Faculty Research Profiles

Bhidé Considers Economic Collapse and Ways of Social Science

Amar Bhidé has a lot to do.

Fresh off his bicycle commute through Medford one September morning, Fletcher’s newest business professor faced piles of boxes freshly arrived from his old office at Columbia Business School and stacks of copies of his new book that needed sending to people like Paul Volcker (who wrote a blurb for the back of the book).

On top of these mundane concerns, Bhidé has more on his mind: The economist has been pondering reforms in the way social science research is valued and professional schools work. He’s also putting together a new class about best practices that he plans to teach next semester.

Bhidé joined Fletcher as the Thomas Schmidheiny Professor of International Business this fall, after teaching at Columbia, Harvard and the University of Chicago. Throughout his career, Bhidé said, he’s been progressively drawn to human issues more than strictly business ones; coming to Fletcher, he said, “there was a draw out of a strictly business school.”

Lately, Bhidé said, he’s grown a new obsession with what he calls “useful knowledge.” The natural sciences have a clear path to advancement, but in other fields – useful fields like medicine, education, business and law – scientific methods of study need serious modification, according to Bhidé.  Social sciences, Bhidé said, have an almost a “schizophrenic view” of what to do: Explain the world or improve the world, and often the result is “properly doing neither.”

This month, Bhidé’s third book in a decade, A Call for Judgment: Sensible Finance for a Dynamic Economy, hit stores. The book, published by the Oxford University Press, analyzes the recent economic crisis in calling for reforms that cut across the partisan divide: More regulation in some sectors, less regulation in others and a basic recognition of the failure of “quant”-centric finance in which mathematical algorithms came to replace the on-the-ground judgment of mortgage lenders and investors.

Bhidé’s argument harkens back to seminal economist Friedrich Hayek’s case against Soviet central planning: That capital is best allocated when people on the ground have the ability to make local decisions based on local conditions. Lending, Bhidé argues, is similarly not an activity that can be centralized easily or well.

The lesson of the most recent crisis, Bhidé says, should not be that people should be told what to do or that enterprise is dangerous. Bhidé argues that good rules for social interaction are a crucial part of allowing people “full leeway” to make decisions.

“But unfortunately, there’s no math and no algorithm that tells us ‘This is the optimal set of rules,’ ” Bhidé said.

In a recent interview, Bhidé said he sees problems in the of the recent financial reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“We’ve gone from the virtually no-rules ethos to a large number of rules established by a small number of lobbyists and experts,” Bhidé said. “I think both extremes are unfortunate.”

The recent financial reform bill isn’t necessarily a good or lasting fix, Bhidé said, pointing in particular to the lack of public debate and understanding of a complex and lengthy act.

The 1933 Banking Act (now known as Glass-Steagall), which cracked down on speculation and established the Federal Deposit Insurance Corporation, Bhidé said, was a 37-page bill established after a “dialectical process of public debate” in which the public knew the arguments for and against deposit insurance.  By contrast, Bhidé said, the Dodd-Frank legislation is a 2300-page bill which “I don’t think the president could have read in its entirety before he signed it.”

While some issues ought to be left to experts – like regulating safe levels of carcinogens in products, for example – Bhidé argued that the public should understand banking laws. “I think rules for social interaction which affect us all ought to be widely debated and widely understood,” he said.

Bhidé argues that the strategic goal of financial reform in the wake of the crisis should be to “bulletproof” the nation’s depository and payment system. The key, Bhidé said, is to separate riskier forms of finance, such as the derivative market from the banking deposit system.

The crisis of 2008 brought us to the verge of a global economic meltdown because banks and other institutions stopped trusting payments from other banks. 
Bhidé’s solution is clear and simple: The U.S. government, Bhidé said, has effectively been guaranteeing all deposits in banks but has not been “demanding its financial pound of flesh”, and has refrained from imposing the kind of conditions that prudent lenders ordinarily would. If the U.S. government simply prohibited banks whose liabilities it guarantees from having anything to do with complex derivatives, the market for derivatives would shrink dramatically.

Bhidé explains it this way in the book: "Without deposit guarantees, who would keep a deposit earning 1 to 2 percent in annual interest in banks that had trillions of dollars of derivatives exposure? And because the government guarantees the deposits of megabanks, it has a responsibility to ensure that the megabanks don’t put trading profits ahead of prudence. Sensible bankers at J.P. Morgan wouldn’t allow its borrowers to build up huge derivatives books. Why should taxpayers let J.P. Morgan do so?" 

The benchmark for what a bank could do is this: Is the activity something that a modestly trained accountant can understand? “If not, then, very sorry, we won’t let you play with the public’s money.”