Silent partners

When economists advise the government, who else are they working for? A UMass professor decided to find out.

By Robert Gavin
November 21, 2010

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Two years after the economy careened to the brink of Armageddon, a key question remains: How did so many smart economists miss the financial crisis?

Was it too much math, and not enough focus on real-world problems, as New York Times columnist Paul Krugman has argued? Or did economists simply put too much faith in the power and wisdom of markets, and ignore the flaws that ultimately led to them to crash?

Two University of Massachusetts researchers suggest another possibility: The vision of economists may have been clouded by their own financial interests.

The nation’s top academic economists — who advise policy makers, testify before Congress, and publish influential papers and articles — are also much sought after by the financial industry as speakers, consultants, and corporate board members. Though typically portrayed as independent experts, they can reap huge fees from financial firms, including those that profited during the housing and the credit bubbles.

In a new paper, Gerald Epstein, chairman of the UMass Amherst economics department, and Jessica Carrick-Hagenbarth, a graduate student, examined a group of influential economists, scoured publicly available resumes, biographies, articles, and interviews, and found that the majority had made money from financial institutions — but very few had disclosed these connections when writing, speaking, or giving interviews on public policy.

In doing so, the authors shed light on practices that have long existed in the ranks of academic economists, but are now beginning to gain widespread attention. A recently released documentary on the financial crisis, “Inside Job,” also raises the question of economists doing business with Wall Street while acting as independent experts on regulatory and other policies.

The sample the UMass authors use is admittedly small: 19 economists who belong to two groups proposing fixes to the financial system. One is the Squam Lake Group, named for the New Hampshire resort area where the economists first met; the other is the Financial Reform Task Force, funded by Pew Charitable Trusts. Both groups published reports on financial reform, and they include economists from the nation’s most prestigious universities, including Harvard, Yale, Princeton, Dartmouth, Columbia, Stanford, University of Chicago, and University of Pennsylvania.

In their paper, Epstein and Carrick-Hagenbarth cite the example of Darrell Duffie, a Stanford professor who, appearing on a panel at the university, addressed two questions about the financial crisis and bond rating agencies, which gave their seal of approval to so-called toxic assets such as mortgage-backed securities. Only when answering a third question near the end of the program did Duffie disclose that he is a director of ratings firm Moody’s Corp.

Duffie, a member of the Squam Lake Group and the only economist named in the paper, said in an e-mail that he has always disclosed outside activities on his resume and website, as well as in speeches. Other members of the Squam Lake Group contacted for this article said they obviously disclose nonacademic affiliations, since the paper’s authors found them on the Internet.

In the paper, Epstein and Carrick-Hagenbarth call for the profession to adopt a code of ethics requiring economists to disclose their consulting contracts, corporate board memberships, and other ties when writing, speaking, or giving interviews on public policy. It’s an issue that is getting more attention these days: Robert Hall, president of the American Economic Association, said it deserves discussion; Duffie suggested the National Bureau of Economic Research, a Cambridge group of academic economists, adopt a standard for disclosure for its researchers.

Ideas spoke with Epstein by phone from his office in Amherst.

IDEAS: Could you take us through some key elements of this paper?

EPSTEIN: We were interested to find out how often prominent academic economists who wrote on and appeared in the media with respect to financial regulation had ties to financial companies, and how often they revealed those ties...of 19 economists, 13, or approximately 70 percent, had financial connections with private financial institutions. Of the 13, only five ever identified these private connections in the media. Only two did it quite often.

We discovered there was no discernible variation among views of the 19 as a function of private affiliations. But what we did sense is there is a kind of club of prominent financial economists who share a fairly common ideology in support of less regulation.

IDEAS: So their views remained the same whether they had outside affiliations or not.

EPSTEIN: They all tend to prefer market solutions rather than strict government regulation. They tend to focus on proposing adequate capital regulations, for example, rather than structural reforms, such as breaking up big banks.

IDEAS: Is this a function of their outside interests?

EPSTEIN: We don’t have evidence to prove that either way. But all these aspects — outside affiliations, prestigious academic positions, ability to work with prestigious economic organizations such as the International Monetary Fund — tend to reinforce each other. I certainly would not claim this is nefarious, but it must influence the overall worldview in some subtle ways.

IDEAS: If their opinions don’t vary with outside interests, why does it matter that they disclose them?

EPSTEIN: Academics represent themselves as objective, scientific experts. If they make a pronouncement, but have a private interest in the outcome, they should make those connections clear.

IDEAS: What are the risks of economists taking fees from the finance world?

EPSTEIN: As we saw from the financial meltdown, a lot is at stake. We need experts and analysts who look with a clear eye. If they are getting material resources from a sector that has strong interest in going back to business as usual, that might compromise the expert analysis we so much need.

IDEAS: What got you going on this?

EPSTEIN: I was listening to an NPR story where an economist, whom I knew had strong affiliations with a financial firm, was arguing against strict regulations. He identified himself as a professor and nothing else. I felt it was wrong. I also knew this was more widespread than just one economist.

IDEAS: This is not something that would seem to win you a lot of friends.

EPSTEIN: The profession is divided, to tell the truth. Some are upset at the directions the economics profession has taken. It sometimes appears to be cheerleading for financial deregulation and the financial sector.

In more of the mainstream of the profession, I’m sure there will be concern. Some people might feel this is unfair finger-pointing.

IDEAS: You propose a code of ethics requiring disclosure. Is that enough? Should there be a clear line: If you want to be a professor of economics, you must give up outside interests?

EPSTEIN: I wish I knew the right answer. At least to start, people should make it abundantly clear that they have their feet in both camps. But there is a more important issue in some ways.

If you look at the most prestigious economics departments, the people who are asked to comment in newspapers, testify in Congress, who are consulted by regulators, it tends to be biased in favor of this club that shares the same ideology and these outside affiliations. We need to open up the club to a broader group of analysts whom the crisis has shown had more insight into what was happening than many of these economists.

IDEAS: Did anything surprise you as you did this work?

EPSTEIN: How seldom these economists identified their affiliations. I thought we would find that they don’t do it enough, but I was surprised at how rarely they do. I was shocked, to put it bluntly.

IDEAS: What lessons should we take from this?

EPSTEIN: For the public and the media, they should ask hard questions of academics: “Do you work for any private firms that might be affected by the analysis you’re describing?” That was another thing that shocked me. The media didn’t hold these people to task.

IDEAS: Since you brought it up, what are your outside affiliations?

EPSTEIN: My main outside affiliation is I’m a co-organizer of the SAFER group [Economists Committee for Stable, Accountable, Fair and Efficient Financial Reform], for which I get no compensation.

IDEAS: Any consulting work?

EPSTEIN: I’ve worked with the United Nations and the International Labor Organization, writing research papers on monetary policy and financial policy.

IDEAS: Do you think there will be support for your proposals?

EPSTEIN: Yes, and not because of our work, per se, but because of the “Inside Job” movie, the severity of the crisis, and questions about the role of economists in missing it. Our economy is not going to get a lot better anytime soon, and these issues are going to linger for quite a while.

Robert Gavin is a business reporter for the Globe. He can be reached at