Tag Archives: Great Recession

Book review: Diatribe, by Amer Chaudri

Diatribe, by Amer ChaudriIf nothing else, the Great Recession has worked wonders for the publishing industry. One can find virtually any perspective on the crisis — the big banks caused it, Bush’s policies facilitated it, Obama’s aggravated it, and so on — and, accompanying each viewpoint, a plethora of books devoted to its promulgation.

Amer Chaudri, a longtime employee of Citibank, falls into the big-bad-banks camp. His book, Diatribe: A Scathing Journey into the Heart of the Financial Corporate Culture (and Related Digressions), represents a Main Street stab at understanding Wall Street profligacy.

I’ve read several books and countless articles, over the past year or two, on the financial meltdown of 2007-2008. Some do a better job than others of navigating the complex world of derivatives trading, regulatory negligence, and underlying psychological factors. In Chaudri’s case, storytelling emerges as his vehicle of choice for the castigation of an industry. Continue reading Book review: Diatribe, by Amer Chaudri

#50: Animal Spirits

How did John Maynard Keynes know I’m not rational? Or at least, not always rational. According to authors George A. Akerlof and Robert J. Shiller, this is one key precept that vanished somewhere along the line from its initial expression by Keynes to the onset of the Great Recession seventy years later. The duo’s book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, is a concise attempt at its revival.

It is now nearly a foregone conclusion that humans act rationally as pertaining to economic decisions. So in the aggregate, the macro-economy will reflect thousands and millions of minor judgment calls that, taken together, constitute the long-sought-after equilibrium. The problem with this theory (even if this never seemed to bother its creator, Milton Friedman) is in its idealism. Are human beings rational? To an extent, yes. At other times, “people really are human, that is, possessed of all-too-human animal spirits,” the authors write.

What are these animal spirits, and what do they do? The definition given here is “the thought patterns that animate people’s ideas and feelings.” This sounds suitably vague, which is precisely the point. In the rush to transform economics into a science, overweening economists threw the baby out with the bathwater, discarding the very real enigma of human behavior along with the failed economic theories of prior eras. Akerlof, the 2001 Nobel Prize-winner in economics, and Shiller want nothing more than to reintroduce these animal spirits to the field of economics and the public at large.

But first, a re-branding. What was then “animal spirits” is now studied as “behavioral economics.” The authors propose five psychological aspects of this discipline: confidence, fairness, corruption and bad faith, money illusion, and stories. Each of these plays a unique role within the macro-economy, but not always intuitively. Money illusion, for example, describes what takes place when wage cuts are instituted following a deflationary trend. Even when the decrease in pay is commensurate with the drop in prices, employees usually feel cheated. A perfectly rational decision by an employer thus becomes an object lesson in the existence of money illusion (and influences the employees’ perception of relative fairness as well).

This flies in the face of classical economics, in which humans are presumed to be supremely rational. (That such theories persist alongside the ongoing public fascination with the likes of Paris Hilton or, say, the British royal family is its own nifty testament to the inscrutability of the human mind.) So Akerlof and Shiller dutifully document the effects of each of their five factors before launching into eight key questions whose answers only make sense in light of the findings of behavioral economics.

This is an enlightening book, and one made all the more pleasant for its conspicuous lack of angry demagoguery. On a spectrum of bitterness from Joseph Stiglitz to Paul Krugman, the authors of Animal Spirits are clearly more aligned with the former. This is an unexpected reprieve, which understandably lends additional gravitas to their cause. Their case can be summarized thusly: don’t buy too literally into the cult of the “invisible hand.” Markets do fail, which is precisely why government regulation (and occasional intervention) is necessary. Of course, with the benefit of hindsight since Animal Spirits was published, it appears their advice — like that of Stiglitz, Krugman, et al — has gone largely unheeded. What comes next is anyone’s guess.

#18: The Big Short

In describing the behavior of Wall Street bankers prior to the financial crisis, many adjectives have been bandied about. Greedy, say some; arrogant, claim others. What is only now beginning to gain ground on these populist declarations of discontent is a third, and far more horrifying, descriptor: stupid. This trait may at first seem less offensive to those of us who flaunt our self-prescribed moral superiority over these perceived miscreants. The reality, however, is anything but comforting. In The Big Short: Inside the Doomsday Machine, Michael Lewis, author of Moneyball and Liar’s Poker, dabbles in the thriller genre, often to hilarious effect, as he details the inner workings of a financial world that was truly ill-prepared for its inevitable Waterloo.

I’ll admit it: The Big Short is a very, very entertaining book. Mine is an admission whose sheepishness can only be understood once one has finished reading the book. It reads like a John Grisham novel, yet John Maynard Keynes is a far likelier neighbor on a library shelf. Lewis is profligate in his use of such terms as “big Wall Street firms” (32 occurrences, according to Google Books) and he is wont to transcribe entire conversations whose accuracy is often questionable but whose content leaves the reader in stitches.

Ultimately, it is funny, isn’t it? Here were our best and brightest, as David Halberstam might say, assuring us that our money was safe, that real estate prices would continue to rise, that subprime loans were the healthy product of a heightened ability to reduce risk, not a house of cards upon which much of the global economy now rested precariously. And they were wrong, not because they intentionally lied (though some did), but because they failed to recognize the bright red flags everywhere on (and sometimes off) their own balance sheets.

The Securities and Exchange Commission’s civil lawsuit against Goldman Sachs this week has resulted in even more vitriolic rhetoric against investment bankers and their ilk, a demographic Lewis takes no pains to please in The Big Short. He opens his book with this: “The willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me to this day.” And he ends it on an account of his lunch with an investment banker, his old boss at Salomon Brothers, recounted with equal parts nostalgia and regret. In between, he rips apart much of the industry, railing against “the madness of the machine” and buttressing his anecdotes with footnotes that occasionally take up half the page.

It’s hard to say whom Lewis ridicules more, the bankers or the ratings agencies: while The Big Short is premised on the fact that high-powered bankers failed to research or even understand their own investments, Lewis makes it painfully clear that the foundation upon which all risk analysis rested was the highly coveted — and, it turns out, highly manipulable — ratings from industry leaders such as Moody’s and Standard and Poor’s. According to Lewis, employees of these firms, instead of conducting far-reaching investigations into the nature of subprime collateralized debt obligations (CDOs), simply took at face value much of what the banks told them. And since there were large fees to be had for each rating bestowed on these shadowy financial instruments, Moody’s and S&P had significant incentive to perpetuate the subprime industry.

In one particularly enlightening passage, Steve Eisman, one of the book’s central characters whose disgust for Wall Street types figured prominently into his investing strategy, explained the lack of incentives for analysts at ratings agencies, a misalignment that helped to create and foster the crisis. “‘They’re underpaid,’ said Eisman. ‘The smartest ones leave for Wall Street firms so they can help manipulate the companies they used to work for. There should be no greater thing you can do as an analyst than to be the Moody’s analyst…So why does the guy at Moody’s want to work at Goldman Sachs? The guy who is the bank analyst at Goldman Sachs should want to go to Moody’s. It should be that elite.'”

The Big Short is filled with quotes such as this. And although not all of them are as penetrating or as keenly observant of the recession’s underlying fault lines, each is helpful in piecing together a panorama of the landscape that existed in and around these “big Wall Street firms.” Michael Lewis has not compiled a tell-all here; if he has revealed any industry secret, it is simply the astonishing truth that, in the subprime lending business, there were none. When the dust had settled around our financial ground zero, it soon became apparent that even Wall Street had failed to understand Wall Street. In this, if nothing else, it shares the same fate as Main Street.

#8: Freefall

“As the United States entered the first Gulf War in 1990, General Colin Powell articulated what came to be called the Powell Doctrine, one element of which included attacking with decisive force. There should be something analogous in economics, perhaps the Krugman-Stiglitz doctrine.”

Yes, Joseph Stiglitz, the author of Freefall: America, Free Markets, and the Sinking of the World Economy, has a fan. This ardent devotee is not, as one might suspect, a fellow academic scrawling her mark of approval onto the book’s cover, nor a book reviewer writing for a newspaper or magazine. It’s not even Paul Krugman, although presumably he too has fallen victim to the spell of his fellow Nobel laureate.

No, the fan is Joseph Stiglitz himself, the author of both the book Freefall and the above quote, found in its second chapter. And as self-aggrandizing as he can tend to be — he joins the litany of economists, politicians, and pundits who vociferously trumpet their early predictions of the current financial crisis — his words are bolstered by an undeniably credible resumé. As the former chairman of President Clinton’s Council of Economic Advisers, the senior vice president and chief economist at the World Bank, and the 2001 Nobel Prize winner in economics, Stiglitz has combined his enviable pedigree as a top-notch economist with the political savvy gained through spending many years in the halls of power.

In the course of reading Freefall, it soon becomes abundantly clear that Stiglitz is not especially fond of deregulation. However, in a departure from the current American zeitgeist, he does not embrace populist rhetoric or condemn bankers unduly for their greed. (In writing this last sentence, I vacillated between enclosing greed in quotes or not; either choice seems equally prejudiced, so I arbitrarily chose not to.) “Bankers acted greedily because they had incentives and opportunities to do so, and that is what has to be changed,” Stiglitz writes. “Besides, the basis of capitalism is the pursuit of profit: should we blame the bankers for doing (perhaps a little better) what everyone in the market economy is supposed to be doing?”

This is an interesting question, and one that is not normally asked in today’s politically charged environment. And yet Stiglitz is just about the furthest thing from an apologist for the banking industry. Responding to central bankers’ claims that allowing inflation hurts those with low incomes, Stiglitz deadpans, “One should be suspicious when one hears bankers take up the cause of the poor.” Elsewhere, he states that “there is an obvious solution to the too-big-to-fail banks: break them up. If they are too big to fail, they are too big to exist.”

Obviously, large-scale problems in the financial sector led to the collapse of the markets and the economy at large, but Freefall is not content to stop at causes. The responses by both the Bush and Obama administrations come under heavy fire too: the former for not recognizing the severity of the crisis or forming a coherent rescue, and the latter for choosing the politically safest responses (tellingly, the author dubs this the “muddling through” approach). A key problem, if Stiglitz is to be believed, is the misalignment of private and social benefits. When banking executives’ compensation is based upon short-term stock price gains instead of long-term profitability, when regulators and top government officials at the Federal Reserve and the Treasury turn a blind eye to the mounting risks in the housing bubble to avoid slowing perceived economic growth, when financial innovations that produce high fees and low efficiency are encouraged instead of fined or prohibited, eventually there will be hell to pay, and we as taxpayers will be the ones paying it.

Indeed, this is exactly what we’re doing right now. Regardless of one’s feelings on Stiglitz’s policy prescriptions — some of which, not unlike those of his earlier book, Making Globalization Work, appear more grounded in political idealism than in reality — the fact remains that it has fallen to the taxpaying public to bear the risk created by the masterminds of Big Finance’s increasingly complex securities and other derivatives. To Stiglitz, this is ample reason to hit the reset button on the American financial industry — or perhaps more accurately, the reformat button. His vision is of a world of free markets, yes, but not completely unfettered and left to their own whimsies.

Instead, President Stiglitz would beef up the regulatory framework: ensuring that banks’ leverage ratios do not stray too high, that conflicts of interest (such as banks running their own real estate appraisal subdivisions) cannot occur, that predatory lending is prohibited (or at least heavily restricted), etc. Furthermore, Keynesian economics would experience a renaissance. (Stiglitz has little patience with the Chicago school, which he finds too theoretical and based on fallacious assumptions anyway. In one of the author’s weakest moments, he shamelessly deconstructs a straw man only vaguely resembling actual conservative ideology.) A global reserve currency would be created, similar (but not identical) to the International Monetary Fund’s Special Drawing Rights (SDR), to prevent the contagion of a worldwide crisis started by one currency’s downward spiral.

By the time one has finished this book, it seems that there is not much to look forward to in Joseph Stiglitz’s version of world events. He sees a financial market in disarray, being slowly rebuilt by the same hands that led to its destruction and leading inevitably to another instance of the same shortsightedness followed by more devastation. This is a hard pill to swallow, but it sheds light on why Joseph Stiglitz chose to write this book so soon after the financial earthquake. An undesirable future can be prevented, and we’re in the ideal scenario to start again from the rubble. By the time the economy begins showing serious signs of recovery, all resolve to change course will have evaporated. And so the gods of irony may be leaving us a silver lining after all in this prolonged economic massacre: the longer we suffer from the effects of past miscalculations and neglect, the more time we have to formulate a new, healthy, and safe framework to avoid a recurrence.