It’s not a particularly radical statement to say that capitalism can be irrational. Keynes got it right back in 1936 when he examined short term behaviour in the stockmarket. And Greenspan knew what he was talking about when he warned of “irrational exuberance”.
One of the interesting aspects of the current financial crisis is that many of the problems are caused by an erosion of trust – banks won’t lend to each other and various markets have come to a halt because no one trusts other actors to have acted responsibly in disclosing how much they’re exposed to bundles of subprime debt. In many quarters, the finger is being pointed at regulatory authorities – because there’s no transparency in what’s going on. But that begs the question of whether immensely complex financial products are actually rational in the first place, or whether this result was always on the cards.
George Soros thinks the latter. Soros tends to cop it because he’s seen as some sort of class traitor – immensely wealthy but now prepared to warn of “market fundamentalism”. That seems to me unfair, and his own experience would suggest that he understands all this stuff better than most. It’s also interesting to read his view on the political economy of the current crisis, because the crazed nature of the way the American economy has been run – underpinned by the USD as reserve currency – is unsustainable, and we’re probably seeing the limits of that sustainability being reached now.
Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.
This also begs another question – what can be done? Soros, in his Financial Times column, argues that what we’ve seen over recent decades is the creation of moral hazard through the intervention in collapsing bubbles by the state. Markets aren’t magically self-correcting, he suggests, and the irrationality which leads to crisis has been exacerbated by the willingness of regulators and government to step in and try to put things right when they go nuts. But he also thinks, for reasons which are quite cogently stated, that the limits of the effectiveness of Fed intervention are close to being reached. What all this suggests is that structural intervention is necessary, and should go beyond regulating for “transparency”.
Cross-posted at PollieGraph.
Mark – a quibble. It seems to me that in both cases where you refer to ‘begging the question’ you actually mean ‘raising the question’.
On the topic of moral hazard, there was an interesting response from Davos economists overnight to the Fed’s latest emergency bailout of the financial system’s speculators and engineers.
Bloomberg reports: ‘The Fed is saying “we are there to clean up after bubbles first rather than to prevent the danger,” Stephen Roach, Morgan Stanley’s Asia chairman, said in a panel discussion. “It’s a dangerous, reckless and irresponsible way to run the world’s largest economy.”‘
Each market downturn since the bursting of the tech bubble in 2000 has been characterised by market pressures for Fed rate relief, irrespective of what was happening in the real economy at the time.
The Fed, under Greenspan, was happy to accommodate these pressures – the origin of the term the ‘Greenspan put’.
Greenspan’s successor Bernanke was supposed to be more of a ‘let-the-forces-of-capitalism-run-their-natural-course’ advocate, but Wall Street now appears to have him in its pocket as well. Funny how the red-in-tooth-and-claw capitalists turn into nanny state socialists at the first sign of trouble.
The upshot is we now have the world’s (formerly?) most important central bank further debauching the world’s (former?) reserve currency, cranking up the asset price bubble machine anew and putting off the inevitable and ever more dreadful reckoning that awaits us all.
No doubt you’re right, Bismarck!
Mr Denmore, have you got a link to those Davos comments?
And aside from the Fed rescuing the Wall Street speculators, they’ve turned to “sovereign wealth funds” for help – ie Asian and Middle Eastern governments.
What we really need to see is something like what FDR did in putting Joe Kennedy in charge of sorting out Wall St – Roosevelt’s logic was that having exploited the previous financial system, he’d know how to fix it. I’m not holding my breath though.
“What we really need to see is something like what FDR did in putting Joe Kennedy in charge of sorting out Wall St – Roosevelt’s logic was that having exploited the previous financial system, he’d know how to fix it. I’m not holding my breath though.”
From the paint it black thread-”Re the losses from Merrill Lynch and Citigroup- , have you noticed that the capital raisings done from sovereign funds have been 50% committed to paying bonuses for the talented staff of these firms? Talented indeed if they can get away with this one !
The japanese learnt to their cost in the 1980’s that you can presume to have the measure of these Wall Street operators but it is rarely the case.”
Good point Murph.
And haven’t our Aussie entrepreneurs covered themselves in glory when they have ventured from our sheltered workshops here in Australia on to the Big Time in the US?
I give you:
Qintex
Bond Corp
NAB
Centro
CSL
Pacific Brands
Geniuses!
Isn’t it? If you’d said people or markets can be irrational, you’d have been on safer ground, but what’s irrational about capitalism? More to the point: what is the more rational alternative?
P.S. it isn’t a catastrophe; it’s a bear market. We haven’t seen the worst yet so the various bleating instapundits should harden the fuck up.
That’s a bit of a handwave, to say the least. What kind of “structural intervention” do you propose?
I’ve just been reading a book called Den of Thieves, which tells the story of the corporate crimes of Michael Milken. While the technicalities of the situation have changed – and combined with a lot of outright criminality which may or may not be revealed in the washup from the current credit crunch – you had people buying debt for which they didn’t have a proper grasp of the risks associated with it, other people overpaying for assets (in this case companies), and a cadre of market professionals collecting ridiculous fees and so encouraging the music to keep going.
My gut reaction is that “structural reform” would just see similar problems popping up somewhere else sooner or later.
Mark, link to Davos story:
http://www.bloomberg.com/apps/news?pid=20601087&sid=alohzhP61Auo&refer=home
I really get a giggle out of tooth-and-claw capitalists turning into nanny socialists. They shoud pay the price of their greed and inhumanity. Not holding my breath though. People have been predicting the collapse of capitalism one way or another since Marx but it hasn’t happened yet.
Soros’ point as I understand it that the repeal of regulation in the last 20 years has left the wrong people in a position where their self enrichment will be too tempting for many to avoid.
Complicated derivatives are fine as long as the client and initiator of the product have perfect comprehension of the risks involved but as has often happened the investment bankers consider their own clients fair game to have their funds removed from them.
This has been going on since the 1980’s in New York – then Colgate Palmolive were ripped off by their bankers( remember Banker’s Trust ?) with the bank’s own tapes revealing the glee as the advisors sold the clients into a losing proposition.
The subprime crisis could have been avoided by requiring that products are regularly priced in accounts at market price ( marked to market at least annually , preferably quarterly )and that loans could only be made after the client’s financial ability met certain basic repayment requirements including obtaining suitable insurances.
Subprime mortgages are inherently risky but selling them in bundles as asset backed securities must be close to fraud.
One of the worst aspects of the last 20 years has been the willingness of governments to sell state owned assets to operators like Macquarie.
These assets are then manipulated so their future income and value is paid out to the bank /advisor in the form of fees , the entity is left with big loans( taken out to pay the fees)and the on going income does little more than service the debt the company has been loaded up with.User fees are constantly ramped up to service the debt and ongoing fees for management soak up any money left over.How people continue to buy into these structures in beyond me and I’d welcome someone pointing out any errors I have in my understanding of how these schemes work.
Paul Volker was the Fed chairman before Greenspan and the main lesson I remember him for is his response to the asset and share market bubble particularly in Japan in the 1980s.” Value will always reassert itself”.
The market will enforce this and the big risk as others have pointed out is the moral hazzard of bailing out those foolish investors who may have been sold a pup by their advisors . Unfortunately these days many people’s retirment funds are tied up in these financial vehicles and the politicians will intervene to stave of their losses today but perhaps will set us all up for bigger losses at a later date.
Mark
the creation of moral hazard through the intervention in collapsing bubbles by the state.
Soros is spot on. But this argues for less intervention not more. Government must stop meddling in the markets. A time-honoured feature of markets is a propensity to overshoot and then collapse. Best left to recover on its own as Soros points out.
So why do you conclude the opposite?
What all this suggests is that structural intervention is necessary, and should go beyond regulating for “transparency�.
- – crazed nature of the way the American economy has been run
Really? Did you think this a year ago, Mark? Did you put it in print? I agree that the sub-prime lending was wildly risky and stupid, but I’m not sure we heard too much about it until things went sour on a large scale…. Your reaction sounds a bit “ex post facto” to me. [You criticised supporters of GW2 for propoundinging the 'tyrannical regime' argument when the "likely WMD" argument crumbled.]
Katz’s list: don’t put Bond there, he was a bloody idiot in his Australian operations (none dare call them crooked) long before he ventured overseas
The big elephant in the room full of causes for this mess is Standard & Poors.
The subprime horsefluff and its accompanying stupidity are actually two different things. The subprime market itself in dollar terms was relatively small in the broader scheme of things. If the subprime market losses were isolated to merely the subprime mortgage originators and direct investors – this wouldn’t be a problem, we’d probably all have forgotten about it – it all would have been washed into the US housing downturn.
The problem was in the accompanying stupidity where the risk attached to the subprime financial instruments were allowed to infect and pollute the risk of a far larger number of financial vehicles, mostly in ways that slipped under the radar.
That migration of “bad risk� into instruments that had “good risk� should have been picked up and accounted for by S&P (and others) in their ratings analysis of financial instruments, and subsequently appeared as upgraded risk assessments attached to those instruments and vehicles.
Financial stability is predicated on market participants if not having directly, then certainly having available at their disposal, a reasonably good idea of :
a) who owns what
b) the risk involved in each ‘what’ that ‘the who’ owns.
But this did not occur because the organisations that most ‘investors’ used for this risk assessment were groups like S&P – but S&P were grossly negligent in the ‘risk assessment’ responsibility the market had given them (a privilege mind you, which they had deliberately sought to cultivate over decades).
If risk is profoundly misqualified – people cannot make decisions based on their preferences for risk aversion. So when shit hits the fan and the real underlying risk becomes apparent (or even hinted at), panic ensues as everyone rushes to reorganise and realign their risk holdings to levels they are more comfortable with. Risk drives investment – it’s the underlying basis for nearly all investment in the financial market.
People blame hedge funds for homogenising the pricing of risk – but that’s a harsh call. It was and is the lack of risk transparency and competent risk rating that has allowed junk bonds based on South Carolina sub prime housing debt to enjoy similar risk prices as New Zealand government bonds.
And the blame for that needs to be sheeted home squarely to those that have sought to monopolise the responsibility for rating risk, a responsibility they have clearly demonstrated they arent up to the task of shouldering.
Standard & Poors and their ilk.
The history of anti-recession efforts is that they are almost always initiated too late to do any good. This chart, based on recession timelines from the National Bureau of Economic Research, shows the enactment of stimulus plans is a fairly accurate indicator that we have hit the bottom of the business cycle, meaning the economy will improve even if the government does nothing. — Bruce Bartlett, author of “Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy.�
Maybe Too Little, Always Too Late
From today’s New York Times. A graph showing recessions since 1948, their duration and how intervention timing is … off. It’s here
Soros is on record elsewhere advocating much tighter regulation of markets.
And that’s spot on.
I didn’t see the subprime thing coming, Ambigulous, but that’s not what I was talking about in that bit. I’ve certainly been pointing out that the willingness of the rest of the world to prop up America has its limits for years.
Tighter regulation includes more open , transparent and market priced valuations. I can’t recall Soros suggesting restrictions on any particular activity .
As Possum Comitatus mentions the role of the ratings agencies will also come in for closer scrutiny and they might be useful scapegoats who will then be burdened with closer supervision.
Well, would someone like to make a case that doesn’t depend on the premise that anything anyone cooks up is necessarily a good thing because of teh free market for the utility of bundling subprime debt?
Thanks Mark, I misunderstood that part.
If I understand your question at 2.15pm Qld time, I’d like to suggest that the banking and finance regulators from various countries get together, and agree on “best practice” in the area of prudent lending to individuals & businesses. [NB: note avoidance of derogatory term 'Mums and Dads']
Borrowing from Australian banks used to be like getting blood from a rock, or radical advice from a Stone
They were cautious. (These days less so, it seems, but still and all I can’t imagine they’ve been up to their armpits in subprime dodginess.)
Ex post facto it seems so obvious….. well, stop these train wrecks happening in the future, gentlemen!! This isn’t radical, but it might settle the horses while still allowing exuberance and innovation and real production.
Yeah, I remember trying to get a credit card in 1990 from the Commie Bank with a limit of $300. They wouldn’t give it to an impecunious student. About 12 years later, a student I knew got another bank to give her an 8k visa card (or rather, it started with 500 bucks when she had a job and then everytime she went the limit, they’d send her an increase your limit check box letter) – I think in the end some arrangement was made with the bank – her income at that time being $90 a week from AUSTUDY.
But this is the nub of my question, really. How much of this (or at least the latter two things) really is generated by people on enormous packages in New York thinking up ever more complex ways to invent derivatives, etc? I’m not trying to be snarky – it’s a serious question.
Possum
You are right. Moodys and S&P are the real villains in the piece. Their method of payment is quite extraordinary. They charge the issuers of debt to rate their debt. This is akin to seeking a valuation for a house from the seller’s estate agent.
The action of the ratings agencies is a clear example of agency risk. The agencies’ business has become dependent on fees charged for “consulting” on the creation and pricing of structured products.
In other words, the agencies – which are supposed to be an independent arbiter of risk – are in bed with the people issuing this junk. Ergo, they have a vested interest in giving them a top investment grade.
The whole sorry saga calls for tougher regulation of the derivatives markets and the banking system that protects end investors.
According to the always insightful global bond guru Bill Grosshttp://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/IO+January+2008.htm, the structured products debacle was just a sophisticated version of the pyramid schemes that erupt every now and then – Amway for rocket scientists.
But the threat this time is much more serious. The global banking system – and by implication capitalism itself – is at risk.
As the world’s biggest bond investor, Gross is a long way from a bomb throwing Trotsykite
If you’d said people or markets can be irrational, you’d have been on safer ground, but what’s irrational about capitalism? More to the point: what is the more rational alternative?
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Funnily enough the rational traders on the stock market are the ones responsible for its randomness.
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They should pay the price of their greed and inhumanity. Not holding my breath though. People have been predicting the collapse of capitalism one way or another since Marx but it hasn’t happened yet.
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What’s exactly inhuman about being greedy? Greed is very human. I’m all for prosecuting white collar criminals and advocate the jailing of most of the US administration but I reckon this capitalists=evil bastards is so 1971. I mean we couldn’t have this conversation without bastards like Steve Jobs. And such bastards in a Soviet or feudal system would expend most of their energy kissing various arses.
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Marx’s predictions re capitalism were s’posed to come after the bourgeoisie ‘civilized the world’. Given that it’s only this year at some time that there’ll be more people living in cities than otherwise for the first time ever I’d say the much lauded reports of late-capitalism are very premature. And if one can envisage a future in which (the demonstrably more efficient) industrial democracy is the norm and most of us own shares (ie are both capitalists and workers) does that qualify as ‘capitalism’ the way Marx conceived it? Or perchance is some form of non-Statist socialism? Compulsory superannuation has various members of the Leftist commentariat actually defending the stock market in the light of the latest crash so perhaps I have a point.
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An innerestin’ et’ical question.
Markets can be rational even if the participants are irrational. The market is an expression of the mass hopes, fears and greed of millions of individual investors. And what we saw this week was an understandable response to uncertainty of the so far unquantifiable real economy repercussions of the credit crisis.
The problem isn’t the market so much. The problem is in products which do not trade on open markets. The synthetic CDOs were not priced in real-time markets, but according to the estimates of ratings agencies and their engineers. What is needed is better functioning, more informed markets. But you’ll never stop greed and fear.
well said Mr Denmore.
Fy….Mr Faarkit re:George Carlin BTW on arses being reamed, by “capitalists”…
http://www.youtube.com/watch?v=pUM9l-obnrw
George I suppose is doing OK but he too should perhaps “harden the fuck up” and not depress the plebs in the “land of the free” more than he has to.
Soros cops it because he was, is, and will always be a manipulative, hypocritical bag of shit.
In my opinion.
Mark @ 22
yes indeed a serious, timely and important question. I hope all Governments are thinking long and hard about it – we could hope that a ‘mini crisis’ might concentrate their minds and their advisors’ minds
BTW, I have a suspicion that the phrase “irrational exuberance” may have been an echo of Keynes’s “animal spirits”. Keynes pointed to the inveterate enthusiasm and optimism of some economic players; was Mr Greenspan hinting that while fuddy-duddies [such as he] might be too ‘rational’ to risk something to gain much, others were exuberant enough to keep he ball rolling by courageously risking some of their cash. [?? not sure - just guessing]
Which brings us back to the Mums & Dads, who should NOT take such risks, usually. Me grandpa said, “only take as many dollars to the reacetrack as you can afford to leave there.”