"I do not say that the current systems of risk management or econometric forecasting are not in large measure soundly rooted in the real world. The exploration of the benefits of diversification in risk-management models and the use of an elaborate macroeconomic model does enforce forecasting discipline. It requires, for example, that saving equal investment, that the marginal propensity to consume be positive, and that inventories be non-negative. These restraints, among others, eliminated most of the distressing inconsistencies of the unsophisticated forecasting world of a half century ago.
"But these models do not fully capture what I believe has been, to date, only a peripheral addendum to business-cycle and financial modeling -- the innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation with little evidence of a learning curve. Asset price bubbles build and burst today as they have since the early 18th century, when modern competitive markets evolved. To be sure, we tend to label such behavioural responses as non-rational. But forecasters' concerns should be not whether human response is rational or irrational, only that it is observable and systematic.
"This, to me, is the large missing 'explanatory variable' in both risk management and macroeconomic models."
Here's another really smart idea along similar lines. It's from the current Economics column in April's Conde Nast Portfolio, plainly titled "The Economics of Fear." Honoring the customary wisdom of venerable economic gurus Ben Bernanke, current head of the Fed, and Lawrence Summers, former Treasury secretary, the author finds he must take issue with their predictions that the current downturn won't get too bad. His column is subtitled, "Why this recession is going to hit particularly hard -- and last longer than you think."
"In economics, as in quantum physics, nothing is certain, but failing housing prices and slumping consumer confidence point to a deep recession that could last for two or three years. Psychology is critical in economics, and right now it is battered....
"Just as consumers are hitting the panic button, companies are also being squeezed, with many of them unable to access money precisely at a time when they need it."
Columnist John Cassidy then goes on to analyze various tourniquets our government and big business are attempting to apply to these arterial gashes in consumer and business confidence. He cites historical examples ranging from the U.S. slump of the 1870s, which lasted longer than the Great Depression, to the Nordic banking crises of the late 1980s and early 1990s. The latter were only resolved after the countries' governments took over major banks as a last resort to solve "systemic banking problems" that, like ours today, were wreaking havoc throughout their economies.
As we might expect, Cassidy stops short of recommending such draconian measures here. But he nonetheless notes that the current "rescue efforts" being attempted, such as interest-rate cuts and stimulus plans, are "too opaque and indirect to restore confidence, which is their ultimate goal. Lost trust takes a very long time recover."
Neither Alan Greenspan nor Conde Nast Portfolio's Economics columnist -- in a magazine subheaded "Business Intelligence" -- might likely claim or even acknowledge notions such as "emotional intelligence." Much less a developmental or, dare we say it?, evolutionary and integral understanding of human consciousness, culture, and society, including finance and economics.
I won't pretend to anything close to profound understanding of macro economic and financial cycles. But I make my way in the world by, among other things, counseling individuals and couples about how they deal with primal emotional passages such as fear and euphoria, distrust and trust.
Which leads to my simple point. Sooner or later the preeminent financial wizards of our time -- the Greenspans, Bernankes, and Summerses -- will have to integrate their wisdom with that of emotional and spiritual wizards, to create new models for such things as risk management and macroeconomic forecasting. Think about it. If the leading edge intelligence of business and finance does not seek out and merge itself with a similarly robust, brilliant, vanguard comprehension of the real roots and dynamics of emotional, psychological, and spiritual cycles, in individuals and collectives, how can we possibly even find the "missing 'explanatory variable'" that Greenspan laments? Much less help millions of ordinary investors and homeowners, as well as big corporations, and even whole nations, ground their own best risk management and macroeconomic forecasting in more complete pictures of how we humans tick? Does macroeconomics depend on macro -- and micro -- emotion?
I guess it's not so much a point as a question. Or two. I'll leave it at that. Along with a prayer that somehow, by everyone's urgent efforts and, yes, plain old grace, we may be spared the worst- or even worse-case eventualities that many wise people find far too likely to unfold, perhaps for years to come.