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Thursday, July 02, 2009

Complexity, Judgment, and the Subprime Crisis - The Hedgehog's View

At the end of April, Dave Hoffman and two of his colleagues at Temple, Jonathan Lipson and Peter Huang, organized a fascinating day-long colloquium on issues of complexity arising in the current financial crisis.  Among other presentations, Barry Schwartz from Swarthmore gave a talk on "the paradox of choice" (i.e., more choice, or more complex choice, doesn't necessarily make consumers happier), and Joe Grundfest gave a luncheon keynote.  One of the questions that kept occurring to me was the context of the complexity issue - what exactly were we trying to fix, if anything?  My analogy was this:  if law is a "science," and something about the financial crisis (whether complexity or something else) reflects a 180px-Igel01 disease, then what is the relationship between what we know about the disease and the regulatory medicine we would want to prescribe?  I liken financial boom-and-bust to bipolar disorder - is there a regulatory equivalent of lithium that we are assured will tamp down the peaks and valleys?  And even if there is, do we want to prescribe it?  Maybe we like the booms enough to bear the busts!  To keep the analogy going, there's a good chance Tchaikovsky and Van Gogh were bipolar - would we have their art if they had been medicated?

More on the hedgehog below the fold.

One of my most treasured Suffolk colleagues has suggested that I am a hedgehog, in the sense of the Greek saying (appropriated by Isaiah Berlin) that the fox has many clever ideas, but the hedgehog has one big one.  My big one (such as it is) is placing the canard "thinking like a lawyer" into the broader category of how people make sense of the world.  (This comes, I think, from spending so much of my professional life as a lawyer not surrounded by other lawyers.)  Nothing provokes this kind of reflection like great calamities, whether they are oceanic or financial tsunamis.  In a nutshell, the question is how we assess what happened against two very different kinds of "oughts":  (a) the normative "ought" of our sense of the way a just world should work, and (b) the descriptive "ought" that a scientist imagines when she comes up with a hypothesis of explanation that has yet to be borne out by experiment.  My working thesis is that thinking like a lawyer - somewhere between advocacy and truth-seeking - gets this all jumbled up.  What lawyers do mostly is look backwards and assess cause-and-effect in a particular way, and make implicit (and not necessary correct) assumptions about predicting the future from what happened in the past.  To put it otherwise, my hedgehog concern deals with difficulties in forward-looking judgment, namely, the difference between looking backward and assessing causation as a matter of attributing blame, and understanding what is going on as a descriptive matter sufficient to make a good forward-looking decision in real time under conditions of significant uncertainty. 

The result (how I spent my summer vacation) is The Epistemology of the Financial Crisis:  Complexity, Causation, Law, and Judgment, in which I've argued this is mostly an epistemological crisis - a crisis of faith in science and algorithm as against the ongoing irreducibility of judgment, whether our own or those to whom we delegate it.  In short, it's scary when we thought we had it nailed, and it turns out we don't know what we don't know.  (I apologize for the use of the word "epistemology" but I like it, despite the warning of a good friend that it's a signal of a high "crap factor.")  There's a little something for theorists of all kinds in there, including a critique of Michael Moore's new book Causation and Responsibility (the first extended treatment of causation in the law since Hart and Honore), Adrian Vermeule's Judging Under Uncertainty, and Richard Posner's A Failure of Capitalism

Posted by Jeff Lipshaw on July 2, 2009 at 07:51 AM in Article Spotlight, Corporate, Current Affairs, Legal Theory, Lipshaw | Permalink

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Comments

Jeff, thanks for the image of law as lithium... I'm going to savor that for a while.

Posted by: Jonathan Simon | Jul 2, 2009 9:34:56 AM

I find the current financial crisis and its relation to assessments of risk fascinating. (I posted on it briefly here: http://law.marquette.edu/facultyblog/2009/02/25/it-was-a-tulip-craze/ .) It reminds me of the downward definition of deviance described by Diane Vaughan in "The Challenger Launch Decision": people who have taken an insane risk once and survived tend to revise downward their assessment of the riskiness involved. So investing in mysterious credit-default swaps or mortgage-backed securities, and actually making money from it, for years on end, got defined by AIG, Fannie Mae, Merrill Lynch, and others as perfectly safe.

Posted by: Bruce Boyden | Jul 2, 2009 11:30:59 AM

Bruce, in the article I talk about some of the difficulties in trying to treat economics as a science in the same way as a physical science - here, the interaction of observer and observed. I cite the work of Brian Arthur, who is an economist with the Santa Fe Institute, with the following comments:

In precisely this way, the economist Brian Arthur criticizes the implicit teleology of traditional modern economics, which models by way of general equilibrium theory. Standard economics assumes diminishing returns, but Arthur argues there are instances in which the assumption of "increasing returns" does a better job of explaining what individual agents are doing. This requires a reconciliation of the apparent end seeking within the amoral market and the real end seeking of market participants. This may or may not be necessary in the market for low-paid workers, but Arthur contends bubbles and crashes are better explained by assuming that "investors cannot assume or deduce expectations, but must discover them." . . . . Arthur contends that it is error to view the economy as a physical object, "a gigantic machine," rather than a construct of its agents. Economics, the most formal and abstract of the social sciences, wants to develop orderly predictive theory, but to do so is it needs to operate on well-defined problems in which "[t]here should be no blurring of agent and problem." Yet traditional economics requires "heroic assumptions" in order to take the agents' purposiveness out of the analysis: "Otherwise well-definedness unravels, agent and problem become blurred, and pockets of uncertainty start to bulge." The problem is the self-referential loop created by the activity of the markets, the participants' awareness of that activity, which in turn influences their actions, which in turn affects the markets, and so on.

Posted by: Jeff Lipshaw | Jul 2, 2009 12:46:42 PM

This looks fascinating and I look forward to reading it. I find the following two articles very interesting in terms of "visions of the future:"

http://www.hoover.org/publications/policyreview/14801241.html ("In the long run, there are no good bets against globalization.")

http://www.newleftreview.org/A2759 ("The East Asian economies, above all China, will likely become ever more critical to global macro-economic trends, while the erstwhile centrality of the US will weaken during its long stagnation.")

Posted by: Frank | Jul 2, 2009 3:44:18 PM

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