The Great Crash
By Kevin
Galbraithian Wisdom
I've got some great quotes from John Kenneth Galbraith in his mid 20th Century book that bears great lessons for us even today.
Wisdom, itself, is often an abstraction associated not with fact or reality but with the man who asserts it and the manner of its assertion.
And after watching 'Inside Job'; you can't help but wonder if Galbraith's forecast turned out to be true for the SEC:
...regulatory bodies, like the people who comprise them, have a marked life cycle. In youth they are vigorous, aggressive, evangelistic and even intolerant. Later they mellow, and in old age - after a matter of ten or fifteen years - they become, with some exceptions, either an arm of the industry they are regulating or senile.
In any case, the documentary got me reading about some of the economist interviewed in the film. In particular, Glenn Hubbard and Frederic Mishkin were both caught a little off-guard in the film's interview by the director's questions. I thought that they handled the aftermath pretty okay (Mishkin here and Hubbard here). Obviously, the director had something he wanted the two professors to show to the audience and did portray them a little negatively but he did so to demonstrate a wider phenomenon as he justified.
From a human point of view, it is definitely easy to empathize with the director and it is what sells the movie. The policy difficulties and the way the crisis arose make it more difficult for the people in charge to agree with the director. There’s both a lack of certain (vs uncertain) information and cognitive bandwidth to process clues at the time before the crisis and during it. With the benefit of hindsight, the director is empowered to challenge the pre-crisis regime. Dommage pour le financiers!
Savings Glut or Investment Spree?
By Kevin
Are we doing it right?
As I previously mentioned, I'm working on a piece on global imbalances once again (fact is that I feel like I've done countless stuff on this but then it is always just some other topic that obliquely references to it somehow). I guess I'm a little behind times on reading about this issue but the more I looked into Bernanke's earlier arguments about the 'Global Savings Glut (GSG)' and his subsequent 'revisions', the more I find it difficult to swallow the notion that 'it's not just the US who is at fault'. Of course, he has softened his stand from a while back in 2005, when he actually believes that the current account deficits were hardly within the control of US and if you need someone to blame, you got to blame the rest of the world. There are many flaws in the speeches he delivered in 2005 (here and here), especially with the benefit of hindsight and additional data. Hence, I would not be launching an attack on those ideas.
In any case, as John Taylor suggested to anyone who would care to scrutinize the statistics (I actually bothered; macroeconomic data on the World Bank Database is particularly handy for looking up stuff that are two years old or earlier), there was no significant rise in world savings (in the recent years). World savings fell from 22.25% of world GDP in 2000 to 20.88% of world GDP in 2003. In that sense, there wasn't really a savings 'glut' to push down interest rates at least during that time (I refer to the beginning of 2005 when the speeches were made). In fact, during that period US investments fell from 20.58% to 18.35% of GDP - a great chance for correcting the current account deficit. But no, the chance was wasted because savings in the US declined even more, from 16.72% to 13.80% of GDP, thus increasing their current account deficit from approximately 3.8% to 4.5% of GDP. Granted, I'm looking at a selective time period and being a bully but that is just a distraction from my main point that if the 'GSG' idea continues, US will forever think they are simply a victim of circumstances when they are clearly not.
Daniel Gross characterized the idea of a 'savings glut' as a meme on Slate when it was first introduced. And I think he can't be more right. It is a matter of perspective but there is this notion of sacrificing current consumption when it comes to the idea of 'savings' but reality is that these 'saving glut' countries were pushed to purchase 'safe' investment products by none other than the deep, sophisticated financial system of the United States. In what WSJ terms as an expansion on his 'saving glut' research, Bernanke supposedly places the blame on US' mismanagement of the capital inflow but, I quote the Luca from WSJ:
The paper’s main focus, however, is on the intense foreign investor demand for what seemed at the time like safe U.S. assets in the years before the crisis.
The paper appears to be suggesting that US is merely giving investors what appears to be products they wanted - the mortgage-backed securities (MBS), safe from the rating perspective, backed by the government somewhat, and also offering the returns. In fact, it goes on further to imply that financial engineers were being efficiently responding to market demands with innovations that would generate the supply to quell this demand. I quote from various segments of the paper:
"...we verify that the “GSG countries”—that is, emerging Asia and Middle Eastern exporters—did indeed evince a strong preference for the safest U.S. assets. On the margin, this preference most likely helped push down yields on MBS relative to other assets, as most MBS were either guaranteed by the Agencies or sold as tranches carrying AAA credit ratings."
"In fact, the strong preference of the GSG countries for Treasuries and Agencies appears to have pushed Europeans and other advanced-economy investors, including U.S. investors, into apparently safe “private-label” MBS."
"Finally, the demand for safe assets by investors, both domestic and foreign, appears to have engendered a strong supply response from U.S. financial firms. In particular, even though a large share of new U.S. mortgages during this period were of lower credit quality, such as subprime loans, Agency guarantees and financial engineering in the private financial services industry resulted in the overwhelming share of mortgage-related securities being rated AAA."
I'm going to use a rather extreme analogy here and say that this is really no different from a doctor saying, "Wow, so many patients only trust me and they would only take medication I prescribe to them, so never mind if the drug is effective, I'll prescribe as long as I get paid really good commission from the drug firms. In fact, let me just prescribe these pills I just found in the cabinet here though I don't even know what they are." Granted, the financial engineers probably really believe that they have managed to tuck risks away and that the instruments were really safe, how about those pushing NINJAs to take up loans they can ill-afford? John Cassidy's How Market Fails is a collection of such stories. There appears to be a culture of absolute irresponsibility - the financial institutions couldn't care less about the fate of clients on both sides (people who took out mortgages and investors who bought MBS).
I guess the 'GSG countries' are just too eager to save they didn't practice their due diligence just like many of their counterparts in US and the finance system only mean all good and no harm. Maybe. But maybe, if the financial system was more responsible, if the culture was not all that screwed up and money was rejected on the basis that there was no more good quality investment opportunities in US and savings were allowed to 'go home' to these 'GSG countries', then things won't be so bad. For goodness sake, if investment opportunities are dried up, then curb excesses. Leave the punchbowl and you get a bust. There you had it.
Right Interventions
By Kevin
Derailing in progress...
While researching for an article I'm working on about the global imbalances (yes, I'm writing on this topic again), I chanced upon John B Taylor's Getting Off Track, which is a really short read for someone who wants to know more about the government intervention aspect of the financial crisis in United States. John does pretty data-oriented research and no doubt emphasize on the importance of empirics when it comes to studying the macroeconomy.
Too often in Economics, we seem to be too quick to classify stances at debates into a 'more government' or 'less government' issue as if the government always has only one course of action. As John pointed out in his book, the US government may have worsen the financial crisis and prolonged as a result of their erroneous diagnosis of the crisis as one of liquidity rather than counter-party risks. The fact is that the government has several course of actions when they are required to 'do something' and this thing they eventually decide to do may not always be effective or good. The question (at that time at least) was whether the contracting liquidity experienced at that time is a symptom or in itself the source of the problem. Of course, with the benefit of hindsight, John confidently concludes that he has been right pretty early on that counter-party risk was the root of the problem.
Now, we turn back to the general question of government intervention. While we always ask ourselves if we should always trust the government to do the right thing, I think the more important point is that we all should be helping to the government arrive at the right course of action. It calls for a greater academic participation in governance and social policies. This, I believe, is something particularly important that Singapore should learn. I pointed out earlier that we need to make better use of data, and academic tools at our disposal. If you peer into the work of John through his book, you'd realise that is exactly the sort of thing our academia should be doing for the government. And this, will also require that the government be more open-minded to external ideas and tap on expertise beyond their numbers. That's what I mean by pluralism in ideas for governance of a country.
The Partnership
By Kevin
Rags-to-Riches
After reading Lord of Finance, I wanted learn more about finance industry of the west in its early days and discovered that I could perhaps learn about the history of the industry from the story of a single firm. Charles Ellis' 'The Partnership' turned out to be a great book for that; it charts the course of Goldman Sachs rise to one of the most well respected investment banks in the world finance community.
At the end of the book, I guess I gained way more than just knowledge about the history of finance industry. The Partnership was a great read, for the rich collection of little anecdotes about the people in the top strata of the great firm as well as the description of how the firm navigated the circumstances of those times. The story of the firm's rise in itself was immensely inspiring; no doubt it was great people who helped to build up the firm. These people helped me learn much about the importance of hard work and persistence, as well as the need to prepare for and learn from adversity. The main character in The Partnership that demonstrates the 'rags-to-riches' idea was Sidney Weinberg, touted as a 'saviour' of Goldman Sachs. Malcolm Gladwell explored the idea of how early adversity can aid one in life in an article on New Yorker, referring to Sidney Weinberg of Goldman Sachs based on the stories mentioned in Charles Ellis' book.
In Malcolm's article, he speculated that the sort of 'dual identity' that underprivileged outsiders can assume might help them succeed. People are more forgiving to the mistakes they might make while they bring in more unusual skills/knowledge that would prove valuable to the privileged circle. This often provide them with great connections that extend over a wide spectrum of 'classes'. This seem to be the advantage that Goldman Sachs rode on in the early days, through its founders as well as Sidney Weinberg. Goldman Sachs, being a little Jewish firm when it started out was the natural destination for the Jewish businesses for commercial paper; then when it started branching into the businesses of the big banks it was overlooked in some sense. The willingness of Goldman Sachs to do business with a wide variety of clients while trying to build up its grand reputation was admirable.
Goldman Sachs' ability to innovate and great foresight thanks to its leaders was important but perhaps not as much as the entire firm's willingness to work hard and push towards their goal. The kind of determination and persistence in trying to get business for the firm exhibited by their bankers and salespeople was absolutely amazing and Charles Ellis managed to convey all that extremely well through his wonderful narration of stories and events after events. The book might be really thick and it holds plenty of what one might consider 'long grandfather stories' but most were inspiring and groups of chapters on the firm under different leaders could be read on their own. The Partnership is definitely a great book for those interested in finance, personal motivation, business and storytelling.
Lord of Finance
By Kevin
Walking towards Depression
After leaving it on my bookshelf for a while I eventually took out Lord of Finance to resume reading books on my journeys. Written by Liaquat Ahamed, I bought it at one of Harris' 20% storewide sales during a period when I was thinking about reading up more about Finance after the recent crisis. I thought it was good to beef up my knowledge of American finance since Age of Turbulence was the closest I got to reading about the financial sector of America.
The book turns out to be more than what I was expecting. Written in the style that feels very similar to Doris Kearns Goodwin's Team of Rivals, Lord of Finance traces the little stories that demonstrated the personalities of the four most important central bankers prior to 1929. They had exerted huge influence on the economies of Europe and United States, and unintentionally engineered in the Great Depression with their policies and beliefs. It was interesting to get a peek at a world still obsessed with the almost divine quality of gold as a storekeeper of value and with poor understanding of monetary economics.
Even more intriguing is that monetary policies and innovations are being created by these people who has a nuanced view of monetary economics and poor understanding of the workings of the economy. The stories and opinions of civil servants, politicians and aristocrats in those years demonstrates the experimentation humans had gone through in order to figure out how this gigantic machinery works. Of course, this study and experimentation carries on today.
Liaquat Ahamed got really good reviews (here and here) from New York Times for this book, especially for the fact that the contents of the book chillingly echos the stories of Wall Street in the past couple of years, involving banking heros and monetary policies, speculative bubbles and a huge crash. The description of the mania and the built up to the eventual crash sounds rather familiar to me given that I just finished John Cassidy's Dot.con a while back. Men's penchant for not learning from History seems particularly pronounced in bouts of 'Irrational Exuberance'.
For that, Liquat gives a brilliant analogy for the role of Central Bankers or the policies makers trying to stabilize the economy and also pushing for growth. He sees them much like Sisyphus in the Myth of Sisyphus, condemned the work hard to create the conditions fertile for economic growth only to have speculation and irrational exuberance extinguish the fruits of their labour - much like Sisyphus who have to push a boulder up a mountain knowing that when the deed is done, it'll roll back to its original position for him to do it again. Perhaps Albert Camus is right, for the struggle probably do fill the central bankers' hearts and the belief of their heroism keeps them happy.
Lord of Finance simply surprises me with the rich collection of anecdotes about the main characters of the story Liquat tries to tell and the manner it imparts knowledge on finance and the workings of money in the economy to the readers - subtly and not too overwhelmingly technical. As a result the book caters to a wide range of audience; students interested in economics, history, finance and perhaps just stories about great men's mistakes.
Those interested in getting a preview before making a purchase of the book or going on a trip to the library to borrow it might like to check out New York Times.
Weekend Reads
By Kevin
More medallions!
We begin this week's reads with an interview with Paul Samuelson by John Cassidy from The New Yorker. John Cassidy recently published a new book, How Markets Fail, which I'll read some time soon. It won't be that soon though - I'm still reading Thinking Strategically and moving on to Art of Strategy after that.
Eric Morris shared something about the cab industry in New York, which eventually concluded with urging for less regulation (ie. raising the supply of cab licenses or "medallions" as they're called). One of the comments revealed a really humourous story of how the cabbie's industry in Ireland got deregulated overnight; I shall reproduce it here:
A similar sitution existed in Ireland up to a few years ago. Change was brought about when the government went to issue more wheel chair accessable taxi licenses. The Taxi driver / owners group foolishly sued the government. They claimed that the government didn’t have the right to issue new licenses. They won but the court ruled that the government didn’t have the power to issue any licenses. The taxi ma[r]ket was deregulated overnight.
The current complaint from taxi drivers is that there are too many taxis etc etc. There were clear winners, the consumer and those new taxi drivers who are now free to ply their trade in a vastly increased taxi market.
The fact that GPS navigation on-board cars/cabs are widely available means that the tacit barrier to entry for the cab business have been significantly lowered. Anyone who can drive and have a car with on-board GPS navigation (and perhaps a meter) can technically offer good taxi services. Knowledge of the city and the different landmarks have become less of an advantage or requirement.
As for talks that you might want to listen to, Magnus Larsson speaks about structuring sand in deserts to prevent further desertification. His proposal won the Holcim Awards.
Irreducible Uncertainty
By Kevin
Relax, it's just fire!
The Straits Times caught my attention again the week before with a particular article by Robert Skidelsky, which was a contribution to Project Syndicate. In Keynes versus the Classics: Round 2, Skidelsky highlighted the problem with today's Keynesians being unwilling to work out the implications of irreducible uncertainty for economic theory. The article was essentially a response to the two economist, Krugman (his article) and Cochrane (his response here and here) who are engaging in an academic quarrel of sorts.
Krugman started out criticising the love for elegant economic theories of classical (implicitly speaking, Chicago school) economists. And Cochrane shot back, arguing that to attribute excessive fluctuations in the market to 'irrationality' is theoretical nihilism. And we all know that all that buying and selling has got motivations behind them even if these were results of false information, pure emotional preferences. I like Skidelsky's analogy about the theater on fire (which might have been used previously by other economists as well):
It’s like what happens in a crowded theater if someone shouts “Fire!” Everyone rushes to get out. This is not “irrational” behavior. It is reasonable behavior in the face of uncertainty.
I'm not sure if Robert Skidelsky is a Post-Keynesian like Hyman Minsky but his extensive research into John M Keynes has brought him to write several volumes about this economist once touted as a saviour of capitalism. In any case, I believe Keynes simply sprinkled some important ideas that are pertinent to our study of the economy and there is definitely a need for further studies into the insights of Keynes about our modern capitalist economy and possible save it from itself once again.
Positive Feedback
By Kevin
Hold it right there!
The economy doesn't (always) tend towards equilibrium as classical economics textbooks suggests. But things are worst when things tend towards an equilibrium that doesn't benefit the society in general, many social phenomena that I've described in a previous post. The social/market forces are pushing the situation towards something no one wants; without an authority mandating stuff, no one have the incentive to help reach the collectively beneficial outcome.
In a recent article by James Surowiecki in The New Yorker, he discusses how success of big banks builds upon success and bring about the mega big banks that results in a concentrated banking system. It is thus possible that we allowed banks to grow big and stay so because the market naturally tends towards that and we have problems assessing the welfare gains from increasing bank sizes, as suggested by Surowiecki:
The trouble is that the “market” for banking is so distorted—by switching costs, by government subsidies and guarantees, and by the banks’ market power—that it’s hard to know whether big banks are adding value or are simply exploiting their oligopolistic positions.
The only problem that we know with the concentrated banking system is that they increase financial risk. That being said, regulations will have to start moving towards managing the risk that is contained in the financial system and if this really do result in policies that have to limit the size of banks then so be it. The government is the only one who can act as a dam holding up the floodwaters of market forces.
Why not Eight?
By Kevin
As I was saying a while back, I stumbled upon Seven Scholar and I decided to 'review' it a bit. I must thank it for the links offered on the website because it unleashed a world of Economics blogs for me. I read through a couple of the recent entries to find out what exactly the site is seeking to achieve since it doesn't have an 'About' page.
The recent entries and probably all the other entries are basically summarized versions of news and analysis from various news publications. For the most recent posts, The Profile of a Bear is perhaps a summarized/paraphrased version of The Economist's Please do feed the Bears while the entry on Milton's String Theory is the gist of a small segment of The Economist article, The Long Climb.
The Seven Scholars don't link the entries to their respective article or news sources (or even bother to cite them), which means that if you're interested to read on about the topics or ideas, you'll have to search on your own. The only reason I could identify the news source of the two entries mentioned was because I happened to be reading that particular issue of The Economist after visiting the site. The academic authority links available on the site are under 'The Scholar's World' Section (don't click directly on it though, hover above the link on the menu bar and wait for the list of countries to appear). No doubt the author reads widely, getting news, analysis and infomation from a wide varity of sources but the lack of direct citations or links makes it difficult to know if the theories and current affairs mentioned is from the author or some news agency.
I have no idea what is the significance of the 'seven' in their name because as far as I can see, only an author named 'Jay' is posting. The site was really very active in July when it probably just started but activity kind of slowed down.
Be Like Goldman
By Kevin
The Survivor
There was a time when I decided to delve into finance immediately after I graduate and then try my best to get into Goldman Sachs. With the Subprime Crisis, I became less certain about my zeal to enter finance but my intellectual interest in the industry remained and to work for Goldman Sachs remains some sort of dream. It probably became more strongly one when I read The Economist a week or two ago and stumbled upon their 'Keeping up with the Goldmans'. It highlighted how surviving through the crisis is helping Goldman thrive even more in this time of gloom and possibly the start of a potential recovery.
Yet a few days back, the entry on Free Exchange Blog alerted me of the dangers which Goldman was so close to meeting during the crisis. It was more or less a response to Joe Hagan's discussion on Goldman Sachs published a couple of days earlier.
Joe's article provides loads of information relating Goldman's potential problem with AIG and covers more intimate details about the time after AIG's Bailout. He questioned the profits raked in by the firm more recently and pose the question of what good the firm does for society. He eventually concludes that their money probably could help to solve their problems, at least for now.
I'd think that there's no perfection in management of a firm or system and circumstances just seem to have often favored Goldman Sachs. It's perhaps not exactly a question of wrong-doing by the firm and at the end of the day Goldman should theoretically still make money from the AIG deal; the fear stems from the potential panicking and questioning of reputation.