The efficient (financial) markets hypothesis still has plenty of defenders, though their arguments are looking rather ragged at present. Coincidentally, it’s ten years since the merger of Time Warner and AOL, the biggest and most disastrous in history. If any single event symbolises the failure of the EMH, it’s this merger, driven by the ludicrous valuations of the dotcom era. As I commented at the time

If the accounting numbers are taken at face value, AOL Time Warner will have a price-earnings ratio of about 350 to 1, modest by Internet standards. When options are taken into account, the ratio is more like 1000 to 1. It is difficult to see how an economy in which investment decisions are based on numbers like these can avoid some sort of financial catastrophe

Hot/cold on the heels of Iceland’s quasi-default, the Roger Lowenstein in the NY Times urges underwater/negative equity homeowners to “Walk Away From Your Mortgage!”. . Lowenstein’s key point is that businesses (including those owned or controlled by the banks themselves) treat default as a straightforward business decision, to be adopted whenever it is profitable to do so. Lowenstein gives a number of examples where leading banks like (inevitably) Goldman Sachs have engaged in strategic default and urges his readers to do likewise. The piece is in a section headed “The Way We Live Now” and it’s striking that it’s taken more than 100 years for the business ethics of Augustus Melmotte to percolate through to the American middle class

To be fair, it’s only in the last thirty years or so that such ethics have become dominant in the corporate sector, to the point where a board that rejected profitable opportunities to stiff their creditors would now be regarded as having violated its fiduciary obligations to shareholders (particularly if the creditors are workers). And despite all the talk about shareholder value, a CEO who passed up opportunities for personal enrichment at the expense of shareholders would be regarded by his or her fellows as a mug.

Millions have defaulted already – (one in eight mortgages is currently in arrears). Bankruptcy is once again as common as divorce. When defaulting on debt is this common, it is hard to sustain any sort of social stigma or internalised notion that this is anything other than a financial option, like refinancing an existing loan. And, as with divorce, we must soon be reaching the point where most people who take out loans will do so in the knowledge that default is an option.

The question is – can the consumer credit system survive this? Probably it can, but the system will need some radical changes. It’s worked for several decades on the basis of creditworthiness criteria that work on the assumption that (nearly) everyone will repay their debts if they can. Until recently, the checks could also rely on the assumption that people would be more-or-less honest in the information they provided in their applications. The financial system, by promoting ‘liar loans’ colluded in the destruction of the second assumption, and by leading the way in strategic default, helped to destroy the first.

The problem for lenders now is that they will increasingly have to act on the assumption that their borrowers (including those who appear creditworthy on the old standards) are planning, at a minimum, to use default as an insurance option. The only good way to protect against this is to demand lots of secure collateral. That means less liberal credit (and, given higher default rates, higher interest rates) for everyone and no credit at all for lots of us.

The financial crisis has, justifiably, enhanced the reputation of Karl Marx as an economic thinker. Marx was the first economist to treat crises and panics as an inherent feature of capitalism rather than as an inexplicable, but fortunately temporary, departures from a natural equilibrium.

Unfortunately, most of his analytical effort, and even more, that of the school of thought that followed him, was devoted to pointless exercises in value theory[1]. Marx’s theory of crisis rested mainly on the idea of the falling rate of profit which seemed at the time to be both a theoretical inevitability and an observable trend. But with technological progress, there’s no necessity for the rate of profit to fall consistently, and it hasn’t. There are other ideas in Marx that might be developed to yield a better theory of crisis, but if this has been done, I haven’t seen it.

And, in the current crisis, Marxian economics seems to be pretty much Missing in Action. I haven’t seen much and what I have seen hasn’t added anything, in analytical terms, to the standard left-Keynesian analysis. Perhaps the problem is that just about everyone expects capitalism, in one form or another, to survive this crisis, contrary to the orthodox Marxist view where crises become ever more severe and eventually precipitate the revolutionary overthorw of the entire system. But it’s equally possible that I haven’t been looking in the right places. Can anyone recommend a good Marxian analysis of the current crisis?

fn1. If I get time, I’ll write a longer post on this point. In short, the idea underlying debates about value theory was that since the sale proceeds of production are divided between the owners of inputs to production (labour, capital, and land in the C19 division) there must exist some natural way of determining the share of the value of output for which each group is responsible. This is essentially an idea about average values, since averages added across a group are equal to the total for that group. But, as the neoclassical revolution of the 1870s showed, prices are determined by marginal costs and marginal rates of substitution and these don’t equal averages. Subsequent attempts to rescue a substantive role for value theory as opposed to price theory by Marxians, Austrians and Sraffians, not to mention the marginal productivity ethics of JB Clark and others, have gone nowhere.

Over at what was the Austrian economists blog, Peter Boettke announces a change of name, saying

As an experiment, over the past six months we have been tracking the use of the term Austrian economics in the news and in the blogosphere. Less systematically, we have also been listening carefully to the use of the term among fellow professional economists and what they think the label means. The results do not fit our intention. Google alert, for example, inevitably points to financial advice or libertarian politics, rarely to the research paradigm of F. A. Hayek, never to the scholarship of Israel Kirzner. Mises is often mentioned, but Mises the ideological symbol, not Mises the analytical economist. The “Austrian” theory of the business cycle is mentioned, but only in relationship to anti-fed politics and hard money advocacy, and never as an ongoing research program among professional economists.

These trends are not recent, but have been constant throughout our respective careers. We have always been among those who attempted to offer resistance to this use of the term. It has become evident to us that our efforts have been futile. Rather than resist the pure ideological identification, we are choosing to devote our efforts elsewhere. The name Austrian economics has been lost as a focal point for a tradition of economic scholarship, and is now a focal point for something else. We have to let it go.

This is pretty much the view I expressed here

although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.

The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but cease to respond in a progressive way to empirical violations of its predictions or to theoretical objections.

Meanwhile, Rafe Champion points to this post suggesting that market liberals (the author prefers “classical liberals”) should abandon the use of the term “capitalism”.

It seems pretty clear that these developments are related to the global financial crisis. The adoption as a badge of pride by Forbes magazine and others of the previously pejorative term “capitalism” was one of the most extreme manifestations of market liberal triumphalism in the 1990s. But, in the wake of the crisis, “capitalism” is a much more problematic term. It works well enough as a generic term covering all advanced economies in which private capital plays a leading role, but one that is, as we have seen, ultimately dependent on government action for sustainability. We can then say that the relatively unregulated, finance-dominated form of capitalism that has held sway for the last 30 years is being supplanted by a different form in which the role of government as ultimate risk manager is more direct and obvious. But this has little rhetorical value for market liberals.

The story with Austrian economics is more complex. On the one hand, the crisis has increased the appeal of Austrian views of the business cycle, relative to other rightwing views like New Classical macro and Real Business Cycle theory. On the other hand, the label has been increasingly associated with gold bugs, critics of fractional reserve banking, neo-Confederates and general fringeness.