If economics is a science, why did so many economists fail to foresee the 2008 financial crises?

 

The economist J.M. Keynes made a lot of money from his investments, but being an economist, won't necessarily make you a rich man, or even a successful businessman. There's something called the "Fallacy of Composition", that suggests that although some people can succeed with a particular business, it doesn't mean that everyone can succeed with it.

 The American economist, J.K. Galbraith, said that "economics is extremely useful as a form of employment for economists." For decades, economists played an important role in creating the conditions for the 2008 financial crisis and dozens of smaller crises that came before it, arising mainly from financial deregulation. The 1982, Third World debt crises and the banking crises in Chile; the 1995 Mexican pesos crises; the 1998 Russian crises and the banking crises in Sweden, Finland and Norway, following financial deregulations in the late 1980s. Most economists didn't predict or foresee the 2008 financial crises that was completely man-made. It didn't arise from any war or economic depression but it nearly collapsed the whole capitalist financial system. It was the equivalent of financial markets getting mad cow disease.

The ‘Sage of Omaha’, Warren Buffet, called 'derivatives", the financial weapons of mass destruction, whereas, Alan Greenspan, of the U.S. Fed, thought they made markets more efficient. The complexity of these new financial products - Asset Backed Securities; Collateralized Debt Obligations and Credit Default Swaps, is exactly what made them dangerous.

In 2013, the Nobel Prize in Economics, was shared by two American economists who held completely opposing views about the causes of the 2008 financial crises. Eugene Fama, who believes in the "efficient markets hypotheses" argued that financial markets were a casualty of the recession and did not cause it. He argued that the U.S. government made lending and credit too easy to obtain and that banks acted rationally, in responding to the incentives put in place by an interfering government. In contrast, Robert Shiller, the other prize winner, stressed how investors can be swayed by psychology and irrational exuberance, which affects the workings of the market.

In a TV interview in 1995, Buffet said: "I personally think that society is responsible for a very significant percentage of what I have earned. If you stick me down in the middle of Bangladesh or Peru or someplace, you'll find out how much this talent is going to produce in the wrong kind of soil. I will be struggling thirty years later. I work in a market system that happens to mean that everyone can succeed within it."

Unfortunately, not everyone does succeed in the capitalist market system and there's a lot of evidence that markets are routinely rigged in favour of the rich and that there's mis-selling of financial products and lies told to regulators. Markets may also fail to produce socially optimal outcomes.