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Blame the Banks?

“The economics profession has to face up to the fact that it has an ethical duty to begin to train economists and to begin to have a conversation about what it means to be an ethical economist,” says Professor George DeMartino. Photo: Wayne Armstrong

The financial crisis that erupted in 2008 — and shows no sign of ending any time soon —has prompted a debate among economists: How much were they to blame?

Considering how many scapegoats have been maligned for their role in the Great Recession — Wall Street bankers, Washington regulators, overextended homeowners — it seems fair game to point the finger at the professionals who predict where the economy is heading and advocate policies that influence its direction.

“It’s the first time in my generation that the economics profession has started to ask the question, ‘How did we get it so wrong, and what responsibilities do we bear for not having predicted or warned about the crisis?’” says George DeMartino, professor of international economics at DU’s Josef Korbel School of International Studies.

The crisis opened a window of opportunity to promote discussion of a subject DeMartino says his profession has not only neglected, but purposely avoided: the ethical responsibilities of economists. Building from a paper he wrote in 2006, the professor tackled the subject in book-length form in The Economist’s Oath: On the Need for and Content of Professional Economic Ethics, published in January 2011 by Oxford University Press.

While conducting research, DeMartino learned that professional groups, including the American Economic Association (AEA), have consistently rejected the idea of professional economic ethics.

“It wasn’t an oversight. This was done by design. Over the last 100 years there had been a number of times when individual economists had proposed to the AEA the need for the organization to adopt a code of ethics or other ethics initiatives,” DeMartino says.

Since the release of his book DeMartino has traveled widely, advocating that economists embrace ethical discussions and that ethics become part of the economics curriculum, especially at the graduate level. Most recently he was invited to join the World Economic Forum’s global agenda council on “Values in Decision Making,” which took him in October to the council’s meetings in Abu Dhabi. He also has been invited to attend the World Economic Forum’s annual meeting this January in Davos, Switzerland.

DeMartino says he tries to make it clear in his talks that he is proposing ethics training, not a code of conduct.

“You don’t need a binding code to get people to think differently about what they do, but you do need to give them some help,” says DeMartino, who has served on the Korbel School faculty since 1993. “You need to give them instruction and support to help them think carefully about their role in the world. In economics, for the new students coming up, we don’t give them anything whatsoever.”

 

Contributing to the crisis

The path that led to the Great Recession can be traced in part to policy decisions by the Federal Reserve, driven by the belief that markets would operate optimally if left unrestrained by regulations, DeMartino says.

“Economists not only pressed for the removal of existing financial regulation but also resisted new government oversight of the financial assets and market contracts that proliferated from the 1990s onward,” DeMartino writes in The Economist’s Oath. “In the face of concern by members of the U.S. Congress regarding subprime and collateralized lending practices and other financial innovations, Federal Reserve Chair Alan Greenspan consistently reassured policymakers and the public about the sufficiency of market mediation to discipline financial markets.”

DeMartino argues that economists advocated policies based on assumptions that proved to be faulty.

“They actually contributed to the crisis through the theories they teach: essentially the efficient-markets hypothesis, which says that the markets always get it right, and that’s the model that economists have been teaching for 30 years at least,” DeMartino says. “If you believe that theory and you teach that theory, you’re not inclined to think that there’s a financial bubble because bubbles don’t exist in that model. If prices are going up really fast, it must mean that something is happening to the underlying fundamentals that is driving the price increase, and you don’t have to worry about it.”

The subprime lending market — marked by the bundling of loans that were repackaged and sold — ultimately led to a housing market collapse and chaos in the financial markets as the inability of homeowners to pay their mortgages caught up with the byzantine chain of investors.

Economists and businesspeople underestimated “the viciousness of the debt cycle,” says William Greiner, president and chief investment officer for Scout Investments, a division of Kansas City-based UMB Financial Corp.

“Economists who don’t look at the variables from a monetary standpoint … would really shrug off debt as not a major issue,” he says. “I think that concept led us—not just the government, but us as a society—to accept more and more debt and not really ask those cutting-edge questions, such as, ‘What happens when this merry-go-round stops going around?’ I think that led to some real problems.”

Greiner, who is working with UMB to present a series of economic lectures at his alma mater, Washburn University, says graduate programs for economics students need to present a wider variety of theory.

“I think diversity of opinion and diversity of economic thought is really something that is important for people to understand,” he says. “Not just one general theory in economics, but a number of different theories because they all bring some meat to the table.”

DeMartino wants to take it a step further: Doctoral students who focus their attention primarily on economic models are unprepared for the political ramifications of their jobs, he says.

“Economics at that level is just applied mathematics,” he says. “Within two or three years they might be working at the World Bank and traveling around the world and finding themselves in extraordinarily complex situations for which they have not had any training whatsoever by the profession.”

 

When it gets real

Tucker Hart Adams, a Colorado Springs, Colo., economics consultant who has taught with DeMartino, remembers her first encounter with politics as a young intern. She had been instructed to evaluate the economic impact of a project that involved persuading businesses to set up shop in other locales around the state rather than in Denver.

“It didn’t take me very long to realize that if you did that, that they would just say, ‘Never mind, I’ll just go to Santa Fe or Salt Lake City,’” Adams says.

Adams soon got a dose of political reality when an assistant to the state official who commissioned the report bluntly told her that its goal was support for his position, not facts.

“I think it would be a really good idea for graduate students, even those who have no intention of doing anything but work in academics, to have an internship and have some hands-on time,” she says.

Economists should not be addressing ethical dilemmas in isolation, says DeMartino, who will continue the conversation in his forthcoming book for Oxford University Press: a “handbook” featuring articles about ethics by nearly three dozen leading economists.

“I don’t think we should leave it to each individual economist to just sort out what it means to be a good guy,” he says. “The economics profession has to face up to the fact that it has an ethical duty to begin to train economists and to begin to have a conversation about what it means to be an ethical economist.”

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