“No problem can be solved from the same level of consciousness that created it.” — Albert Einstein
Can scientists help economists and regulators stabilize financial markets?
A number of scientists – people who pride themselves on acknowledging the limits of their knowledge and who use a rigorous process to expand the boundaries of what’s knowable – say “yes”.
We need to understand how and why the crisis happened and why warnings over the last years were not understood or heeded. We need to use this knowledge to stop this crisis and get the economy functioning again. In the longer term, we need to redesign and reregulate the financial system so that it performs its necessary functions without leading to periodic crises of global scale…
(A) critique of the neoclassical paradigm has been developing from within economics as well as from the study of complex systems for the last twenty years. To this can be added other insights about how to describe markets which depart from neoclassical assumptions. These can be combined to yield a new scientific conceptualization of economic systems. This needs to be developed before it can yield precise detailed models of the economy of sufficient complexity to be reliable. But it offers a lot of promise…
The real success of the American economy has been in its functioning well as an incubator for innovation in real goods and services. This has given us expertise and technology, which has now led to the invention of financial instruments whose use, in a failed theoretical context, largely unregulated or comprehended, threatens to undo all the economic progress of the last decades. The question in front of us is whether the same spirit of innovation can be applied to the principles of economic theory that governs financial markets so as to base the design and regulation of those markets on correct and verifiable principles and models…
If we had embraced uncertainty management rather than risk management and done even a rudimentary job of estimating the uncertainty in the system, the mathematics would not have been nearly as courteous to the preposterous positions taken in the markets, which doomed our last financial system. This is to say nothing of the myriad principal-agent problems with incentives rampant throughout the system.
Not everyone agrees with them of course, but it seems like they could hardly do worse than those with “titles or authoritative baritones” that have allowed their speed to execution outpace their speed to comprehension. Because in the last analysis:
(We) don’t believe that citizenship in the United States should now hurriedly be converted into forced participation in an unaccountable secretive national hedge fund which buys lousy assets at inflated prices from banks mismanaged for personal profit by multi-millionaires, and makes non-consensual capital calls on uninformed, captive, financially unsophisticated families.
No indeed.
In one of my former lives I was a stock-broker. Once, when asked by a young trainee what qualities made for a successful stock-broker I replied: “Either a PhD in mob psychology or 15 years experience as a riot control officer at the State Pen–preferably both.”
One word covers what caused the market crash, one. It doesn’t take a scientist, or economic magicians. It’s not complex, it’s simple. What caused the whole mess was greed. At the root of each and every part of the system that led to the crash, was plain old greed. Why does gas cost around a buck fifty right now, vice the almost four two months ago? Speculators feeding the greed machine on the future cost of oil. When that little Ponzi scam tapped out, speculators started cashing out, and joila, the price came down to a realistic floor.
I won’t get into Freddie and Fannie, it was a bad, nasty day, and I don’t want to get any more irritated than I am. Mad, you don’t want to see or hear.
A significant part of this problem was in fact caused by mathematical models developed by people with very high IQs and often with PhDs.
Crusty old loan officers, with IQs of 110 or so but with lots of experience in reading people, would probably not have screwed up nearly so badly.
It pleases me to see I am very much in agreement with both ByronA and DavidF above.
Unmitigated and under-regulated greed (and now fear) savaged the financial industry and the free market. Exacerbating it were those PhD “quants” who propelled unabated greed to absurdity. Now we must all bear great pain for their extreme errors.
We also don’t need no more stinkn’ scientists who know little of the dismal science, and whose mathematical colleagues helped to create this mess…. Just a little more basic common sense, honesty, integrity, transparency, and oversight will do quite nicely.
It strikes me that as a business gets very large and complicated, it moves in a sense from “VFR” to “IFR.” In a small business, or sometimes even in a modest-sized one, many things–are the customers happy? is that loan applicant trustworthy?”–are open to direct sense impressions. In a large & complex business, they have to be derived from the instrument readings, so to speak. And the number of competent “IFR business pilots” is probably a lot less than the number of competent “VFR business pilots.”
I have been saying for sometime now that too many of our best and brightest have been attracted to the financial services industry where, instead of applying their intelect and talents, say, developing better automobiles for GM, they have been dreaming up even more complex ways to make something from nothing. That those schemes worked for many and made them all killings until the walls came tumblin’ down only made a bad situation worse.
I am no economist but it seems to me that any sustainable economic system should have a very healthy part of it based on creating wealth by adding value through the creation of products. You know, take one part raw material. add two parts intellectual capital, one part labor and create jobs for middle class and wealth for the investors. Contrast with finanacial products that seemed to be designed only to create ever more incomprehensible forms of leverage designed to attract ever more numbers of investors until well…you know.
One way to make money requires real work and creates real wealth in the process. One is designed to create profits for little work. A free lunch if you will.
Now the smart guys that put all this together weren’t so dumb after all – it wasn’t their money they lost after all and I’ve yet to see one person associated with the scandal at any level offer even a pro-forma insincere apology let alone demonstrate any real shame. On the contrary it seems like most are scheming just to see how big a bonus they can get away with without calling too much attention to themselves.
I’m all for smart people figuring out how to prevent this but I don’t think its all that hard to understand – raise the margin requirements on all instruments and stop leveraging the hell out of everything. There were some calling for this and warning of the consequences long before the crisis erupted. Of course they were overruled by those, in effect, on the take, from the financial services lobby.
And they aren’t apologizing either.
Lex, I have 25+ years as a Ph.D. economist working on finance issues. The are two great threats to the country in the financial crisis. The first is that the system breaks down and catastrophic, long-lasting damage ensues. (If you think the present situation fits that bill, I would ask you to consider recalibrating….) The second is that Congress critters, regulators, and the general public accept the “greed” story as if it is the truth. This completely misses the fundamentals.
It will be a while before we understand all the interactions between some good, some awful decisions made by financial industry firms, incredibly stupid decisions by Congress critters, decisions by regulators (some of which will undoubtedly look terrible in retrospect), and unprecedented shocks to the financial system.
Everyone has a stake in the outcome of the ongoing restructuring process. My prediction is that anyone who stops thinking about the state of play and settles for the “greed” claim are highly likely to conclude later that they had it wrong.
Virgil:
Interesting observation re. qualities required for a stockbroker…would also note that during WW2, the Navy sought out brokers to act as FDO’s (Fighter Director Officers) to work in the carrier CDC’s. Why? Because they could handle a large volume of data, sort accordingly, do mental math (calculating intercept geometries) and not lose their head in the process…
- SJS
Bob:
What do you see as the “fundementals” that are at the root of the current crisis?
Bob, at what point in time did greed not have a hand in this mess? Whether it be money, or power? Please. Elaborate. I’m just a poor, unschooled common laborer.
We are talking about the same (loosely defined) group of people who can’t agree on whether or not global warming/climate change is or is not occurring and if it is man made or not.
Right?
Those people?
Yeah, that’s what I thought…
Oh yeah, and Byron is right… GREED.
SJS:
It works the other way, too. The manager of the Louisville Merrill Lynch ofc while I was there was an ex-Marine Korean War vet whose son was a Marine. He thought ex-military types to be not only cool under pressure but basically “squared-away” mentally as compared to their civilian counterparts of the same age, so hired a lot of vets. We had me (AF), a ex-Navy P-3 driver (was a fraternity brother from Colgate) and two ex-Navy F-4 “aviators”; three Army types (one was an ex-Caribou herder IIRC) and a couple of WWII vets, one ea. from USMC and Army.
Let me say at the outset that I believe there is plenty of shared responsibility for this mess. Here is an incomplete list of what I believe to be some important factors:
1. Congressional interference in mortgage lending that led to bad loans that spread default risk far and wide. The securitization of mortgages worked for over 20 years without difficulty. The change is that Barney Frank, Chris Dodd, and some others forced Fannie/Freddie to make bad loans.
2. Credit default swaps are a way to handle default risks in a setting where basically good loans are being made. AIG, in particular, screwed up on these contracts, but without point 1., the mess is not a mess.
3. Leverage at individual financial firms was considerable, but the shocks that hit the financial system weren’t firm-specific, they were systemwide. That means that the unlevering process had to work across all firms at the same time. Under the best of circumstances, unlevering is tough. It is impossible to imagine that it happens across an entire financial system without incident.
4. The regulatory response created uncertainty and made it exceptionally difficult for investors and managers of financial system firms to sort out the way forward. Letting Lehman Brothers fail while saving other firms just looks stupid. Arguably, saving Lehman puts a stop to some of the insanity.
5. Bad decisions by senior management at financial firms plays a role…..no doubt about it. Firms raised too little capital, risked too much money, and did too little serious risk management. The failure wasn’t that they listened to the Ph.D. quants, it was that they didn’t push their work hard enough. It wouldn’t have saved them in all circumstances, but those conversations would have raised red flags everywhere.
There are aggravating factors at work here, too. Households in the aggregate have borrowed too much, saved too little, spent too much, and generally have lived too high off the hog. The Fed under Alan Greenspan held interest rates way too low for too long, and this led to a housing boom that created many problems. The list could go on……
Honestly, if financial firm managers were paid $1 a year, it wouldn’t have made a bit of difference. Paying them $1 going forward won’t sort out the mess either. That dog won’t hunt.
I am particularly concerned that the Congress critters that had a huge role in creating this mess are the same jokers who are going to “fix” the problem. Resigning their seats and wearing a hairshirt would be a step in the right direction, but it won’t fix the situation.
Finally, expectations of future prospects are quite crucial to recovery. The foolishness on the network evening news is, in my opinion, contributing to the problem because it is relentlessly negative and the reports are often misguided. If they wrote that on an exam in my course, they might get a D on partial credit. The level of the discussion on television is appalling. The Wall Street Journal is quite good, but the NYTimes is still best used to line the cat box.
OK……that’s probably enough crap for one day from me.
Bob:
Good points and I appreciate the education.
I’m concerned at all levels thst the leaders who got us in to this mess as the ones being expected to get us out. Dodd and Frank, the CEOs and others at the financial firms, the CEOs and others at the failed auto firms, etc.
At the risk of venturing into a realm I am not qualified to opine I will say one of the characteristics of the Naval Service culture I admire is the, at times seemingly harsh, sense of accountability. Something goes wrong on a ship and whoever is in command resigns, etc. The lack of accountability and sense of entitlement in our government and other institutions is endemic.
Franklin Raines presixed over an era at Fannie marked by huge accounting scandals and laid the groundwork for the failure of the firm. Yet I’ve never read where anyone dares hold him, or anyone else accountable even as he persists in pursueing his NINE figure severance. He s but one, and as a Washington insider a particularly well connected example of what this leadership culture of these institutions has reaped.
If we could only throw the whole lot under a literal bus and start over….
OT6P,
Sir, I share your disgust with the lot of them. I also believe that your analysis of leadership and the culture of these organizations is dead on the money. One need only look around to see that there are some very substantial banking firms (Wells Fargo comes to mind) that have not been beset by the troubles. The reason is that senior management steered the firm away from trouble through a series of important decisions. Let me put this more plainly, financial ruin wasn’t inevitable, but followed from poor choices.
I am at a loss to understand why the accountability standards of the U.S. Navy (and its sister services to one degree or another) aren’t emulated in private industry. I understand the economics of why this happens (there is an entire branch of financial economics that studies conflicts between the interests of managers and shareholders), but the lack of honor and integrity among senior managers is disgusting. There is no justification for screwing up royally and then hanging around to collect another year’s salary. I have no problem with high salaries in finance, but if you screw up a firm like some of these guys did, you have to leave and forfeit the big salary. Consequences……
As for the lack of standards in Washington, D.C., my disappointment is with voters who refuse to throw the bums out the door. A little more Navy-style integrity would go a long way toward a better country…….
Thank you for serving, too!!!!!
OldT6Pilot. Exactly right. (and BTW I think the T-6 is a whole lot of fun to fly). The lack of accountability for this mess is stunning. Perhaps because there are so many to blame, none are?
Many businesses, ours included , embrace the GE mentality where employees are held to metrics, and force ranked. “A and B” players are retained. Bad decision making, bad leadership can cause the whole ship to sink.
Those associated with the financial debacle should not be allowed to have a hand in guiding the recovery.
So many great points have already been made, thus my limited financial systems knowledge may contribute little but here goes. . .
It would appear the collapse, at least in my mind, goes hand in hand with the cultural morass which has been growing over the past several decades. Culturally we are moving away from moral absolutes in favor of anything goes as long as you think it is okay. I opine that we cannot look at the senior leadership of the financial industry as separate from the greater culture which has come to believe in large part that cheating is acceptable (in so many ways).
Those of us who do still cling to a higher moral code, can clearly see what Wilco has questioned above that there are so many to blame. . . and we know at least in large part who they are and what part they played. But unless the greater society stares into the looking glass and sees how it’s settling into the low lying swamps of relativism and sloth directly contributed to this situation we shall not overcome it in a way favorable to the future freedoms.
Old T6Pilot;
The key word in the last sentence of your analysis is “literal.” None of this “virtual” stuff indeed….
PS: I always knew your bird as the “AT”-6, even when used strickley for tng, when did they drop the “A”?
Bob:
Some very cogent comments which parallels my experiences. As a Political Scientist who also worked in Wall Street after a stint in the Air Force, then academia, I can totally agree with you about the cynicism and greed that pervades much of the financial services industry. But CHRIS makes the excellent point that this leadership evolves from a general culture whose moral fabric also has frayed. Greed being not limited to just the big kids, but is a common trait of all men–often held in check only by lack of opportunity–opportunities to be had a-plenty in this last go round.
Your point about the level of discussion on tv as “appalling,” while true, somehow doesn’t do it justice–perhaps I would say “shockingly appalling” but at this stage of my life I’m beyond much shock. Oh, btw, you forgot the bird-cage…
The rule of law is one of the few constraints upon opportunism. If you agree that a moral worldview works alongside it, then you are in good company with John Adams.
“Avarice, ambition, revenge, or gallantry, would break the strongest cords of our Constitution as a whale goes through a net. Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other”
Virgil- brought out my POH for the T-6. It dropped the “A” in 1949 when the USAF rebuilt the Texans and they became actually T-6G
I belive they dropped the A from the AT-6 when the Air Force was formed. The A was for “advanced” trainer and at least for a period of time the T-6 was used for “primary” instruction in the 50′s I am told. Imagine your first solo in one…..
Yes the -G models were remanufactured from old airframes, added – P-51 style tailwheel, wing bladders for additonal fuel, single action hydraulic system (no activation lever). and new SNs.
They are a blast to fly but sadly I had an incident with mine….
http://www.vansairforce.com/community/showpost.php?p=280336&postcount=23
Virgil:
I chose “literal” on purpose…..but my solution as proposed would create a mess of the busses and the streets. Firing squad perhaps??? Bring new meaning to the term “live fire training”?
[...] discussion about the financial crisis, Wall Street, management and accountability at Neptunus Lex. The initial post is merely the starting point for some insightful comments by readers. Worth [...]
[...] discussion about the financial crisis, Wall Street, management and accountability at Neptunus Lex. The initial post is merely the starting point for some insightful comments by readers. Worth [...]
OldT6Flyer
Oh, I KNOW you did–and I’m with you all the way–also, maybe let the Army ROTC types do the firing squad bit–give them a leg up on their marksmanship proficiency prior to active duty.
OldT6Flyer:
After reading your link about your accident, I couldn’t help but think of my 1st cousin (my Mother was 20 yrs younger than the rest of her siblings) who flew P-47s in WWII. Taxiing and landing on those narrow slick PSP runways in rainy, icy, snowy Northern Europe must have been a fine art–all you could see forward was nothing BUT cowling.
Bob:
As for throwing the lot in Washington out the voters aren’t really offered much of a choice in most cases. Something like 98 percent of House seats run unopposed or with token opposition at election time. I have come up with a couple of ideas to address that issue with, with the groups indulgence, I will expound upon.
The issue seems to be money. Incumbents start with a huge fund raising advantage and the source of the majority of those funds (PACs, etc) seem to like take a “devil you know” (or have bought) approach versus funding unknown opposition candidates. The way to address this is to, via constitutional amendment, limit candidates for Federal office from receiving or spending funds for campaigning other than from individual constituents in their districts. Why should whomever decides to run for the vacent Senate seat in New York or Illinois raise funds for their election other than from the people of their state?
This would not attempt to regulate lobbying, which is rightfully a form of first amendment protected speech. Go ahead and lobby all you want PETA, Geenpeace, the NRA, etc. Just don’t raise money to elect people.
If the candidates had to actually appeal to the voters who they are to serve instead of “other” elements you would open the door for more representative government and make incumbents have to be more accountable.
Of course this idea will go nowhere given the forces who like the system just fine the way it is. And we are left with the kind of dishonorable (yes that is the word) leadership we have sadly come to expect.
As for corporate governance. I don’t know how we break the cycle of croneyism that has led us to the level of decadence we see in so many of our largest institutions today.
Virgil,
I concur in your point about the bird cage! Sorry to hear that you have seen much of the bad behavior up close and personal. That is one major reason why I operate in the academic world……we have plenty of stupid, greedy, short-sighted, selfish people here, too. I just don’t have to interact with them in the same way……limits the damage in some ways. Still, I find myself standing in front of finance classes talking about the importance of doing the right thing….no looting and pillaging!! I wonder what their parents said to them….
OTF: I concur with your assessment about candidates. I am persuaded (at least for the moment) that the basic problem is partisanship in setting the boundaries of Congressional districts. Those in power are perfecting the gerrymandering of districts, so even if someone has the money, the district boundaries are set to tip the scales in favor of the incumbent. A federal mandate to have redistricting undertaken by non-partisan commissions would go a long way toward upsetting the apple cart……….which is why the Congress critters won’t hear of it. I actually think dishonorable is a pretty apt description of these folks: it isn’t illegal, but I would knock the snot out of a kid of mine who acted like that.
One of the wonderful ironies is that the same guys who block non-partisan redistricting after each Census are writing the rules on corporate governance. Any wonder that the rules aren’t really working as we would hope? There are folks in the business school faculty world who have some interesting proposals on how to eliminate egregious abuses…….we mostly have to talk to ourselves, since there is little interest in serious reform in Congress.
OTF: I completely agree on limiting campaign contributions to those who reside in the district. What we have now is a complete disgrace.
#13 Bob – Indeed there is plenty of shared responsibility and blame for this mess. The current economic storm we find ourselves in had many contributors, had many years in its evolving, and included regrettable acts of commission and omission. Thus any list – yours, anyone’s – and mine are likely to be “incomplete.”
I do agree generally with your five delineated factors and also, especially with your aggravating factors. Where we differ is the relative weight you seem to give certain factors, and a few very important factors surprisingly omitted. And then there is that ever underlying matter of “greed” which I will address further.
1. A recurring theme in your comments seems to be an emphasis on Congress (and certain members) for having “a huge role in creating this mess.” While I certainly do agree that Congress must shoulder some of the blame, but as far as bad actors or enablers, they are hardly at the top of the list, as you seem to imply. Indeed, there are greater culprits in this – including but greater than Fannie and Freddie – despite what Congress may have “forced” anyone to do.
2. Congress did not cause AIG to fail. Nor did Congress cause the explosion (bubble) of credit default swaps (CDS). Bubbles break, and the CDS bubble (and CDO bubble) would have eventually broken, if not by the mentioned Congressionally aided sub-prime debacle, then some other instigator in our deteriorating national economic well-being. While CDSs have utility, they rapidly became instruments of speculation for pension funds, insurers, and especially hedge funds. As unsecured derivatives, speculative bets could almost be limitless (without regulation) and many seemed to be. And no one seemed to care or understand, the leveraged risk. A former securities regulator called CDSs a “‘Ponzi scheme’ that no self-respecting firm should touch.” And when the music stops…………..
3. Yes, the leveraging at individual financial firms was considerable (and unprecedented at well over 30 times in some cases!… and it was mostly and unfortunately unregulated). Interestingly, the WSJ yesterday, while mentioning the culprits of mortgage bankers writing bad loans, investment houses packing the loans into complex instruments whose risk they didn’t understand, ratings agencies who gave their seal of approval, investors on margin, and regulators who were asleep………..The WSJ laid primary blame on the “four bosses of Wall Street.”
4. While I do agree there was indeed uncertainty and confusion in the “regulatory response,” this was after the barn was well burning; it was also understandable. But the greater problem was that regulation had been on the wane for decades prior, and indeed this increasing lack of regulation combined with the explosion in exotic derivatives within a less than transparent environment, caused the barn to burn in the first place.
5. Agreed that bad decisions were made by senior management. But why? In an environment of unabated greed with revenues and bonuses unprecedented, caution is often left by the wayside. There were in fact, “red flags everywhere.” But as long as the gravy train continued, fueling the insatiable greed, many wore blinders while pocketing the bonuses.
I totally agree about our excessive and conspicuous consumption, fueled by too little household savings, incredible levels of consumer credit card and equity debt. And yes, Greenspan deserves much blame, as does the administrations of Reagan, Clinton, and Bush. Nixon’s taking us off the Gold Standard contributed, as did China’s massive savings rate and artificial Yuan. Repealing Glass-Steadall and other deregulation provided both tinder and fuel.
But it was still basically greed that caused unsophisticated buyers, who previously could not buy a house, to buy above their means. It was greed that caused speculators to buy and ‘flip’ houses with leverage as fast as they could for big profits. It was greed that allowed loan officers make loans they knew were at best shaky, but the commission was still good and immediate. It was greed that allowed mortgage companies to pocket the money and slough off the risk to somebody else. It was greed that allowed under-regulated investment banks to generate unprecedented revenues through egregious leverage and untenable risk, blindly and foolishly hoping the boom would continue.
It is sad that while most all lost, the greediest individuals walked away with millions if not billions, while the least greedy are now homeless.
Finally I must add that the long and flawed reign of the Chicago School of Economics is finally over. RIP
Taxes are a huge part of the problem. I’m an engineer and now have my own small firm. When I worked at a large firm,my fellow engineers used to always complain about how much the finance guys were paid. I asked them how many of them could double the corporate profit margin by anything they did. The answer was not many and only by making some breakthrough discovery. The finance guys only had to avoid taxes.
High tax rates (and the US is a world leader in corporate taxes) require that business spend huge amounts of effort in tax management. Once that mentality takes hold, all kinds of financial machinantions are accepted
Greed, being a most common of human traits, needs to be held in check by other character traits, learned, developed, and nurtured by societal norms. A sense of honor and duty to serve something greater than self must be accompanied by negative consequences of shame and ostracization should one fail in upholding the moral tenets of the group.
While large segments of our society seem to hold such views as quaint and a relic of a irrelevent past, I would suggest Wall Street offers exhibit A as to the consequences for society as a whole when such basic principles are mocked. Yet they mock them still. Witness the Senatorail appointment this afternoon in Illinois.
I was thinking of an example of this morning while reading the sports pages. I live in Dallas yet am a diehard Redskins fan. Both franchises are owned by individuals who personify this “the old rules are quaint and we are going to change the established order” kind of thinking. Both organizations spend lavishly on players, coaches, have new stadiums, and compete annually for the number one ranking in the monetary valuation of their enterprises in Forbes annual ranking on that topic. The companies make a lot of money but not as a result of accomplishment on the field – rather in spite of it. They both remind me a lot of the captains of Wall Street – very good at playing the game (and enriching themselves doing so) – but not so good at building anything of permanance or creating organizations that are grounded in excellance. To not call them successful would be foolish. To celebrate their success will be fleeting.
I would wish for more Lamar Hunt’s of this world to emerge who see sucess defined in creating something greater for everyone to enjoy.
But such notion’s are quaint relics of time before “seat licenses”, credit default swaps or 8 figure bonuses on Wall Street.
Dave:
You hit the proverbial nail on the head. As one CPA once said to me–and this was back in the early 80s–”Under today’s Tax code a businessman can make more money saving taxes than he can making money.” People forget the tax shelter abuses caused by a combination of high taxes and high inflation and stagnant growth during the Carter years. Once the driving force of the economy becomes financial manipulation it drives the best minds to work in that domain.
And the tax code leaves plenty of running room for inventive minds. Are you aware that Congress has NEVER EVER yet defined “debt” and “equity” for the purposes of Tax law? There are, as a result, gray areas in the code as large as the Pacific for energetic, intelligent CPAs and “quants” to play with. I could show you several of the more “exotic” financial instruments that can be tailored to act like debt instruments under one form of tax treatment and as equity under another–depending on what one needs in order to minimize one’s tax exposure under various filing scenarios. Tax law, coupled with people seeking to park their money in areas of highest growth, almost always creates areas of excess.
Harking back to the Carter era of excessive tax shelter abuse and unoccupied office high-rises built not for economic reasons, but for the miracle of the tax write-off, one architect friend of mine said to me at the time: “I just hope this thing (bubble) lasts long enough for me to build my own mega-bucks see-through office building and make my national reputation!” LOL
Bob:
Look, the psychology of the whole thing is that one never knows when the bubble will burst, so each individual is penalized financially and professionally if he doesn’t
“go with the flow” and reap the financial mega-buck rewards as long as it lasts. If not, he gets fired. Guess which choice most people make. Who among most of us is willing to sacrifice the house, pension and their children’s education by forgoing the bucks and/or being fired in favor of some nebulous “general good?”
And besides, haven’t most of the major players made out like bandits with their severance packages even AFTER the house of cards collapsed? Obviously cynicism and greed PAYS.
And just think of the psychology operative in the early stages. With luck most of the “big kids” (well, mid-level “big kids) figure they will be retired, pension, bonuses and deferred compensation packages well in hand, sitting in Sarasota at Micky Ds early in the am sipping coffee, reading the WSJ and contemplating an afternoon on the links well before the bubble bursts.
The really BIG “big kids” contemplate the South coast of France or Lake Como with digs next to George Clooney.
PS to Bob.
And remember, there was an Army of lawyers and CPA’s advising everybody that everything was totally legal, rational,and a wise deployment of assets. So who was to believe that anything was wrong, let alone illegal?
And most of it WASN’T “illegal” it was, as Talleyrand once said in different circumstances, “far worse than a crime, it is a mistake!” Most “crimes” are by nature limited in scope (save for treason) and relatively easy to get behind one–even large financial ones. The right “mistake,” in comparison, can, as Talleyrand knew, totally ruin a nation.
fliterman,
Many, many good points…….we probably differ only on the weights to assign to the various actors in this wretched production. I stress Congress’ failures here because some of their number took the crucial steps that generated the housing bubble and all the associated bad loans that are at the core of all the mess we see. The CDS business ran into trouble in the mortgage side, not the corporate side. I don’t disagree that financial firms badly mishandled these instruments in retrospect. With normal loss rates on mortgages, we don’t have the problems we see now.
Let’s be very clear: there is shared responsibility all around on this mess. What prompted me to post the first time was my concern that most Americans are being fed a line of nonsense about high CEO pay and greedy Wall Street traders being the core of the problem. There are many sinners, and some of the biggest are spinning this line of nonsense on Capitol Hill and are lining up to ‘fix’ the problem. I’d rather have a root canal without anesthesia than have the likes of Barney Frank and Chris Dodd ‘fixing’ the problem.
What about the greed issue? As virgil (and others I think) have noted, this failing is widespread. Folks with regular jobs and no real estate speculation experience were buying and flipping houses to make quick money. It was stupid, and I don’t know any other explanation for it than greed. Too much leverage and too much risk were common among some Wall Street firms. Some of these guys thought they understood what they were doing and got it wrong. Some were just plain stupid/greedy. There is a big difference between these two sources of mistakes on Wall Street, although their consequences look pretty much the same.
At the end of the day, a much more widespread and conservative approach to risk-taking and investing is clearly called for at the level of the household. Wall Street has to get way more serious about modeling risks and limiting risks to much smaller levels. If you want to risk a bunch of money, invest in a hedge fund. You can make a bunch, but you can lose a bunch, too. (One of my former students has blown up two hedge funds; I wouldn’t have given the guy a nickel to invest…..the most deficient character I have ever seen in class….just awful.)
Measured risk-taking is good…….greed isn’t. We need to come out of this mess with a financial architecture that allows the former while exposing the latter to the market’s punishments.
A last point: Chicago Economics is alive and well. It has been seriously miscast in the news. Some of the harshest critics of stupid, greedy behavior have been Chicago guys…….What should be dead is mindless application in the economic policy arena of simple-minded sound bites attributed to Chicago economists by self-serving politicians.
My thanks to all who have joined in here……much better discussion than I have had at the lunch table with other academic finance profs.
Virgil, you said a mouthful, and I’m part of the problem. I’m a farmer. Gentleman farmer, 73 acres that I let a neighbor farm and I get part of the crop to feed to the critters, turkeys and chickens and horses and what-not.
My second year here I got a subsidy check from the USDA. $18. I’m thinking boy howdy now Mom can have that operation!
Then I hired a new tax guy. Once he went to work I discovered all sorts of fun that reminded me of the Carter years, when taxes were high but deductions were plenty.
We deduct the cost of cat food, they being a pest control device. We deduct the cost of fuel, oil, replacement parts, heck I can buy a $250K dollar snowblower and so long as I use it to get to the horse-barn it’s entirely legit as a write-off.
Of course, since I don’t pay $250K in taxes each year it’s kind of a moot point for me, but the end result is that we’re farming the government and tax code as much as we are the land.
Old joke: How does a farmer double his income?
Answer: installs another mailbox.
– Max
#35
Bob,
Thank you for your comments, and for expressing your unique and informed perspective on these matters. Fascinating stuff for me, especially since our differences on the subject are more of relative weighting, rather than diametrical.
It’s late, so I must be brief and therefore unable to do justice to your learned comments. But while I suspect our personal ideologies may differ, I find it interesting and reassuring that our combined assessment of the situation is very close.
My apologies however, for the Chicago Economics comment. It was a cheap shot, as you might have assumed. But as the rare Liberal antagonist here, I occasionally have been known for such missives, as many here will attest. Sorry.
A final comment – as a private investor with an interest and a bit of experience in economics and finance, I could see serious economic trouble building on the horizon, long ago. In fact, lex may remember a (tuned-down, for me) economic doom-and-gloom post I made here, perhaps a year ago in December, forecasting our current situation. In his reply, I remember his satirical and witty tongue-in-cheek comment to me was, “meet you in the bread line.” Fortunately, neither of us is there, and never should be.
My point is this. I knew long ago very difficult times were ahead. And while I was somewhat well diversified, and I did fortunately make some serious adjustments to my portfolio in June of 2007, it was hardly enough. Thus, although I knew better, I still really got hammered in the markets’ recent fall, similar to how I got hammered in the dot-com bust.
Why? Because of greed.
In both bubbles, I had made so much money I felt invincible, despite well knowing the growing risks and impending turmoil ahead. And I didn’t want to miss out on that last marginal return before the eventual crash. My failure was not economics, government, regulation, ethics, or anything else but the sheer stupidity that greed breeds. And I unfortunately have a lot of company.
A government guarantee is a blank check on the taxpayer’s account, effectively off-budget and unregulated. Ironically, it makes us LESS secure financially.
It is a subsidy to the institution that is guaranteed, and results in a massive liability when the expanding unfunded risk of the institution is uncovered. Think bank deposits (S&L Failure of the 1980′s), Social Security, Medicare, and of course the guaranteed bonds of Fannie Mae and Freddie Mac supporting the resulting housing bubble and financial crisis.
The government ran an off-budget loan-department (Fannie and Freddie) that borrowed $5.4 trillion ($5,400 billion), as much as the total debt of the US before that. Fannie and Freddie were regulated and directed by the House Financial Affairs committee, chaired by Barney Frank (D. MA) and controlled by the Democratic majority for the last two years. The bad loans were made mostly in the last two years, under their direction and encouragement.
The crisis was powered by the unlimited guarantee of the U.S. Government through Fannie Mae and Freddie Mac, along with Government influenced ratings agencies that put AAA ratings on pools of sub-prime loans (Their Motto: Historical models predict they will be OK)
We Guarantee It is my detailed review of the government intervention that led to our financial crisis.