By Larry Marsh, Kansas City Star Midwest Voices columnist 2009
In Kansas City Fed chairman Ben Bernanke defended bank bailouts saying he stopped a 2nd Great Depression and called for Congress to create new ways to handle future, large bank failures, but he didn't get at the source of the problem: systemic flaws that cause failures in business strategies and economic analysis.
Every business must evaluate its risks and rewards, but it should never take the economy's course and speed for granted. Nowadays it is critical to evaluate both US and international sources of risk, not just for your own business and the immediate market, but for the economy as a whole.
Just as businesses make the mistake of taking the economy's course and speed for granted, government and academic economists take business rationality and efficiency for granted. Efficient Market Theory assumes that all available information about all possible risks and rewards are already taken into account in the price of a product or service.
For way too long, too many businesses have operated under the assumption that current economic conditions will continue to prevail. Should you take more risk to go for that extra buck, or prepare for the worst so that you will survive while your competitors die when the worst happens?
Business economists tend to assume that the overall economy will always operate efficiently. Instead they just focus on how to avoid their own mistakes and possible inefficiencies. On the other hand academic economists assume just the opposite. They assume that individual businesses will always operate efficiently - a monopoly will always efficiently maximize its profits - but the system as a whole may develop problems from mistaken government policies or exogenous perturbations like crop failures.
I attended Milton Friedman's birthday party a few years ago at the University of Chicago where Ben Bernanke was the main speaker and gave his famous admission that the Fed holds substantial responsibility for prolonging the Great Depression. Now is the time to admit that economics as a whole has failed us.
Masters and Ph.D. programs in economics must now face the fact that markets are not perfect and can go into disequilibrium for extended periods with cataclysmic outcomes.
In particular all economists must become sensitized to contagion effects where correlated behavior drastically increases risks. Business should not just ask: "Will I make more money if I do this?" but also: "What if everyone does this?".
Running worse case simulations must now become standard practice for both business and government economists. We must pay more attention to places like The Santa Fe Institute which specializes in studying dynamic, nonlinear systems. Academic economists must train their MBA students and Ph.D. candidates in system dynamics.
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Also see:
System Dynamics is key to success in economic forecasting.
Research needed to end economy's boom-bust cycle.
Enhance financial security, cut income tax with tax-deferred savings plan.
Financial crisis exposes deficiency in economic theory.
Without taxes, money would have no value.
Should California be allowed to create its own money?.
Trashing diet for cake and ice cream exposes flaw in economic theory.
Ostrom and Williamson win Nobel Prize in Economics.
Some Wall Street greed can never be satisfied.
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Ben Bernanke must also accept some measure of blame ....
.... for his own actions in creating the sense of unease.
Early last December, an internal review determined that the bank bailout program was having problems overseeing how funds were being used.
That report was withheld from public view until December 31 -- just after Congress voted on providing funds for additional bailouts.
Withholding information which would be classified as significant and substantive represents a fundamental failure on the part of Bernanke, along with the ex-treasury secretary and the ex-chair of the Securities & Exchange Commission.
An honest response on Bernanke's part would have been to acknowledge deficiencies in oversight along with reaffirmation of a pledge to make corrections and improvements. Instead, Bernanke, et al concealed facts.
I can't trust anything Bernanke says any longer for that reason.
As to Mr. Marsh's comments, I think he has made a compelling statement and I commend him for having done so. His reference to "contagion effects" is particularly appropriate.
a wider-angled lens
I believe that we need a more global view of the economic system(s) as analyzing and modeling market behaviors with "us only" in mind discounts the reality of a world with multiple market systems and various models of government, each capable of nuanced change management given their authority. You probably see this as well, Larry and perhaps that’s another column.
Dr. Bernanke’s academic expertise lies in the historical analysis of the (not so) Great Depression. As a historian, he’s adept at deconstruction, yet as our Fed Chairman, he’s challenged to construct or make something new. We may be expecting too much from him to think that he can lead an overhaul of a complex system with so many flaws and faulty prediction models, most of which are well-guarded proprietary decision and mathematical case tools.
And in business, I suppose that your lens is as wide as the one you can afford…
Tom Ryan
The Crossroads