Saturday, April 25, 2009

Economists and the Crisis

Today's article in the IT by economist Alan Ahearne offers a defence of the Government's plans for NAMA while opposing his colleagues' proposals on nationalising the banks. The reactions to his article raise broader issues about the role of economists in the present crisis and the nature of economics as an academic discipline.

On nationalisation, there is a developing consensus among academic economists who see nationalisation as a necessary evil which is part of an essential project: putting our banking system back on a sound footing. They would not share the enthusiasm of Sinn Fein and other left-wing commentators for nationalisation per se and they want the banks re-privatised at the earliest practicable moment. Of course, we have already nationalised a bank and it is not clear why this course of action was chosen for Anglo-Irish but not for others.

In my view, banks are the very last sector of the economy which should be nationalised because the opportunities for political interference (i.e. corruption) would be manifold and exceedingly difficult to control.

Nonetheless, I agree with those calling for nationalisation because I see it as the only way to ensure the taxpayer does not overpay for the assets which NAMA will acquire. Ahearne argues that "the taxpayer is protected from unforeseen losses through the Government’s commitment to levy the banks for any losses incurred." That depends on your view of the Government's handling of the ICI debacle. AIB and the Department of Finance like to say that rescue cost the taxpayer nothing. In reality, the 2% insurance levy was a charge on the general consumer, not on the financial institutions who were adept at passing on costs to their customers (with the result that our insurance costs became a serious impediment to our economy).

Ahearne also argues that that taxpayer would see some upside from the option to acquire 25% of ordinary which is attached to the re-capitalisation programme. This would be a very modest return for a huge investment in defunct businesses.

The sharp division of views between Ahearne and his colleagues raises questions about economists are a profession.

Is there a scientific basis on which this crucial issue can be decided? What relevant cases which could be studied? Are there agreed criteria to judge success or failure in this cases? There is much talk of the Swedish model but they did not completely nationalise their banking system. If not, are economists akin to sociologists - a large pool of expertise where experimental evidence is never conclusive because the variables are too complex? This crisis must be an opportunity for he "new economics" which challenge orthodox views. If traditional economics is not capable of offering a coherent response, it will have failed to meet a crucial test.

There is a related problem: where were the economists when we needed them? Why were they apparently silent when the banks lost the run of themselves? There were some honorable exceptions but they were so few and so subsidiary that it can fairly be said that the profession as a whole was culpable of non-feasance if not of malfeasance.

There were egregious examples of economists employed by banks and estate agents who were utterly devoid of objectivity and used the media to advance their employers' agenda under the guise of academic expertise. Beyond those sinners were the bulk of academic economists who may have cautioned against the housing bubble but made no concerted effort to expose the false basis of our credit boom. Alan Ahearne fell into this category and co-wrote a paper which claimed that the house price increases were due to changes in contraception laws but predicted that democgraphics would continue to underpin house price growth.

Journalism and the public service also have questions to answer. Were they sufficiently detached from our political masters? Some journalists have done outstanding work in documenting the crash and Simon Carswell wrote a book exposing the nefarious carry-on in our banks. His article today on NAMA is another example of his ability to see the shape of things to come, at least in the coming weeks.

I think it would be a serious misjudgement to give Peter Bacon a leading role in NAMA. His expertise as an economic consultant is not enough to prevent a serious conflict of interest given his history with Ballymore.

Similar issues arise in a global context and Yves Smith offers some sharp answers which I think also apply here. Her critique of Alan Greenspan and the Fed is riveting.
John Hurley gave the Oireachtas an extrordinary account of his stewardship of the Central Bank but it was left to politicians to criticise him. This goes to the core of our financial crisis yet the economists seem to shy away.


  1. Medical professionals regularly disagree about the best way to treat a sick patient, but do so without worrying about the academic basis of their discipline.

  2. I don't know that economists not getting it right means the science is of itself wrong in any way. I would liken that to thinking that if you ever had a riot or social disturbance that the law system is fundamentally wrong. Part of what we are going through now is a massive learning curve and when you rely heavily on history you don't always see into the future accurately, its like driving down a road trying to navigate using only the rear view mirror. there are flaws to the system but its the best that we have for now.