Home > Uncategorized > Krugman and Eggertsson’s model of the Global Financial Crisis of 2007-8

Krugman and Eggertsson’s model of the Global Financial Crisis of 2007-8

from Geoff Davies and RWER

Yet consider a model of the Global Financial Crisis of 2007-8 by Eggertsson and Krugman (2012), the latter a pseudo-Nobel prize winner. They made two models, one for before and one for after a crash, with the difference between the models being effectively that the amount of available credit was presumed to be less in the second. Nothing in the model determined the amount of credit, it was imposed from the outside. Their equations of optimisation did require sophisticated, though old-fashioned, analytical methods to solve, but that says nothing about the usefulness of the models.

 

Both models are equilibrium models. But if the “before” state of the market, with high prices, was an equilibrium state there would be no crash. Therefore the model must be missing the imbalance that drove the crash. It is therefore incapable of telling us why such a crash occurred. It cannot tell us anything about the dynamic process of boom and crash, the inflation and bursting of a debt bubble. It is not a useful model, it is a useless model, a dead end as far as understanding an observable economy is concerned.

read more: http://www.paecon.net/PAEReview/issue95/Davies95.pdf

  1. September 14, 2021 at 10:47 am

    Accepting Richard’s thesis of the need to reintegrate economics and morality, my concern is that the fragments he is having to work from have misinformed him in a way that prevents his seeing why it is persisting and what can be learned from looking at the facts. The blog editor has taken up the story shortly after Richard’s most significant bit of misinformation:

    “Also in this [Luther] period, the Catholic Church had the hubris to claim authority to convert the peoples of Europe’s new world to Catholicism even if it killed them. The Church’s hubris transformed into enlightened hubris and then capitalist and socialist hubris with respect to transforming or killing other cultures in the name of developing them”.

    A lovely bit of rhetoric, but I am writing as a Catholic knowing the other side of this story. In the medieval church the problem of hierarchy had been settled by the Pope, the father figure in the Catholic Church, having moral authority over the king, the father figure in secular matters: this at least since the then English king’s men killed Thomas a Beckett, leader of the English church. The Pope is no more the Catholic Church than our Queen is England.

    Hubris is a fault of individuals, and dna makes sure no two are the same. In 1492 not only did Columbus discover the West Indies but a Borgia became pope and in 1494 approved of Spain and Portugal [i.e. their leaders] dividing the New World between them. The Catholic Church eventually took Luther seriously enough to start a counter-reformation in 1545 at the Council of Trent. The king of France became Catholic in 1593 and guaranteed religious freedom in the Edict of Nantes. 12 years later he was assassinated; the different French king a century later revoked the edict. Other evidence shows how the church went to the Americas to teach; Machiavellian kings persuaded the pope to close thriving missions by claiming them heretical.

    Conditions in London’s docks shocked Pope Leo XIII into writing “Rerum Novarum” in 1891, calling for reconsideration of economic principles in light of human needs lost sight of in the New Age. More recent popes added the political principle of subsidiarity, the justice principle of reciprocity and the appeal for solidarity which undermined the soviet system in Poland. All this never gets considered when even mention of God or Catholic triggers knee-jerk reactions. Yet the “Small is Beautiful” sequel to it is precisely what open-minded people are seeing has become not only necessary but urgent.

    The etymology of the word ‘church’ is interesting. It comes from the Greek word for ‘Lord’, i.e. belonging to the lord, religion being seen by thinkers as thanking our Father for dying that we might live, and by the empirical and Doubting Thomases as a building they see religious folk going into. Why do people think so differently? Why the clash between Right and Left in politics? Again studious Right-minded economists accept the clash rather than ask the question or study the Left-minded artist who answered it in terms of brain logic rather than knowledge. Have I not repeatedly mentioned G K Chesterton and Jung, yet still Ikonoclast above sees the French rather than the Copernican style of revolution as the only remedy for injustice. But hence again the difference between ‘economics’ and ‘ecology’: the one having a name for every ‘thing’ without knowing how it works, the other looking at everything to see how it works.

    Again economists are still looking for static systems of mathematical relationships rather than studying how communication works to transform them in telephone exchanges or computer switching logic; or how C S Peirce’s system of scientific logics (in order: abduction, deduction and induction) explains stable results when cycled continuously and change when not. What they haven’t seen is how Right-minded mathematicians transformed iconic geometry (earth measuring) into symbolic (undefined) algebraic symbols, and hence left them disconnected from the earth they are supposed to be studying. Newton knew better than that: he used the old three-dimensional visual geometry and trigonometry to justify his findings.

  2. September 14, 2021 at 11:08 am

    Apologies, Geoff. I thought I was posting this to the Richard Noorgard blog, which is still up on my computer on a different screen.

    Regarding our own observations, I can but agree. The above is not so much about why as suggesting what to do about it. We actually need geological rather than some undefined nominal equilibrium, but we are way off track and need right now to be back-tracking, repairing the damage as we go.

  3. September 14, 2021 at 2:37 pm

    Anyone ignoring US investment banks & European banks could leverage their capital 62.5 times with MBS rated AAA to AA, or assets with a default insurance (CDS) issued by AAA rated entities, like AIG, has no idea about what caused the 2007-08 GFC.
    https://subprimeregulations.blogspot.com/2016/09/if-ever-allowed-following-would-be-my.html

  4. Ikonoclast
    September 14, 2021 at 10:55 pm

    “There is nothing permanent except change.” – Heraclitus.

    Since everything is in process in our time-governed world, we should regard an equilibrium as a process pause. An equilibrium is just a pause or hiatus in a longer process or processes. Equilibria exist as a sub-set of system processes. Hence equilibrium theory must exist as a sub-set of system process theory.

    The three “metas” of system processes (including process pauses as equilibria) that we are interested in are (to lay them out provisionally);

    (a) Expansion (as processes like accretion, growth or explosion);
    (b) Stasis (including dynamic stases like homeostasis)
    (c) Collapse (as processes like decay or implosion).

    Disruption of equilibria and inflection points in a given process can be illustrated on the same graph, with the horizontal axis as the time axis and the vertical axis showing the variable under consideration. An equilibrium will be a straight, horizontal line with minor “noise” or perturbations, like a graph of a healthy person’s temperature. We don’t see many graphs like that in economic phenomena do we? Can anyone think of one? I can’t. Ergo, equilibrium models are pretty much nonsense when it comes to conventional economics.

    Instead, we see graphs like the one Geoff Davies has produced. We see growth and collapse junctures and then more growth. We see dynamic processes. Of course, endless growth to date does not imply endless growth is possible indefinitely. Indeed, endless growth is impossible on a finite planet. When we see major and rapid “reverse disjunctures” in growth or decline graphs (like the one in Geoff Davies’ graph) then it is reasonable to look for causes. The appearance of the disjuncture in itself does not usually reveal the cause by itself. The action we must take (usually action is required) must depend on discovery of the cause.

    If an explosion occurs in a big city, our action depends of the cause. An explosion in a big city could be a gas accident, an industrial accident, a vehicular accident involving large quantities of industrial fuels or chemicals, an explosives accident or a deliberate bombing. There are other probable causes. It could be an aviation accident. We must find the cause. Then we will know what to do, at least in broad terms, to begin remedying the situation, as far as possible.

    I will pause my discussion at this point and come back to the issue of causes. Suffice it to say I will talk about real causes and formal (rule) causes of behaviors in the economic system. We need to talk about this because a socioeconomy or political economy is influenced by both types of causes. And if we don’t separate out and then understand real causes and formal (rule) causes we are never going to unravel the Gordian Knot of “economics”.

  5. Ikonoclast
    September 15, 2021 at 2:28 am

    Please read my comment above on September 14, 2021 at 10:55 pm, before reading this comment. That comment sets the scene.

    Part 2.

    I need to state something front. What I present below is not any part of so-called “game theory” in conventional economics. That “game theory” is supposedly “the study of mathematical models of strategic interaction among rational decision-makers.” That theory holds no interest or value for me. It presumes the existence of “atomistic” and unrealistically rational actors without a full real environment context and without a full social context. That model is already so curtailed it is too abstract to tell us anything descriptively valid and useful about real socioeconomies or political economies. Instead, I propose to look at something I term competitive-cooperative game theory. Let us enter upon the subject as below.

    What controls the action on a basketball court? I mean “controls” especially in the senses of “directs” and “causes”. We can list the basic factors that control the action on a basketball court as follows:

    (1) Fundamental Laws (The arena of investigation of the hard sciences).
    (2) The actions of humans. (The arena of behavioral and social sciences).
    (3) The extant rules and parameters of the game. (The arena of legal law and custom).

    The game happens in the real world on a physical field (a court in this case) where physical events closely obey at least all known fundamental physical laws. The game is played by physical humans taking decisions and actions. (A decision is an action too in the monist materialist, not the Cartesian dualist, purview.) The game has rules and parameters. Parameters are a sub-set of the rules which define the physical field of action. The parameters define the size of the field, the height of the basket ball ring and the size and type of ball for example. The rules essentially prescribe freedoms and limits for the players (as actors or agents). Basketball is an example of a competitive-cooperative game.

    We need to define the term “competitive-cooperative game”. A simple definition is that people compete and cooperate to set the rules and parameters for an enterprise or game so that competition and cooperation may take place within the field, bounds, rules and parameters of the game. There is a sense of both the “nesting” of levels here and of dialectic or iterative feed-backs between the levels. A governing body of a game typically has a rules committee. People will compete and cooperate to get on the committee and/or to get rules through the committee. Active coaches and players are typically not on the rules committee unless in a minor, advisory and observing role as coaching or player representatives. Otherwise conflicts of interest could easily arise.

    Players compete on the court or on the field. But it is both a competitive-cooperative game and a cooperative-competitive game. People cooperate to compete and they compete against the other team to enjoy (hopefully) winning cooperation on their own team. Watch groups cooperating at a neighborhood court to set up a competitive neighborhood game of basketball. They cooperate to compete. Watch the high fives of celebration after the winning cooperation of the winning team. Watch the re-strategizing and “low fives” of mutual encouragement in a losing but still functional team. Groups compete with the outgroup to experience cooperation in an in-group. The need to belong and cooperate is strong. This is particularly noticable when game competition is required to replace more existential struggles in tribe versus nature or tribe versus tribe competition, in more strictly existential survival settings.

    A political economy is a competitive-cooperative game. It has a real arena: two levels in fact as real environment and real economy. It has humans acting, as I often say, as rule makers, rule takers and rule breakers. To search for fundamental laws outside of the real environment and real economy is fruitless. And when it comes to the real economy I mean fundamental laws which govern real production, like rain governing crop yields unless we can irrigate, chemistry determining how paints can and cannot be be manufactured and so on. Once we hit the level of humans, their behaviors and actions – other than their autonomic nervous system functions – are the realm of what we term voluntary behaviors and actions. Our voluntary actions take the form, in a society with rules, of making, obeying and disobeying rules.

    Instead of looking for fundamental laws in political economy, we simply should be looking for good and bad rules. And we need to look radically at our most prescriptive rules. The axiomatic rules of private property, as constructed in modern neoliberal or unfettered capitalism, lead to the continuing concentration of wealth. The concentration of wealth is a theorem-outcome of the current axioms or rules of private property and the calculative “rituals of finance”. If you want to change political economy, change the rules.

    If often seems to be assumed that all players in the political economy system want a “level laying field” as in fair rules for all. This is the implicit claim of market economics: that the market rules are fair, known to all and all have an equal chance to participate and compete in the market. And there are no power differences , like those between owners and workers, Yeah well, LOL and Bulldust to that!!!

    It is much more realistic to assume selfishness and bad faith rather than kindness and good faith, especially in a system which synergises and empowers selfishness and bad faith as does capitalism (and not only capitalism). We have to assume bad faith, cheating, rule manipulation, regulatory capture, gaming and loopholing as standard behaviors in any system which prioritizes competition and personal rewards over cooperation and communal sharing of rewards.

    This suggests that mass and communal action to reset the game rules (of the competitive-cooperative political economy enterprise) will be far more effective than economic theory which falsely imputes fundamental laws and behaviors to a rule-system. There are indeed secondary real effects of a rule-system (prescriptive system) applied to a real system. That would take another post to talk about. There are also secondary technicalreaosn where there are requirements for “pure” economic theory. But all these are secondary and of secondary and technical importance after you set fair rules by political and direct action.

    I would start with rules and direct actions changing the meaning and scope of private property in our society. I mean reducing the power, size and scope of private property privileges in our modern economy. I mean passing anti-trust laws, anti-monopoly laws, excess property and excess wealth laws and so. Re-implement state monopolies for natural monopolies. Confiscate and tax away excess wealth. Change the rules to change the game! It’s as simple as that. Pretending that complex economic theory needs to be involved is just part of the obfuscation and mystification game of capitalism. Time to call bulldust on all that.

    Oh this will cause fights will it? Of course it will. Status quos, ruling elites, are never overthrown without fights. There are many ways to fight and those without power have to fight asymmetrically and in their own opaque, grey war manner against the black letter law and naked force of capitalism. It is better not to give reactionaries and capitalists the excuse of the naked violence which they love meting out. The ultimate standby of capitalist owners has been to shoot workers and other dissident or marginalized groups. Always has been. Always will be. The preferred option is to shoot fleeing, unarmed people in the back. This is the standard practice of capitalists and their captured state apparatus when people too vigorously and openly try to change the rules that grotesquely and extremely favor capitalists. The final logic of capitalism is the logic of gangsterism: rigged games, extortion, stand-over tactics, protection rackets, pay back and terroristic violence.

    https://www.npr.org/2021/01/25/956177021/fatal-police-shootings-of-unarmed-black-people-
    reveal-troubling-patterns

    https://www.hrw.org/news/2020/09/23/why-police-shoot-people-back

  6. pfeffertag
    September 15, 2021 at 8:26 am

    1) laws, 2) actions 3) rules. All right. But what about luck? Wouldn’t that be another basic factor?

    Also, in addition to rules there are norms which guide activity. They’re a bit different and they can’t be changed easily.

    The basketball game analogy is okay but there are also games that are purely competitive – a foot race, downhill skiing, singles tennis and golf do not seem to have much cooperation about them.

  7. September 15, 2021 at 10:51 am

    Ikonoclast didn’t answer the question I asked again (as it happened) above:

    “Why do people think so differently? Why the clash between Right and Left in politics? Again studious Right-minded economists accept the clash rather than ask the question or study the Left-minded artist who answered it in terms of brain logic rather than knowledge”.

    Pfeffertag does, in a way, though Ikonoclast missed his own point when he claimed

    “A decision is an action too in the monist materialist, not the Cartesian dualist, purview”.

    That dualist purview is nothing other than the distinction Ikonoclast makes between (1) and (3), which a mathematician may see as partial derivatives of a reality that is both active and recorded in memories and other physical structures. Ikonoclast lumps custom with (1) laws when the laying down of laws is a subset of (2) action, which physically includes growing up. This, as pfeffertag suggests, is a somewhat chancy business that materially affects future decision making.

  8. September 16, 2021 at 3:03 am

    Ikonoclast, you are oblivious. You completely miss what my article is doing, you just carry on with your own pseudo text book, banging on about obscure analysis, getting nowhere (as I frequently comment here).

    “(1) Fundamental Laws (The arena of investigation of the hard sciences).”

    There are no fundamental “laws” in the “hard” sciences. There are hypotheses that have proven themselves useful, some to the point they are called theories. Actually you can use a similar approach with living systems (as I do in the example in this post), but you have to be very aware of the limitations of what you infer, because perceived patterns can shift around.

    I was going to leave this blog alone for a while, but then my piece was posted. Then Ikonoclast came barging in again, perfectly illustrating what I find a waste of time on this blog (not everything, but too much).

    Ikonoclast, do your stuff if you must, but I’d prefer you didn’t attach it to my stuff and totally obscure what I’ve said in your dense and irrelevant smokescreen.

  9. Ken Zimmerman
    September 18, 2021 at 8:42 am

    There are hundreds of elements involved in market crashes. Plus, many others that are invisible to us. Lines on a graph, straight, curved, or squiggly can never show us what’s going on. For that, close and frequent observation is first, then the experiences necessary to interpret these observations, and finally the writing skills to write up the observations and interpretations for all who are interested to read and discuss.

    According to Henry Blodget, once the darling of Wall Street, bubbles, panics, and similar events are inevitable in the capitalist system. “Most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational — or at least they ’re a rational and unavoidable by – product of capitalism.” In Blodget’s view, greed is an innate part of human nature. In this, he follows Sigmund Freud, who wrote, “Culture has to call up every possible reinforcement in order to erect barriers against the aggressive instincts of men.   . . .   Its ideal command to love one’s neighbor as oneself is really justified by the fact that nothing is so completely at variance with original human nature as this.”

    In my view Blodget has it wrong. There are too many existential faults with markets as constructed today for this explanation to hold water.  Before we get to that, we need to consider this. In the words of E.  P. Thompson (1971:  91), the ‘market model’ is ‘a superstition,’ a ‘self-validating essay in logic.’  Like any superstition, the model may be true after all.  If it is true, however, it is not so in any self-evident way or for the reasons that the  model  uses  to  arrive  at  its  truths. While the ‘market model’ is complex and even internally contradictory,  a  point  brought out by many, according to its advocates the model includes several fundamental elements which I argue are not as theses advocates depict them and can be a source dysfunction, mania, and market crashes.

    Let’s begin with the assumption that market actors are autonomous individuals who deal with each other at arm’s length.  Such independent, rational, dispassionate actors are necessary to the  model,  because  only  this allows judgements necessary  if  purchasers  are  to  get the  greatest  benefit  for  the  least  cost.  For  firms, rational  independence  is  necessary  for  the  greatest  possible  profit,  which  is necessary  for  survival  in  competition  with  other  dispassionate, independent  market  actors.  However, most individuals and firms do not conform  to  this  ideal,  and  those  who  deviate  are often at an advantage relative  to  those  who  conform. For example, firms who hire through other than labor markets have frequently out performed those who use labor markets. Research also shows when  firms  deal  with  each  other  over any  significant  length  of  time,  commonly  they  abandon  the impersonality and autonomy of the market, and instead establish relatively  durable relationships  that have  a clear moral  component (see  also  Block  1990:  69-73;  Macaulay  1963).  For  Dare  (1983:  479), these  relationships  “become  regulated  by  criteria  of  fairness.”

    Many actors (individuals and firms) also incorporate a clear moral component into markets. It  is  possible  to  see trustworthiness  as  a market  attribute  that  makes  the  actor  more  attractive  (see,  for example,  Gambetta  1988),  just  as  some  consumer-goods  firms portray  themselves  in  their  advertising  as  trustworthy  and  seek to  promote  durable  moral  relationships  with  customers  (see Carrier  1990).  Such  an analytic  strategy is likely to produce  a  model that more closely represents  the actual behavior  of firms,  as James Acheson  (1985)  shows  in  his  discussion  of  the  Maine  lobster industry.  This marks  a retreat  from the  conception  of  the  impersonal  and  asocial  market, a  retreat  from the notion  of  the  detached commercial  sphere.

    Another common element of the model  of the  market is  that  actors  are  clear-headed  and  economically  rational.  One could argue that markets  require  not rational actors, but only actors who make choices. In practice, however,  such an argument reduces the  model to  the  assertion  that people  want  what  they  want  given the  circumstances.  An example  of this,  in  formal economics,  is  an assertion  of  Gary  Becker’s:  “A person  enters  the  marriage  market if  he  expects  his marital income  to  exceed  his single  income”  (1991: 119;  ‘market’  and  ‘income’  are  technical  terms).  In  other  words, single people  think  about getting married when they think  getting married  might  be  nicer (income and pleasure-wise)  than  staying  single.  This  proposition  is  a tautology,  its  truth  following  automatically  from  the  specialized definitions  of  ‘market’  and  ‘income.’  It  is  only  by  positing  some basis  of  choice,  like  rationality  (or,  for  anthropologists,  culture), that  tautology  is  avoided,  a  step  that  also  makes  the  proposition’s truth problematic and ‘unrealistic.’

    In  the  market,  advocates claim, clear-headed  calculation  is  an  attribute  that  is forced  on  firms  especially,  if  only  because  those  who  lack  it  will fail  in  competition  with  those  who  have  it.  Again,  however,  many market  actors do not conform  to  this  expectation,  as  is  apparent  in William  O’Barr  and John  Conley’s  (1992)  description  of  actors  at the  core  of  capitalism, Wall  Street.  They studied the  managers  of pension  funds,  who,  they  found,  deviated  from  the  model’s standards  in important  ways.  Here  I  consider just one aspect of that ‘deviance’:  the  ways  that  pension  fund  officials  dealt  with the  outside  investment  firms  that  they  had  contracted  to  manage some  of the  pension’s  funds.  O’Barr  and  Conley  found  that,  once hired,  these  outside  managers  were  almost never  fired  because  of their  objective  performance, their rate  of return.  Outside managers were selected on the basis  of their investment strategy,  and  so  long as  they maintained  that strategy they were effectively exempt from dispassionate  scrutiny  by  fund  officials  and  their  position  was secure.  The  reason  that  fund  officials  gave  for  this  is  that  poor performance  by  an  outside  manager  is  likely  to  reflect only  the fact  that  the  manager’s  investment  strategy  is  ill-suited  to  the current  phase  in  the  cycle  of  the  stock  market.  The outside manager would  do  better  at  the  appropriate  phase  of  the  cycle.

    This  argument  appears  to  be  rational  in  market  terms,  for  it speaks  of  the  rational  calculation  of material gain.  However,  that appearance  is  deceptive.  The argument reflects not the calculated financial  judgement  of  fund  officers,  according  to  O’Barr  and Conley,  but the uncertainties  that confront  any official  who  wants to  assess  the  objective  performance  of  outside  managers.  Should they  be  assessed  relative  to  the  performance  of  the  stock  market generally?  If so, against  what  measure  of  the  market?  There  are many  measures,  such  as  the  Dow-Jones  Industrial  Average,  the Standard and  Poor’s  100,  the  Standard  and  Poor’s  500,  the  Wilshire 1000,  the  Wilshire  3000,  the  Wilshire  2000  (which  is  the  Wilshire 3000  minus  the Wilshire  1000), the  Wilshire  5000  and the  New York Stock Exchange index,  and  they  produce  different  statements  about the  performance  of  the  stock  market–sometimes  markedly different.  Alternatively,  should  outside  managers  be  assessed against  other  managers  who  followed  a  similar  investment strategy?  This  would  seem  reasonable,  but  information  on  rates of return  of other managers was secret and effectively unavailable, so  that  this  means  of  assessment  is  foreclosed.  Also  there  is uncertainty  about  the  period  over  which  the  outside  manager should be  assessed.  Ought it  to  be  a  short period  like  three  months or  a  year?  Some  argue  that  they  should  be  assessed  over  a  whole market  cycle;  but  this  is  an  ambiguous  period  defined  by  an uncertain  concept.  Some  say  that  the  market  went  through  an entire  cycle  in  the  1987 crash; some deny that  cycles  exist.

    This sort  of  uncertainty  pervades many aspects  of the world  of fund  officials,  and  in  the  face  of  it  commonly  they  retreated  to subjective  interpersonal evaluations  of outside  managers:  are  they pleasant,  are  they  easy  to  deal  with,  do  they  seem  sensible?  The retreat  to  these  evaluations  may  be  reasonable,  given the  circumstances  in  which  these  officials  find  themselves.

    However,  they are  not  rational  in  market  terms. These  reasonable  but  not  rational  officials  do  not,  however, represent  a  pocket  of  incompetence  at  the  heart  of  the  American capital  market.  Instead,  they  represent  a  failure  of  the  model  of the market.  In  asserting  that market actors  are  rational  calculators, the  model  assumes  that  actors  can  foresee  the  consequences  of their actions fairly well and that they can foresee the  actions of  others  equally  well.  No  doubt,  in  some  circumstances  some actors  do  have the  foresight necessary  for  most  practical  purposes. These  fund  officials  do  not,  however,  even  though  they  oversee funds  of  enormous  proportions  and  have  the  resources  to  command extensive market research.  One  could  argue,  of  course,  that the  model  does  not  apply  here,  because  the  stock  market  is  so imperfect  that  it  is  not  a  true  market.  But  if  the  New  York  Stock Exchange  is  not  a  market,  then  what  in  this  world  is?

    The lesson that can be drawn from O’Barr and Conley’s  work  is  simple and  hardly  surprising.  The greater the uncertainty, the  less  it  is possible  to  be  a  rational,  calculating  market  actor.  To a degree uncertainty  is  one result of the length  of  time  between  making  a decision  and  being  able  to  assess  its  outcome;  and  these  fund officials  were  thinking  in  relatively  long  terms.  Their  situation resembles  that  of  the  firms  that  Dare  and  Granovetter  described. There  too,  actors  were  thinking  in  the  relatively  long  term,  and thus  confronted  the  associated  uncertainties. And  in  consequence it  makes  sense  for  them  to  try  to  build  and  rely  on  stable,  moral relationships  rather  than  trying  to  meet  each  situation  anew  with fresh  dispassionate  calculations  of  the  abilities  and  intentions  of other  firms and individuals.

    How does this fit in with market crashes and panics? In 2008, for example, groups of financial traders with longstanding bonds (friendships) set about robbing anyone not in the group – banks, pension funds, other big and small investors, etc. This is a pattern repeated in many other panics and crashes. Done mostly for enjoyment it seems. Just like any ‘pump and dump’ scheme. The first such was probably the South Sea Bubble of England (1720). The South Sea Company proposed a scheme by which it would buy more than half the national debt of Britain (£ 30,981,712, equivalent to   £ 6.1 billion in today’s money based on average earnings), and would issue new shares, along with a promise to the government that the debt would be converted to a lower interest rate, 5% until 1727 and 4% per year thereafter. The purpose of this conversion was to offer liquidity in return for a lower interest rate. It would allow a conversion of high-interest but difficult-to-trade debt into low-interest, readily marketable debt/shares of the South Sea Company. All parties could supposedly gain. This sounds suspiciously like some of the securitizations, swaps, and restructurings that were engineered during the first decade of the 21st century, and contributed to the market crash of 2008, proving once again the validity of Karr’s observation that “plus ç a change, plus c’est la même chose” (the more things change, the more they stay the same).

    The South Sea Company then set to talking up its stock with “the most extravagant rumours”   of the value of its potential trade in the New World, which was followed by a wave of   “speculating frenzy ”(today we would call that an “intense promotional campaign” as part of a “pump-and-dump operation”). The share price had risen from the time the scheme was proposed, from £128 in January 1720 to £175 in February, £330 in March, and, following the scheme’s acceptance by the Bank of England, to £550 at the end of May. The price finally reached £1,000 in early August (at the height of the “pump” phase), but then the level of selling was such that the price started to fall, and dropped back down to £100 per share before the year was out, after the “dump” phase. Altogether, a classic pump-and-dump scheme. And as with the crisis that broke in 2008, many well-known members of society were fleeced. The noted bluestocking Lady Mary Wortley Montagu invested in the hope of using the profits to pay off a blackmailer with whom she had had an indiscreet romantic correspondence. Poets, bishops, Sir Isaac Newton, and King George I were all drawn into the euphoria. This was the first of many Ponzi schemes, which are primarily equal opportunity scams.

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