Economics/Finance

As a sort of response to Daniel’s post, I’d like to toss up some not fully digested thoughts about the fact that there have been very few high profile criminal prosecutions of bankers or others in the finance sector arising from the 2008 meltdown. There was of course the Madoff case, but it’s something of a rule-proving exception – Madoff was essentially a one-man show and he got caught for the very simple reason that his Ponzi scheme ran out of money.

The general immunity of the financial sector is an exception to the usual pattern described in JK Galbraith’s theory of the bezzle (exemplified by Madoff). The bezzle is the amount of undetected corporate fraud. As a boom continues, and everyone does well, people realise they can siphon off money and use it to make even more money. If they are threatened with detection, the original amount stolen can be returned to the till, and thye are still ahead. But, in a crisis, this can’t be done and, in any case, outside accountants are all over the books. So, embezzlers are caught and the bezzle shrinks. It stays small in the early stages of recovery when most decisions are being made by the cautious types who survived the crisis. But as the boom continues, hungrier and less-risk averse types come to the fore and the bezzle begins to grow again.

It’s also typically true that actions seen, while profitable as corner-cutting at worst, and as cleverly overcoming silly regulatory obstacles at best, are commonly prosecuted under much more aggressive interpretations of the law when lots of people have lost their money.

Why is it no one, or hardly anyone has been caught and convicted this time around? A few possible explanations over the fold, along with an attempt to respond to DD on whether this matters.

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Joris Luyendijk’s new project up at the Guardian is aiming to apply the methods of social anthropology to the financial sector in the City of London. He’s carrying out interviews in pubs and coffee bars with people at all levels and in different roles in financial services industry, to get a proper picture of how the social roles all fit together. So far, he has made at least one major discovery:

• People in the Guardian comments section really, really hate bankers

I know, I was just as surprised. I’ve been doing my own amateur social anthropology exercise too. By which I mean that I’ve got a Twitter account and some spare time, and as a result, have been collecting[1] prime specimens of banker abuse. So far, I’ve gathered that I, personally, have stolen from every single benefits claimant in England, and that Sir Fred Goodwin (crime: got a big pension, managed a bank poorly) is clearly a bigger criminal than Sir Anthony Blunt (crime: betrayed dozens of serving agents to Stalinist Russia). And, of course, during the recent London riots, dozens of variations on “who is the real criminal – the man who smashes a shop window and steals an iPod, or the man who gets paid a bonus?”

Because, at the end of the day, Dr Harold Shipman murdered 52 infirm old women in order to steal money from their wills, but bankers, get bonuses. Who is the real criminal, eh??

It is without any anticipation of popularity or agreement (or even any real hope of not being called an asshole on my own blog, although I must say that would be jolly nice if you were in the mood) that I tell you that I think this is all rather a pack of bollocks.

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It isn’t a good thing to have contradictory beliefs. Since I’ve notice what appear to be such beliefs in myself recently, I thought I’d share, both because I guess that there are others out there who also have them, and in the hope that Crooked Timber’s community of readers can tell either that I should discard some of them (on grounds of falsity) or that I’m wrong to think them contradictory. So here goes.

Belief 1: As a keen reader of Paul Krugman, Brad DeLong (yes, really), our own John Quiggin and other left-leaning econobloggers, I believe that most Western economies need a stimulus to growth, that austerity will be counterproductive, and that without growth the debt burden will worsen and the jobs crisis will get deeper.

Belief 2: As someone concerned about the environment, I believe that growth, as most people understand it, is unsustainable at anything like recent rates. Sure, more efficient technologies can reduce the environmental impacts of each unit of consumption, but unless we halt or limit growth severely, we’ll continue to do serious damage. There are some possibilities for switching to less damaging technologies or changing consumption patterns away from goods whose production causes serious damage, but the transition times are likely to be long and the environmental crisis is urgent.

Belief 3: Some parts of the world are just too poor to eschew growth. People in those parts of the world need more stuff just to lift them out of absolute poverty. It is morally urgent to lift everyone above the threshold where they can live decent lives. If anyone should get to grow their consumption absolutely, it needs to be those people, not us.

Belief 4: The relative (and sometimes absolute) poverty that some citizens of wealthy countries suffer from is abhorrent, and is inconsistent with the status equality that ought to hold among fellow-citizens of democratic nations. We ought to lift those people out of poverty.

If I were to attempt a reconciliation, I’d say that this suggests zero or negative growth in material consumption for the wealthier countries but a massive programme of wealth redistribution among citizens at something like the current level of national income, coupled with a commitment to channel further technological progress into (a) more free time (and some job sharing) or a shift in the mix of activity towards non-damaging services, like education (b) switching to green technologies (c) assistance to other nations below the poverty threshold. All of those things need mechanisms of course if they’re to happen — and I’m a bit light on those if I’m honest, outside of the obvious tax-and-transfer. What we don’t need is more in the way of “incentives” to already-rich supposed “wealth creators” and the like. What we certainly don’t need is a strategy that purports to assist the worst off in the wealthiest countries by boosting economic activity without regard to the type of activity it is, in the hope that this gives people jobs and, you know, rising tides, trickling down and all that rigmarole. The trouble is that Belief 1, which I instinctively get behind when listening to the austerity-mongers, is basically the same old tune that the right-wing of social democracy has been humming all these years. It is just about the only thing that will fly for the left politically in a time of fear, joblessness and falling living standards, but it seems particularly hard to hold onto if you take Belief 2 seriously.

A bunch of standard measures of US economic wellbeing (median household income, real wages for workers with high school education, educational attainment by age 25 and so on) show strong improvement from 1945 to the early 1970s, followed by stagnation or very slow growth thereafter. A variety of arguments, have been put forward to suggest that the standard statistical measures understate improvements in wages, incomes and so on since the 1970s. Some of these arguments are valid (for example household size has fallen), some not (for example, the fact that we now have more of goods that have become relatively cheaper). Regardless of validity, the main reason people believe these arguments is that, for anyone who was around at the time, it seems implausible that our parents’ living standards in the 1970s were comparable to our own today (assuming roughly similar class positions)

This reasoning is invalid for a reason that should be familiar to those on the conservative side of debates over inequality. The measures mentioned above compare snapshots of incomes at different times. But (as conservatives regularly point out) standards of living are determined mainly by lifetime incomes, not by income in any particular year. Given the pattern described above, lifetime income for someone who worked, say, from 1940 to 1985 was well below that for someone in a similar class position who started work in 1970, just when the long increase in real wages was slowing for most and stopping for some. For every year of their working life, the 1970 starter gets a wage (adjusted for age, education and so on) that’s as high as the maximum attained by the 1940 starter after 30 years of steady growth. Unsurprisingly, that translates into a bigger house, and more of most items that require savings, whether or not their price has risen relative to the CPI.

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Aside from containing a brilliant exposition of how blogospherical “rebuttal” actually works — basically endless posts by halfwits repeating that X (an eminent scholar) is an ignoramus because X has contradicted the received wisdom of a tribe — this post by Dave Graeber at Naked Capitalism has to be one of the most informative and entertaining pieces I’ve read in a long while. What happens when the findings of anthropologists about earlier societies clash with the a priori assumptions of economists about how things _must_ have happened? Well, you can guess. The really interesting stuff is in the anthropological detail, so read the whole thing, as they say, but I’ll just quote Graeber on economics and scientific method:

bq. Murphy argues that the fact that there are no documented cases of barter economies doesn’t matter, because all that is really required is for there to have been some period of history, however brief, where barter was widespread for money to have emerged. This is about the weakest argument one can possibly make. Remember, economists originally predicted all (100%) non-monetary economies would operate through barter. The actual figure of observable cases is 0%. Economists claim to be scientists. Normally, when a scientist’s premises produce such spectacularly non-predictive results, the scientist begins working on a new set of premises. Saying “but can you prove it didn’t happen sometime long long ago where there are no records?” is a classic example of special pleading. In fact, I can’t prove it didn’t. I also can’t prove that money wasn’t introduced by little green men from Mars in a similar unknown period of history.

The latest data on US incomes make for grim reading, both as regards the bottom of the income distribution where the number in (absolute) poverty is at an all-time high (the proportion of the population was the highest since 1993), and in the middle, where median household incomes have fallen back to the 1997 level. For some groups, such as male wage earners without college education, real incomes haven’t risen since around 1970

Having discussed this issue before I’m familiar with most of the standard arguments[1] used to show that things really aren’t that bad. The big ones are
(i) household size is decreasing
(ii) the consumer price index doesn’t take adequate account of product quality
(iii) the Earned Income Tax Credit isn’t taken into account
(iv) health insurance and other benefits are undervalue

Looking at the period from 1970 as a whole, there’s some truth in these claims, though not enough to offset the dramatic contrast between the huge gains before 1970 and the relative stagnation thereafter. But over the last decade or two, these excuses have run out.

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My piece in the National Interest is now up under the exciting headline China’s imminent collapse. That’s great for reader interest – the piece has only been up a few hours and is already #1 on the Most Popular list, but I fear readers will perceive a bit of bait and switch when they reach the conclusion

Given the opacity of the system, there is no way of telling how and when a breakdown might occur except to observe that is likely to be precipitated by an economic crisis of some kind. Moreover, there is no way to tell whether a crisis would produce a relatively smooth transition towards democracy or something more chaotic and perhaps bloody.

Paul Krugman tells me he gets to choose his own headlines, a rare privilege in the world of newspapers and magazines. I asked my Australian Fin Review editors about this and they have said I can suggest them if I want to, though the tradition there runs more to cute subeditorial puns that I can’t really replicate.

Meanwhile apologies to readers for not providing accessible links to the papers I mentioned in my previous post. Through a mental process I won’t try to explain, I’d convinced myself that simply uploading the papers to CT would result in the imminent collapse of our hosting facility. Looking at the filesize that’s silly. So here are near-final drafts of:

The Politics and Society piece on financial markets
The Chronicle of Higher Education piece on inequality and the admissions race

CT has long been the go-to blog on the cultural significance of underwater zombies (as in this classic). But now as reported by Paul Krugman in the NYTimes, they’ve taken over the ECB.

John Kay has a “piece”:http://www.ft.com/intl/cms/s/0/faba8834-cf09-11e0-86c5-00144feabdc0.html#axzz1W9LvZiR2 about the travails of modern economic theory in the Financial Times today. This analogy struck me as a bit unfair.

bq. The only descriptions that fully meet the requirements of consistency and rigour are completely artificial worlds, such as the “plug-and-play” environments of DSGE – or the Grand Theft Auto computer game. … Economists – in government agencies as well as universities – were obsessively playing Grand Theft Auto while the world around them was falling apart.

After all, as best as I am informed, _Grand Theft Auto_ has an entire simulated world, with multiple interactions between quasi-autonomous, if scripted personalities. Dynamic Stochastic General Equilibrium models – not so much. But this spurred me to think – how would _Grand Theft Auto_ work if it looked a little bit more like a DSGE model? All interactions taking place with a single modal gangsta, whose preferences were taken as representative of all gangstas across the entire economy? Frictionless exchanges, in which gunfire never occurs because all actors anticipate what other actors are likely to do, and hence avoid welfare-lowering actions? My imagination is limited, both (a) because I’ve never actually played Grand Theft Auto, and (b) because my exposure to the relevant economic arguments primarily consists of dim memories of snotty comments about Robert Lucas in lectures by neo-Keynesian Peter Neary (who taught advanced macro to my undergraduate class and was keen on the Malinvaud tripod). But I’m sure that other members of the CT community don’t labour under these twin disadvantages, and can do better. Also, I recognize that the title of this post is quite unfair, since Kocherlakota, whatever his other faults, is “not especially keen”:http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4428 on DSGE arguments, but if the belabored wordplay fits, then wear it …

Continuing the all-Yglesias all-the-time quality for which Crooked Timber is lately renowned, Matt’s post here could be stronger. He’s pointing out that a Grover Norquist tweet is nonsense (not an unusual circumstance, I surmise, but there is a point to be made.) “If Keynesian economics worked — shoplifting would create jobs.”

Matt points out that Norquist is committing what he calls ‘the broken windows fallacy fallacy’, which requires some explanation of the money supply in 19th Century France. There is an easier way. W.W. II ended the Depression. So Hitler is like shoplifting, only more so. [click to continue…]

Here’s an interesting (or at least provocative) new piece of psychological research (link may need academic subscription) with findings concerning the moral framework generally favoured by economists:

bq. In this paper, we question the close identification of utilitarian responses with optimal moral judgment by demonstrating that the endorsement of utilitarian solutions to a set of commonly-used moral dilemmas correlates with a set of psychological traits that can be characterized as emotionally callous and manipulative—traits that most would perceive as not only psychologically unhealthy, but also morally undesirable.

“The mismeasure of morals: Antisocial personality traits predict utilitarian responses to moral dilemmas”, by Daniel M. Bartels and David A. Pizarro, Cognition 121 (2011) 154–161.

The National Interest has just run a piece I’ve written on the S&P downgrade. I had understood this was a conservative publication, but I tend to got lost in the varieties of US conservatism (and, for that matter, liberalism). Anyway, they seemed happy to run this as well as an earlier piece on Europe. A quick look at the website didn’t suggest I was in bad company – most of the foreign policy stuff was anti-war, and the other economic pieces were eclectic.

Is there an up-to-date guide for overseas visitors to the US scene? It’s nice to be called up from the Australian farm team, but I don’t want to end up in some glossy publication that turns out to be funded by LaRouche.

It’s rare to take on Paul Krugman in an argument and win, and I agree with him most of the time anyway (these two facts are correlated!). So, this is the first time, and will probably be the last, when I can claim a win in such an argument.

Krugman has long criticised the eurozone on the grounds that it is not an optimal currency area and that the European Central Bank must therefore pursue an unsatisfactory “one size fits all” policy, too contractionary for economies that are doing badly and too expansionary for those that are doing well. Back in February, I argued that in fact ECB policy was “One size fits nobody” and that even Germany was vulnerable to its contractionary effects.

The latest statistics suggest that German growth was already stalling then. Today, Krugman is also pointing to a “one size fits none” policy.

At this point, it’s time for a suit of clothes, and that means a new tailor. And, in that respect, the bad news may have a silver lining.

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Michael Lewis’s recent article brings up again the question of why Germans bought so much toxic financial waste in the run-up to the financial crisis. It seems clear that his ‘because they’re all obsessed with shit’ theory isn’t any better an explanation than his Provo gangsters and fairy rings take on Irish economic disaster. But that still leaves an open question.Peter Frase takes one go at it here, first using Lewis’ earlier work to ding the ‘idiots’ theory of why the meltdown happened:

bq. One popular interpretation of the crisis, and of Lewis’s book, is that the explosion of sub-prime lending and securitization was the result of mass stupidity, and that huge numbers of people simply failed to understand or account for the incredible financial risks they were taking. This is basically the approach Ezra Klein takes when he quotes Larry Summers’ famous remark that “there are idiots” and concludes that the crisis was a consequence of human weakness and error in the context of a system with few regulatory restraints. … Yet idiocy does not stand up as a the central causal factor behind the crisis. For one thing, it seems odd that there would be such a concentration of idiocy in the most lucrative field of the American economy, one which has been leeching the brightest minds out of the rest of the society for decades. Moreover, it is necessary to explain not only the preponderance of idiots, but the tendency for their idiocy to work systematically _in the same direction._ … In academic finance, the technical term for idiots is “noise traders”, and they are thought to provide erratic and irrational actions that may destabilize markets but do not systematically move them in one particular direction. …

bq. Though the financial crisis produced a great deal of institutional calamity … the individual people responsible for the worst decisions of the last decade managed to greatly enrich themselves even as they nearly annihilated the global economy. … it’s undeniable that some of them, particularly toward the end, were getting high on their own supply, taking the the bogus triple-A ratings on toxic subprime garbage at face value even though they had an inside understanding of the con game they represented. …ultimately, these people–who in a just world would be penniless and serving extended prison terms–walked away with millions of dollars. There are plenty of apt descriptions for people like that, but “idiots” isn’t the one I would choose.

and then pointing out that even if everyone wasn’t an idiot, there did appear to be a heavy concentration of them in the investment arms of German banks.

bq. German institutional investors, or as they are called at one point, simply “Dusseldorf”. Lewis never really tries to explain their outsized appetite for murky subprime instruments. … In the language of the “varieties of capitalism” school of comparative political economy, Germany is what is known as a “coordinated market economy” or CME, whereas the U.S. is a “liberal market economy” or LME. The structure of the market in a CME is fundamentally different in that it relies heavily on coordination between firms, based on tight long-term inter-linkages and above all, trust. This contrasts with the more ruthlessly competitive ethic of the LME, in which formal contracts take the place of reciprocal trust relations. So German bankers and investors were a) relative novices at modern securities wizardry; b) steeped in a capitalist culture quite different from the dog-eat-dog rapacity of the American version.

The stylized story that is doing the rounds among comparative political economy of Europe people is a little different than this. It points to how the EU forced Germany to get rid of rules that favored its regional and local banks, obliging these banks to seek new investment opportunities outside the local and _Land_ businesses that had previously provided their bread and butter. And when they went international, they found many people who were willing to sell them unimpeachable investment opportunities, and little internal or external capacity to figure out when someone was trying to sell them a pup …

Here, the suggested problem is an organizational one as much as (or more than) a cultural one – 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. 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. Of course, this isn’t to say that this theory is _right_ : political scientists often have a poorish enough understanding of what is happening in markets – but if there are better ones, or contradictory evidence for this one, I’d be interested to hear it.