Tuesday, March 31, 2009

Good article in today's paper

I extracted and reproduced the following here because I believe the author has a useful philosophical perspective into the current world financial crisis.

Definition of foibles: a quirk, idiosyncrasy, or mannerism; unusual habit or way (usage is typically plural), that is slightly strange or silly;
Definition of hubris: Excessive pride, presumption or arrogance

Markets are ruled by human foibles, not by science
Daniel Cloud

March 31, 2009

To understand how we got ourselves into our latest economic mess, complicated explanations about derivatives, regulatory failure and so on are beside the point. The best answer is both ancient and simple: hubris.

…. The problem is that no matter how "scientifically" these new beliefs were formulated, they are still false. Capitalism is, among other things, a struggle between individual people over the control of scarce resources. Like boxing and poker, it is a soft, restrained, private form of warfare. Military strategists have known for centuries that there is, and can be, no final science of war. In a real struggle over things that matter, we must assume that we are up against thinking opponents… if profit can be made by understanding the model behind a policy… , sooner or later so much capital will seek that profit that the tail will begin to wag the dog, as has been happening lately.

…. The truth is that such models are most useful when they are little known or not universally believed. They progressively lose their predictive value as we all accept and begin to bet on them.

…. If investing is simply a matter of allocating money to an index, however, liquidity becomes the sole determinant of prices, and valuations go haywire. When a substantial fraction of market participants are simply buying the index, the market's role in ensuring good corporate governance also disappears.

.… Despite this, in the course of the past 20 years economists began to act as if we thought we could genuinely predict the economic future. If the universe didn't oblige, it wasn't because our models were wrong; "market failure" was to blame.

…. We repeatedly rescued bubbles, and never deliberately burst them. As a result, our financial markets became a pyramid scheme.

…. But a market is not a rocket, economists are not rocket scientists, and moral hazard is, in human affairs, the risk that matters most.

…. Governments think we can stop this process by throwing money at it, but there are many reasons to believe that this won't work. The banking system is probably already past saving — many institutions simply aren't banks any more but vast experiments that didn't work out as predicted.

If we cleave to the false security of a supposed science that isn't working, and forget about the philosophy behind it and ideas such as personal responsibility and the right to fail, our leaders will very scientifically give us no recovery at all.

Daniel Cloud teaches philosophy at Princeton University and is a founding partner of two hedge funds, Firebird Fund Management and Quantrarian Capital Management. Copyright: Project Syndicate/Institute for Human Sciences, 2009. www.project-syndicate.org

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