Administration.

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