Hubris, Denial, and the Financial Services Culture

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I am still recovering from the Milken Conference, and unlike my fellow blog panelists Paul Kedrosky, Felix Salmon and Mark Thoma, have not written any posts on particular sessions. In part, that was because in my other life as a consultant, I am well aware of the dangers of relying on memory even though mine is pretty good, and I had decided to listen rather than take notes.

But the other reason was in almost all the sessions has a strong element of overt pressure on the speakers to maintain an upbeat tone, combined with repeated reinforcement of Republican/Chicago School of Economics ideology. Normally I would not deem that sort of thing worthy of mention if it were a minor and only occasional element of the program; indeed it would have been valuable if other views had been tolerated and some sparks flew. No, the private sector/deregulation cheerleading was pervasive and baldfaced, and made it hard for me to sort out signal from noise. There were enough cases where I knew the data and knew it to be misrepresented so as to call a lot of what I was hearing into question.

I did manage to see one session that was free of that, by theoretical physicist Lisa Randall talking about her work (needless to say, it was way beyond me, but she did a good job nevertheless), and putting in the lone plea I heard for government intervention. She said the US was losing its edge in her kind of science due to our inability to make commitments that we will adhere to for large scale experiments, like the one at CERN this summer. And she told us it will not make a black hole that will destroy our universe, since the energy involved will be insufficient to produce anything other than a black hole that would dissipate immediately, and the odds of even that were extremely low. But her session had at most 60 in the audience, while the big presentation later on, with Eric Schmidt of Google, Craig Venter (famed for decoding the human genome) and Muhammad Yunus of Grammen Bank, had frequent comments by Venter about how badly the government funded efforts to decode the genome has performed relative to his efforts (with Milken as moderator making supportive noises). Um, isn’t it possible that different types and scales of science require different approaches? And no one seemed willing to acknowledge that our vaunted pharmaceutical industry depends heavily on Federal funding (I’ve seen estimates in the 40% to 55% range).

Mind you, there were some signs of dissent from the Panglossian posturing. Myron Scholes, both in the large lunch (“Four Nobel Prize Winning Economists”) on Tuesday and in a panel discussion on innovation in financial services on Wednesday, attempted at several points to take issue with some of the ideas that might have been oversimplified, and met considerable resistance, as did Edmund Phelps, And I noted what care Scholes took to be precise and non-controversial in his presentation. For instance, in the lunch, Milken, who was the moderator, put up a quote from Joseph Stiglitz which said that we were in the worst financial crisis since the Great Depression. Note that Stiglitz isn’t alone in making that sort of observation; Soros and various private analysts (and not just Nouriel Roubini). Even the IMF has been unusually outspoken about its concerns.

So what was the response? The economy is not in a recession, unemployment is low, ergo all this talk is off base. Scholes pointed out that we aren’t through this yet and in hindsight things might look different, and was almost hooted down (the response was something like, “we are here to try to forecast the future. Looking back is easy.”). Similarly, it was Scholes on the second panel who was the ONLY one I heard mention (and only obliquely) the massive facilities the Fed has implemented, and the efforts made by other central banks.

So this group was also a singularly ungrateful lot. Not only was there NO acknowledgment of the magnitude of the efforts made on behalf of the financial services industry, but every time the government was mentioned, it was with derision and elicited considerable applause.

Not that everyone there drank the Kool-Aid, mind you; in fact, the number of like minded might have been quite substantial (during the dinner the second night, the mention of Obama elicited more applause than the other candidates). I had some very good discussions with some others participants despite the impediment of a conference badge that read “Press.” One was quite incensed (“Where’s the humility?”) and later said the fans were turned up high so no one could smell that they were shitting in their pants. Ouch!

But the example that bothered me the most was the panel on financial innovation. The panel consisted of Lewis Ranieri (who created the mortgage backed securities business), Richard Sandor (who invented financial futures), Myron Scholes, and Milken. Some of the lines of thinking were truly peculiar. What was bad about our financial crisis wasn’t that is has and will continue for at least the next couple of years to do damage to people’s lives and businesses. No, it was that other countries might become skeptical about financial innovation and thus deny themselves the opportunity to use financial innovation to solve problems like climate change and poverty

Ranieri was far and away the most downbeat on the panel, yet was repeatedly steered away from expressing his views fully. He felt that the problems we witnessed are not inherent to the products (ahem, are the bad incentives inherent or not? How do you separate that out?). He pointed out that the economic difference between doing a mod with a borrower who had some ability to pay was 30% (and in context, he seemed to mean 30% of the value of the original mortgage). He acknowledged that the modifications weren’t being made, that the industry needed to cut the Gordian knot and might require legislative relief to do so. He also said that things could get very bad (he invoked the Great Depression) if this path wasn’t taken. Mind you, that train of thought came out in snippets, with many attempts to steer him away from it. Milken, by contrast, claimed it was another example of highly regulated banks doing stupid things, just like in the sovereign debt crisis of the late 1970s (conveniently forgetting the role Wall Street played in structuring and selling the product, and in repeated and aggressively contacting mortgage orginators and telling them they wanted more product). Milken also maintained that the government should not get involved, the private sector could do a far better job of handling this, again conveniently ignoring the massive subsidies extended by the Fed via negative real interest rates on the short end of the yield curve and an alphabet soup of new facilities. I could go on, but you get the point.

An article earlier this week in the Financial Time by Abigail Hofman focused on the deeply-seated cultural issues that produced the crisis:

I worked for 18 years in investment banking and several aspects of the culture unnerved me. Investment banks are all about making money. At the extreme, this means making money for employees not shareholders. The big revenue producers are revered. It is not considered prudent to upset them by asking too many questions. The subprime meltdown is a perfect example of the “emperor has no clothes” phenomenon. These were complex products, yet obfuscation was considered acceptable. Bank chief executives should have asked more questions. I suspect they saw the juicy profits and hoped underlings understood the risks.

Moreover, investment banking culture has a cult aspect to it. If you work on Wall Street or in the City, you toe the party line. Despite lip-service to “diversity”, diversity of thinking is not encouraged. This atmosphere of craven conformity breeds at first complacency and then mistakes.

The Milken conference provided vignettes of how to cultivate conformity: select the likeminded, or at least sympathetic, for high profile roles, and apply subtle and not so subtle pressure to make sure they stay within approved boundaries. But as Hofman’s comments suggest, this isn’t a Milken conference problem; rather, the conference illustrated certain behaviors found widely in the financial services industry (note also that, at least in my day, most firms were agnostic about their staff’s political leanings).

A long time ago at McKinsey, one paradigm they mentioned was that people fell somewhere on the spectrum of internalizers and externalizers. Internalizers tend to blame themselves for what happens whether it was their fault or not. They are very conscientious and strive not to repeat their errors. Externalizers blame everyone else for their problems. They are very resilient and well suited to sales jobs. And they are incapable of learning from their mistakes, since they never make any.

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  1. Anonymous

    Sounds like the Milken conference got things right, despite the socialist leanings of the academics! Great to hear. Next year I’ll plan to attend.


  2. Anonymous

    Actually, it sounds more like the Moonies than an economics conference.

    Never mind, good old physical reality will sort out this particular manifestation of folly in due course. The underlying human frailty is less tractable.

    49 1/2

  3. Richard Kline

    The degregulation/innovation crowd, on the Street and in the academy, has gotten nearly everything _wrong_ in a generation of noisemaking and policymaking. When ‘the Crisis of Our Times’ is over, many of their policies are going to look very different or be junked, and their intellectual reputations are going to be devestated. It is no surprise that, facing career discredit, the response of that lot is to deny there is a problem while hinting that should any problem at some point occur it was/will be created by someone _other than them_. Reality will sum the book on their intellectual and practical contributions to their society, and the number is going to be negative in most cases.

    Lew Rainieri: He has repeatedly popped un on record in the last nine months with rather humble statements of real concern for securitization and the credit squeeze generally, which says something for his perspicacity and perhaps his honesty. He didn’t design securitization for it to be turned into an automated sandcastle-making machine, and perhaps is prepared to acknowledge just how corrupt that process had become.

    Lisa Randall: I have a pronounced if non-technical interest regarding the areas in physics in which she has come to specialized. Her thinking is extremely elegant, and she also has the ability to present complex ideas in forms readily comprehensible for lay audiences, an ability which tends to correlate well with intellecual insight. I’m not surprised, though certainly pleased, to hear lucidity and candor emmanating from her place at the table. Certainly she shows these in her professional work.

  4. Anonymous

    The investment banking culture is shoulder deep in psychopathic behavior, and completely without adult supervision. It is cultish, and childish, enabled by the free option in its risk taking compensation structures.

  5. Anonymous

    Marked to market accounting may well turn out to be the big lie, and the big history lesson, from this crisis. This is also a product of a childish, toy-obsessed (e.g. derivatives) investment banking culture.

  6. Anonymous

    Sounds like the “moral hazard” was on full display. The frat boy sociopaths continue to call the shots while the Government scurries after them cleaning up the mess.

    All derivative financial models “derive” their value through the inherent assumption that the return of capital is of fundamental importance. Clearly,
    derivative securatization has been employed as a vehicle for committing fraud on an unimagineable scale. The securities were misrepresented and sold by the financial industry to collect short term fee based income with the clear intent of defrauding the public.

    Gangsters are always full of hubris and sociopathic cruelty. The corruption has penetrated government to the core, including law enforcement. The complete collapse of the financial system may be the only outcome possible under the current structure.

  7. mickslam

    I’ll write something longer later, but have a short indication of how slanted this culture of the financial world is.

    For years, I was known as the “commie bull” because was bullish the stock market in the late 90s and didn’t spit in anger every time someone said the word “taxes”.

  8. Anonymous

    “These were complex products, yet obfuscation was considered acceptable.”

    It’s called plausible deniability – and Milken only wishes he could have insulated himself so well.

    I visited the Milken Institute site. Under the “History” section, it says the following:

    “Philanthropist Michael Milken and his brother, Lowell, endowed the Milken Institute for Job & Capital Formation in 1991.”

    Philanthropist? The first entry in his bio should read. “Milken – previously convicted for six securities and reporting felonies, after being charged with 98 counts of racketeering and fraud.”

    This is how we got here.

    Shouting-down dissent is a well-known “conservative” debate tactic. I thought we’d have learned.

  9. Anonymous

    I like Panglovian. It has a nice spoonerist/spoonerism aspect to it.

    Panglovian: someone who asserts, everytime they hear the ringing of a bell, that we live in the best of all possible worlds.

    In an economic context, a Panglovian is someone who, when asked for advice about an economic situation, always responds that free and unregulated markets will deliver the best possible result.

    On a personal note, I am an economist by training. I was in (then) Soviet Georgia for a wedding in 1991, a few weeks before the failed coup. The groom’s father was a well connected industrial manager who wanted me to meet with the economic minister and give him some advice about what they should be doing. This didn’t sound interesting to me, and I got out of it (a couple of others went in my place) by parroting (parodying?) “Supply and Demand, Supply and Demand.”

  10. Anonymous

    I’ve seen this inability-to-face-the-music attitude for years in the sheltered professional class. I’ve worked with them and gone to school with them. There’s a simple reason for it– if all the shit finally hit the fan, most of these people would be helpless.

    How many of them know how to change a tire? Or win a street fight? Or drain a hot water heater for clean water? Or how to dam a small stream and spear the fish you trap. Or growing food? Or even how to fix a paper jam in a copy machine? There is nothing more pathetic than watching a grown man flip out and scream for a secretary because the copy machine has a jam, and he can’t fix it by following the instructions on the panel.

    What am I talking about? When a person has actual hands-on survival skills (beyond sycophancy and following the herd) then he or she can’t bring themselves to face the reality that when things go wrong they are helpless. Sure they are good at yelling at the copy repair guy/butcher/mechanic/security guard and threatening them with a lawsuit, or threatening their secretary with termination. But, they know, deep in their hearts, that if we ever DID suffer an economic reversal like the depression they would be helpless if they had to really scrape by.

    For people who like to call themselves the ”masters of the universe,” facing the fact of their own actual helplessness.

  11. Jim Bowery

    The problem is economic rent seeking in _both_ the public and private sectors. The solution is to stop taxing economic activity and instead charge a use fee for net property rights equal to the risk free interest rate times their liquidation value in place — and then distribute the revenue thereby collected to all citizens equally. This gets rid of both private rent seeking and public choice rent seeking.

    Of course, since the entire edifice is riddled with rent seekers in both public and private sectors, this measure is not going to be enacted prior to its collapse.

    The Federal Reserve is one of the most egregious examples of the conjunction between the sides of rent seeking I’m sure no one at the conference went around trumpeting the abolition of the Fed.

  12. donna

    Republicans are well known for not wanting to listen to any viewpoint that differs from their own. I would say the hubris is what will eventually take them all down, but not before doing insane amounts of damage to the country. I don’t know if we can even recover from the last eight years. Their damage to the financial system is in line with their damage to everything else they touch, caring only for their own profit and damn the consequences.

    Evil bastards, indeed.

  13. minka

    “they are incapable of learning from their mistakes, since they never make any.”

    This can be a sign of sociopathic personality disorder.

  14. STS

    This is a typical black/white discussion of a gray issue. Financial product innovation is just fine, but it has gotten far ahead of the regulatory response. The regulations needed are mostly to do with transparency: put high volume OTC derivatives onto standardized exchanges with clearinghouses; and incentives: tie those big bonuses to continuing success of a business, not just to this quarter’s rigged number.

    Milken and company are right to fear unfortunate consequences of the backlash — but naturally fail to see how their own arrogance and simple-minded “government is always bad” ideology makes such backlash dramatically more likely. (Funny, they don’t seem to object to government when they need the cops to evict someone they have foreclosed on …)

    Financial reform is too important to be left entirely to “Wall Street’s Finest”. They’re paid not to understand the problem. But it doesn’t follow that “shutting down the big casino” is a sensible policy either.

  15. Anonymous

    money can buy respectability. orthodoxy is central to respectability.
    diversity has entertainment value, but intellectual diversity can lead to, ahem, inappropriate thoughts.
    inappropriate thoughts can lead to behaviors that are, ahem, inappropriate and condemned by all respectable people.
    er, didn’t I just spend all that money endowing myself a foundation to buy respectability.
    stop thinking and start conforming.
    life is good.
    just do it.

  16. Anonymous

    Thanks for a great post – and as a long-term employee in the financial services sector, thanks for recognizing the cultural aspects of the issue – particularly the distinction between internalizers and externalizers.

    The cultural issue speaks to a question of core values, which too often economists do not adequately recognize in their assumptions, and merely assume that progress toward maximal utility occurs.

    However, progress requires learning, which is awfully difficult for our species…

  17. Lord

    I think gapingvoid put it best. The social pyramid/corporate hierarchy is formed by the losers surmounted by the clueless and crowned by the sociopaths.

  18. PrintFaster

    One comment on the point made by one economist on the fact that unemployment was low by historical standards.

    Unless economists wake up and protect the integrity of their data by rejecting constant rejiggering and readjustment, they will never be able to draw any accurate conclusions. If you look at traditional measurements of unemployment, we have been over 9% for a long period. Some measures have us at over 12% using traditional techniques.

    We are like a frog in a boiling pot of water who believes that it cannot be very hot if the thermometer is broken, or short of mercury.

    Economists as a profession face the total loss of credibility if they lack the character to demand accurate and consistent data, otherwise they are analyzing tea leaves.

  19. dd

    The issue is transition. Financial instruments create wealth but in and of themselves have no value. Milken understood that; as many financiers before him. Public acceptance is crucial. We have moved to the new realm of virtual valuations. This transition is as hard as the move from gold to fiat. The Fed supports it and the younger generation is comfortable with virtual valuations. It could work yet. But the danger of “reality” might undo it yet.

  20. Anonymous

    dd: cold fusion could work yet… so far it hasn’t… so far its been a hoax… but, who knows, there’s something it its ring that promises that maybe, possibly, down the road, put in the best hands and given long enough .. well it might work….

  21. Juan

    Of topic but “A long time ago at McKinsey” reminded me of (former) McKinsey analyst Frank Ostroff and the wonderfully thought provoking discussions we had during the mid-1980s about what came to be called globalization.

    Very sharp guy who really helped me concretize my thoughts/writing about ‘Global Finance Capitals’ (GFCs, the fusing of production and finance capitals, their internal contradictions but moreso those between these entities and national states).

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