The poverty of rationality

by John Quiggin on September 24, 2011

Steve Williamson has written a much longer critique of Zombie Economics. It’s a lot more temperate in tone than the blog post I criticised here, and there are some valid points. Nevertheless, the new version exhibits the same fundamental confusion I pointed out last time, trying to claim that rationality assumptions are both important and unfalsifiable.

I’m criticising it again because, in making this mistake, Williamson is not exactly Robinson Crusoe[1]. The same confusion is evident among a great many economists, and even more among proponents of rational choice models in political science and other social sciences. This, despite the fact that the key error was skewered by William Hazlitt nearly two centuries ago, writing on self-love and benevolence.

[click to continue…]

Banks and the bezzle

by John Quiggin on September 24, 2011

As a sort of response to Daniel’s post, I’d like to toss up some not fully digested thoughts about the fact that there have been very few high profile criminal prosecutions of bankers or others in the finance sector arising from the 2008 meltdown. There was of course the Madoff case, but it’s something of a rule-proving exception – Madoff was essentially a one-man show and he got caught for the very simple reason that his Ponzi scheme ran out of money.

The general immunity of the financial sector is an exception to the usual pattern described in JK Galbraith’s theory of the bezzle (exemplified by Madoff). The bezzle is the amount of undetected corporate fraud. As a boom continues, and everyone does well, people realise they can siphon off money and use it to make even more money. If they are threatened with detection, the original amount stolen can be returned to the till, and thye are still ahead. But, in a crisis, this can’t be done and, in any case, outside accountants are all over the books. So, embezzlers are caught and the bezzle shrinks. It stays small in the early stages of recovery when most decisions are being made by the cautious types who survived the crisis. But as the boom continues, hungrier and less-risk averse types come to the fore and the bezzle begins to grow again.

It’s also typically true that actions seen, while profitable as corner-cutting at worst, and as cleverly overcoming silly regulatory obstacles at best, are commonly prosecuted under much more aggressive interpretations of the law when lots of people have lost their money.

Why is it no one, or hardly anyone has been caught and convicted this time around? A few possible explanations over the fold, along with an attempt to respond to DD on whether this matters.

[click to continue…]