Econ with Angry Sprinkles

Yglesias recommends this piece by a Barry Eichengreen, a PoliSci/Econ prof at Berkeley. It's way tl;dr (unless you like to get annoyed by academics), but the takeaway is that economists and the government were under the sway of "cognitive regulatory capture" that contributed to the bubble. It's exactly the sort of thing that you'd expect a tenured professor to write, who discusses calculating VaR on 1970s punchcards.

Ph.D. economists did just fine, and not because the academic job market is cushy and they were invited to give guest lectures to industry at "ski-slope retreats." Many of them predicted this state of affairs, like this guy, and many of them were hired by prominent hedge funds over the past decade. Yeah, the whole financial industry has taken it on the chin over the past year or so, but if you recognize that the entire boom/bust cycle goes back several years, HedgeFundLand is still way, way ahead. They didn't hire no fools.

I think the correct mode of analysis is at the micro-institutional level. People who have worked on Wall St. know who risk managers are. They're the guys who are lucky to make $80,000 a year who are charged with overseeing the trades of millionaires. The good ones make the switch to the "front office" where they have a shot at making their millions, and the mediocre-to-bad ones climb the backoffice hierarchy according to the Peter Principle. How much oversight do you expect out of these guys? How do you create authority? How do you de-allocate funds from a manager who just had two blockbuster years in a row because his product was hot when you know his performance will revert to the mean?

If you zoom out to a national level, the problem becomes even more apparent: an under-funded SEC paying people $60,000 a year to understand innovative-yet-fishy derivative transactions, an FDIC that stopped charging insurance premiums because it went 2.5 years without a bank failure, all orchestrated by a bunch of congresscritters who spend most of their time on the phones trying to raise a few thousand dollars a day so they can get re-elected. Eichengreen would seemingly have you believe that the oversight was supposed to come from the Econ departments at our nation's leading universities. I'm not sure who he thinks was asking George Akerlof or Robert Engle about the political and economic policy issues of the past 8 years that have lead to this debacle, but perhaps it's more charitable to interpret his article as a suggestion that we start doing so.