Daniel Friedman, UCSC professor of economics, welcomed the public to hear his research on the financial crisis. Photo by Devika Agarwal.
Daniel Friedman, UCSC professor of economics, welcomed the public to hear his research on the financial crisis. Photo by Devika Agarwal.

If the global financial system is a planet, then the implosion in 2008 was just its surface.

“It looked like a Rube Goldberg type of device,” said Daniel Friedman, Ph.D., an alumnus and professor of economics at UC Santa Cruz who delivered the 44th annual Faculty Research Lecture on Monday at the Music Center Recital Hall.

The Faculty Research Lecture, annually awarded by the Academic Senate, is a foremost research honor for UCSC faculty.

Friedman, an economist who received his doctorate in mathematics from UCSC in 1977, has been teaching at his alma mater since 1985. He recently published a book, “Morals and Markets,” and was an honoree at UCSC’s 2009 Founders’ Day event.

His lecture “Beyond Fear and Greed: The Moral Roots of Financial Crises” was Friedman’s narrative on the calamities of the global economy, using insight from his own research in experimental economics.

Friedman runs the Learning and Experimental Economics Projects (LEEPS) of Santa Cruz, a research lab that does experiments with human subjects involving money, testing the actual motivations of economic activity. The lab has been open since 1986 and is at the forefront in the new field of behavioral economics, a field that combines cognitive science and psychology with economics.

“[He] works on an incredible number of projects. [LEEPS] involves many fields and many disciplines,” said Alessandra Cassar, a professor of economics at the University of San Francisco and co-director of LEEPS.

Friedman explained the layers of the financial system using metaphors of planetary geology.

“I want to give a tour of ‘Planet Finance,’” he said a few days before the speech.

Friedman began his lecture by outlining the events that led up to the 2008 crash. This is the crust of Planet Finance, Friedman explained, describing it as similar to a “seven-ring circus.”

Friedman said that in the early 2000s a housing bubble grew. Prices on homes went up, and anyone — even those without income — could take out a mortgage on a house.

These mortgages were traded like stocks or bonds, using advanced mathematical formulas developed by astrophysicists. When housing prices fell in the summer of 2007 the bubble popped, investors lost millions of dollars, and the financial system froze. The snowball effect only worsened the crisis until the global economy itself was impacted.

The details of this ultimate crash of the global financial system are known by most: bailouts with taxpayer money, loss of state revenue and a 10 percent unemployment rate almost two years later.

To better understand Planet Finance, Friedman pushed further below the surface. Just below the crust is the mantle, and Friedman compared this to underlying trends in the global economy: globalization of finance, complex financial innovation, and deregulation.

At the center, or planetary core, is the origin of our finance and its function. Friedman explained that the core of our financial system grew out of a desire to provide for the future. This core involved promises and cooperation — a system that could efficiently turn people’s savings into others’ investments. This system failed in the 2008 crash because finance became more of a tool of excessive greed than a way of distributing resources.

“There are important things they haven’t dealt with yet,” Friedman said. “Before we’re done, we are going to need more thorough reform.”

He warned against the human instinct to only punish bad bankers, saying Americans should also implement more transparency in Wall Street and find a way to measure firms that are a systematic risk to the whole economy.

Friedman’s lecture gave a stratified look at the 2008 global financial crisis, and how people underestimated its far-reaching effects.

As Friedman said before the lecture: “My worst-case scenario, in my own thinking, was about half as bad as it turned out to be.”