Three items in today's New York Times are sufficienly pungent to warrant mention. Lohr's article gives a clear exposition of the fact that the nation's banking system is effectively insolvent, it's debts being greater than its assets. Krugman again notes the futility of current plans which avoid shutting down the bad banks (and wiping out their investors) and saving the solvent ones. And Brooks, in an OpEd piece that motivated me to go ahead with this post, paints a pessimistic imagined future scenario for 2010 influenced by his reading of current cognitive neuroscience (Here, for example, is a relevant article, more recent than the work that Brooks was aware of, showing structures that appear to be more important than the amygdala in dealing with uncertainty). From Brooks' piece:
The problem was this: The policy makers knew how to pull economic levers, but they did not know how to use those levers to affect social psychology.
The crisis was labeled an economic crisis, but it was really a psychological crisis. It was caused by a mood of fear and uncertainty, which led consumers to not spend, bankers to not lend and entrepreneurs to not risk. No amount of federal spending could change this psychology because uncertainty about the future remained acute.
Essentially, Americans had migrated from one society to another — from a society of high trust to a society of low trust, from a society of optimism to a society of foreboding, from a society in which certain financial habits applied to a society in which they did not. In the new world, investors had no basis from which to calculate risk. Families slowly deleveraged. Bankers had no way to measure the future value of assets.
Cognitive scientists distinguish between normal risk-assessment decisions, which activate the reward-prediction regions of the brain, and decisions made amid extreme uncertainty, which generate activity in the amygdala. These are different mental processes using different strategies and producing different results. Americans were suddenly forced to cope with this second category, extreme uncertainty.
Economists and policy makers had no way to peer into this darkness. Their methods were largely based on the assumption that people are rational, predictable and pretty much the same. Their models work best in times of equilibrium. But in this moment of disequilibrium, behavior was nonlinear, unpredictable, emergent and stubbornly resistant to Keynesian rationalism.
...The nation had essentially bet its future on economic models with primitive views of human behavior. The government had tried to change social psychology using the equivalent of leeches and bleeding.
(A friend of mine claims to know a former hedge fund manager who has converted his assets to gold coins, and bought a safe, and a shotgun!)