Causation and the Financial Crisis
Robert Waldmann
Matthew Yglesias discusses the financial crisis and the idea of causation. He shows that he was a philosophy major. I’m delighted. The question is whether the answer to the question “What caused the financial crisis?” is of the form “A, because if A had not been true, then there wouldn’t have been a financial crisis.” Yglesias notes potential problems with that approach. I critique after the jump.
OK jumpers, here I admit that, while I am delighted to have philosophy applied to finance, I think that among other things Yglesias made up some pseudo problems. He is commenting on an excerpt from a post by Barry Ritholtz
Understand that this is a theoretical discussion based on counter-factuals — what is likely to have occurred if various elements leading up to the crisis were different. We are trying to discern the differences between primary and secondary factors, separating the causes from the exacerbators.
Whenever someone asserts as a cause an event or force relative to a particular outcome, you should always ask: “Is this a “BUT FOR cause of that outcome?” In terms of a specific result or outcome, “But for” this factor, how would the outcome have changed? Would the result have been the same or different?
I will comment on the passage quoted by Yglesias (note I have not read the post).
That little passage is vulnerable to a serious practical critique. It relies a lot on the word “likely.” Now one thing we have learned from the crisis is that it is a bad mistake to look at the most likely outcome and assume it is certain. In practice, the sort of result we can get from trying to understand the causes of the crisis is that it probably wouldn’t have occurred without those causes. That’s not good enough for financial regulation.
More to the point, we can figure out that a crisis in 2007-8-9 would have been unlikely but for the following factors, but we can’t conclude that without those factors another crisis is unlikely to ever occur. Obviously different crises can have different causes. If the same factors exacerbate crises with different causes, it might be better to address the exacerbators and not the causes of the current crisis.
This is not the criticism Yglesias makes. I’m going to try to be relatively brief for now and focus on two issues. First he notes that but for causation and legal liability are different. He has examples in which people are, and should be, punished for damage they didn’t cause in the sense that it wouldn’t have happened but for their actions.
Then he writes “One is that when something very large-scale and bad happens, we probably have a few different interests. One is in punishing perpetrators and one is in preventing recurrence.” Huh ?!?! Matthew Yglesias and I are inclined to be consequentialists (in my case at least it means I was inclined to be a utilitarian — was exposed to convincing arguments against utilitarianism and watered down my beliefs to something vague enough to be unrefuted).
I at least absolutely believe that the only possible justification for a punishment is to prevent a recurrence. I definitely do not think that we have an legitimate interest in punishing perpetrators except to the extent that it prevents an occurrence. I had thought that Yglesias agreed with me on this. He certainly has repeatedly described himself as mostly consequentialist.
This implies that I oppose vengeance for the purpose of vengeance. That, in turn, doesn’t imply much in practice. I think one effective way to prevent a recurrence of the crisis would be to tar and feather 10% of bankers chosen at random as collective punishment. I do not advocate this course of action, because tarring and feathering is torture and because there are costs of having terrified bankers which are even worse than the occasional financial crisis due to excessive risk taking.
Then Yglesias comes up with an abstract example.
The second is that when something complicated happens, it’s plausible that you’ll see confusing webs of preemption that defy simple counterfactual analysis. Imagine that A, B, C, D, E, F, and G all happened. And suppose that to produce a crisis you need A, plus either B or C, plus any two of E, F, and G. If you try to do a “but-for” analysis on all seven factors, you’re going to reach the conclusion that “A caused the crisis” while B, C, D, E, F, and G all may have contributed in some way but didn’t actually cause it. But it’s not clear that that’s the right thing to say. And it’s definitely not clear that the correct policy response is to focus on A. Maybe A had lots of really beneficial effects, while B and C are both useless.
Here he is probably making a correct analysis of how attempted “but for” causal analysis will mislead us. However, the shorthand of referring to factors with letters is key. This is one case in which language influences causal analysis (in a way in which id doesn’t influence logical inference). Let’s say there is another language in which the same word is used with two English meanings B and C. In Italian the same word “fare” means “to make” or “to do” and the same word “forza” means “strength” and “force.” On the other hand there are two translations of “to be” “essere” and “stare” and of “to love”If they do the but for analysis they will conclude that both A and “B or C” are causes.
This means that we can make a mistake if we take the division of entities into categories to be either a known truth or a harmless convenience. Here Yglesias doesn’t say that understanding what caused something is unimportant. He notes that it is hard. I tend to share his belief that analysis of causation by English speaking lawyers and judges is invalid, because they take the English language as know to be right and true (unlike all other languages) or, more exactly, because they assume that the decision to reason in English is harmless, innocent and doesn’t matter.
Philosophers know that arguments which seem valid are proven to rest on unexamined conventions. They do this by inventing new words. I agree with Yglesias that one problem with legal efforts to find causation is that they rely to much on plain English and are too suspicious of neologisms and jargon.
I am not joking.
OK that was the punchline but we are after the jump so I go on.
In the simple case of A, B, C, D and E, where each can be true or false it is possible to construct the whole set of possibilities (there are 32) and say which imply a crisis. This means that the same long boring report is written whether we think that “A or B” is an elementary category and saying “A but not B” a pointless quibble or if we think that “A” and “B” are elementary categories and “A or B” is derived from them.
In the real world, it is absolutely impossible to get anywhere without risking having been lead there by the irrelevant history of the evolution of language. The innocent language in which every possible state of the world has it’s own name has an infinite vocabulary and no one can learn it. IIUC philosophers have long since given up on finding a language such that using that language can’t lead us astray.
Just to go on and on some of Yglesias’s other examples are interestingly irrelevant.
After the Ritholtz passage he continues
I’m broadly sympathetic to that account, but it’s worth emphasizing that there are a lot of complications. Consider this example from L.A. Paul and Ned Hall, “Causation and Preemption”:
Suzy and Billy, two friends, both throw rocks at a bottle. Suzy is quicker, and consequently it is her rock, and not Billy’s, that breaks the bottle. But Billy, though not as fast, is just as accurate: Had Suzy not thrown, or had her rock somehow been interrupted mid-flight, Billy’s rock would have broken the bottle moments later.
So you can’t say that the “but for Suzy’s toss, the bottle wouldn’t have broken.” But I think a normal person would want to say that Suzy broke the bottle. There’s a lot of work done on this and other philosophical topics. But I would note that in a politics/policy context it often just depends on what we care about.
Yes and, in this case, what we care about is preventing a recurrence so, for our purposes, Billy’s and Suzy’s actions are the same. They are like B and C in the abstract example.
In plain English, “Sally broke the bottle” is true and “Bill broke the bottle”. The example shows how we can’t completely describe the events usefully with two sentences of only 4 words each. This is not a surprise.
OK this is the example which caused me to write this post.
Imagine I’m in the elephant house at the zoo on a crowded day. A couple of elephants get loose and start stampeding through the crowd. I have a gun on me, and spot some dude I don’t like and decide to take advantage of the chaos by shooting him in the end. Eventually, it turns out that 80 percent of the people who were in the elephant house that day wind up dead as a result of the stampede. From a “but-for” perspective, it’s not clear that I actually caused the dude’s death. But from a legal perspective, it’s clear that I’m a murderer. The point of the statute is precisely to punish people who shoot other people in the head. But from a policy perspective, the bigger issue here is arguably elephant stampedes rather than guns at the zoo. At a minimum, elephant stampedes are killing more people.
Again huh ?!?!? I would say that the purpose of the murder statute is to prevent murder and the purpose of preventing murder is to keep people alive. To mean, punishing murderers is a means to an end not an end in itself. So I think the character named “I” should be jailed. We jail for 2 reasons and both have to do with intention and not “but for” causation. We want to deter murderers. Punishing someone for killing someone who would have died anyway but he didn’t know it works just as well. Deterrence depends on what people think will happen to them and people generally don’t kill other people if they know the other person is about to get stomped by an elephant (some bloodthirsty person might and there is no point in deterring him but no harm either so punishing people for killing people who are going to die anyway is just as useful as a deterrent (also we are all going to die sooner or later)).
Another purpose of jail is to incapacitate. We lock people up because the crime they have committed convinces us that they are likely to commit more crimes. In theory if we could determine who would commit crimes in the future consequentalism tells us we should lock them up before they have committed a crime. The rule that people are to be locked up only after they have committed a crime is needed, because the alternative is to grant some person or group arbitrary power to lock others up if they say they think the others will commit a crime.
Our forecast of future murder depends again on intent.
Now I will argue that I am really really fanatically consequentialist and have been for a long long time. When I was in 4th grade, I said that the prison sentence for attempted murder should be longer than the prison sentence for murder. My logic was based on incapacitation (I’m pretty sure I didn’t believe in deterrence at all then). The prediction of future murders depends on the intent I argued (as I argued above). Plus if the attempted murder is unsuccessful we know that there is someone that the defendant wants to kill. If the murder had been successful, maybe the murderer would be satisfied.
This is very consequentialist thinking. It totally freaked out my classmates and teacher.
Years later, I understood what was wrong with my reasoning. I was assuming that we knew for sure that an act was an attempted murder. In the real world, severe punishment for attempted murder would lead to locking up people whose aim was assault not murder. Indeed the word lead me astray. There are many degrees of intent from trying and seeing if it works to absolute determination to make it work. The difference between a murder and an attempted murder may be partly chance, but it can also be partly based on determination.
My proposal was like locking up people who will commit crimes but haven’t yet. Under absurd assumptions about what we know, it makes consequentialist sense, but in the real world, we can’t know that much or trust people who claim to know that much.
Robert,
You’ll go crazy trying to micro manage life. Better not to try.
I find people blameworthy if they act with moral turpitude and their acts cause harm. I’m not obsessed with it though.
Actually fundamentally it was greed and in addition the national desire to get rich quick, that are the sources. Get rich quick was how the country was founded (Va with a desire to get gold, NY as a trading place etc). Then add it Ca which was a pure get rich quick scheme (gold rush), as was NV,CO, MT and to a lesser extent other western states, as well as western NC, and the UP of MI, as well as the lead boom in western IL. Wall Street is all about get rich quick and of course Las Vegas is one big get rich quick scheme on several levels, the Casinos of course, and then its real estate market. I sort of view Las Vegas as a old fashion mining boom town that just mined the (gamblers,suckers) wallets. So it now has hit the same fate as Virgina City,Austin, Eureka, Rhyolite and other thriving cities in Nevada.
“In practice, the sort of result we can get from trying to understand the causes of the crisis is that it probably wouldn’t have occured without those causes. That’s not good enough for financial regulation.”
Really? Do we really have the certainty you indicate? Don’t we have to rely upon playing the odds?
(Not that identifying probable necessary causes is all we need to do.)
An issue can be analyzed to the point of total obscurity, but as Freud said, “Some times a cigar is just a cigar.” There seem to have been a set of regulations in place for several decades during which time the financial markets were relatively free from total crisis and mayhem. Thanks to guys like Phil Gramm, only one prime example, those regulations were thought to be too “confining” to the imaginative contrivances of the banking industry and so were eliminated. Voila! The financial world dug itself and the rest of us into a nice big hole. The bankers appear to have climbed out of that hole with the significant assistance of our tax dollars. Too bad the rest of our personal wealth seems to have been lost down that same hole. So when regulations seem to have worked so well, and things go pop after the elimination of such regulations, it seems a good bet that the best reaction is to restore those regulations. Maybe it would also be a good idea to prosecute the primary instigators of the initial deregulation. Funny that several of those same guys seem to be holding key positions in what is left of the government’s financial regulatory apparatus. And I think good old Phil has retired into his personal knigdom of wealth after a brief stint at UBS. No bad deed goes unrewarded. Apply the “but for” analysis to that scenario and pponder where we would have been today. But that’s the problem with looking at the world of crisis from the woulda, coulda,l shoulda point of view. China has a much more pragmatic approach though I’m not sure it works any better.
PS: The same analysis can be applied to the deregulation of media ownership and the take over of the FCC by corporate toads about two decades ago. That helped set the stage for what followed in the world of banking and finance. But that’s another one of those “but for” situations.
If you want to prevent outcomes from being repeated, then punishing outcomes is more important than punishing intent. Reading GW’s Economic Blueprint from Feb 2001 makes it pretty evident that he truly intended the economy to do well during his tenure. Similarly, the folks who bet big and lost (whether people buying homes or the geniuses repackaging loans and selling them) all intended for things to go well.
I was inclined to be a utilitarian — was exposed to convincing arguments against utilitarianism and watered down my beliefs to something vague enough to be unrefuted.
I can help you with this. There are three big problems with utilitarianism as described by philosophers. The first is that benefits don’t combine linearly as the slogan “the greatest good for the greatest number” suggests; similarly, we can’t just model “benefit” and “harm” as merely positive and negative numbers. Second, utilitarians and consequentialists often restrict the range of outcomes they consider; the apparently consequentialist slogan “the ends justify the means” often means in practice that “these particular ends justify all the other (usually unspecified) ends.”
But the biggest problem with utilitarianism is that it fails to account for uncertainty in Keynes sense of the word: situations whose outcome is not just unknown, but where the probability distribution of the possible outcomes is unknown. (To a lesser extent, utilitarianism similarly fails to account for situations that might have a probabilistic outcome that’s tractable in theory, but it’s too computationally expensive to predict the outcome under time pressure.)
None of these factors affect the philosophical basis of the general family of pragmatic or consequentialist ethical theories. Pragmatism is still true (were it not, it would be logically possible for some act to both be intrinsically good as well as having the consequence that all of humanity is tortured for the remaining life of the universe), but we just can’t know — in a deep fundamental way — the consequences of our actions. Hence we must use principles, which appear deontic, to make actual choices to achieve the pragmatically best outcome.
From cognitive science, it appears empirically that our minds really do work not as accurate future-predicting systems, but rather as principle-management and -application systems. From this view, an evolutionary story for the development of both our minds and our societies kind of pops out: there’s variation in the principles and meta-principles in people’s minds, and there is are natural selection pressures operating on those principles, keeping them imperfectly tracked with pragmatic reality.
Jack,
You have a point but remember bringing back the regulations means funds will become harder to come by, interest rates will rise, middle class families will have less access to credit for things like buying a house, sending their kids to college, buying a new car, or just buying a new dress or pair of shoes on credit. On the corporate and business side less available funds means less funds for new businesses, business expansion, IPOs, and real estate construction, and other items that they may want to finance.
The old system caused a bubble and had had a hard time adjusting downward given fixed or scheduled payments are not ajustable (goes with the word fixed). The derivatives and bundling was not the issue.
Cactus,
If you want to prevent outcomes from being repeated, then punishing outcomes is more important than punishing intent.
This is a military ethic that I don’t believe is appropriate for civilian life.
What is civilian law for?
Cantab: “The old system caused a bubble”
Which bubble are you talking about? The old system ended with Reagan.
Min,
Which bubble are you talking about
The one that started to pop in 2007. That should have been obvious to you.
Rdan,
What is civilian law for
Civilian affairs. And in civilian affairs we don’t have a tradition of just punishing outcomes without looking at intent or negligence. I think both the Naval and Army commanders were sacked after the Japanese attack on Pearl Harbor. The outcomes were sunk ships and bombed airfields and other targets, and in this case the outcomes alone were enough to sack the commanders.
what caused the financial crisis –
in very small nutshell, rate of return to financial capital [fictitious capital] becoming substantially higher than production capital’s rate of profit [ fror and prop are qualitatively distinct] — which also means having to answer what caused rate of profit to fall away, sharply and then tendentiously, over a multi cyclic period from the later 1960s, and the various reactions to this, one of which was a change in mode of organization [e.g. transition from mnc to tnc] justified through neolib ‘tina’ ideology. ‘financialization’ was no afterthought but grew out of systemic contradictions which ‘weve’ been aware of for nearly 150 years.
within this an evident turn to credit inflation, financial dependency and failure to recognize absolute limits but instead pretend risk away.