Gur Huberman points to an article on the financial crisis by Bethany McLean, who writes:
lthough our understanding of what instigated the 2008 global financial crisis remains at best incomplete, there are a few widely agreed upon contributing factors. One of them is a 2004 rule change by the U.S. Securities and Exchange Commission that allowed investment banks to load up on leverage.
This disastrous decision has been cited by a host of prominent economists, including Princeton professor and former Federal Reserve Vice-Chairman Alan Blinder and Nobel laureate Joseph Stiglitz. It has even been immortalized in Hollywood, figuring into the dark financial narrative that propelled the Academy Award-winning film Inside Job. . . .
Here’s just one problem with this story line: It’s not true. Nor is it hard to prove that. Look at the historical leverage of the big five investment banks — Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley. The Government Accountability Office did just this in a July 2009 report and noted that three of the five firms had leverage ratios of 28 to 1 or greater at fiscal year-end 1998, which not only is a lot higher than 12 to 1 but also was higher than their leverage ratios at the end of 2006. So if leverage was higher before the rule change than it ever was afterward, how could the 2004 rule change have resulted in previously impermissible leverage? . . .
On Jan. 3, 2009, at the annual meeting of the American Economic Association, Susan Woodward, a former SEC chief economist, highlighted the rule change in a presentation, a slide for which read: “2004 — SEC eliminated capital rules for investment banks” and “Average I-bank ratios of capital to assets: before 2004: 1 to 12. After 2004: 1 to 33.”
A number of prominent academics who were there went on to repeat a version of Woodward’s claim. They include Robert Hall, who was then the incoming president of the American Economic Association, Ken Rogoff, and Alan Blinder. . . . Thus did the “fact” become part of the conventional wisdom about the crisis. . . .
The funny thing is that this is a mistake that no one has corrected. Although Erik Sirri, who was then the director of the SEC’s division of trading and markets, rebutted the claim in 2009, the New York Times didn’t cover it. Lockner says he wrote to a handful of economists; only Niall Ferguson responded and was chagrined to find out he was wrong. Of the people I cited earlier, only Blinder, Johnson, Kwak and Susan Woodward responded to my calls or emails. Blinder now says: “It’s true that very high leverage was a big source of the problem, but the net capital rule does not appear to have changed that much.” . . .
More recently, Andrew Lo, the director of MIT’s Laboratory for Financial Engineering, wrote a paper analyzing 21 books on the financial crisis. In his paper, he pointed out the fallacy of blaming increased leverage on the 2004 rule change. Although Lo’s paper was picked up by the Economist, even that didn’t spur any of the academics who made the mistake to correct it. . . .
I know nothing about the substance here; setting that aside, this story interests me for two reasons. First, as Gur writes, it’s a story of “a posterior formed from a prior without letting the facts get in the way” and as such related to our discussions about communication difficulties and confirmation bias. Second, from a formal causal inference perspective, it’s a story of an “instrument” or treatment (a change in the leverage rule), followed by an “mediator” or intermediate outcome (the actual changes in leverage) and then an ultimate outcome (the financial crash). The claim is that the initial treatment had no effect because there was no change in the mediator. There would seem to be other possibilities (for example, perhaps the rule change, which allow the possibility of actual changes, was enough to motivate various dangerous outcomes), but I don’t know enough about the context to say anything more.