A physicist friend who worked at the United States patent office once told me that the fastest way for a patent clerk to lose his or her job is to approve an invention that violates the laws of physics. Give a perpetual motion machine the green light, he said, and you'll quickly find yourself holding a pink slip.
Another physicist friend, who about six months ago quit her job at a financial firm, told me that she'd watched with horror as her colleagues fed numbers into a pre-fabricated black box of a model and made decisions based on what it spit out, despite having no idea what went on inside. As a physics student, she was taught to defend answers with rigorous proofs and scrutinize her own ideas for leaps of imagination and faulty thinking. She knew that the worst mistake she could make as a physicist was to fall in love with her solutions. Yet her colleagues comfortably made decisions in intellectual darkness, with far graver consequences than a few missed points on a homework assignment.
Sound familiar? In a New York Times article published in the early part of the economic crisis, David Leonhart wondered how good the good old days really were. Should it be our goal to achieve the fat years we saw before the fall? Or was America just in love with a non-rigorous solution because it told them what they wanted to hear?
The great moderation now seems to have depended—in part—on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.
Physics is comfortable with the notion that you can't get something for nothing and that engines can't run with perfect efficiency. When hot coffee cools down, it won't spontaneously warm up again. Loss is part of physics—and life. It's so dependable that a patent clerk doesn't have to think twice about throwing a blueprint for a forever-spinning waterwheel straight into the garbage.
In familiar economics speak? Bubbles burst. And no, this time isn't different.
Where are the equivalent fundamental laws of economics to provide simple, revealing tests of policies and financial practices? Few economists, if any, second-guessed the Wall Street quants' inventive alchemy that transmuted risky mortgages into fail-safe investments. Fortunes were made and ruined, houses were bought and homes lost, on creative modeling that no one looked at too closely, because no one wanted to. In a part of human life where even "what goes up must come down" is gleefully pooh-poohed, we need a few sobering laws of nature to rein in imaginative thinking and help us take a second look at tantalizingly lovely solutions.