I always compare Wall St to Las Vegas, as both offer a very similar financial service, ie. gambling, except Wall St has two distinctions:
1. Wall St pretends it is not gambling when in fact it is. Actual return on investment for any stock or fund is completely non-deterministic, and therfore it is gambling.
2. Las Vegas casinos are more carefully regulated than Wall St banks. In Las Vegas the rules and the odds are clearly known, and standards are carefully enforced. Indeed casinos don't even need to cheat to be profitable, because the math of the already works in their favor.
So Wall St and Las vegas are the same, except Las Vegas is honest.
>Actual return on investment for any stock or fund is completely non-deterministic, and therfore it is gambling.
I could not disagree more. That is not a definition of gambling. Does that mean that investing in a large-cap index fund for a period of 40 years is gambling? What about putting your money in the trust of a bank? Even the bank's returns are non-deterministic. The government could collapse. Even keeping money in your house under the mattress includes risk (what if your house catches fire?). What method of saving or investing wealth would you say is deterministic?
A better measure of whether or not something is gambling is how much risk is associated with it. If I bought a US government bond, nobody would call that a gamble, because it's very unlikely that the the government will collapse. Similarly, if I bought a mutual fund comprised of a mixture of large, stable companies and various bonds, it is unlikely that it will go down in value over the long term. "Over the long term" is the key here. If the US economy has an overall downward trend for the next 40 years, then think about what that would mean. That government bond isn't looking too great, either, in that circumstance.
Anywhere you choose to put your money where the outcome is uncertain is gambling. Wall St's investment offerings have so many degrees of uncertainty the no one can assess their actual risk. Stocks like Enron and MCI Worldcom were sold as safe low risk investments for conservative go-long investors, and the astute analysts had no reason to suspect otherwise. At least in Las Vegas you walk up to a blackjack table knowing exactly the odds are the same no matter where you sit.
1) What actors and activities are you referring to exactly when you say "Wall St"? There are lots of players, and they have different roles. The performance of a given stock/fund is irrelevant to many players (exchanges, market makers, etc.) But yes, there are players that hold positions. You can call that gambling if you want, they definitely have risk, but all investments carry risk (even "risk-free" investments like government bonds). What exactly do you have a problem with? Vegas-style gambling is typically a zero sum game, with most of the money going to the house. Long term stock market investing generally yields a positive return.
2) The financial industry is also heavily regulated. I'm not sure why you're comparing Vegas and Wall St in this respect. You say that in Vegas "odds are clearly known", but this is not true in some common cases and it’s not clear what you’re getting at. What do you propose for Wall St in that respect? Odds can be published for games whose probabilities are known in advance (slots, roulette, etc.) But this is not true for things like sports betting and games of skill (poker, blackjack, etc.) No one knows what the “true” probability is that the Yankees will beat the Giants. What the casino will tell you is how much you need to wager to win a certain amount of money. You can infer an implied probability from that, but the same is true for prices in financial markets. If you look at prices of stocks, options, bonds, interest rates, etc. you can infer all sorts of information such as expected default rates, expected volatility of the price of a commodity, expected profitability of a company, etc.
When you say "casinos don't even need to cheat to be profitable" you seem to be implying that Wall St does. Exchanges charge transaction fees. Market makers earn a spread on their buys/sells. Brokers earn commissions. Banks earn the difference between the interest rates they charge vs. pay out. Can you explain why you think Wall St needs to cheat to be profitable?
> Actual return on investment for any stock or fund is completely non-deterministic, and therfore it is gambling.
Investors like Warren Buffett, Joel Greenblatt, and David Swensen have achieved well-above-market returns for decades using investment methodology they both practice and preach publicly. Are they just very lucky coinflippers? Paul Graham has no guaranteed return from his VC investments; is YC just a game to swindle pg, and startup investments no different from Vegas? Even when web startups and publicly traded companies can be analyzed similarly?
It's not just scale, if I understand things correctly. One problem is that a lot of state and city treasurers think that it's smart to take some of their tax revenue and hand it over to banks for investment, making them as vulnerable as normal citizens.
In theory, this is a good idea because that money gets loaned out to startups and homebuyers. In practice, well... crises and stuff. This is largely what I've gathered from my brief foray into understanding why a state bank is a good idea.
Wall St brokerages pretend they are not in the gambling business by presenting their offerings as something every resposible adult should be pruchasing to secure their financial future, and then only making passing obligatory mention of the risks in way down the fine print. In fact the general public has bought into the whole notion that not giving your entire retirement savings over to Wall St to manage for you is irrepsonsible on your part, and letting money sit in the bank and do nothing is irresponsible.
Yes, I agree, Wall St. is predatory and misleading. To think an investment does not have some associated risk is ignorant. But there are different levels of risk. I'm still going to argue that there are fairly secure ways to be involved in "Wall Street" investments, as long as one is diversified, attentive, and cautious. Giving your entire retirement savings over to Wall Street is definitely too much of a gamble for most people, but giving over some fraction of it is usually a good idea. We participate in this economy every day. Why not invest in it, as long as we are prudent and cautious? It grows over the long term, and has done so for the last several decades, or even centuries.
Now, that does not mean that the economy will continue to grow, and that is where the risk is involved. But I choose to believe that, over the long term, on average, the world economy will continue to increase in value. I also believe that personally owning very small portions of it will increase my own net worth.
I think that this is the kind of cronie-capitalism that Ayn Rand and her modern day followers attack. Their idea is that capitalism is good in a purer form where large inefficient businesses are simply allowed to fail.
In fact this is a major theme of "Atlas Shrugged," that the government supports weak businesses run by cronies of political leaders.
This wasn't government arranging favors for large, well-connected businesses. It was large, well-connected businesses arranging favors for each other, at the expense of everyone else. What's happening now is the government putting a stop to it.
You may believe that there's some alternative to government regulation that would prevent this sort of thing happening --- but to date, that's what's worked most effectively, and Rand & co. would take it away.
I think that Rand is an excellent writer and she does have interesting, if idealistic, ideas. That said I have not drank the Rand cool aid. For example, the idea of totally dismantling the EPA (current republican political plank) grosses me out. Also, one of the few valid functions of government is to enforce a small set of laws. Remember that 50K new government regulations were created in 8 years of W. Bush and I am confident that it will be as bad at the end of the Obama administration. There really are no absolutes: different philosophies all have their own strengths and weaknesses, but in different ratios :-)
I certainly agree with you that this is a long term trend but in my lifetime (I am 60) it seems to have become much worse in the last couple of decades.
I try to take Rand with a grain of salt, but do find myself associating to her work more and more these days.
This LIBOR scandal feels like a rather typical case. We set up stupid crooked rules, incentivize people to break them and appoint regulators to prevent the same. And when this mess blows up we blame it on "capitalism" and say we need more regulation.
I think the limits of financial and regulatory "architecture" are similar to those of software architecture; there's a tradeoff between the desired properties of a system and its complexity - and your complexity budget is not infinite. You cannot have every combination of desirable properties you can dream up. There will be combinations that are too expensive. The example here is that we want a reference rate called "LIBOR" that is set by the market, but that is defined for every point in time. That's just not possible, because markets can freeze up. When there are no transactions there is no market rate. Either we accept that or we go down the road of increasing complexity, "panels of banks" emulating a market, the inevitable failures, more regulations and complexity in a never ending downward spiral... At least that's my feeling. :)
The solution is close to hand and it does not involve regulation--at least the kind that regulators want. The solution is transparency. Just make all the big banks report their actual transaction on a live feed. This simple solution would have been infeasible even 20 years ago, but not any more.
The implications would be enormous. No more need for accounting reports, indexes or anything else that requires a judgement call by a corruptible human. The job of watching the banks would pass from the power hungry (or worse, sleepy) regulators to the public (you and me).
Once upon a time I performed the risk mgmt. function for a portion of a large bank. We used a couple of servers running every night to track a few thousand positions. The system knew every detail of about 95% of the positions. Today a team of 50 could track the entire banking system--given the right feed. Make the same information I used public and open to competing teams of analysts and then risk becomes a known quantity.
Of course, banks and regulators would be strongly opposed to this approach. They will howl about privacy, proprietary information etc. But the fact is when you ask a bank for a loan, they know all of your relevant financial information in order to judge your risk. It's only fair for the taxpayers to turn the tables and end our old-fashioned and broken system of disclosure. And if the risky part of banking is driven into a part of the industry that doesn't share information, then their investors should do without a safety net.
It certainly would if only one bank did it. However such a rule would have to be evenly applied. My belief is that this would drive down volatility in markets since it would end the game of "Old Maid" in a crisis. Depending on how many institutions were under this rule, trading volumes may decrease, although I could argue this the other way as well.
In Case you want an idea of how LIBOR rates looked to people in the industry while this was going on -
"Frankly, anyone with a Bloomberg terminal in 2008 would have been in on this, as one could see that the rates various banks had submitted did not reflect where they could fund. Deals were getting torn apart all over the place because no one could ramp up funding at a decent rate, despite what those screens said."
.....
"But it was just accepted. A great number of people didn’t even clock that there was a whistle to blow. Why might that be? We’d posit it’s because they didn’t even perceive what was going on to be wrong, and that it probably has a lot to do with social conformity (within the sphere of banking)."
I feel that a lot of the blame heaped upon the finance industry is unnecessarily antagonistic (and personal).
The problem, at the core, appears to be one of misaligned incentives meeting societal level trust.
Do you blame the fox for eating your chickens, when you yourself placed him in the coop, to protect them from marauding wolves? Or should you blame yourself for foolishly trusting a fox with your chickens?
It is all well and good to blame the "evil" finance guys for all your problems. But it is much too simple a solution.
We, as a society, have given these people the power to do such damage at such scale to incredibly important societal systems. We must design our systems such that we never entrust anyone with the ability to manipulate public common systems (markets/government). This is because no matter how "noble" people say they are (they may be sincere!) - abuse will inevitably become rampant - it is human nature. This is also why communism/Marxism and libertarianism can't work in reality.
> Power corrupts. Absolute power corrupts absolutely.
We need to stop trusting people - period. This is why, at least in the US, we have 3 branches of government, so that each one will check the other out of self-interest and balance possible abuse/corruption (not perfect - but pretty darn good!).
An easy fix would be to require all big traders in any market to not have a sell-side department at all - the Chinese Wall in financial institutions is a complete farce (as a cynic once told me: If it can be exploited - it will be exploited).
Other examples would be to have all trades rate limited that they can't lock up the market at any one point in time - similar to DDOS measures used by websites (click too many times and you just gotta wait). You shouldn't be able to dump a $4 billion short position on the futures market over just one second, let alone over an hour. You must rate limit entry and exit of trades so that we can smooth market dislocations and reduce the thundering herd problem found in extreme volatility.
Disagree pretty strongly with the first few paragraphs here. The vast majority of U.S. and U.K. citizens had jack-all to do with putting the fox in the henhouse; financial regulators are appointed, not elected.
But I agree with a large part of what you're saying. This is, in many ways, a systems problem and not a people problem. Even if it's a people problem at the local level, it's a systems problem at the macroscopic/scale level -- and so it's much more effective to work at the systems level than at the people level.
That's what our regulations attempt to do: put in place systems, checks, and balances, that will prevent bad behavior via incentive structures and pure mechanics. Unfortunately, some of the key systems and stopgaps in place have been vastly eroded in recent years. And I'm not even talking about Glass-Steagall. I'm not even talking about the blatant failures in oversight that allowed the banks to grow as large, as consolidated, as vertically and horizontally integrated, and as systemically important to the economy as they are ("too big to fail"). I'm talking about things like the Citizens United decision, which will only exacerbate these problems in the long run by allowing money to completely influence our political system.
It isn't the U.S. taxpayer who put the fox in charge of the henhouse. It's the fox who purchased the henhouse. That shouldn't be allowed to happen. Instead of playing a game of constant one-upmanship with financial regulations, forever trying to outwit the "financial hackers," we should start by drawing clearer divides between money and politics.
Of course it isn't the common man I'm blaming - he has enough trouble paying the damn electricity bill!
This is not the fault of the common man.
This is the problem of intelligent people doing stupid things for selfish reasons. We (meaning those who understand these systems) must fight and convince the common man that regulation IS good IF the situation calls for it.
People think regulation is bad and capitalism is good. We should convince them that both are great GIVEN the correct situation. I love capitalism - I also love having my electricity stay on and stable (remember Enron energy trading in Northern California people? - dark times (pun intended!).
I merely state that regulation has a PR problem and that the people who have the ability to change that, should.
Somewhere in the last 30 years, to your point, the American people were sold the idea that regulation is the diametric opposite of "freedom," that trust-busting is "socialist," and other such nonsense. We need a modern-day Teddy Roosevelt, who can articulate in capitalist terms the importance of regulation and antitrust activity as vitally important to the health of the competitive, free market.
Fact is, the market should have punished the malfeasors in the 2007 financial crash, as it should be punishing the malfeasors in the Libor scandal. Shareholders should be abandoning these banks, and the banks' access to capital should be severely restricted by sheer virtue of nobody's willingness to lend to them (or to lend to them at typical rates). But that couldn't happen in 2007, because, Lehman Bros aside, everyone got propped up, dusted off, and given a fresh coat of paint via taxpayer dollars. Because the banks were "too big to fail," and not bailing them out would have been catastrophic. Because nobody had ever stopped them from growing so big, and so systemically integrated, in the first place.
The failsafes that should have prevented banks from being so directly tied to the macroeconomies of nations were not in place, and are still not in place. There is literally nothing in place right now that will prevent anything about the 2007 crisis from occurring again, and that is deeply troubling.
> Fact is, the market should have punished the malfeasors in the 2007 financial crash, as it should be punishing the malfeasors in the Libor scandal.
Yes, it should have, but the regulators didn't want that to happen.
However, you're missing a very important part of the story. Regulators were part of the problem leading up to these disasters.
In the LIBOR case, UK regulators knew about the rigging and tacitly encouraged it because they thought that the rigging stabilized the market. (US regulators knew about and accepted said rigging.) That's understandable - many of you want them to stabilize the market and the rigging probably did have that effect. However, if you're looking for an honest market....
Things are even worse wrt the 2007 problems. Regulators were in that up to their eyeballs on both the mortgage and securities sides. (In fact, securitization was encouraged by regulators.) Fannie and Freddie were especially bad because they reported bogus stats that threw off everyone's risk analysis.
Until we start punishing regulators and the politicians who push these policies....
Punishing regulators? Sure. What about punishing the people who snuck it by the regulators?
I absolutely cannot stand the libertarian line on this. For decades, it was all "don't regulate the banking sector, you're hurting freedom, they should have the ability to combine investment and consumer banking, don't regulate them", and then when they fuck up the economy?
"Oh, you should have let them fail. That would have been free market."
Great, that's a lot of help. We should've let your ideology destroy the modern economy. You know how much it burned non-libertarians to have to bail those banks out, after listening to all this crap from you guys for decades about how deregulation was the way to go? But we still supported it, because we're adults, and didn't want to flush the economy down the toilet.
So here we are in 2012. Still hearing that the banks shouldn't be regulated. They're the "free market". Sure.
> What about punishing the people who snuck it by the regulators?
You're missing my point - "they" didn't sneak anything by regulators. Regulators (and policy makers) wanted "the market" to do certain things. Those things blew up.
For example, "real" LIBOR values would have spooked the market during 2007 and probably caused the collapse of various banks. What should a regulator tasked with stability do in that circumstance?
Add in the fact that many regulators (and policy makers) are, in fact, tools of the folks they're supposedly regulating, and regulation can't do what you want it to do, especially if you're unwilling to punish regulators and policy makers.
> We should've let your ideology destroy the modern economy.
Now you're just babbling.
Either you want stability, which will require things like the LIBOR "fraud". or you're going to have to let banks fail. You can't have no failures and no fraud. (You can have both fraud and failures.)
As to "too big to fail", surely the same applies to govts as well. After all, regulation is, by definition, systemic risk. If everyone plays by the same rules, you've got a problem when those rules don't work....
> all this crap from you guys for decades about how deregulation was the way to go
The problems didn't come from deregulation. (Besides, there actually wasn't significant deregulation, apart from the repeal of Glass-steagal, which actually helped a great deal during the crisis.)
The problems came from govts "encouraging" (and subsidizing) bad economics to accomplish social goals. They got out of hand in part because GSEs lied.
Opposing fraud and for the "free market" (aka laissez faire) are mutually exclusive. Just wishful thinking.
On open market requires regulation. For instance, we need contract law, transparency, fair and impartial court system, for the market to work efficiently and effectively.
Are you saying that, for practical reasons, fraud cannot be effectively punished without more regulation than most libertarians would support? This is a coherent claim that may or may not be valid, but I would be interested to hear support of it rather than simple assertion.
On the other hand, if you are asserting that most libertarians oppose a court system in which people can (at least in principle) be tried and convicted when they commit fraud, then I think you are incorrect in your assessment of the position of most libertarians. Even anarcho-capitalists (per the wikipedia article) seem to view fraud as something that can be responded to with force - they just don't want it to be a "government" that does so.
That depends on which "libertarian utopia" you're talking about.
The American Libertarian Party would probably say that the court system is paid for by government revenues from taxes and tariffs like the Constitution says.
Anarcho-capitalists would say that it's paid for by whatever revenue stream Courts, Inc[1] develops; they wouldn't presume to enforce a single business model, you see (I assume).
In the case of "left libertarian" thought, it again depends on the particular society envisioned - I don't really have enough understanding of the various models to give a clear answer, but most left libertarian utopias are even further from our modern situation than the right libertarian ones. Of course, most wouldn't have the financial infrastructure at the heart of this particular case anyway.
This is not to say that I have any high degree of confidence that any of the models discussed or glossed over above would actually work (well or at all), but disagreement does not sanction misrepresentation.
[1] Although I think some of them are opposed to limited liability, so it might or might not be "Incorporated"...
The regulators, themselves are also bankers. Or have strong tires to bankers. Kind of hard to ask the SEC (for example) to come down hard on say, Goldman, when most of the executive staff at the SEC worked and have their own positions at Goldman.
(I'm only using Goldman as a example).
But the opposite is also true. The best regulator is a experienced regulator. And you get that experience by working in the field.
A better approach is punishment. Look I used to trade (on the CMO floor at Kidder), and the more important thing is not to lose money. If traders (actually everyone in banking) don't lose money nothing changes. I mean, why ruin a good thing, right? Just that simple.
It used to be easier, because before 1999 investment banks were a sort of a partnership - if you lost money the firm lost money. Now so these days. Why even care? Traders take such stupid risks cause it's not their money. And now, we all know, they don't even face any sort of punishment. In fact, most of the banks MADE money, in the form of TARP (and cheap loans from the Fed).
And now we have Libor. No trader has gone to jail. No executive has gone to jail (and I doubt anyone will). The bank (in this case Barclays) might have to pay a fine, which is peanuts compare to their profits.
So what's the message? Steal, loot, lie. And until people are made to pay, personally, it will remain so.
> In fact, most of the banks MADE money, in the form of TARP (and cheap loans from the Fed).
Claiming the banks made money off of TARP is like claiming I made $600k last year because I took out a mortgage. TARP provided loans to banks that were paid back with interest.
Actually up front you are correct. BUT the banks also used those loans (which by the way, were granted with VERY favorable terms at VERY low rates) to pay bills due to other banks
Take AIG for example.. Banks made billions on payouts from AIG. Where did the money for those payouts come from? Us. The American taxpayer. So not only did the banks get their bad debts marginalized (at our expense. example: look at the sale of Bear Stearns to JP. Who assumed most of Bears' junk debt in that deal.. that's right, the tax payer.); they also got cheap cash at cheap rates; and all the inter-banks fees were paid.
In other words, the whole mess was a giant shell game. I have no doubt that some bankers knew exactly what they were doing during the whole mess. They played the Fed, Treasury and us.
And the got away with it. And they will again.
Make no mistake, the game is rigged. And not in your (the masses) favor.
Until we start punishing regulators and the politicians who push these policies...
Hate the game, not the players.
The correct answer is, and has been, to have a balance of powers. The forging of the US Constitution has been described as an "orgy of mistrust". Having mutual antagonists playing off each others, preferably in a three way fight, is the best medicine devised thus far.
> Because the banks were "too big to fail," and not bailing them out would have been catastrophic. Because nobody had ever stopped them from growing so big, and so systemically integrated, in the first place.
If these banks are too big to fail (and thus shouldn't exist), what does that imply about large state govts (such as CA) and the US federal govt?
Note that regulation is, by definition, systemic risk.
"This is the problem of intelligent people doing stupid things for selfish reasons."
I'm gonna disagree. What these people are doing is very much the smart thing to do. They make huge, I mean HUGE amounts of money by doing just these sort of things, and yet what was the risk for them? Even those people who are directly implicated by this scandal will probably just have to pay some fines, or maybe even be forced to resign! Dear god how will they survive? Oh that's right, they'll survive off their massive net worth that they stole.
I personally support a minimum sentence of life in prison. Not because I hate them or anything, no, it's a matter, as everyone says, of incentives. In any other crime the magnitude affects the sentencing, and these guys colluded and stole money in the billions, maybe trillions of dollars. If they don't all end up in prison, what does that say to any future banker criminals? It says: steal as much as you want, because even if you get caught there's really nothing we can do about it.
I'm going to pull the following statement out of my ass, but I'm willing to bet it's probably true:
"There are already laws punishing theft and fraud in America."
The law doesn't apply to everyone in the same way. Making a new severe law to punish Wallstreet crime sounds exactly like the kind of thing that will have no lasting effect. These bankers pay our politicians, inject themselves into regulatory bodies, lobby for lower oversight/more exemptions, they know how to get around this stuff.
This problem needs to be tackled on an infrastructural level.
We need some basic state-owned utility banks in America, that'd be a start, something like they've got over in Germany:
If it is a problem of intelligent people doing stupid and selfish things then it seems to me that blame on them ought to be antagonistic and personal. Necessarily so.
I pretty much agree with everything you wrote except that your original comment seemed to suggest a view that the finance industry are unwilling conspirators. In my opinion they deserve vilification.
In one sense you are very right, on the other I think this is a very wrong way of thinking of these things.
At some point liberal economics-philosophy became very uncomfortable with the whole concept of ethics, norms, conventions and such. Slightly ironic as Smith was (IMO) a moral philosopher primarily (eg "The Theory of Moral Sentiments") with "economics" being a supplementary way of understanding right & wrong.
When you view the word entirely from an economics/incentives/meta-institutions I think you are giving up on some things that are extremely important. Societal norms, shame, morality: these are a natural and integral part of how human society works. Laws and regulations are important too, but one cannot replace the other. There is a problem with diffusion of responsibility combined with corporate mandates and institutional mentality eroding how people behave.
Taking the cold incentives view, you look at employment for example as an agreement fully captured in a contract with no further responsibilities on either side. It's negotiated based on market prices. That's true in one sense, but looking at employment that way does not capture a lot of crucial nuances. Treating it that way is not a natural way for humans to interact and will not achieve the best results, psychologically or economically. You need employees to be intrinsically motivated, believe in the company, belong, be obligated. They expect respect and care and empathy and responsibility from the employers. This is very basic and it plugs into parts of human behavior that are older than money and older than humans as a species.
Its hard to capture in an equation or a model. It's even hard to capture in a "theory" of psychology, sociology, history or whatever. So, there's a tendency by people trying to understand things to ignore these crucial elements. That's absurd. A society from a household to a company to a country cannot function based on individuals narrowly and coldly following their self interests (even though you can prove that they do).
More importantly, no "law" can work if the only reason anyone follows it is fear of punishment.
Very well put. And, as hard as it is to capture all those nuances in an equation or a model, the biggest problem is that there are too many theorists, and common people, believing that the "real market" is the one that comes out of the theory - with its completely unrealistic homo economicus - and not the real markets, those which develop in the real world and are so much more complicated, non linear, and working on human reactions.
A theory can be useful in dealing with complex situations. But believing that the theory can become the reality is the same mistake that marxists made.
Homo economicus is real. Economics is useful and its really important (though imperfect) way f understanding the complex interactions between people all over the world.
The problem is that we are not homo economicus. We are Homo Sapiens. Europeans & Mexicans & Italians and Londoners. Some of us are even Americans. We are also brothers and lovers and criminals and parents.
Homo Economicus is a a description of a certain set of homo sapiens character traits.
@netcan allow me to disagree. People make part of their choices partially basing them on rational reasoning (and, even for that part, mostly based on incomplete data and often faulty logic). But just check what works in marketing and you'll see how limited that rationality really is.
I mean "exists" in a pretty weak sense. If you present people with complex economic choices, they make rational choices and maximise their economic utility. IE if they are using second hand computers running hacked up linux to play movies on their TV and a good, cheap alternative presents at a lower price, most will eventually switch to that.
Describing them as such allows us to predict their behaviour.
And yet, if you're interested in studying these "moral effects" rigorously, you'll attempt to model them mathematically. Not necessarily with from-first-principles equations -- sometimes the big data / machine learning approach is best. Plenty of (most? all?) economists understand the need to model human irrationality in order to properly predict economic behavior, but if you ask me the solution is not to somehow adopt a less rigorous humanities approach to economics, like you seem to be implying.
I'm not purely incentive (that would be much too simple :).
We must use any and all tools at our disposal to ensure the correct working order of valuable systems - such as finance (proper allocation of capital to risk is a great thing!).
Exploiting human desire, psychology, biases, irrationality and behaviour to create robust systems is a great idea! The are just some of the many tools that we have at our disposal to protect ourselves from abuse by "nasty" agents. This then allows us to move forward towards a more prosperous, robust and stable society in the future.
What I don't like is treating the symptoms (these financial hackers if you will :), instead of the cause (improperly checks and balances at centres of power).
Bring on the shame and the like - I'm all for it. But we should at the very least focus on fixing the causes (exploits in the system) rather than the hackers that exploit them (just like in security research).
I'm sorry if It sounds like I was straw-manning you. I was replying to the general approach and I guess that is a straw man.
BTW, I often take a similar opinion to the one you iterated. You can probably see in the comment, I'm on the fence. I agree that yelling about ethics is very silly and won't change a system. Changing rules and working with incentives is the way that we, as societies, run by institutions can fix things.
On the other hand the mentality we are cultivating (in ourselves) by thinking this way is nihilistic and (poignantly) silly.
Anyway, if we are examining institutions, the corporation might be one to put under the glass. While corporations are an innovation (in law of all things!) that has created incredible wealth, it's also pathological. At least it generates pathologies in people. It narrows a company (group of people)'s duties to investor profits. That's not normal for humans. Humans are made to balance a wide set of "interests" and understand them intuitively. I don't mean to imply that signing a piece of paper suddenly makes a business pathological but internalizing the implied mentality does. That's happening on a global level.
The problem with having a no-trust rules-only society is it would be terribly inefficient and things would grind to a halt. Every day you take actions and make decisions that rely on trusting others. In general people do not steal and cheat at every opportunity, and treating the world that way would be counter-productive. Taking the argument to the extreme, if you trust no one, you must have no expectations of any privacy as that is the only way to really be sure that people aren't acting differently than you would like them to. If everyone else is being watched you better believe you will also be watched. The cost of this regulation and surveillance would be obscene and the pace of progress would grind to a halt.
I think the reaction here is appropriate. There are laws that were broken. This is not scapegoating, it is punishing behaviour as should be expected. Yes reforms may be needed, and they should certainly be considered and I am sure they will be, but punishing those who knowingly broke the law and abused power for personal gain cannot be considered scapegoating, or punishment of any criminal activity must be considered scapegoating as it means society simply gave them too much power and trusted them too much to allow that activity to happen.
Note I didn't say no trust. I merely said watch incentives and balance of power.
I also didn't say every decision.
It's a balance. You have drivers licenses to ensure a standard of safety and trust - but after that you leave people alone (risky if driver's do bad things). It's a tradeoff.
However in this case, society has seen it fit to give a few individuals too much power, without placing the correct checks and balances upon them. This creates a situation that allows "nasty" agents to exploit it for their own benefit.
Don't blame the hackers. Blame the system designer (a security researcher told me this).
You must assume, upon creation of a system, untrusted and "nasty" agents and deal with them (at some cost). This is how cryptographers and security researchers work to ensure our safety. Maybe we should get them to look into this problematic mess (they love finding flaws in systems :D).
It's easy to blame Hitler for the Holocaust (which was a despicably evil thing). But you must also consider how one could've stopped a situation from developing such that an artist drop out could end up seizing control of an industrial powerhouse.
If you say don't blame only the hackers, I agree. But the hackers that - knowingly and selfishly - violated the law must be punished, not given a free pass because it was the fault of the system.
Then you should also improve the system; the two things aren't mutually exclusive.
Ah but you see here is the kicker (and I totally understand your point).
When designing systems you must severely reduce the ability of "nasty" agents to take advantage and exploit you for personal gain.
We should also enforce standardized punishment for those that successfully exploit the system.
LIBOR left the gate wide open! That's 10x more important than punishing any one person that just walked in (and they should be punished - I don't disagree). But focusing on the people is the wrong mental attitude to adopt.
I keep hearing things like "So and So has $100 million dollar salary and he should be punished for bringing the house down". I really want to hear things like - "Who the bloody hell let this happen in the first place?".
That's all I'm saying. Punish hackers all you want but if you want true robustness you must rectify the exploits present in the system.
Ok, agreed that fixing the system (which isn't itself an easy thing) is more important. But punishing the perpetrators of the actual crimes isn't only important for this single problem; it is also very important as both an example for others that could be tempted, and an encouragement to honest people. The OP was against the justifications that are put forward to somehow save those people, not against also changing the system.
"I feel that a lot of the blame heaped upon the finance industry is unnecessarily antagonistic (and personal)."
This is clearly a response to the defensive, entitled, and holier-than-thou attitude the financial industry had in the wake of the 2008 crisis, not to mention the lack of consequences to finance directors or serious financial reform. They closed ranks, hard, which by necessity elevates the level of the attacks against them, which therefore seems antagonistic.
Tried talking to a banker about this stuff in 2009? Impossible to have a discussion not rife with blame-shifting.
I agree that social systems should be designed to minimize the amount of damage corrupt individuals can do. But that doesn't mean we shouldn't blame the corrupt individuals for their behavior. The author mentions regulatory capture and specifically refutes it as a defense for bad behavior. I also don't think it is possible to build a complex social system that doesn't rely on trust. I suggest reading "Liars and Outliers" (http://www.schneier.com/book-lo.html) if you're interested in this stuff. I enjoyed it a great deal.
This is because no matter how "noble" people say they are (they may be sincere!) - abuse will inevitably become rampant - it is human nature.
We have this thing called "prison" which is supposed to curb those abusive tendencies when they get out of hand. We seem to be underutilizing this resource in our handling of financial fraud.
Of course it's a systemic problem. But individuals are components of that system. If you don't punish people who engage in fraud, you remove a valuable disincentive against fraud. So while the system as a whole needs to be reformed, making individuals take personal responsibility for wrongdoing is part of that.
We didn't let the foxes in the hen house, the hens asked and got more freedom to manage the coop. They invited hens and animals from other farms over used them to run an abbatoir. Our imagination can't believe it, so we talk of foxes.
I agree with most of your points, except that the umbrage directed at the Fin industry is too personal or heated.
I think most people who are intelligent, can't fathom the level of the atrocity being committed here.
For Libor, they are being accused of flat out fraud. Fraud so utterly blatant that it was normal for the industry.
And Barclays is one of the 'good banks' - its getting off of on good behavior.
This is just rapacious greed, fraud, and abuse at a scale that the word definitions come across as weak.
> We need to stop trusting people - period. This is why, at least in the US, we have 3 branches of government, so that each one will check the other out of self-interest and balance possible abuse/corruption (not perfect - but pretty darn good!).
I think you have the right intuition, but you don't go far enough. The root problem in finance is that people have turned over to government the power to control money. There is too much trust in government officials and in the banks that fund them.
Government's ability to control money has resulted in fiat money that is constantly being devalued, encouraging people to make risky investments and to take on debt. This has been very profitable for government, which has ready access to low-cost funding. Fiat money has also been very profitable for banks, which through the "magic" of fractional-reserve banking, have been able to loan with interest money they can simply create.
The solution is to take away the power to control money from government. Let people decide what they will use as money and they will choose money that maintains its value. They will also invest in institutions that do not use fractional-reserves and other risky schemes and thus are not subject to bank-runs.
A US politician that is talking about real reform is Ron Paul. The bill that would allow currency competition is The Free Competition in Currency Act. It's about one page long. http://www.govtrack.us/congress/bills/112/hr1098/text
Give people the freedom to choose their money, let them choose to invest it in the institutions of their choice, and problems like the Libor scandal will stop being so important. The people who committed fraud will be prosecuted. Damages will be paid. Reputations will be damaged. People will choose to bank elsewhere. No problem.
By trusting government to control money, fraud in the few institutions favored with a bank charter becomes a very important issue. It doesn't have to be.
Indeed... We need to go back to feudalism where we can sell our hacking skills in exchange for slavery to our VCs for 8 years. After the 8 year mark we can finally start drawing a salary instead of just getting room and board and catered lunches.
The reason for fiat money is to allow for venture capital and allow new people (immigrants, new births) room in the economy. Granted what has gone in recent times clearly gives certain people more leverage and ability to escape punishment when they play outside the rules. Something should be done about that, but going back in time to feudalism isn't going to solve the problem.
Surplus wealth, not fiat money, is necessary for investment. Investment is just surplus wealth that is spent to increase future production rather than for the present. This surplus wealth can be invested by the people through their voluntary savings, or can be extracted by deceit and force with fiat money. Deceit because people don't realize that they can buy less than they produce because their money is worth less. And force because people are forced by legal tender laws to use and accept debasable money.
Ok James Madison, but we have 200 years of economic data and reasons for the fiat money. You're hand waving and claiming that it's an evil without acknowledging that it solves some pretty fundamental problems. People aren't poor now because their vast wealth has been decimated by inflation. It's because we are doing more with less and commoditizing the types of work they were doing.
> People aren't poor now because their vast wealth has been decimated by inflation. It's because we are doing more with less and commoditizing the types of work they were doing.
Efficiency in production makes society as a whole richer, not poorer. For example, programming computers to drive cars will ultimately enable a lot of taxicab drivers to do other things to help society that they couldn't do before because they were busy driving. When self-driving cars become widespread, society will benefit because it will have the same benefits of transportation that the taxicab drivers used to provide as well as the new goods and services the former drivers are now providing. The fallacy that machinery reduces wealth and employment is debunked in longer form by Henry Hazlitt in Economics in One Lesson. See http://www.fee.org/library/books/economics-in-one-lesson/#0.....
That's great but go to the rural south where people are dirt fucking poor. Average is an inane statistic by itself--just because in aggregate we are richer because we can afford a $200 meal in Nor Cal doesn't mean that wouldn't be a boon to feed a family at the bottom elsewhere.
I keep thinking that it really is this simple. All the problems of recent years are problems of scale. In a world of thousands of banks landing to each other in a big market, you can simply measure the rates instead of trusting a handful to come up with LIBOR. In a world with thousands of banks, a handful would have gone under from bad exposure to real estate volatility and spooked the rest into being more conservative, instead we had to wait for Lehman to fail to realize how bad things were.
There's no social or economic value to the BofA & Chase-sized monsters that I can see. Just chop them up and put an incentive in place (extra tax beyond a certain revenue, say) that encourages them to spin off more banks.
I see it pretty much the same way. All of the talk is just putting too fine a point on it. The benefit to society for having banks so large is negligible compared to the costs.
> The notional size of the derivatives involved is on the order of $360 trillion.
Total worldwide wealth is estimated at only $200 trillion. These derivatives are not serving their useful function as a hedge and are instead being widely used for speculation.
I don't think the problem is with the financial industry. The issue is most definitely with the financial/political system. We haven't run true capitalism in the Western nations for decades. It has been a hodge-podge of crony capitalism mixed with token dribs of 'social democracy' championed by wealthy political elites that no more understand the life of eg a bus driver than a tea leaf understands the history of the East India Company.
Take the Libor scandal. Would this have happened if the banks had not been repeatedly bailed out - 'too big to fail' - giving traders the impression that they worked in a politically-sanctioned realm where the normal rules of capital did not apply? There is no danger of your company going bankrupt through loss of reputation or massive, penal fines for criminal behaviour if you have an unconditional sovereign back stop.
Exactly. Take entrepreneurship: the founder is rewarded financially if he/she succeeds but is punished financially if he/she fails. The banks, on the other hand, were rewarded financially when they made money for their clients (in the form of performance bonuses), but were bailed out when they failed to carry out their job successfully. This asymmetry is antithetical to capitalism.
I like how Nassim Taleb put it: "the incentive system put in place by financial companies has produced the worst possible economic system mankind can imagine: capitalism for the profits and socialism for the losses."
One should also beware the insurance industry - it has essentially the same incentive structure.
Sell cheap insurance while times are good - take profit/options/stocks and leave.
When a catastrophe happens - go bankrupt and allow the government/people to socialize the losses for improper risk management. They also take advantage of socialized protection such as national defence, fire-fighters, police officers and ambulance drivers. They don't have to pay for them in proportion to the reward they receive for their services (society pays for them). Hence their risk is mitigated by society whilst privately profiting from our shared risk.
Insurance is a great thing (no doubt about it!) - but these moral hazards exist in many systems around the world and they must be addressed.
This is also why insurance is so highly regulated - the ability for financial impropriety and abuse is just too damn high!
From the case data - the scam was going on from 2005 - at least. Thats way before Too Big to Fail, and even before the domino of the Mortgage Market fell.
What would have happened if they weren't bailed out can be answered - They would act the same way they were already acting.
The problem is with the financial industry. I promise you.
Heck, its not incentives, they just don't give a shit. Really. At one point someone was designing CDOs to explode, so that they could take the insurance money. Except that once financial jargon is applied to this, it stops being fraud and its starts being "caveat emptor".
EdIT: The creator of above trade would also be held in high esteem by his peers for its elegance. After reading what keeps coming out the industry at this moment, going to the forums, working with people in it, I have no doubt that they aren't evil by individuals, but irredeemable in aggregate.
Here - Information is power and what not: Annotated guide by the NYT covering the Order Instituting Proceedings. One of the first few links in the Parent article
1. Wall St pretends it is not gambling when in fact it is. Actual return on investment for any stock or fund is completely non-deterministic, and therfore it is gambling.
2. Las Vegas casinos are more carefully regulated than Wall St banks. In Las Vegas the rules and the odds are clearly known, and standards are carefully enforced. Indeed casinos don't even need to cheat to be profitable, because the math of the already works in their favor.
So Wall St and Las vegas are the same, except Las Vegas is honest.