I believe in synchronicity, so I found it noteworthy that I came across two articles that gave great prominence to the issue of values, one Jeremy Grantham’s April newsletter, “Immoral Hazard,” the other a post by Willem Buiter on, of all things, the Olympics.
Grantham’s excellent piece is unfortunately too long to present in full; so we’ll give some key sections. He starts by focusing on incompetence (object lessons being Volcker versus Greenspan) but as you will see, the real issue is the question of having standards, both individually and as a society. The issue of competence is a subset of this broader concern.
Grantham does a particularly good job of savaging the idea that we can’t afford failure, um, economic dislocation. He argues that tolerating imprudence has costs that are dismissed too casually.
From Grantham (courtesy reader Scott):
It’s not that the former Fed boss Greenspan was incompetent that is remarkable. Incompetence is common enough after all, even in important jobs. What’s remarkable is that so many people don’t seem, even now, to get it. Do people just believe high-quality self-justifying blarney? Or is it just that they apparently want to believe that critical jobs in a great country attract great talent by divine right. Sometimes, of course, they do, but sometimes the most important jobs – even that of a presidency or a Fed boss – end up with mediocrities….
Paul Volcker inherited about as big a mess as we have today. He worked out what he had to do and did it with unusual lack of concern about what Congress thought of the necessary pain involved and the number of enemies he might make. He paid the price for forthright behavior by being replaced, despite a record for correct and tough behavior that makes for the most invidious comparison today. When Volcker was replaced, by the way, he did not moan and groan but like an old soldier quietly disappeared. There were no high-profi le announcements about the economy or any $300,000-an-evening appearances paid for by financial firms.
Greenspan came onto my radar screen in the late sixties as a seller of economic and fi nancial advice to the investment industry. To be brutally honest, he was considered run of the mill by anyone I knew then or have met later who knew his service then. His high point in most memories, certainly mine, was a famous call in January 1973 that, “it can,” a few days before a market decline of over 60% in real terms, second only to the Great Crash in a century, accompanied also by a bitter recession. This was one of the first of a long line of terrible prognostications for which he has remarkably not been remembered, except by a handful of us amateur historians. Then in the midseventies he disappeared into some government job, of which I was barely aware, until he re-emerged with a bang in 1987, without as far as I can find having done anything documentably very well. And we can agree that at least occasionally people can indeed prove their effectiveness beyond doubt…..We can all wonder at the incredible vision, drive, organizational skill, and willingness to sacrifice resources that were required by the Manhattan Project and compare it to the rudderless or even deliberate avoidance of leadership of the greatest issues today: climate change and energy security. We can only wonder what a Manhattan Project aimed at alternative energy might have accomplished by now, had it been started 15 years ago.
What we have had in lieu of vision, leadership, and backbone is a series of easy paths taken. At the time that Paul Volcker broke the back of infl ation in the early 1980s, the recognition that risk and leverage had consequences was baked into the pie: if you were to take excessive risk you had better win the bet. If you missed the target, the expected result would be more or less total failure, and that seemed then and for decades earlier a reasonable law of nature. Now in contrast we get ready to celebrate the 20th anniversary of the era of the Great Moral Hazard. Slowly at fi rst, but with steadily growing traction, the idea was planted that asset bubbles would be tolerated, but consequences of their bursting would be moderated or avoided entirely by increasingly vigorous actions sometimes, like now, bordering on the hysterical. This is to say that if all went well, enormous profi ts could be made by speculators – largely the great fi nancial fi rms, including some formerly conservative blue chip banks – by riding and leveraging the bubbles. If all went badly, then the costs would be passed on to others.
The idea that occasional economic setbacks might benefit the system in the long run was one of the early ideas to
disappear. Yet if you prop up weak sisters who would otherwise fail and in failing present their more efficient competitors with extra growth, you must surely weaken the system. Desperation pricing from weak fi rms who simply should not exist can weaken the profi tability of a whole industry, as it has for the airlines. The average efficiency of most industries is reduced with at least some effects on our global competitiveness. With a slightly lower average return on equity, the ability to reinvest drops so that, in this world of moral hazard where recessions are few and mild, GDP growth is a little less than it might have been….
The defense of bailouts is that the alternative is ugly.But surely the penalties for excessive risk taking, issuing flaky paper, passing it on – often in its entirety – to others, and not even understanding the consequences of the low grade paper that you yourself issue should be ugly. “Yes, of course, we would like to punish the excessive risk takers” goes the line, but we can’t do it without hurting the innocent economy. But we will never know what can be absorbed if the penalties are always removed by a bailout. In more traditional times, say, from 1945 to 1985, the economy could absorb substantial punishment from recessions and still grow faster than it has done in the last 10 years.
The real incompetence here goes back over 20 years: the refusal to deal with investment bubbles as they form, combined with willingness, even eagerness, to rush to the rescue as they break. It’s almost as if neither Greenspan nor Bernanke allows himself to see the bubbles. Greenspan was always confl icted and contradictory about whether bubbles could even exist or not. Bernanke, in contrast, has more of the typical academic’s certainty that the established belief in market effi ciency is correct and therefore investment bubbles must be merely the product of investors’ overheated imaginations. It would be convenient to have such an important role as Fed Chairman fi lled by someone who actually deals with the real world, messy or not, that is given to inconvenient bursts of euphoria and riddled by considerations of career and business risk, which modify behavior far away from economic efficiency….
As discussed many times in the investment business, pessimism or realism in the face of probable trouble is just plain bad for business and bad for careers. What I am only slowly realizing, though, is how similar the career risk appears to be for the Fed. It doesn’t want to move against bubbles because Congress and business do not like it and show their dislike in unmistakable terms. Even Fed chairmen get bullied and have their faces slapped if they stick to their guns, which will, not surprisingly, be rare since everyone values his career or does not want to be replaced à la Volcker. So, be as optimistic as possible, be nice to everyone, bail everyone out, and hope for the best. If all goes well after all, you will have a lot of grateful bailees who will happily hire you for $300,000 a pop. By the way, that such payments to prior Fed offi cials are in themselves a moral hazard and an obvious confl ict of interest that could moderate their prior behavior, is apparently too crude an accusation even to have surfaced yet. Well it should surface. Selling services to financial interests whose fates have been in your hands should simply not be tolerated as acceptable or ethical behavior by a former Fed Chairman.