It’s becoming increasingly clear that not only did the actions of many of the big hitters in finance hurt all of us, but that they really hurt their own firms too: witness the long list of big names who’ve been burnt in the Madoff affair, and don’t even appeared to have wanted to ask basic questions before handing over 100s of millions of dollars of their investors money.
But the observation that there exist greedy people who will do anything for a buck is not exactly earth-shattering. A more interesting question is this: why weren't people in government and even academia not as critical as they might have been about these things, and why are they still so muted in their response?
I think it's because of the psychology of wealth and its almost seductive lure. How often do you see a seemingly sensible person happen to meet someone Very Rich and come away gushing "He's such a smart guy, I hadn't realized what amazing insight he has" etc. People - especially otherwise rather impoverished academics and MPs - love to be around real money, and over time, invites to attend parties and speak at events start to affect their thinking. It's not usually corruption in the sense of brown paper bags or money wired to Swiss bank accounts, but a more subtle corruption of thought.
Economists who work in finance and related areas have a lot of clout via newspaper op-eds and being consulted by both private firms and the government. However, if you toe the line (or make a few interesting comments, enough to seem independent but not enough to case doubt on the whole enterprise) you get invited to cool rich parties and paid very well to speak at business lunches and so on. If you're more open, you will never enjoy any of that.
Equally, if you're in government, if you're too trenchant in your critique, you will be cut out of these activities. And you may be a long time retired from whatever cabinet post you currently hold. Think of how well former chancellors are received on the business circuit and among wealthy society: and how much they'd be hated if during their term they'd said things like this.
This is what I would call implicit corruption: it's not money in brown paper bags and conspiracies hatched in dark halls, but the insidious perversion of reason by the lure of wealth.
For me, this aspect of how extreme wealth distorts information gathering and regulatory activities in society (and tehreby makes the economy less efficient) is one of the strongest arguments in favour of limiting extreme wealth. I am convinced that Page and Brin would have started Google for expected future earnings in the millions (provided no one else was making more: people are very competitive). But if no one has vastly more than that, it's harder to bring about intellectual and political corruption on the grand scale we're now seeing.
Friday, December 19, 2008
Political economy of the housing bubble
I’ve argued below that the housing bubble was like an economy-wide Ponzi scheme. But how did it start and why was it allowed to keep inflating? I think the reasons are mostly political.
For the bubble to even start, you had to have major changes to mortgage regulation, which allowed people to get huge loans, leading to an "arms race" effect which had a key role in bringing about the bubble. This happened mostly in the UK, US and a handful of countries heavily influenced by these two (Ireland, Australia, Spain). These changes were in turn an important part of the conservative shift in these countries. Reagan, Thatcher, Aznar, Howard all made a big deal out of the notion of an "ownership society”. Politically this had the effect of making people on quite modest incomes feel some kinship with the rich: after all, if you own your home and maybe even some stock, aren't you one of “them”? (Among other things, this led to counter-intuitive effects such as poor people seeming to support policies that hurt them, like the repeal of inheritance tax, and reductions in capital gains.) I agree it's hard to make a causal argument here, but the political and economic changes were clearly coupled at some level.
But let’s be nice and assume that the origins of the housing bubble were random and unplanned. I would still argue that the decision to keep it inflated was largely political.
The crucial thing was the collapse of earnings growth for middle-income people. Remarkably, in recent years, in the US in particular, real median income didn’t grow at all even as productivity grew, mainly because the top were taking such a huge slice (as beautifully documented by Piketty and Saez). Harvard's Elizabeth Warren has shown very carefully what this meant at the household level: budgets became much, much tighter, with disposable income (after basics) going down: money tight in (what should have been) a time of plenty.
If you're in government the right thing to do would have been to start to address the reasons for stagnant incomes (i.e. look at executive compensation, the City, tax loopholes etc.). But if, for ideological reasons, you've already decided you don't want to talk about those things, that route is closed to you. Yet if people are really struggling, on a day to day basis, you’ll lose the elections. So when people start using their homes as ATMs and so on, you encourage it. This allows you to achieve something extraordinary: to engage in a massive transfer of national wealth to the rich and win popular elections at the same time*.
*Unfortunately, the downside is net destruction of national wealth, but by then you're out of office, or you pretend the whole thing is an exogenous shock, like a hurricane.
For the bubble to even start, you had to have major changes to mortgage regulation, which allowed people to get huge loans, leading to an "arms race" effect which had a key role in bringing about the bubble. This happened mostly in the UK, US and a handful of countries heavily influenced by these two (Ireland, Australia, Spain). These changes were in turn an important part of the conservative shift in these countries. Reagan, Thatcher, Aznar, Howard all made a big deal out of the notion of an "ownership society”. Politically this had the effect of making people on quite modest incomes feel some kinship with the rich: after all, if you own your home and maybe even some stock, aren't you one of “them”? (Among other things, this led to counter-intuitive effects such as poor people seeming to support policies that hurt them, like the repeal of inheritance tax, and reductions in capital gains.) I agree it's hard to make a causal argument here, but the political and economic changes were clearly coupled at some level.
But let’s be nice and assume that the origins of the housing bubble were random and unplanned. I would still argue that the decision to keep it inflated was largely political.
The crucial thing was the collapse of earnings growth for middle-income people. Remarkably, in recent years, in the US in particular, real median income didn’t grow at all even as productivity grew, mainly because the top were taking such a huge slice (as beautifully documented by Piketty and Saez). Harvard's Elizabeth Warren has shown very carefully what this meant at the household level: budgets became much, much tighter, with disposable income (after basics) going down: money tight in (what should have been) a time of plenty.
If you're in government the right thing to do would have been to start to address the reasons for stagnant incomes (i.e. look at executive compensation, the City, tax loopholes etc.). But if, for ideological reasons, you've already decided you don't want to talk about those things, that route is closed to you. Yet if people are really struggling, on a day to day basis, you’ll lose the elections. So when people start using their homes as ATMs and so on, you encourage it. This allows you to achieve something extraordinary: to engage in a massive transfer of national wealth to the rich and win popular elections at the same time*.
*Unfortunately, the downside is net destruction of national wealth, but by then you're out of office, or you pretend the whole thing is an exogenous shock, like a hurricane.
Wednesday, December 17, 2008
Is it a lie if you believe it?
The anti-hero George in the TV show Seinfeld once says something to the effect that it ain't a lie if you believe it. Do financiers understand that at the best of times their industry contributes far less to society than the rewards they have claimed would suggest and that their actions are now directly responsible for destruction of wealth on a massive scale, which simply put means worse lives for everyone - more preventable deaths, lower living standards, higher unemployment - than need have been the case?
The FT's John Kay has had a ringside seat in London, and offers his view in today's paper:
I think that's a no.
The FT's John Kay has had a ringside seat in London, and offers his view in today's paper:
It would be consoling to believe that these individuals know in their hearts they are at fault, but are advised not to admit it. If you are in a road accident, every decent human instinct is to say “sorry” but the small print of your insurance policy dictates otherwise. However, mostly these titans of finance do not experience regret because they do not feel it. They truly believe they were victims not villains, that if the world does not allow them to make large profits the fault lies with the world, and that government agencies should protect them from the consequences of their own actions. They prattle about free markets and the evils of government but deny personal responsibility.
I think that's a no.
Tuesday, December 16, 2008
Brown, Greenspan = Madoff ?
Madoff was operating a "Ponzi scheme" in which there was no real growth, but payouts were made from the money that came in because the fund appeared to be doing so well. Why is this morally and legally wrong? Because it's unsustainable, and the operator knows it.
But how different is a housing bubble, if it's patently obvious to the government, central bank and other key players that it is indeed a bubble? Like a Ponzi scheme, a housing bubble gives illusory returns, not based on any real increase of value but rather through the attraction seemingly high returns have for new entrants to the game. This is surely morally equivalent to a Ponzi scheme?
If so, aren't Gordon Brown and Alan Greenspan guilty of perpetrating (for political rather than pecuniary gains) Ponzi schemes at the level of the entire economy, whose effects are vastly worse than even Madoff's historic scam?
(Agreed, these key players may not have been 100% certain it was a bubble, but it was pretty clear some time ago. But look at it this way: suppose Madoff was, well, mad, and genuinely believed his investors would get those sorts of returns if they stayed with him long enough. Would that make his fraud better? It might affect personal responsibility, but the policy imperative would remain the same. So at some level, what matters if whether it was possible to know it was a bubble: I would claim it was. Of course, when you add to this the story of how a relatively small write-down in the value of some real estate led to this mayhem, you only get more evidence against Greenspan, Brown and the legions of bankers they served.)
But how different is a housing bubble, if it's patently obvious to the government, central bank and other key players that it is indeed a bubble? Like a Ponzi scheme, a housing bubble gives illusory returns, not based on any real increase of value but rather through the attraction seemingly high returns have for new entrants to the game. This is surely morally equivalent to a Ponzi scheme?
If so, aren't Gordon Brown and Alan Greenspan guilty of perpetrating (for political rather than pecuniary gains) Ponzi schemes at the level of the entire economy, whose effects are vastly worse than even Madoff's historic scam?
(Agreed, these key players may not have been 100% certain it was a bubble, but it was pretty clear some time ago. But look at it this way: suppose Madoff was, well, mad, and genuinely believed his investors would get those sorts of returns if they stayed with him long enough. Would that make his fraud better? It might affect personal responsibility, but the policy imperative would remain the same. So at some level, what matters if whether it was possible to know it was a bubble: I would claim it was. Of course, when you add to this the story of how a relatively small write-down in the value of some real estate led to this mayhem, you only get more evidence against Greenspan, Brown and the legions of bankers they served.)
Sunday, December 14, 2008
German housing
Some thoughts on the German housing market:
* They didn't experience a bubble (certainly nothing comparable to the UK/US craziness).This was largely a consequence of "old-fashioned" mortgage practices.
* Yet, despite these more restrictive mortgage practices, the fact of the matter is that Germans, at essentially all levels of society, live in better houses than Brits. That is: rich Germans have nicer houses than rich Brits; ditto the middle-class and poor. Comparisons with the US are harder, because the countries are so very different in their use of space and living habits. But I don't think anyone would disagree that German homes are better built.
* This may come as a surprise if you read enough of the business press in the Anglo world, but the purpose of housing markets is to give people somewhere to live.
* So let's get this straight, leaving out any economic jargon: Germans live in better homes, while paying less, and experiencing less volatility in house prices. How is this possible? Simple: good mortgage rules, regulations regarding build quality and schemes to make sure there are enough professionally trained builders. This is not rocket science.
* Do we in the UK and US perhaps have something to learn from them in this instance?
* They didn't experience a bubble (certainly nothing comparable to the UK/US craziness).This was largely a consequence of "old-fashioned" mortgage practices.
* Yet, despite these more restrictive mortgage practices, the fact of the matter is that Germans, at essentially all levels of society, live in better houses than Brits. That is: rich Germans have nicer houses than rich Brits; ditto the middle-class and poor. Comparisons with the US are harder, because the countries are so very different in their use of space and living habits. But I don't think anyone would disagree that German homes are better built.
* This may come as a surprise if you read enough of the business press in the Anglo world, but the purpose of housing markets is to give people somewhere to live.
* So let's get this straight, leaving out any economic jargon: Germans live in better homes, while paying less, and experiencing less volatility in house prices. How is this possible? Simple: good mortgage rules, regulations regarding build quality and schemes to make sure there are enough professionally trained builders. This is not rocket science.
* Do we in the UK and US perhaps have something to learn from them in this instance?
Can we please finally get back to basics?
The unemployment situation in the US is truly scary, the nerds at the US Bureau of Labor Statistics publish a more inclusive unemployment figure (called "U6") than the one reported as headline unemployment which is arguably closer in spirit to European notions of unemployment. It now stands at 12.5%. There are some observations I think are worth making about both what is likely to happen and what it says about what has already taken place:
* Unemployment is a so-called "lagging indicator" in that there tends to be a delay before economic problems translate into unemployment (because of inertia in employment contracts, hiring etc.). So unemployment will probably go up a lot in the next year or so, upto 15% or more in U6 terms.
* For ten years, the UK and US have kept employment up basically on the back of what we now can clearly see was a massive - and often fraudulent - bubble/Ponzi scheme. This has hid a truly terrifying hollowing out of real productive capacity in these two countries. This kept employment in these countries in some sense artificially high. Artificial in the sense of not based in fundamentals and therefore not sustainable. (One thing that's striking is that even during the bubble, unemployment, properly measured was actually not that low, which underlines just how poorly managed these economies have been by those useful idiots Gordon Brown and Alan Greenspan.)
* Now that the bubble's burst, it's panic stations. Many of the major employers who make real stuff in these countries - as opposed to the bogus finance industry - have not been competitive for years. It's all very well to say labour will be re-deployed doing "other stuff", but do we here in the UK any longer have the large scale management and engineering know how to restructure fast enough? Equally, much of US management is disgraceful compared with northern Europe or Japan, and as fantastic as the US research sector is, it's simply not a big enough sector to keep millions of families going.
* Meanwhile, if you take the example of Germany (who've for years been derided by the Anglos for being "old-fashioned" for making useful stuff not keeping pace with all those wonderful financial innovations) their continuing productive capacity is astonishing. They are in trouble too, but their biggest problem is lack of consumer demand in the US (and consequently industrial demand in China), which means no customers for them. This is a huge problem for their economy, but it's important to realize that it's a second-order problem, driven by the collapse here and in the US. They make stuff people want to buy: we no longer have the capacity to buy anything, which hurts everyone. This is different from pursuing policies that lead to primary collapse.
* I hope the lesson has been learned, but has it? There is nothing to be gained by paying management tens of millions. GM's CEO makes vastly more than Toyota's (really!): but who's going under? Super-high pay creates perverse incentives. Put it this way: do you really want someone in charge of a firm who doesn't have enough passion to want to run the company for $1m a year, but would do it for $50m? To me, such a person is surely a bit pathological.
* It's simpler: you have to treat people well; train them; make good products; pursue engineering excellence; invest long term in schooling and public health and so on.
* These are simple social democratic ideas which have their worth in the US heyday between 1950 and 1970 and in northern Europe since the 70s. There has been a war against these common sense ideas by a handful of financial robber-barons and wannabe robber-barons. Can intelligent people now stop listening to these economic fairy tales and come back to reality?
* Unemployment is a so-called "lagging indicator" in that there tends to be a delay before economic problems translate into unemployment (because of inertia in employment contracts, hiring etc.). So unemployment will probably go up a lot in the next year or so, upto 15% or more in U6 terms.
* For ten years, the UK and US have kept employment up basically on the back of what we now can clearly see was a massive - and often fraudulent - bubble/Ponzi scheme. This has hid a truly terrifying hollowing out of real productive capacity in these two countries. This kept employment in these countries in some sense artificially high. Artificial in the sense of not based in fundamentals and therefore not sustainable. (One thing that's striking is that even during the bubble, unemployment, properly measured was actually not that low, which underlines just how poorly managed these economies have been by those useful idiots Gordon Brown and Alan Greenspan.)
* Now that the bubble's burst, it's panic stations. Many of the major employers who make real stuff in these countries - as opposed to the bogus finance industry - have not been competitive for years. It's all very well to say labour will be re-deployed doing "other stuff", but do we here in the UK any longer have the large scale management and engineering know how to restructure fast enough? Equally, much of US management is disgraceful compared with northern Europe or Japan, and as fantastic as the US research sector is, it's simply not a big enough sector to keep millions of families going.
* Meanwhile, if you take the example of Germany (who've for years been derided by the Anglos for being "old-fashioned" for making useful stuff not keeping pace with all those wonderful financial innovations) their continuing productive capacity is astonishing. They are in trouble too, but their biggest problem is lack of consumer demand in the US (and consequently industrial demand in China), which means no customers for them. This is a huge problem for their economy, but it's important to realize that it's a second-order problem, driven by the collapse here and in the US. They make stuff people want to buy: we no longer have the capacity to buy anything, which hurts everyone. This is different from pursuing policies that lead to primary collapse.
* I hope the lesson has been learned, but has it? There is nothing to be gained by paying management tens of millions. GM's CEO makes vastly more than Toyota's (really!): but who's going under? Super-high pay creates perverse incentives. Put it this way: do you really want someone in charge of a firm who doesn't have enough passion to want to run the company for $1m a year, but would do it for $50m? To me, such a person is surely a bit pathological.
* It's simpler: you have to treat people well; train them; make good products; pursue engineering excellence; invest long term in schooling and public health and so on.
* These are simple social democratic ideas which have their worth in the US heyday between 1950 and 1970 and in northern Europe since the 70s. There has been a war against these common sense ideas by a handful of financial robber-barons and wannabe robber-barons. Can intelligent people now stop listening to these economic fairy tales and come back to reality?
Wednesday, December 10, 2008
Riots
Are the Greek riots at least partly a reaction to economic issues? I have no idea, but they might plausibly be. In a number of countries around the world - certainly the US and UK, but in the last five years or so, even in solidly social-democratic countries in Europe - there has been a massive transfer of wealth from the lower and middle strata of society to the top. This has led to the rather remarkable spectacle of median wages remaining stagnant (or even falling) while productivity increased. Meanwhile, in China, one way of looking at what's happened is that only some of gains from their huge leap in productivity have found their way to workers, the rest having being used to prop up the US and help pay for ridiculous financial shenanigans in the West.
To be clear: I'm not saying there was a coherent global conspriacy, only that there was a prevailing economic ideology, unfounded in theory or empirical evidence, which favoured some people, who therefore both believed in it, and sought to spread its influence.
In any case, the net result of all this is that the amazing gains brought about by (i) advancing technology (often underpinned by publicly funded research and carried out by poorly paid scientists) and (ii) hard work on the part of ordinary people all over the world flowed disproportionately to a handful of businesspeople (perhaps we should call them rent-seekers, or even parasites), who contributed little to (i) or (ii).
For a whole host of reasons people didn't see the extent to which they were being ripped off. However, now that the years of looting are taking a more obvious toll, people are not happy.
I would therefore not be surprised (very sad, but not surprised) if in the next few months and years we see more unrest, in even less obvious places than Greece, perhaps in the UK, Germany or even China.
Will things change? I think probably not very much. What I've called The Looting simply isn't understood widely enough to be a political issue. The crisis has already been carefully spun to sound like an act of Nature, and people are bracing themselves for hard times. The parasites remain very close to government on both sides of the Atlantic, and it is by no means clear that the crisis has taught them anything, dampened their hubris or reduced their political clout.
To be clear: I'm not saying there was a coherent global conspriacy, only that there was a prevailing economic ideology, unfounded in theory or empirical evidence, which favoured some people, who therefore both believed in it, and sought to spread its influence.
In any case, the net result of all this is that the amazing gains brought about by (i) advancing technology (often underpinned by publicly funded research and carried out by poorly paid scientists) and (ii) hard work on the part of ordinary people all over the world flowed disproportionately to a handful of businesspeople (perhaps we should call them rent-seekers, or even parasites), who contributed little to (i) or (ii).
For a whole host of reasons people didn't see the extent to which they were being ripped off. However, now that the years of looting are taking a more obvious toll, people are not happy.
I would therefore not be surprised (very sad, but not surprised) if in the next few months and years we see more unrest, in even less obvious places than Greece, perhaps in the UK, Germany or even China.
Will things change? I think probably not very much. What I've called The Looting simply isn't understood widely enough to be a political issue. The crisis has already been carefully spun to sound like an act of Nature, and people are bracing themselves for hard times. The parasites remain very close to government on both sides of the Atlantic, and it is by no means clear that the crisis has taught them anything, dampened their hubris or reduced their political clout.
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