Bailouts, Professors, and "Inside Job"

-- Posted by Neil H. Buchanan

Last Friday, the local independent movie house held a special showing of "Inside Job," the documentary film about the causes of the ongoing financial crisis. The viewing was followed by an audience Q&A led by Cornell Law Professor -- and Dorf on Law blogger -- Bob Hockett. Professor Hockett's discussion was extremely helpful to the audience, even though the first two questions were from (1) a person who thinks that we should go back on the Gold Standard, and (2) a guy who thinks that monetary policy is a Ponzi scheme. Defusing that kind of craziness -- which was rather unexpected in a college town -- was no easy task, but the entire session was great. It is a shame that only about a hundred people were able to join in the fun.

The film itself was excellent, in almost all respects. It was directed by Charles Ferguson, who also directed 2007's "No End in Sight," which explored the lies that led the U.S. into war in Iraq. Both films are unabashed advocacy pieces. Of the two, "Inside Job" was a bit less interesting to me; but I suspect that this is merely because it happens to focus on a subject that I have studied at some length. For those who have not studied the causes of the current crisis, this film offers a clear explanation of the elements of the crisis -- financial deregulation, credit default swaps, the role of ratings agencies, financial conflicts of interest, excess compensation, the high-risk culture of Wall Street (including disgraced former NY governor Eliot Spitzer discussing the use of drugs and prostitutes by Wall Streeters -- while quite aware of his, let's say, unique status in such a discussion), the inadequacy of the regulatory and legislative responses, and so on. It also makes people angry, in a good way.

There were, however, two areas in which the film's arguments fell short. The first was Ferguson's handling of TARP, the now-wrongly-reviled Trouble Asset Relief Program, aka The Bank Bailout. To its credit, the film makes it clear that TARP was enacted during the Bush presidency, not by President Obama. For someone who is unafraid to call out liars, however, it was surprising that Ferguson did not make a point of the Republican Congressional leaders' energetic endorsement of TARP. A film in 2010 that fails to point out the hypocrisy of people like John Boehner and Mitch McConnell, who rode populist anger about bailouts to electoral gains (and, in Boehner's case, a tearful embrace of the Speaker's gavel), is missing an important political phenomenon.

On the substance of TARP, moreover, Ferguson's argument was simplistic and dangerous. After accurately describing the basics of the program, Matt Damon's narration simply says that, after TARP, unemployment kept rising and foreclosures continued. On to the next subject! This is precisely the nonsensical reasoning that gives us arguments from politicians and ideologues that "the stimulus didn't work." Yes, it is true that the economy continued to get worse after TARP was enacted, but that does not mean that it was a bad idea or a failure.

As I discussed on this blog earlier this year, in "The Economic Catastrophe That We Avoided," the difference between the economy that we have today and the economy of 1933 (or worse) is TARP, the stimulus, the auto bailouts, and the Federal Reserve's interventions. It is true that the financial bailouts were mishandled politically, and that the Bush and Obama teams both failed miserably in setting conditions for receipt of the government's help. That, however, does not mean that TARP or its cousins were failures. Ferguson's cavalier dismissal of this important point seriously harms the public's understanding of just how bad things could have been without government intervention.

The second area in which the film's argument falls short is in its discussion of the economics profession. Ferguson correctly points the finger at the very large number of very prominent economists whose work promoted the ideas that financial deregulation was an unqualified boon to the economy and that bubbles were (and still are) impossible. He excoriates Larry Summers, of course. He also interviews lesser-known players like Frederic Mishkin, a former Fed governor, and Glenn Hubbard, one of Bush's former chief economic advisors. Mishkin ends up looking like a fool, and Hubbard provides a nasty little outburst that was a wrapped gift for a documentarian like Ferguson.

Having noted the important role that economists played in justifying the disastrous, bipartisan policies that led to the Great Recession, Ferguson sensibly asks why so many highly-respected economists were so wrong. If the problem on Wall Street was too much money for high-fliers, Ferguson apparently reasons, perhaps the problem in economics is greed as well. Ferguson does not claim that economists want to get rich to buy fast cars, drugs, and women. Anyone who has met an economist would laugh at such an idea. He does, however, go to great lengths to describe just how rich a person can become by writing papers and giving speeches that support Wall Street's bottom line.

The film does an excellent job of discussing the lack of professional standards governing disclosures of conflicts of interest in economics. Ferguson asks why economists who have been paid by Wall Street banks to write papers that support Wall Street's agenda are not required to disclose that fact. Various prominent economists tell him that this is absolutely no problem. When Ferguson points out that medical journals rightly insist that researchers disclose the sources of their funding, one Harvard economist is literally rendered speechless.

Ferguson, however, essentially leaves it at that: Summers, Hubbard, and others have made millions by being shills for Wall Street, which must explain why they did it. That is simply wrong. I cannot imagine that either of those men wrote what they wrote to become rich, or that they continued to write such things after having been seduced by the riches of Wall Street. They are true believers whose arguments are congenial to Wall Street. Becoming rich was incidental to their career paths. They sought career success in top-flight economics departments, and the rest fell into place.

The better question, therefore, is how it has come to pass that the economics profession is dominated by men (and it is still very much a boys' club) who believe such nonsense. Some of these guys still think that there was no bubble -- that the financial crisis was actually a rational, equilibrium response to economic fundamentals. And even those who will not say anything quite that crazy publicly are still unfazed by the manifest failures of their ideology.

The important dynamic at work in the economics profession is that it has come to be dominated since the 1970's by a very narrow viewpoint. If a person does not begin his theorizing by assuming that individuals rationally maximize their own utility, then that person is dismissed by economists as "not serious" or, even worse, a sociologist. (The horror!) This is not merely the most widely-accepted methodological starting point for economics. It is the only acceptable starting point. It is true that some economists have built successful academic careers by putting bells and whistles on the basic model, exploring assumptions, such as "bounded rationality" and other forms of cognitive or other "errors," that change the results of models. Still, the starting point is always the same. If everything that might lead one to conclude that markets are not perfectly efficient (and incapable of crashing) is merely a modification of the only acceptable model, then a person who wishes to be successful in the economics profession knows where to begin. And where one begins is all too often where one ends up.

There are some very good economists who, even within the skewed ideology of modern economics departments, have risen above market fundamentalism. Joseph Stiglitz, Paul Krugman, Robert Shiller, and Brad DeLong are reasonably well known examples. The question is why their voices are (accurately) considered to be deviations from the dominant norm in economics. The idea that the rest of the economics profession is doing what it is doing in the pursuit of million-dollar paydays is simply not a credible answer to that question.

But see the movie anyway. The errors noted here are nothing compared to the strengths of Ferguson's analysis.