At the World Business Forum: October 6, 2010
Steven Levitt, co-author with Stephen Dubner of “Freakonomics” makes complex economics both accessible and entertaining. Perhaps this is why his book sold four million copies. Ordinary folks can finally understand the economy we live in. Part Jon Stewart, part Bill Gates, the self-deprecating and affable Levitt rocked the World Business Forum audience with economic straight talk. The world-renowned economist warns that mainstream economists will become “irrelevant” if math wizards don’t change their models.
One of the most shocking discoveries during the financial crisis was the economics models for mortgage securities that top investment banks and securities firms depend on were not just flawed-they were completely wrong. Complex mathematical models such as “VaR,” Gausian Coppolas, and algorithms (yada yada) predicted the housing market would go up and up like a great big helium balloon and never come back to earth. We found out the hard way that markets are not made of helium. Ordinary folks knew this of course, but brilliant economists on Wall Street somehow missed it.
In the case of the later subprime mortgage security products created from NINJA loans (no credit, no income, no jobs, no assets), the markets were literally created from thin air, not helium at all. And gravity brought these faulty financial instruments crashing down with a big bang heard around the world. This bang has dramatically shifted the global economy and reshaped the world economic order going forward. The early 21st century’s greatest economic legacy will be how many “smart” people were so remarkably clueless when it came to understanding that what goes up must come down.
One of the problems economists face both on Wall Street and in the government says Levitt is that, “Economists are not interested in macroeconomics. Instead of looking at the real economy, they create formulas and models to avoid looking at the real economy.“ Why do our nation’s economic policies continue to be inadequate? Levitt says, “The role of economists in policy is not one of setting policy, but one of putting rubber stamps on it.“ Freakonomics Levitt declares that economics forecasts are based less on fact, than on politics.
Similarly, the financial markets functioned this way before the crisis. Firms wanted models that proved housing would continue to go through the roof. (No pun intended.) Economists who were skeptical were completely ignored. The result is found in the economic pain the world continues to endure three years later.
What’s the solution according to the charismatic Steven Levitt? Learn how to say, “I don’t know.” If we admit we don’t know, we might try to find out. That simple solution is the answer to many economic, social and political challenges. How can we resolve that? I don’t know.
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