How Economists (and Pundits and Politicians) Helped Steer America Off a Cliff

By Joshua Holland, AlterNet. Posted February 12, 2009.

JH: Now, we've heard that all of this was impossible to see. And of course, you saw during the run-up of the stock market bubble, the price-to-earnings ratios of some of these companies were just absolutely ridiculous.

And then, the stock market bubble burst and you saw a run to the housing market, because people thought, 'Well, OK, we can live in our houses.' You mention in the book that there was this kind of idea that as there was less security in the stock markets, people ran to the housing market. And again, you saw this huge bubble rise up.

When I interviewed you several years ago, this was something you were talking about. And yet, at the same time, virtually no economists -- none who have a bully pulpit in our media, who get a lot of attention in the press -- were talking about this. Why is that?

DB: Well, I think economists have very little incentive to really think for themselves. If you just say the exact same thing as everyone else, there's not really a downside to it. So just think of the incentives. Think about economists the way economists would think about economists -- or should think about economists. People respond to incentives. And, in this scenario, their incentives are all just to repeat, say the same exact same stuff as Alan Greenspan and everyone else is saying, and don't think about it.

Because, if you step out of line, if you get out there and say, "There's a real big bubble. It's going to be real bad news. It's going to wreck the economy, and we're going to have the worst recession since the Great Depression," well, you're taking a real big risk. Because obviously you don't know for sure that you're right. You might think you're right, but you don't know for sure. And if you're wrong, well, everyone's going to laugh at you. You'll be humiliated. You'll be ignored. No one's going to take you seriously. You won't get promoted. Who knows? You could even get fired.

So, economists shouldn't be trusted to ever step out of line, they shouldn't be trusted to think originally, creatively, because there's no reason for them to. It's all risk and very little upside. So, what we should expect is that all these economists, including many highly paid economists, are going to say exactly what every other economist will say, whether they agree with it or not. It doesn't even matter, because that's the incentive structure.

JH: At the same time, you had the raw data. I mean, home prices rose with wages and inflation for 100 years, essentially. And then, between 2002 and 2006, you point out in your book, real home prices rose by 70 percent. And, at the same time, you pointed out years ago -- when we spoke about your last book -- that there had always been a close relationship between rental prices and purchase prices, but that relationship got totally blown up in the early 2000s.

And it's just very difficult to grasp how it is that not only the media and economists, but also policymakers, could have ignored this. It's almost like there was this institutional desire to stick one's head in the sand.

DB: Well, I would certainly agree with that. You know, whenever I suggest that some people from the Clinton administration who are very much associated with these policies that brought us this disaster, who thought bubbles were fine back in the '90s. They thought the stock bubble was cool. You know, if you say that those people shouldn't have gotten top positions in the Obama administration, people think you're being vindictive. To my mind, though, well, you messed up in a really big way. That should affect your career. It's a reasonable thing. But, that's not the way it works. It's more like a fraternity. Once you're a member, you're a member, and it really doesn't matter what you do. And, that's the story.

JH: OK, let's move on to the current debates that are going on. We hear an enormous amount about a credit crunch. And this is supposedly a problem -- articulated by George Bush and Hank Paulson and many others -- where even qualified individuals and qualified firms are unable to access capital. And, you have been pointing out repeatedly that the real story here is quite different. Tell me what's going on today, in terms of the credit markets.

DB: Well, you know, I have to be careful there. I wouldn't say that there's no issue of firms not being able or having difficulty getting credit. Obviously, some are. And some of them are relatively healthy firms.

But the point I've made is, first off, that that's not the big problem. The big problem is that we have a lack of demand because we've lost on the order of $6 trillion in housing wealth and perhaps $8 trillion in stock wealth. And you'd expect, even if our banking system was totally capitalized, totally solvent, that that would cause big problems. That's what happens when you lose many trillions of dollars of wealth. People stop consuming. And that's really where our big problem is.

But the second point is that there are issues where people can't get credit. But in many cases, that's because they're a bad credit risk. They weren't bad credit risks two years ago, but they are today. And, this shows up very clearly in housing. If you look at the number of applications for home mortgages it's, again, one of these simple statistics that just tells you about everything you need to know. If you look at the number of applications for home mortgages -- new mortgages -- those haven't risen.

See more stories tagged with: baker, financial crisis, bubble economy

Joshua Holland is an editor and senior writer at AlterNet.

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