18 December 2008

What do you mean, there was no credit crisis?

One of the most memorable passages in the James Clavell novel, Noble House is one in which Quillan Gornt starts a run on a bank with a simple phone call. The notion of the contrived crisis came readily to mind when reading the Celent report, "Flawed Assumptions about the Credit Crisis: A Critical Examination of US Policymakers" (Table of Contents available here ).

In many cases, it appears that these policymakers’ assumptions regarding the credit crisis are incorrect. Far from seeing a tightening of credit, a number of measures show that credit has expanded, and Celent finds that the lending markets are in surprisingly good health. Data published (in most cases by the Federal Reserve itself) show that:

Overall lending by US banks is at a record high and has increased during the credit crisis.
Interbank lending is at record highs and has increased during the credit crisis.
Consumer credit is at record highs and has increased during the credit crisis.
Commercial paper markets are operating within their historical norms.
Lending by banks to businesses is at record highs and has been growing rapidly.
Municipal bond markets are operating within their historical norms.
Deposits at banks have shown a substantial increase since the start of the credit crisis.
“It appears that policymakers are making a variety of mistakes regarding the current financial crisis. If that is the case, the policy tools that they are employing may very well be the wrong ones,” Octavio Marenzi, head of Celent and author of the report. -- From the Press Release.
The report does not suggest that Bernanke and Paulson lied. They probably didn't. At best, they simply made what Doug French, called "Ben Bernanke's Pretense of Knowledge," (here):

[T]here is the belief that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level.

So while Bernanke, Treasury Secretary Hank Paulson, and soon-to-be Treasury Secretary Tim Geithner think they can crunch the data, make a diagnosis, concoct the right monetary witch's brew, and inject lots of it to make us all employed and living happily ever after, the fact is that's impossible. In the physical sciences, that may work; but...such complex phenomena as the market, which depends on the actions of many individuals, all the circumstances which will determine the outcome of a process … will hardly ever be fully known or measurable.

The wise ones at the Fed and Treasury are only looking at factors that can be quantitatively measured and disregard any factors that can't. Thus, they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.

No single observer could know all the factors determining prices and wages in a well-functioning marketplace. But because policy makers think they know, an almost exclusive concentration on quantitative measurable surface phenomena has produced a policy which has made matters worse. -- French, "Ben Bernanke's Pretense of Knowledge", internal quotation marks removed.

The French article mentions F.A. Hayek's Nobel Lecture, "The Pretence of Knowledge," here. There's a very relevant passage in that speech:

To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm. In the physical sciences there may be little objection to trying to do the impossible; one might even feel that one ought not to discourage the overconfident because their experiments may after all produce some new insights. But in the social field, the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous-ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. We are only beginning to understand on how subtle a communication system the functioning of an advanced industrial society is based — a communications system which we call the market and which turns out to be a more efficient mechanism for digesting dispersed information than any that man has deliberately designed.

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants. There is danger in the exuberant feeling of ever-growing power which the advance of the physical sciences has engendered and which tempts man to try, "dizzy with success," to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society — a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.-- Hayek, "The Pretence of Knowledge".
One would be well-served by reading the whole speech, as well as the entire French article.

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James Frank SolĂ­s
Former soldier (USA). Graduate-level educated. Married 26 years. Texas ex-patriate. Ruling elder in the Presbyterian Church in America.
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