Wednesday, February 25, 2009

Parallel universe

Some people are still living in the parallel universe of Big Finance. This comment piece by Anatole Kaletsky has to be read in its entirety for full effect, but I will whet your appetite with one choice passage:
If, on the other hand, public opinion rejects this message and forces American and British politicians to drive their banks into insolvency and full-scale nationalisation, then this week will mark the end of 200 years of market-based capitalism throughout the world.

Monday, February 16, 2009

Moral Hazard 2.0

If you'd asked bankers a year or two ago whether, if they'd just bankrupted their own institutions and brought financial calamity upon the world, they would get bailed out by the taxpayer on the scale they have with as few strings attached, I suspect all but the most optimistic would have hesitated to say "yes". And now? Surely most would nod their heads in agreement and confide that even in their most optimistic moments they hadn't realized just how far you oculd take this game.

If the bailouts continue in the manner they have (as opposed to some mix of full nationalization, bankruptcy, new "good banks", prosecution) what does this portend for the future? In a few years, the immediate feeling of crisis may have abated, but the memory of what happens when it all goes wrong (you keep your beach house, everyone else gets fleeced) will stay with the financial industry. The implication is this: moral hazard will become an even bigger issue after the dust has settled on these bailouts than it already is. The next generation of bankers will really believe that they can get away with almost anything. We have to get the bailouts right, now.

(I'm using the term "moral hazard" pretty loosely here to mean the propensity of agents within financial firms to engage in risky activities because of their insulation from the consequences of those activities. There's a huge principal-agent problem here too, with the principals being firms and shareholders and the agents being employees.)

Sunday, February 15, 2009

A plot I'd love to see

Income level (on the horizontal axis) with the proportion of people in that income bracket who are in finance, real estate or closely related to either (e.g. mortgage broker, lawyer working primarily for financial clients) on the vertical axis. I would guess it shoots up to close to 100% for very high income levels.

To put this another way: I would guess that when you see someone driving a really expensive car, most of the time they will be people who benefitted from the upside of the bubble. And are now leaving you (and your kids) to deal with the downside.

Too pessimistic? Maybe, but I'd love to see the data.

Black swan takedown

Via Andrew Gelman's wonderful blog, a link to an excellent review of Taleb's Black Swan by legendary Bayesian statistician Dennis Lindley (you don't have to be a mathematician to follow this):

My feeling from reading Taleb and seeing him speak is that although he thinks he has found some huge flaw in probability (his hubris really is breathtaking), his real beef is not with probability or statistics but with finance. His critique is really one of conflicts of interest, perverse incentives and so on: he is talking about political economy, not mathematics.

And from that perspective, he's quite right. Building bogus models and making nonsense predictions pays pretty well (and continues to do so), so it's really just another case for that Upton Sinclair quote I use too much: "It is difficult to get a man to understand something when his job depends on not understanding it.

What De Long might call the London Times Death Spiral Watch

From a piece in today's London Times on bonuses:
It would be surprising if Brown did not meddle in this politically charged vote winner, but I suspect he’ll bungle it. These are migrant international workers and if Brown were to block pay-outs they would take their skills to other financial centres — if not now, then when the next upturn comes. ... Excessive interference would damage London’s status as a financial centre and stop financial innovation.

What planet does this guy live on? Note the language - "meddle" for the possibility of government acting for it's citizens against an oligarchy that has brought the entire nation to its knees. London's status as a financial centre is gone, my friend. And that "financial innovation" is leading us into what is now certainly the worst downturn since the Great Depression.

This is why the UK may be affected even more than the US: here the rot has set even deeper, an entire generation has internalized the nonsense spouted by the banking sector.

The compensation these people have received in the last few years was (i) out of all proportion to their contribution and (ii) a direct cause of behaviour that led to the crisis. The crisis will get even worse before it gets better, and if at the end of the day we end up with a utility-like financial system (see Canada), and a better balanced economy, so much the better. If at that point - after many trillions of dollars of losses worldwide and enormous distress - some people still want compensation of the kind that was available during the bubble and some country is enough of a financiers' oligarchy to offer such compensation, then it surely would be a good thing if these rapacious characters left our shores.

Bankers playing us for chumps

Watch this interview with Simon Johnson. Now.

Johnson was formerly Chief Economist at the IMF and is currently a Professor at MIT's Sloan School of Management, so he's not exactly a leftie. Which it makes it all the more worrying that he chooses to phrase his case this way: "The bankers think we're chumps."

Wednesday, February 11, 2009

Should economists be apologizing too?

As a natural scientist, my perception is that a lot of my peers feel less than entirely happy with economics, and its role in the current crisis, especially in the English-speaking world. Here are some initial thoughts:
  • It's not simply the case that the crisis was caused by rapacious bankers. This is true, of course, at one level, but it was important that the game they were playing appeared to have some sort of intellectual foundation. This was tacitly (and sometimes quite explicitly) provided by economics.
  • I realize that it's not as though there was ever a theorem which said that what was happening (e.g. wages, impacts on the wider labour market) was in some sense optimal, at least under real-world conditions, but the impression was often given that there was.Countless WSJ and FT comment pieces from the boom years have this tone, sometimes pretty explicitly. This was an intellectual deception, which I think played a key role in getting us to where we are today.
  • I realise that economists, if asked about this point blank, would always be equivocal, but my impression is that during those years the bulk of the profession was happy to go along with the story. Why? Well, it didn't hurt the profession as a whole to be so closely associated with an industry sector raking in 30-40% of all corporate profits. I'm not talking about direct benefits like endowments and speaking fees, but more the intellectual glow of feeling that your work provides the theoretical edifice on which what seemed a hugely profitable sector was based.
  • Again, there were dissenting voices, but my impression is that these people (for example Dean Baker and Steve Keen; quite often Krugman and Stiglitz) were viewed as academically minor-league (DB, SK) or politically motivated (PK, JS) and therefore not entirely in tune with the academic mainstream in the profession, at least on these issues.
  • To take one example: most people outside economics always thought that salaries in finance were somehow wrong. This was a widely shared perception. Yet economists mostly seemed to support the notion that these wages reflected value added (perhaps this is the wrong term, but you know what I mean), or least didn't appear to question what were huge changes in the labour market. It is now clear that lay people were broadly correct.
  • It's perfectly alright to be wrong about something, especially when the subject of study is something as complicated as the economy. I do not pretend natural science has the answers, and I hugely respect economics for taking on the challenge of at least trying to understand these things. But when the profession as a whole was wrong, or at least seen to be supportive of positions that were wrong, I think it's time to explicitly refute some of the intellectual claims of the bubble era.
  • Surfing the econ blogs, I see a lot of technical discussion about the crisis but little by way of apology, contrition or even just a "hey we were really wrong about this".

Monday, February 09, 2009


Scientific research is feeling the pinch too. From a piece in Nature Biotechnology:
...even before the economic slowdown, the UK Engineering and Physical Sciences Research Council had planned to reduce its grants portfolio for physics from £137 million ($206 million) for 2006–2007 to £97 million for 2008–2009, according to council reports.

I'm struck by the numbers here: the amount spent on physics research in the UK is tiny in absolute terms (and just got smaller). Less than 100 million UKP is the national budget for the the only research which will give us long term solutions to our energy woes (and much, much more)? The long-term ROI on this spend must be huge: economists, what's going on, why is this stuff so woefully under-funded?

Sunday, February 08, 2009