In today’s New York Times, in the magazine, Paul Krugman asks, How Did Economists Get It So Wrong? In the article he recounts how it happened that the world’s finest experts in macroeconomics were unable to adapt their models and, in doing so, develop better models able to predict the housing market implosion.
In my earlier post, the Second Order position vis a vis belief was explored. There are many ways to describe a Second Order belief. One way says: such a belief is a knee jerk reaction. Another option says: such a belief automatically follows from a specific predisposition. Enter an internalized model of any kind into the fundamentals of a predisposition, then where there is Second Order belief derived from the model, it follows inevitably from the model.
In other words, the model, in effect, programs the belief. Idealized programs very often generate idealized, absolute beliefs about the model.
But the self-described New Keynesian economists weren’t immune to the charms of rational individuals and perfect markets. They tried to keep their deviations from neoclassical orthodoxy as limited as possible.
But there was something else going on: a general belief that bubbles just don’t happen. What’s striking, when you reread Greenspan’s assurances, is that they weren’t based on evidence — they were based on the a priori assertion that there simply can’t be a bubble in housing.
In short, the belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history.
What would you say about a model purported to model macroeconomic actuality, where total belief in the model itself causes the model user to be blinded to particular actualities? What would you say about the nature of total belief in any blinded model. Apparently, best and brightest economic experts can come to be irrationally exhuberant about their own models.
When the financial crisis unfolded a year ago, and in response to the onslaught of ideologically-biased beliefs that rose up to ‘explain’ it, I took it upon myself to investigate the macroeconomic particulars. I did this as a smart lay person might do so. I immersed myself in academic research and the literature. Soon enough I latched onto an over-arching question: ‘when were the first warnings sounded?’ At the same time I familiarized myself–as best I could–with the arcane concepts of finance, especially derivatives.
To delve into intricacies, even superficially, is to develop a sort of heuristic ‘folk’ model populated with minimally understood concepts and operations. Yet, even from this modest base, one can also ask other pertinent, even if naive, questions. For example, I wondered: ‘how was it that the ways new financial instruments may tend to alter the orientation of a system, is perforce understood to only make the system more efficient?’
This naive question is a Third Order question. In other words, it grasps at implicit, different means for reckoning with an important supposition, posit, or principle. Implicit in this specific question are possible different answers about the aspects of orientation and efficiency or lack of efficiency. Alas, I possessed no repertoire from which to choose different ways to address the question. However, I could try to dig up instances where questions like this were being asked by experts and were not, then, naive questions at all.
What I soon enough discovered is that there were numerous outliers who, for example, asked questions about the possible perturbation of the efficient system which might be caused by the repeal of Glass-Steagall, a principle regulatory legal mandate for banks, in 1999.
And, so it went. How early on did some experts note the potential for a speculative housing bubble?
Byron Dorgan in 1999:
Jane D’Arista in 2000? Gramlich in 2001? William Ackman in 2002? McCarthy and Peach in 2004?
Alan Greenspan in 2005 testifies that the housing and mortgage markets will “bear more scrutiny in the coming months.”
Greenspan either wasn’t paying attention, or, the data outliers supplied was being heavily discounted.
Greenspan’s comment is not much different than a Tea Party person fretting about death panels. In both cases, reality doesn’t intrude on the programming.
Infatuation with a model or worldview or perspective or systematic framework or quasi-system is a hallmark of Second Order belief. Being infatuated often will support buffering of criticism. In fact, Second Order beliefs may be hermetic, in effect sealed off from any critical culture–even the critical culture part and parcel of the very domain of the system.
You can test this yourself in asking an advocate of a particular system, belief, perspective, worldview questions such as:
1. What are the weak spots in the model?
2. In what directions and to what ends are future developments of the model aimed?
3. Is there a critical literature about the model?
4. What are the most salient points critics have made?
5. What can the model not explain?
Etc.. These are questions a lay person may ask. If the subject isn’t forthcoming, or rejects in a knee jerk fashion any prospect for the model, (or what-have-you,) coming under critical pressure, then it may be that the model is held in the Second Order mode, thus is held not to be subject to any pressure.
This may be the case with many: people worried about having their liberties stripped away by treasonous socialists; people convinced 9-11 was put up by the executive branch; people who advocate the scientific sensibleness of Intelligent Design; people who are ideologically fixed to idealized economic models…on and on.