Persistent Illusions

It is amazing to what extent ideologues will go to justify their madness. In an article in The Week, Brad DeLong takes Richard Posner to task for their persistent denial of reality:

Richard Posner, leader of the Chicago School of Economics and Fourth Circuit Court of Appeals judge, uses his new book, “A Failure of Capitalism,” to try to rescue the Chicago School’s foundational assumption that the economy behaves as if all economic agents and actors are rational, far-sighted calculators. In some sense, Posner must try. For without this underlying assumption, the clock strikes midnight, the stately brougham of Chicago economic theory turns into a pumpkin, and the analytical horses that have pulled it so far over the past half- century turn back into little white mice.

Thus he writes: "At no stage need irrationality" on the part of markets or their participants "be posited to explain” the collapse of financial markets last year and the current deep recession.

Posner’s effort looks to me like an earlier effort to “save the appearances” in the face of discomfiting contradiction. The Jesuit astronomers of 17th-century Rome wanted above all to maintain the assumption that the sun revolved around the earth—for if it did not then the Bible’s declaration that Joshua called on God to make the sun stand still in the sky was a lie, and a Bible that lies even once cannot be the inerrant foundation of faith.

Thus the Jesuits created much more complicated models than the elegant heresy of Copernicus, in which the earth revolved around the sun. They succeeded in their attempt to save the appearances. Posner’s attempt does not: It is definitely a retrograde motion, for we see many things in the financial crisis and the recession that are not what we would see in an economy populated by smoothly rational utilitarian calculators.

• It was not rational for Bear-Stearns CEO James Cayne, with his own $1 billion fortune on the line, to allow his firm to become hostage to the excessive risks taken by his subordinates in the mortgage markets.


• It was not rational for Citigroup CEO Charles Prince to keep dancing to the music, without thinking which seat Citi would claim when the round of musical chairs came abruptly to a halt.


• It was not rational for shareholders of newly incorporated investment banks to offer traders large annual bonuses for performance assessed by a year-to-year mark-to-market yardstick—rather than rewarding them with long-run restricted stock that would hold its value only if the traders' portfolio strategies proved durable.


• It was not rational for the shareholders and executives of General Motors and Chrysler to ignore the need for a Plan B in the event Americans fell out of love with SUVs.

The litany of financial lunacy is longer than even the Eastern Orthodox litany of the saints. Yet Posner’s insistence that the crisis cannot spring from compound irrationality drives him to a claim that the real cause is a failure of government—specifically a too-lax, too-nurturing, insufficiently strict Mommy State that raised the children all wrong.

I've bolded the key delusion of this economic school. This irrational belief was the life blood of politics for the last 30+ years.

Go read the whole article, it is well worth your time. For example, DeLong points out:

Yet while Posner insists on saving the appearance of individual rationality, he is willing to jettison the Chicago School's conclusion that markets are everywhere and always perfect. As Robert Solow observed: "If I had written that, it would not be news. From Richard Posner, it is." Abandoning the conclusion of market perfection opens the door to the idea that government needs to properly check, balance, and regulate markets in order to help them function as well as possible. But clinging to the assumption of individual rationality forces Posner’s view of what regulation is appropriate into a very awkward straightjacket.

And this:

The key irrationality was a private-sector failure on the part of the shareholders and top managements of the banks to make sure that their traders had an appropriate stake in the long-run survival of the bank and not just in constructing a portfolio that would be marked-to-market at a high valuation on Dec. 31. And the government needs, for all our sakes, to compensate for this private-sector irrationality. That’s the conclusion that Posner’s book should have reached. But it never gets there: Because to get there, he would have had to begin his book by acknowledging that it matters that the earth revolves around the sun.

This is an excellent analysis of the dangerous illusion that was foisted on us by right wing ideologues and has persisted for so long to everybody's detriment. It is time to let the sun in and clear out the cobwebs. A new day of intellectual honesty is hopefully dawning.