To understand how we got ourselves into our current economic mess,
complicated explanations about derivatives, regulatory failure, and so
on are beside the point. The best answer is both ancient and simple:

In modern mathematical economics, many people in the rich world
decided that we had finally devised a set of scientific tools that
could really predict human behavior. These tools were supposed to be as
reliable as those used in engineering.  Having ushered scientific
socialism into its grave at the Cold War’s end, we quickly found
ourselves embracing another Science of Man.

Our new beliefs did not stem from some new experiment or unexpected
observation, the way a real scientific paradigm shift does. Economists
do not typically conduct experiments with real money. When they do, as
when the Nobel laureate Myron Scholes ran the hedge fund Long Term
Capital Management (LTCM), the dangers often outweigh the benefits (a
lesson we still don’t seem to have learned.) And, since almost every
observation that economists make turns out in a way that wasn’t
predicted, no unexpected observation could ever actually change an
economic paradigm.

What really produced the change in economics that led to disaster
was the simple fact that you could now get away with saying certain
kinds of things in public. Some of us honestly thought that history was
over. And after all, you can’t have a final, utopian society without
having a final, scientific theory of human behavior, together with some
mad scientists or philosophes
to preside over the whole thing.

The problem is that, no matter how “scientifically” these new
beliefs were formulated, they are still false. Capitalism is, among
other things, a struggle between individual people over the control of
scarce resources. Like boxing and poker, it is a soft, restrained,
private form of warfare.

Military strategists have known for centuries that there is, and can
be, no final science of war. In a real struggle over things that
actually matter, we must assume that we are up against thinking
opponents, who may understand some things about us that we don’t know
about ourselves. For example, if profit can be made by understanding
the model behind a policy, as is surely the case with the models used
by the United States Federal Reserve, sooner or later so much capital
will seek that profit that the tail will begin to wag the dog, as has
been happening lately.

The truth is that such models are most useful when they are little
known or not universally believed. They progressively lose their
predictive value as we all accept and begin to bet on them. But there
can be no real predictive science for a system that may change its
behavior if we publish a model of it.

Markets might once have been

fairly efficient, before we had the theory of efficient markets. If
investing is simply a matter of allocating money to an index, however,
liquidity becomes the sole determinant of prices, and valuations go
haywire. When a substantial fraction of market participants are simply
buying the index, the market’s role in ensuring good corporate
governance also disappears.

The formation of large bubbles in recent decades was partly a
consequence of the commonness and incorrigibility of the belief that no
such thing could ever happen. Our collective belief that markets are
efficient helped make them wildly inefficient.

Despite this, over the course of the last 20 years, economists began
to act as if we thought we could genuinely predict the economic future.
If the universe didn’t oblige, it wasn’t because our models were wrong;
“market failure” was to blame. It is not clear how we could know that
markets were failing whenever they fell significantly, but believed
that we had no business second-guessing them when they climbed. Nor is
it clear how we all knew that LTCM’s failure or the post-September 11
malaise posed grave risks to the system, but could seriously doubt that
the dot-com craze was a bubble.

We repeatedly rescued bubbles, and never deliberately burst them. As
a result, our financial markets became a pyramid scheme. Moral hazard,
we thought, could safely be ignored, because it is “moral,” which, as
every true scientist knows, just means “imaginary.”

But a market is not a rocket, economists are not rocket scientists,
and moral hazard is, in human affairs, the risk that matters most. The
false belief that we can collectively see the future using science has
led us all to make various binding promises about things in
that future that no human being can possibly guarantee. A promise
of something that we should know cannot be guaranteed is also known as
a lie. That vast tissue of lies is now tearing itself apart.

Governments think we can stop this process by throwing money at it,
but there are many reasons to believe that this won’t work. The banking
system is probably already past saving – many institutions simply
aren’t banks anymore, but vast experiments that didn’t work out as

We could easily be “stimulating” and “rescuing” the economy for a
rather long time, in ways that only delay the needed adjustment, before
we are finally forced to allow the required creative destruction to
occur. But that is not the real problem. The real problem is the
pseudoscientific ideology behind today’s crisis. A final science of man
has no room for the unplanned and unpredictable recovery that is the
only kind a capitalist economy can have after a crisis of this size.

If we cleave to the false security of a supposed science that isn’t
working, and forget about the philosophy behind it, ideas like personal
responsibility and the right to fail, our leaders will very
scientifically give us no recovery at all.

Daniel Cloud teaches philosophy at Princeton University, and is a
founding partner of two hedge funds, Firebird Fund Management and
Quantrarian Capital Management.