What I'm Reading
By Arnold Kling
A review copy of Markets on Trial: The Economic Sociology of the US Financial Crisis, edited by Michael Lounsbury and Paul M. Hirsch. One of the essays, by Ezra Zuckerman, says,
sociologists’ opposition to neoclassical economics generally, and to the EMH [efficient markets hypothesis] in particular, suggests two reasons to suspect that we might be comfortable in the role of contrarian. First, we sociologists clearly think that our value is greater than that reflected by our disciplinary status, especially relative to economics. Thus, there are at least some realms in which we are comfortable judging intrinsic value and disregarding “market price.” Second, insofar as Greenspan’s quote suggests that the contrarian position is the opposite of his own, and insofar as the contributors view themselves as opposed to Greenspan (and the efficient-markets ideology he espoused), one might conclude that the sociological orientation is that of the contrarian.
He proceeds to hedge this statement, and to discuss some other possibilities. Shortly thereafter, there is a printing error, where a blank page occurs, leaving a gap in the text. There is also at least one other blank page/gap elsewhere in the book. [UPDATE: I received the following from the publicist:
I’m sorry you appear to have received a faulty copy of the book. We have raised this issue with our printers, who have asked us to pass on their apologies. We’ve checked other copies of the book and it appears this is a one-off error, as all other books appear fine. I’d be more than happy to send you another copy of the book if you wish to return your faulty copy. As this was a one-time error and not a consistent problem, I’d be grateful if you could remove the section of your review where you refer to a printing error.
My main complaint about the book so far (it is nearly 700 pages, and I have read about 20 percent of it and skimmed another 50 percent) is that there is not much sociology. I would have liked to see some analysis of regulators as a class, of financial executives as a class, of the relationship between the two, and of their cultural norms. Instead, for my taste, the book contains too much narrative about the structure and growth of the mortgage-backed securities markets.
More comments below the fold.I admit to suffering from a fear that just about anything counts as economic sociology–that the paradigm imposes no constraints on its practitioners. You get some scientific-sounding jargon to employ, which you can use to express whatever prejudice you choose.
For example, there are several chapters applying something called “normal accident theory” to the financial crisis. However, Charles Perrow, the originator of that theory, denies that the financial crisis fits his model, indicating that he prefers something else:
It is the role of human agency, of human interests, that in the case of powerful governmental and business elites, can shape structures in their own narrow interests and promulgate cultures such as free market ideologies that will mask or justify narrow interests…It could be called “knowing malfeasance.” I see this elite behavior repeatedly in the financial meltdown. I see little acknowledgement of it in current structural and cultural theories.
The book is filled with criticisms of economic liberalism and the “Chicago school” (always using scare quotes). However, the authors seem to have no direct experience with reading any conservative or liberatarian economic thinkers. The economist most often cited is Paul Krugman. I would say that getting your view of conservative economics by reading Krugman is like getting your view of the Obama Administration from Glenn Beck.
One of the few authors who even refers to works by conservative economists does not appear to have read the works that he cites. John L. Campbell writes,
neoliberals who have argued that less government regulation is better…This, of course, is a view rooted in the classical writings of Friedrich Hayek (1944) and Milton Friedman 91962) who argued for free markets and against any form of state planning or state intervention into the economy other than for purposes of rectifying the most serious market failures or negative externalities. The largely unbridled pursuit of self-interest, they believed, facilitated the most efficient market behavior…
Economic sociologists and historians disagree with this view. They have argued that market activity is always embedded in and constituted by political rules and regulations…
Campbell and others in this volume accuse market-oriented economists of doing bad economics. Campbell writes,
I have argued that many roots of the financial meltdown stemmed from a number of regulatory decisions taken over the years that facilitated the creation of a large and ever riskier supply of credit into the housing market. Many of these decisions echoed the neoliberal prescriptions that policymakers in Washington embraced increasingly since the 1970s. The result was a massive market failure that sent the financial services industry and eventually the entire economy into a tailspin as economic sociologists and historians would have predicted.
I wonder whether this sociology will stand up empirically. Most of the regulatory changes that took place, including repeal of Glass Steagall and adoption of risk-based capital requirements, were not sold in terms of ideology. The stated goals were not to free markets but instead to modernize regulatory structures in light of technological change.
Were classical liberal economists on the inside? I think you will find that the financial regulatory agencies are staffed by people who believe in regulation, not by free-market ideologues.
The Shadow Regulatory Committee, which truly did represent the real Chicago school, was on the outside looking in when it came to policy. They argued for reining in Freddie Mac and Fannie Mae. They correctly predicted that risk-based capital requirements that were based on agency ratings of securities would lead to the corruption of those ratings.
The sociologists want to argue that regulators were market purists and yet were captured by the large banks. For example, Neil Fligstein and Adam Goldstein write,
Regulators mostly trusted in market actors to self-regulate.
Yet on the very next page they write,
the MBS [mortgage-backed securities] market is a case where regulators and banks have co-evolved in a way that has put the government in the position of creating the market, underwriting it, working to make it expand…Indeed, the government had to coax the banks into the MBS business. Democratic and Republican presidents and Congresses pulled the banks into the business by providing financial reforms that expanded the MBS market and worked to allow the largest banks to do anything they wanted.
Two pages later, they write,
all attempts to regulate these markets were thwarted by the regulators themselves, who bought into the arguments of the banks.
Throughout this book, there seem to be two views of regulators. One view is that they were devoted to free-market ideology. Another view is that they were captured by large banks. Those views are only reconcilable if you believe that the interests of large banks coincide with the position of free-market economists. This is simply not the case. Again, I refer you to the history of the Shadow Regulatory Committee for the positions actually taken by free-market economists in the 1980’s and 1990’s.
If the regulators were blindly devoted to ideology, it was not the ideology of free markets but the ideology of “affordable housing.” This motivated the creation and expansion of the secondary mortgage market. It motivated quotas and goals that pushed regulated institutions into riskier markets. It kept regulators from questioning the wisdom of the lending practices that emerged in the years leading up to the meltdown. As Fligstein and Goldstein put it,
in 2004, the MBS market experienced a supply shock…the supply of conventional mortgages peaked in 2003 and began a rapid decline thereafter. Approximately $2.3 trillion worth of conventional prime mortgages were bought in 2003 and this dropped to $1.35 trillion, a drop of almost 50%, in 2004. The steep decline in mortgage originations reflected neither weakness in the housing market nor slackening demand from the secondary market. Rather, a saturated prime market and an interest rate hike led to a significant drop off in the refinancings that had driven the 2003 boom…This meant that there was a huge incentive to increase the number of mortgages…and led to the rapid growth of the “subprime market,”
…In 2001, the largest conventional (prime, government-insured) originator did 91% of its origination business in the conventional market. By 2005 the largest conventional originator was doing less than half of its origination business within the conventional sector.
I assume they are talking about Countrywide.
Basically, the mortgage industry ran out of good borrowers in 2004, as prudent households became less active during the housing bubble. Instead, lenders discovered the subprime borrower. Regulators did not fight against this change. If anything, they cheered it on. The reasons for that are worthy of some investigation by empirical sociology.
But empirical sociology is exactly what is missing in this volume. Even if you are inclined to endorse the view that the crisis was caused by economic liberalism and deregulation, you will search in vain for empirical evidence. Where is the content analysis of regulations issued and their accompanying statements? Where is the social network analysis of the staffing of regulatory agencies? Where are the case studies of proposals made by free-market economists evolving into regulatory practice at financial agencies?
This book is worth reading, because market-oriented economists ought to try to understand what economic sociology is before we criticize it. I wish that economic sociologists felt the same way about market-oriented economics.