Economists' 'Inside Job' problem requires more than just disclosure

Bloomberg published an interesting column on the American Economic Association's new guidelines that require economists to disclose all potential conflicts of interest when publishing papers or making public comments.

This disclosure should be valuable, particularly if the press refers to it when seeking public comments.

However, this disclosure does not go far enough.

In the course of discussing the form of this disclosure, economists also talked about creating the equivalent of the Hippocratic Oath for economists ('do no harm').

While I think this is moving in the right direction, I much prefer a simpler disclosure attached to all economic papers:

The following are the three most important assumptions on which this paper is based.  If they are not correct, accepting or applying any aspect of this paper, including its recommendations, is likely to cause significant economic damage.

Please note that this puts a heavy responsibility on the author and the reviewers of the paper.  Between them, they have to actually ask the question of what are the three most important assumptions on which the paper is based.

Let me give you an example of how this might work.

The paper, Haircuts, I have chosen was written by Gary Gorton and Andrew Metrick.  They examine what they refer to as the 'Run on the Repo' and assert that the financial crisis that began in August 2007 was a banking panic that resulted from the previously informationally insensitive debt, the repos, becoming informationally sensitive.

The following are the three most important assumption on which this paper is based.  If they are not correct, accepting or applying any aspect of this paper, including its recommendations, is likely to cause significant economic damage.

1. The invisible hand does not require that buyers know what they are buying.  [In Econ 101, everyone is taught that the necessary condition for the invisible hand to work properly is that buyers know what they are buying.  Therefore, if buyers have to know what they are buying, then by definition there can be no such thing as informationally insensitive debt.]
2. The invisible hand can work properly in the presence of information asymmetry.  [In Econ 101, everyone is taught that if one party has more information than another, the price a good exchanges between the two parties will favor the party with more information.]
3. The invisible hand can work properly in the presence of opacity.  [In Econ 101, everyone is taught that prior to buying a good/security buyers must have access to all the useful, relevant information in an appropriate, timely manner.  Opacity exists when the buyer does not have access to all the useful, relevant information in an appropriate, timely manner.  The result of opacity is that the buyer cannot properly assess the value of the good/security and an exchange will mis-price the good/security.]

Professor Gorton was a derivatives consultant for AIG and developed a model used by AIG to assemble a large portfolio of derivative contracts on sub-prime mortgage backed securities.