Wow, is Black fast. I had just seen the Krugman post decrying how the three academic authors of Romney’s white paper on economics – Glenn Hubbard, Greg Mankiw, and John Taylor – repeatedly and aggressively misrepresented research they cited in support of their positions, and wanted to say something.
As much as it’s good to see Krugman call this sort of thing out, it nevertheless raises a basic question: where has he been? He was soft on his colleagues when the movie Inside Job came out, which discussed corruption in academic economics, focusing on Frederic Mishkin, Larry Summers, Laura Tyson, and….Glenn Hubbard::
OK, about the economist-bashing: I thought it was basically fair. There aren’t, I think, all that many cases when economists are literally paid to offer a specific opinion — although Greenspan’s defense of Keating qualifies. But the movie didn’t say there are. What it suggested, instead, was a kind of soft corruption: you get paid a lot of money by the financial industry, you get put on boards, but only if you don’t rock the boat too much. Besides, you hang out with these people, and get assimilated by the financial Borg. I think all of that is very true.
In other words, the problem is cognitive capture. Right. So how do you explain Glenn Hubbard, who co-authored a solid piece that raised serious questions about LBO firms “Taxation, Corporate Capital Structure, and Financial Distress,” in 1990. Even though he put a major stake in the ground then, a scan of his subsequent articles indicates he has not revisited this topic. Might it be because he’s since joined the boards of KKR and Ripplewood Holdings (which BTW you don’t find on his official CV)? Oh, and might they have asked him to shut him up? Don’t laugh, it was common practice in the go-go M&A days of the 1980s to sideline the number one hostile takeover banker, Bruce Wasserstein (“Bid ‘Em Up Bruce”) by retaining him.
A Bloomberg editorial at the beginning of the year also suggested that the problem was more deep-seated than mere cognitive capture, and that money did play a corrupting role:
Academics often depend on the business community for the data they need to do their research, for the consulting gigs and board appointments that pad their salaries and for the contributions that keep their departments running. Also, in order to publish the papers that make their careers, they commonly face the scrutiny of editors who themselves are positively disposed toward the interests of business.
As a small test, Zingales looked at the 150 most-downloaded papers that had been done on executive pay. He found that papers supporting high pay for top executives were 55 percent more likely to be published in prestigious economic journals. They were also much more likely to be cited in other papers.
The test will be whether Krugman continues in his new-found enthusiasm for calling out bad behavior among his peers.
By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Cross posted from New Economic Perspectives.
Paul Krugman has written an article entitled “Culture of Fraud” about the Romney economics team.
Still on vacation, but I have internet access for a bit, and have checked in on a few matters. The big story of the week among the dismal science set is the Romney campaign’s white paper on economic policy, which represents a concerted effort by three economists — Glenn Hubbard, Greg Mankiw, and John Taylor — to destroy their own reputations. (Yes, there was a fourth author, Kevin Hassett. But the co-author of “Dow 36,000″ doesn’t exactly have a reputation to destroy).
And when I talk about destroying reputations, I don’t just mean saying things I disagree with. I mean flat-out, undeniable professional malpractice. It’s one thing to make shaky or even demonstrably wrong arguments. It’s something else to cite the work of other economists, claiming that it supports your position, when it does no such thing….
Is it really surprising, then, that the economists who have decided to lend their names to the campaign have been caught up in this culture of fraud?
I have often written about economists’ tribal taboo on taking fraud seriously or even using the “f-word.” (For economists, it’s like saying “Voldemort” out loud.) It is one of the leading shapers of the intensely criminogenic environments that create the perverse incentives that drive our recurrent, intensifying financial crises. Krugman seems particularly surprised that Mankiw (Harvard) would join the fraudulent culture, but Mankiw has been notorious in this regard for nearly two decades. He was a discussant at Brookings in 1993 when George Akerlof and Paul Romer presented their paper (“Looting: the Economic Underworld of Bankruptcy for Profit”). Akerlof and Romer explained how accounting “control fraud” occurred, why it was a “sure thing,” and how it hyper-inflated bubbles and drove financial crises. Akerlof and Romer (working in conjunction with savings and loan regulators and white-collar criminologists), ended their article with this paragraph in order to emphasize their central message:
Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (George Akerlof & Paul Romer, 1993: 60)
Mankiw dismissed the article’s thesis and conclusion using the economists’ favorite term of disdain (“anecdote”). Mankiw’s dismissal was dishonest, the article he was reviewing was not anecdotal. Mankiw’s infamous conclusion was that “it would be irrational for savings and loans [CEOs] not to loot.” Indeed, he expanded on his fraud-friendly thesis:
Consider an owner of a savings and loan who is taking excessive risks, hoping that they pay off and make him rich. It is only prudent for him to loot as much as he can, because he knows that his gambles might not pay off.
Looting one’s shareholders and creditors was not only “rational,” it was the “only prudent” strategy under “Mankiw-morality”.
Mankiw rejected Akerlof and Romer’s explanation of how deregulation created the perverse incentives that drove the fraud and claimed that the problem was overregulation. Akerlof and Romer’s warning (a warning that we the regulators and white-collar criminologists made contemporaneously) could have prevented a repeat of the financial disaster. Unfortunately, the Clinton and Bush (II) administrations followed Mankiw’s policies and produced the criminogenic environments that drove the accounting control fraud epidemics that produced the Enron-era crisis and the ongoing crisis.
Reading Mankiw’s claims as discussant, where he missed everything important in Akerlof and Romer’s (and the S&L regulators’ and criminologists’) insights and pronounced his faith in the dogma of efficient markets preventing all fraud make particularly painful reading today. His statements as discussant foreshadow all the most destructive creeds that produced the Enron-era and ongoing fraud epidemics.
It is vital to understand that the claim that “accounting fraud” is impossible was not an isolated dogma shared by only a few acolytes. Under even the weakest variant of the efficient market hypothesis, accounting control fraud could not exist or markets would (particularly given the Gresham’s dynamic that Akerlof explained in his 1970 article on “lemons) not be efficient. Because the efficient market hypothesis is the foundation on which all of “modern finance” is built, the circular belief that fraud is impossible because we know markets are efficient was the dominant dogma among finance theorists.
The Frontline special (“The Warning”) explains that Alan Greenspan believed that fraud could not exist and therefore eagerly destroyed Brooksley Born’s (CFTC Chair) effort to protect us from credit default swaps (CDS). It was that same dogma that led Greenspan to an even more catastrophic refusal to act. The Federal Reserve had the unique authority under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to ban endemically fraudulent liar’s loans. Greenspan refused to do so despite pleas from colleagues and housing advocates (including ACORN). Indeed, the refused pleas to even send the Fed’s examiners in to the holding company affiliates making the fraudulent liar’s loans to determine the facts. Greenspan and the Fed economists then, having refused to find the data, shamefully dismissed pleas to use HOEPA to ban liar’s loans by experts who explained how the frauds and predatory lending occurred on the grounds that the experts’ reports were “merely anecdotal.”
Similarly, a generation of American lawyers who have studied corporate law have been reading Frank Easterbrook and Daniel Fischel’s assertion that: “a rule against fraud is not an essential or … an important ingredient of securities markets” (Easterbrook & Fischel 1991). They do not inform the reader that Fischel, in his capacity as an expert economist for Charles Keating (who looted Lincoln Savings), tried applying this fraud-free dogma in the real world. He, and Greenspan (who served as both an economist and lobbyist for Keating – Keating used Greenspan to recruit the five senators who became known as the “Keating Five) opined that Lincoln Savings was a superb S&L with stellar management. Lincoln Savings proved to be the most expensive S&L failure and Keating the most infamous fraud.
To sum it up – the surprise is that Krugman is surprised. Neo-liberal economists, globally, have been the most valuable allies to control frauds. Mankiw is not a late convert, but among the earliest and most strident apologists for the elite frauds. Mankiw’s mendacity has been on open display for nearly two decades. Here’s the really bad news: the room full of prominent economists who listened to his praise for the looters expressed no disapproval of his “friending” of the frauds. Harvard, under Larry Summers, epitomized the economics taboo against taking fraud seriously. Andrei Shleifer remained the editor of the most prominent journal in the field, protected by Summers from any consequences. My recent column explained how a New York Times columnist (Eduardo Porter) cited Shleifer as his primary source on fraud and the Gresham’s dynamic it can produce without Shleifer informing the journalist of the fraud decision that had just dome down against Shleifer.