You Know, Not Everyone Missed The Problems That Were Brewing

I have already mentioned Edward Weick from the world of financial affairs who out in front of the current crisis, but in the world of academics let me also nominate my colleague Richard Wagner.  Dick Wagner is one of the leading scholars of political economy in his generation.  A product of the Charlottesville years of the Virginia School, Dick has been a leading thinker on the political economy of fiscal policy and public economics in general since his graduate student days.  He has also done astute analysis of the business cycle.  He is the author of several of my favorite articles in economics: e.g., "Boom and Bust: The Political Economy of Economic Disorder"and "Romance, Realism and Economic Reform"and one of my favorite books, To Promote the General Welfare: Market Processes vs. Political Transfers, and one of the more creative books written in the Austrian and public choice literature in recent years, Fiscal Sociology and the Theory of Public Finance.

Richard Wagner is a profound and wise thinker in economics and political economy.  Advice to students and faculty --- read everything you can find that is authored by him.  Of course, as I have said repeatedly on this blog, his Democracy in Deficit: The Political Legacy of Lord Keynes(written with James Buchanan) is the single most relevant book for understanding the mess we are in, and the mess we are continuing to create for ourselves.

As Alex points out over at Marginal Revolution, Dick asked the following question on a PhD field exam 3 years ago:

Joseph Schumpeter claimed that capitalism would give way to socialism largely for ideological reasons. This does not seem to have happened, at least directly. But might it be happening indirectly? Consider, for instance, a significant change that has occurred in the economic organization of debtor-creditor contracts. Not too long ago, lenders held their loans in their portfolios. They would lose if the borrower defaulted, which gave the lender a strong incentive to monitor the borrower, particularly for large loans. Now, lenders split their loans into numerous small pieces and disperse them throughout the economy. (For instance, many people who hold mutual funds and retirement accounts will find that they are holding small pieces of large loans made by commercial banks.) The burden of non-performing loans is thus dispersed throughout the economy rather than residing with the original lender. Does this development weaken the incentive offenders to monitor borrowers and thereby weaken overall economic performance? That is, can market transactions generate institutional arrangements that impair the market economy? However you address this topic, do so clearly and cogently.

Do note the details of the analysis in his question, this is not just saying that easy credit distorts the pattern of exchange and production.

Can you give other examples of somebody who analyzed the flaws in the system and the precise mechanism by which it would collapse?

Comments

[Edward J. Dodson]

I can think of at least four economists who have accurately analyzed and forecasted the economic crisis in which we have fallen. What each has in common is a very strong understanding of the operation of land markets and how the infusion of credit has fueled the inherently boom-to-bust nature thereof.

These are: Fred Harrison (in the U.K.); Mason Gaffney, Fred Foldvary and Michael Hudson (in the U.S.)

[Greg Ransom]

Mason Gaffney's popular articles are collected here:

http://www.masongaffney.org

Gaffney is an expert on forestry economics, with a background in old school capital theory (I once discussed the economics of Wicksell with Gaffney).

Gaffney makes the same point some others have made -- there is a great difference between wealth stored in production goods and wealth stored in "bubble" inflated land values (much of the housing boom in California has taken place in areas with a huge premium due to land scarcity -- an effect you don't get in say, Texas or Idaho).

Gaffney also happens to be something of a Georgist on land taxation.

[mthomas]

I would be interested if any full credit was given for answers to this question. If so, was there a market-oriented mechanism outlined?

That would be not only interesting, but helpful at this point.

[Sheldon Richman]

If there are no explicit or implicit guarantees from a government agency, I wouldn't expect the outcome the question inquires about. Without guarantees investors in securitized mortgages would be buying a pig in a poke. Why would they do that?

However, if regulation creates barriers to entry and investment firms are sheltered from competition, they may do reckless things that they never would do in a competitive environment.

[Sheldon Richman]

If there are no explicit or implicit guarantees from a government agency, I wouldn't expect the outcome the question inquires about. Without guarantees investors in securitized mortgages would be buying a pig in a poke. Why would they do that?

However, if regulation creates barriers to entry and investment firms are sheltered from competition, they may do reckless things that they never would do in a competitive environment.

[Bob Murphy]

Wow that is an amazing question. And I don't just mean because of its prescience, I mean because it actually refers to something in the real world.

I am exaggerating, but only slightly, when I say that at NYU such a question would be deemed unfair because you would have to know what was going on in the financial sector to really get the point, versus knowing how to calculate the shadow price of capital.