Last week, a group of eminent economists gathered in Bretton Woods, New Hampshire, to review responses to the financial crisis at a conference organised by the Institute for New Economic Thinking, a group founded by financier George Soros. The event led me to reflect on the phenomenon of confirmation bias, or the tendency to find evidence to support what one already believes.
Three years after it began, enemies of modern capitalism look back and perceive egregious instances of the failure of the market that they had always deplored. President Nicolas Sarkozy and Chancellor Angela Merkel see new flaws in an Anglo-American economic hegemony that they had long detested. Others on the right deplore the mistakes of inept regulation, lax monetary policy and poor policy responses.
The crash challenges established views, people will tell you, but this seems to be a recommendation to others, rather than a personal statement. Lessons have been learnt, they will say, but the lesson most people have learnt is that they were right all along.
This bias receives organisational reinforcement, too. In politics and corporate life there is strong competition to support the opinions of the great leader, be it the head of the International Monetary Fund, or a major bank. Media developments also make it all-too-easy today to find information only from sources that reflect one’s existing opinions; think Fox News or the blogosphere.
In economics, the academic realm ought to be the home of pluralist discourse but the growth of peer review and journal publication has undermined this. University economists, of the sort gathered at Bretton Woods, are now under relentless pressure to conform to a narrow, established paradigm. Inexplicably most supporters of that paradigm also feel that the crisis confirmed its validity.
All these factors played a part in the origins of the crisis. Within financial institutions, there was no incentive to challenge practices that appeared to be profitable. States saw little reason to question these same activities, which also contributed mightily to tax revenues. CNBC told everyone they were getting richer and the academic theory of finance reassured that all was for the best in the best of all possible worlds.
If this self-confidence was to take a knock in 2007-08, it was not for long. Alan Greenspan appeared then to partially recant when he told Congress in 2009 that he now doubted the models of rational behaviour on which he had long relied. But a recent article in this paper, criticising the Dodd-Frank Act, suggests that he has now recovered his composure. Mr Greenspan will no doubt be an enthusiastic viewer of Atlas Shrugged, the film of the novel by his mentor Ayn Rand, which is released in America this week. Many libertarians will go to cheer; a few on the left to jeer. But again no minds will be changed.
Britain’s Gordon Brown did stun the audience at Bretton Woods by seeming to admit an error in not having recognised the degree of interdependence in the global financial system. It may be churlish to criticise a man so relaxed now that the terrible burden of office has been torn from him. But his admission was but preliminary to a reminder that such interdependence reinforced the need for the much more extensive global financial regulation he had always advocated.
Mr Brown’s call will be well received at the impending annual meetings of the IMF and World Bank, as it was no doubt intended to be. If IMF head Dominique Strauss-Kahn runs for France’s presidency, there will be a vacancy to be filled by a European statesman. It is the custom at these global conclaves to conclude that the financial crisis requires that the institutions that host them should be strengthened.
In similar vein, the European Union discovered that the crisis demanded that its institutions should be proliferated and their powers enhanced. The Basel committees – which spent two decades devising complex rules on bank capital adequacy that proved perfectly useless before the crisis and damaging afterwards – quickly urged a still more extensive set of capital adequacy controls; and so on.
It was perhaps harder for banks to argue that the crisis proved how right they had been. But, as it turns out, not impossible. Here their revisionist view shifts responsibility firmly on to government – and even the public, which was guilty of robbing banks of money they never wanted to lend. “We were just the waiters at the party,” I heard one executive explain, clearly in ignorance of how much waiters are paid, or that most waiters do not get to determine their own tips.
Not everyone suffers from confirmation bias. If I eschew a visit to Atlas Shrugged, it will be because the plot is silly and the prose turgid, not because of its message. I also believe, on a dispassionate view of the evidence, that the crisis shows tougher regulation of the banking industry is preferable to supervision of its conduct – a view I have always shared with Sir John Vickers. I did misinterpret some elements of the crisis, believing that the securitisation bubble would create mayhem in the hedge fund sector rather than, as it did, in the major banks. But the outcome still provides strong support for the notion, a view I have long had, that risk capital is best provided by smaller institutions in close touch with investors, not the banks to which we entrust our savings. Funny, isn’t it, how even one’s errors confirm the power of one’s ideas?