Dummkoepfe

As of the late 1990’s (I haven’t worked in this area since then), German banks were divided between the Land-level banks that were small and reliant on embedded (Soskice would probably call them institutionally complementary) relationships with clients on the one hand and the large, well capitalized, international banks headquartered primarily in Frankfurt. The former group generally conform to the CME stereotypes, but in my experience they were watched over carefully by the Land-level regulators, of whom the ones that I have encountered were quite sophisticated and represented some of the more impressive minds I know of from the Bundesbank. In 1998, these people were determined to protect their charges against an expected flood of foreign competition offering financial services that small businesses and depositors were not sophisticated enough to evaluate fairly. They were planning their battle carefully and knew the EU rules proposals very well. It is my understanding that they largely won and that penetration of foreign banks into the deposit and small business credit markets were not very great, though this is only an uninformed impression. More significantly for this discussion, however, is the fact that these small players were not directly involved in the international SIV markets. Inasmuch as they participated, they went through the big banks in Frankfurt. I suspect without evidence that they played a role similar to pension funds in the U.S. relative to the big banks: credulous and unsophisticated investors to be fleeced.

The Frankfurt banks in 1998 were looking forward to going to to toe with London and New York – ac competition in which they were convinced they had a huge advantage because of their exceedingly strong capitalization and the high quality/stability of their assets (ownership in and loans to German manufacturers are pretty damn safe). These banks were hiring American and British analysts and sending their own people abroad to be prepared for the deregulation. In my opinion, it would be insane to claim that these banks were clueless victims of LME hucksters who were offloading toxic securitized investment vehicles. I suspect that they were just playing the same game that their colleagues in the U.S. and London were playing at the time, but they had large piles of safe but low or long-term earning assets that they could use as a basis for leverage AND access to the savings of depositors locked in the ‘low performing’ Land-level banks (with which these banks had longstanding relationships).

I would give a great deal to go back and talk to the NRW bank regulators again now and hear about what happened in the decade between 1998 and 2008.

Just uninformed speculation by a comparative political economist who doesn’t think that the VoC framework is all that useful when talking about the last decade of large scale international finance.

What this explains (and the cultural explanation does not) is why it is that Deutsche Bank (which was far bigger) appears to have done conspicuously well out of the crisis, while its smaller compatriots have done very badly indeed.

Given that Landesbank managers are well-known to be morons, I would have thought this to be the most obvious explanation: they are morons.

LME or CME have got nothing to do with it; failure to do and ineptitude at doing due diligence, lots.

it seems odd that there would be such a concentration of idiocy

Considering that throughout history, groups of the most powerful, informed, and educated people have moved together in a fashion that often ensured their physical as well as economic destruction, I have no trouble whatsoever believing that the well-known human tendency towards pack behaviour and wishful thinking far outweighs the combined reasoning of any number of the elite (or anyone else).

We are crooked timber.

Thanks for posting this …. I always wondered why the Germans got sucked into this. I had faith in their orderliness and intelligence and was surprised they would believe Americans who were obviously lying and getting away with it.

Which Zizek book is it in which he spends several paragraphs pontificating on different European countries’ approach to shit (as manifested through their approach to toilet bowl design)?

Interestingly (at least to my mind) the discussion is repeated, almost verbatim, in one of the short stories in DFW’s Oblivion. The characters having the discussion are rather air-headed secretaries, and I’ve wondered if giving them this particular dicussion is Wallace’s way of stating on his evaluation of Zizek’s profundity.

First, what is hard about understanding why people did things that made giant fortunes from doing something that in the middle or long run was insane? Or that wrecked the economy generally while they stepped away intact?

Second, there was this: “banks which are geared to a certain kind of business, and which suddenly find themselves being pushed out of that market, are likely not to have built up the expertise that will allow them to prosper in new ones. ”

That is exactly what happened with dereg of the s&ls in the early 80s, and caused the s&l crisis. Sleepy small town s&ls were told they had to step up to more sophisticated business to deal with the impact the spike in interest rates was having on their business. And they did stuff that was crazy and stupid.

SB – yes, you are obtuse, in several ways:
1. Henry is blogging here, not writing an academic paper – the reason academics like to blog is, among other things, that it allows them to test out ideas and conjectures, without going through the labor and time intensive process of assembling all the necessary evidence. Having such an idea is often the first step in the process – before you engage in the actual deep research, you want to make sure you’re not overlooking anything obvious.

2. There is not much research about the crisis yet, and even less on the specifics of the German case. For the reasons stated in 1., research takes time. For research to get published and gain sufficient amount of attention to be worthwhile to try to falsify takes a lot of time. Somehow people find that harder to deal with in the social sciences than in physics, but the issue exists in both fields.

3. This is a stylized version – it’s useful for a big picture, but it has a lot of moving parts that require a lot of research to nail down. Various researchers are working on in depth accounts of various parts of that explanation – the Höppner group at the Cologne Max Planck, for example, has done a lot of work on the effect of the EU in pushing Germany to dismantle parts of its model. Most of that work is on corporate governance, but they’ve branched out to other issue areas.

4. Yes, people disagree on aspects of this – but the fact that there is some agreement on the basic contours of what’s going on isn’t a bad thing.

SB, I think you’re more looking at the difference between a field where people would like to use the results for decisions, and fields where the main short term interest is from other researchers. Ask cosmologists about dark matter, and you’ll get many just-so stories that don’t have as hard evidence as people would like to have. But they’ll still tell it’s probably mostly WIMPs, because that’s where things are vaguely pointing towards.

But the only interested people, outside of the field, are people with a purely intellectual interest in the question. It’s much safer to toss around unsubstantiated working hypotheses in such an environment. You can continue saying “not proven yet” as long as you want.

But in some fields, and much more in social sciences, people completely outside the field would like results now, if possible. If a likely but unsubstantiated working hypothesis is the best result available, they might run with that.

And FWIW, I’d certainly agree that you can draw a direct line from the removal of the AAA guarantee from the Landesbanks to their piling in to US subprime via SIVs and ABCP conduits.

Don’t know anything about German banking, but ‘idiocy’ is (or used to be anyway) a technical term. Surely none of those bankers had an IQ below 30; likely above 120, for most of them. So, call it what you want, but it’s certainly not idiocy or even stupidity. Institutions operate on their own logic.

SB is probably ScentofViolets.

The idiocy thing is interesting. Do we have to tell ourselves that they were stupid? Is it too scary for us to admit that really really smart people can do lots of damage when they are wrong/deceive themselves?

Walt, Sebastian

I don’t know who Scent of Violets is. I don’t have any particular prejudices regarding social sciences. I merely expressed my surprise and interest in a process which is quite different from that of physical sciences research.

But you do remind me of one of the funnier comments made to me at a small but very good conference in Europe. I left a talk to find the ladies room and immediately ran into a junior faculty from a state school in the Midwest. He introduced himself and then looked at my name tag. Without pausing to allow me to introduce myself, he said “Oh, you MIT people think you’re so smart!”

Just because I come from a different discipline doesn’t mean I have a preconceived notion about yours. Now, I am not interested in having some silly on-line argument. I was interested in knowing more about the process of social sciences research. Thank you Zamfir for your thoughtful response. My apologies to Henry for the distraction.

I’ll let everyone get back to the main thread.

SB, I’m a mathematician. I think you may want to reflect on the lesson of that “Oh, you MIT people think you’re so smart!” story some more.

You missed the point of it entirely.

The point wasn’t that you shouldn’t jump to conclusions based on little bits of information?

Alex,

The point is that people often bring their preconceived notions into a situation. Just as the junior faculty from xxxx made an unwarranted assumption about me, I found that instead of responding to my query, Sebastian and you appeared to respond to an impression of what kind of person must be asking those questions. I was hoping for enlightenment – Crooked Timber is wonderful that way – I get to learn about something I don’t do – and instead I got on-line aggression. I understand that it is displaced, but it is annoying nonetheless. And I lost an opportunity to learn something that really interested me.

Can we stop arguing now?

Best,
SB

I’m going with the mass stupidity theory. I took one half-credit economics course a million years ago and dropped it. I expect I might have passed, but I wouldn’t bet more than a nickel on it, so I feel well-qualified to chime in.

Long and short of it is this: only a nation of idiots could have believed Wolfowitz and Cheney when the cost of the Iraq war was being discussed. Free or 5 million dollars?. America’s spectacularly low casualty rate helped support the illusion that America was so awesome that the US could ship a hundred thousand troops half-way around the world with equipment, stick them in the desert and the entire exercise would pay for itself.

Saw a good interview with Dr. Doom who put the cost of the Afghan and Iraqi adventures at 2 trillion and counting.

The real question for me is what would have happened had their been a comprehensive discussion on the real financial costs to America of the invasion. From what I recall of the time, the urge for catharsis/revenge was shared across the political divide. Folks forget that for all Bush’s follies, he actually did a fairly good job of channeling this sentiment away from American Muslims. My great fear during the Bush years was that Bush would launch a major attack on Iran. I’m not convinced, therefore, that a frank discussion of the real financial costs of the war would have averted invasion.

Indeed, my guess is that given the choice between a two trillion dollar price tag for a marginally successful prosecution of two war that would tie up US troops for ten years and the cost of nuking Baghdad, Tehran, and several cities in Pakistan or Afghanistan, a large number of Americans would have argued for the latter. That would have been bad. Doing nothing certainly was not an option. Was lying about the real cost of the war the right thing to do at the outset? I don’t frankly see Americans being talked out of doing something wild. Recall Friedman and his “suck on this” observations. Twas an ugly time. And we’re all still paying for it. You know we’re all in deep doo-doo, btw, when the strongest and most consistent anti-war political figure in America is Ron Paul.

I read the Lewis piece and thought that the ‘scheisse’ angle was a bit overdone but I had no real problem with the cultural story. Henry ‘pits’ this against an alternative institutionalist story but I don’t see them as rival. The following strikes me as running in the same direction:

a) Lewis is right, German like rules. I am married into a family of them. (This is not a scientific finding, but I know). The Eu’s solution to the massive agency problem at the heart of the Euro that we are now dealing with was to try and write a complete contract that got around the problem of ex ante specification of all possible states of the world by writing rules that would limit behavior to a set of delimited parameters that the institutions of the Euro could cope with. Rules. Problem was the minute that they were announced everyone violated them, even the Germans themselves. Contrast that to the incomplete contract that is the EU’s political project and that worked rather well.

b) The Landesbanks were shoved out into the market and they were suckers. It is also true that in 2006 New York short-hand for ‘garbage pail’ was Dusseldorf. But its not inexperience alone. I heard that first in an interview I did with a CDS designer back in 2007. If it has an official wrapper from S and P (a government authorized NRSRO remember) then they would buy it. The game was turning crap into something rated and then you sold it to the Germans (or Norwegians apparently).

c) The ‘idiocy’ all goes in one direction story is true. The notion that idiocy moves in different directions and cancels itself out is exactly the type of fallacy Nassim Taleb has been railing against. It presumes some kind of large numbers, normal distribution, and a real world that is apparent to non-idiots that we are all informationally aware of and converge upon in our trading decisions.

If that were in any way true we wouldn’t be sitting in a world were markets squeal for budget cuts, and then when they get them they squeal louder about a lack of growth. It wouldn’t also be the same world where the German government is simply unable to accept any responsibility for flooding the periphery with cheap money for a decade so that everyone could buy BMWs and now wants the same folks they gave the cash to to pay it all back via budget cuts that undermine their own economy (as seen in today’s figures).

Idiocy going the one way is the norm. It is not an error.

In sum, its a complex world. Why look for one ‘right’ story?

It’s also possible that Germany’s role was purely structural. As a nation with a huge trade surplus, it can’t but be a huge net saver. As a nation with a trade surplus and an ageing population and strong financial regulation, it was very likely to account for a lot of demand for AAA securities. Given that the financial sector invented a machine to print AAAs without limit, it’s not surprising that a lot of AAAs ended up in Germany.

“Germany” here is really a synecdoche for export-intensive developed economies – the only big exception was China. But “German” banks were competing – they couldn’t just offer T-bill rates. Chinese banks had to hand over their dollars to PBOC because, well, otherwise they’d all be shot. Hence the “Germans” ended up with the famous Deutsche Bank CDO whose only means of support was a Las Vegas cocktail waitress’s tips (ISTR D^2 can actually quote the reference number), or rather, several hundred of them who lived in the subdivision the underlying mortgages came from. And the Chinese got the full faith’n’credit of those there United States.

Regarding economic stupidity, the sad thing about rat-ex is that there’s surely so much intellectual potential in trying to understand economic stupidity and come up with a formalism that gives you useful results in an economic model. Obviously, it’s going to be hard, but that’s another way of saying “interesting and important”. There’s probably more than one Nobel in it, plus any number of top-tier publications and quite a few careers. But they chose to dodge the question.

For example, even if you accept the notion that irrationality is random, just questioning how long it takes to regress to the mean has interesting results. If the crazies rush in one direction and take a while to drift back, that implies a source of business cycle fluctuations and an opportunity to make out like a bandit. If they sober up quickly, well, then the standard assumption wouldn’t be far off the truth.

Another one: is irrationality endogenous?

#10 Beat me to it.
#32 The relevance of the Iraq comparison may be the prestige of the US; its military capacity, its economic strength. Who could believe what a wreck it would turn out to be? I hardly mean to imply that we are finished, just easily over-estimated at times.

The credit cycle has always amused/puzzled me. Wouldn’t banks do better by avoiding the extremes of easing/tightening? Probably; their employees, not so much.

Are we functionally more intelligent than lab rats, or just better rationalizers?

I find the ‘global glut of savings’ a persuasive theory of the GFC in general. Yes, people will engage in the usual misdeeds, torpor, credulousness, but even more so when there is an external locomotive force. A rising tide floats all schemes.

SB – unfortunately there were two Sebastians involved here – I only wrote the first answer, I don’t really know who Scent of Violet is, either (s/he’s a frequent poster that gets into lots of fights). Next time you’re interested in other people’s work and disciplinary differences, maybe use the words “interested,” and “curious” rather than “alarmed”… (also, you might want to read some philosophy and/or sociology of science if you think any science actually works according to Karl Popper).

Mark – I find this “Germans like rules” meme incredibly irritating. I am German. Coming to the US I was bombarded with a plethora of rules and social norms that it took me years to – more or less – figure out. Some Germans may be more direct in pointing out to you when you’re breaking such rules than most US-Americans, but that doesn’t mean those rules don’t exist and aren’t followed here. And in terms of economics, Germans break rules all the time. Germans are corrupt – probably about as corrupt as Americans on average. They cheat on their taxes – about as much as Americans. As you say yourself, they broke the EU stability pack without much qualms. I just don’t see how this alleged rule obsession tells us anything about political economy.

Sebastian (1). You came to the US and stayed. maybe that tells us something?

You may find the rules-meme irritating but try teaching a semester at a major German university and then compare that to the UK, Denmark, France and the US (where I have also taught) and tell me rules are not more important in one context than the other. Perhaps the general point is this. If Germans don’t think the rules would work why bother designing a whole continental political economy around them? Or, why continue to hold other countries to them after the fact when its self-apparent that they are harmful (from maastricht to austerity)?

If Germans don’t think the rules would work why bother designing a whole continental political economy around them?

To be fair, the other nations and institutions involved spent a lot of their time second-guessing what the Germans would want from the eurozone. Trying to work out what Hans Eichel would accept, what he would actually prefer, and to what extent the first could be influenced on some topic by starting with the second on another, was the top priority of several world class diplomatic services for most of the 1990s.

And to some extent, this was a reflection of the stereotypes of Germans the French and Italians and Eurocrats painted on their walls.

Ajay: ““Most smart people work in banking” is, even if it’s true (which it isn’t), not the same as “most people who work in banking are smart people”. I live in London. Thanks to the presence of the Royal Ballet and its supporting schools, it’s probably true that most British ballerinas live in London. London has in fact been leeching the best ballerinas out of the rest of the country for decades. But you try stopping an average Londoner on the street and asking her to do a quick grande jetée.
And, that aside, it’s certainly not the same as “the people making the decisions about structured product investment strategy are smart people”.”

Your logic is flawed; the correct analogy would be how skilled London *ballerinas* are at ballet. The original comment pointed out that Wall St has been hiring smart people for quite some time, and is highly competitive, externally and internally. Those who can’t/won’t hack it are kicked out. That suggests that the survivors, which all decision-makers there would be, aren’t dumb, and don’t get fooled too often.

If Germans don’t think the rules would work why bother designing a whole continental political economy around them? Or, why continue to hold other countries to them after the fact when its self-apparent that they are harmful (from maastricht to austerity)?
You can’t put that on the Germans. The importance of rules on the European level is that they can agreed upon in advance by by negotiation between national government, who are in the end the only institutions that truly have the democratic mandate to make political decisions.

The alternative to rule-based actions (implemented by relatively constrained technocratic processes) is to give more ability to European institutes to make political decisions on a case by case basis. But the current EU is not set up to give much mandate to such institutions, nor is there very much popular support for changes in that direction.

Sure, the current setup is far from perfect. But nearly every alternative (like the Eurobonds) comes down to a transfer of decision making power to a federal European level without an accompanying construction of a democratic frame that can control and give mandate to such power.

mark – the reason I’m here is a combination of the fact that the US has a comparative and absolute advantage in graduate education for social scientists (which was much larger when I came 7 years ago when neither MPI nor Bremen had graduate schools) and path dependency. I like it here, but I certainly wouldn’t mind going back to Germany/Europe either if opportunity (now for two people…) arises.

I’m with Zamfir on the rule-based institutions. People were aware of the economic risks posed by a single currency area with relatively heterogeneous members and tried to write rules to address those risks.
Given the uniqueness of the situation (and thus inherent uncertainty), I can see how one could tell a Mark Blyth ;-) type of story about the role of ideas in determining which rules exactly they wrote and which potential problems they focused on.

But “Germans like rules” – that just doesn’t make sense as an explanation. Why did they (or rather their politicians) break the rules right away then? I thought Germans all obey the rules like when they drive cars in a traffic jam? Also, in the current crisis, they seem to make things up as the come more than follow any rules. It’s not like Merkel is super insistent on Maastricht Criteria atm – and austerity isn’t a specific set of rules – it’s the same type of stuff the IMF used to impose – and I don’t think the IMF has ever been accused of undue German influence.

Zamfir@49

Sure, the current setup is far from perfect. But nearly every alternative (like the Eurobonds) comes down to a transfer of decision making power to a federal European level without an accompanying construction of a democratic frame that can control and give mandate to such power.

I think the current setup is “close to perfect” if you are President Sarkozy or Chancellor Merkel.

The failure to build a European “democratic frame” does prevent effective pan European government but it should be remembered that this suits major national political parties in the larger states and the surplus countries just fine. If you are in the winning political party in Germany or France you effectively choose the broad fiscal policy options that will be on offer for the rest of Europe, and particularly the Eurozone, to choose from. Any kind of more federal solution with the EP playing a more significant role would lessen the size of the prize for elections in France and Germany, so expect their collective enthusiasm for more pan EU popular democratic input to be at a low level until the EU has already acceded to all of their demands.

This has little to do with Michael Lewis’ article but it might explain why the proposed solutions to the European portion of the GFC do not seem to involve losses coming home to roost in either France or Germany, and why sneering discussion of German and French banking or character failures are less common than might otherwise be expected.

@shay, no matter what you think would be good about a federalized Europe, the current system has to work with a European population that is for a large part not asking for a federal Europe, and that definitely does not agree on how such a federal Europe should look like.

Thing is, I don’t really like the ‘shock doctrine’ kind of logic you lately hear about Europe, that the current crisis should be used to implement a more centralized Europe without asking the people who would only say no.

The original comment pointed out that Wall St has been hiring smart people for quite some time, and is highly competitive, externally and internally. Those who can’t/won’t hack it are kicked out. That suggests that the survivors, which all decision-makers there would be, aren’t dumb, and don’t get fooled too often.

No, I’m afraid there are a lot of unaddressed assumptions in that one as well. Wall Street indeed hires some very smart people. It doesn’t necessarily follow that it hires only very smart people, or that being able to hack it is a result of being very smart, or even that the sort of jobs that the very smart people get hired for are also the sort of jobs that allow you to progress to being a senior decision maker.

That suggests that the survivors, which all decision-makers there would be, aren’t dumb, and don’t get fooled too often.

Right. On the other hand, actual recent history suggests that the survivors do in fact get fooled fairly regularly.

ajay, there’s a difference between losing a good gamble, and being fooled (by taking an a priori bad gamble). Both cases leave you without a chair when the music stops, but they are IMO not quite the same thing.

A lot of post-crash analysis seems to come down to asking whether we are looking more at the first or more at the second in specific cases. The Landesbanken (as organizations) look like a good fit for “got fooled”, either by themselves or by smarter operators. Because there don’t seem to be much examples of them that played the high finance game and won.

But many individuals in the financial sector don’t seem to have lost, compared to any likely other career they could have had. Some people did really lose out, but a lot of those seem more cases of losing a good gamble, than of being a fool.

It’s astounding that Lewis was able to amass that word count in VF on that topic and never mention the Depfa/Hypo affair, in which a German bank spins off to Ireland to take advantage of light-touch regulation and low taxes but gets bought by the clowns at Hypo right before a multi-billion dollar hole appears in its balance sheet.