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Brooks Wilson's Economics Blog: Didn’t See It Coming

Wednesday, January 19, 2011

Didn’t See It Coming

In response to the post, “Markets and Government,” a student asked, ”I would like to know if economist knew that we were going to suffer from the financial crisis? If so, why didn't they do anything about it? I find it kind of interesting that nothing was done to keep us out of the financial situation we are in now....or was it just too late?”

The answer to the first question is a little embarrassing, few economists saw the financial crisis coming.  Although not a satisfying answer, the main reason so few recognized the danger is that the vast majority of economists have expertise and interests outside of the housing market and finance.  The answer is not satisfying for a second reason, few financial economists saw it coming either and their warnings were largely ignored. Raghuram Rajan, who I quoted in “Markets and Government,” was one economist who saw the writing on the wall.  Others included Nouriel Roubini, and Nassim Taleb.  The financial crisis was the confluence of many problems, most of which were seen and understood.  Government officials carefully created a system of regulation to deal with these problems and economists added a great deal of insight into these regulations.  This implies that my student’s assumption in framing the second question is probably wrong, it wasn’t that the government did nothing; it was that the steps it took were ineffectual or inadequate.  As Seabright wrote in Foreign Policy,  “The Imaginot Line,”
There are important lessons to be learned from the [financial] crisis. But we'll learn them better if we realize that the intellectual and political architects of the system that failed us were not naive at all, but immensely clever and subtle; it was their cleverness and subtlety that undid them. And that is bad news for all of us, for naivete can give way to learning, but cleverness has no obvious higher state.
Seabright explains the regulatory philosophy that guided the government and why it failed.  His article is a good place to start, but the issue of what caused the financial crash is so enormous that economists will debate its root causes for a century. 


  1. I agree that the cause of our current financial crisis will be debated for a century. I feel sure that it has many contributing factors, some we're aware of and no doubt some that haven't come to immediate attention. And I also feel sure the blame would have to go to a lot of people making bad decisions, over a period of time; not just a president, and not just a handful of politicians.
    Principle 8 of Economics, concerning productivity, states that to boost living standards, policymakers need to raise productivity. They can do this through better education for workers, and better technology. Maybe these would be good places to start, to improve the situation.

  2. Lisa R Smith20/1/11 9:29 PM

    I think the financial crisis is a result of too many people over-spending with borrowed money. We as a society want everything now and don't want to put in the time it takes to earn it so we borrow it. The same is true in the financial market if you over extend yourself over what you can afford you eventually will crash. Government involvement in our free systems always leads us having less control. The market would have recovered on its own but everyone got scared and made rash decisions.

  3. Carla Wilson20/1/11 10:44 PM

    I agree the finiancial crisis is a result of too many people over spending. This allows people to get into financial debt and people start purchasing things they are not able to afford. There are credit card companies that offer higher credit limits giving people the opprtunity to purchase things to boost the economy. In this effort its hurting many people credit and its making it hard to recover

  4. I have only been studying economics for 2 weeks. I am the furthest thing from an expert that it gets. However, the more I read about the science of economics the more I think it is like a biologist trying to apply scientific protocol in a petri dish while riding a roller coaster blindfolded.

    That may be an overstatement, but it is a scary thought to think that professional economists can be seduced so easily and blinded to such a vast paper mache replica of a real economy.

  5. There were several contributing factors to the financial crisis our country is facing but I don't think anyone expected it to get as bad as it has. Anytime the government steps in it seems to make things worse. The only bailout I agreed with was for Fanny Mae and Freddie Mac only because the government caused the downward spiral of the housing market. There is a reason people have credit scores and when the government's credit is below minimum then who are they to decide for other companies how to run their business.

  6. I think it is ridiculous that our professional economists did not see this coming. We pay them the big bucks for a reason and they are not living up to their reputation. I agree that it is scary to live in a world where no one can predict things like this from happening.
    Now I can say that no one expected all of this spending of money that we honestly don't have. People have credit and abuse the heck out of it. I've seen money being abused more than I can count.

  7. I must admit that I find it a little surprising that more economists did not see that we were heading for such a large financial crisis. With that being said, I think to point fingers and play "the blame game" now is pointless. Even if they had seen it coming, would they have been able to predict the way the government handled the situation? As stated above, few economist did warn of the potential for such a crisis, but they were largely ignored. The country as a whole contributed to the financial down fall by living outside of their means and frivolously spending borrowed money, but I do feel that the governments handling of the situation only made it worse. I believe that is something that the economists could not have predicted and should not be blamed for.
    ~Kim Huffman