I highly recommend this short interview by John Authers of the Financial Times with Amar Bhidé, a professor at Tufts, in which he argues that a proper reading of Friedrich Hayek would lead to considerable skepticism about whether most of the changes in finance over the last three decades actually represent progress. Amar’s viewpoint is radical: he thinks very few financial markets have the inherent traits that lend themselves to arms-length, anonymous trading and they would not exist in their current format (at least for all that long) absent government support. He also thinks that bad incentives are an incomplete explanation for the crisis, as in better incentives won’t assure better outcomes when you have standardization gone too far and resulting loss of information.
There are a couple of places where Amar makes passing references to orthodox monetary ideas. I’ve known Amar for (lordie) 30 years, since we both worked at McKinsey on the Citibank account; he was also briefly a proprietary trader before going into academia, where he has focused on finance and entrepreneurship. He’s long been iconoclastic and his views on finance don’t depend in any way on macroeconomics but on market behavior and institutional arrangements.
This is a clear and provocative chat, and I trust you’ll enjoy it.
A proper reading of Adam Smith would yield different results too! Which goes to show that the 1% will use anyone and anything, as a means to gain as much power as possible.
How could anyone claim that there has been progress in finance over the last three decades, when confidence in the global banking system remains so dangerously low?
I like the clarity of Amar Bhide’s arguments.
But TPTB (“The Powers That Be”) are not listening.
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” – Upton Sinclair, I, Candidate for Governor: And How I Got Licked
The result is the infliction of TPTB (“Total Pain Total Bullshit”) on We the people.
The half-assed Dodd-Frank financial reform act of 2010 made sure that there was no fix of the regulatory efforts that go back nearly 150 years.
In 2012 Bhide wrote:
“Giant banks are mega-receptacles for hot deposits…Banks vie with one another to attract wholesale depositors by paying higher rates, and are then impelled to take greater risks to be able to pay the higher rates…competition for fickle yield-chasers that helps set off credit booms and busts… mysterious denizens of the shadow banking world…an overwhelming proportion of the “quick cash” in the global financial system is uninsured and prone to manic-depressive behavior, swinging unpredictably from thoughtless yield-chasing to extreme risk aversion. Much of this flighty cash finds its way into banks through lightly regulated vehicles like certificates of deposits or repurchase agreements. Money market funds, like banks, are a repository for cash, but are uninsured and largely unexamined…
“…radical, 1930s-style measures may seem a pipe dream. But we now have the worst of all worlds: panics, followed by emergency interventions by central banks, and vague but implicit guarantees to lure back deposits. Since the 2008 financial crisis, governments and central bankers have been seriously overstretched. The next time a panic starts, markets may just not believe that the Treasury and Fed have the resources to stop it.” – Amar Bhide, “Bring Back Boring Banks,”
“Experience is accumulating that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.” – Keynes
Re: bad Incentives [the bonuses paid to corporate executives and to traders]
Also, John Authers of the Financial Times, his review of Andrew Smithers’ The Road to Recovery: How and Why Economic Policy Must Change:
“…startling and authoritative attack on the system of tying executives’ bonuses to the share-price performance of their companies…For Smithers, the bonus system was the principal cause of the financial crisis, and is now the main reason why the recovery has been so weak.”
Like the post yesterday about how it is logical to have higher interest paid on capital for various risks but illogical to pay any interest on risk free government backed securities. But what about when capital goes frantically chasing return after it has exploited the entire planet? Bhide says the financial market cannot stand on its own without government intervention. We’ve certainly learned that first hand. Government intervention has simply given the banks free rein to write their own risk protection and that, in addition to commodifying everything on the planet, has centralized finance in a perverse way. And so much capital has accumulated to the top that they are now spinning out of control because there is no investment good enough to save them. So the solution is to decentralize. (Yes, but how?) That means also – at the same time or it won’t work – decentralizing the wealth. In fact they will have to spread the wealth first, like Timmy says: foam the runway. The corporatists would much rather take their ill gotten gains and go buy a plantation in Africa. Until they can’t play that angle any more… but never decentralize. Decentralization is the antithesis of corporation.
My brain is like a rickety old particle collider. I keep trying to crash two ideas together and see what is revealed. So here’s another one, from David Suzuki’s little video on Huffpo wherein he explains exponential growth. Whether bacteria, population or finance, the end comes suddenly. It looks like the financiers finally outgrew the petri dish, doesn’t it? So, being mortal, they will want to colonize other niches. There might be a danger in “decentralizing” finance if the rules are not changed to control for exponential growth. Because every new decentralized “market” will grow the same way. The problem is with the pace of growth itself.
Also, I apologize in advance for this one, I’m thinkin information can neither be created nor destroyed. It resides somewhere in its own system. The 1.2 quadrillion market for derivatives is probably the place where it all goes. Parse that out and you will know everything in the universe of finance.
And I keep wondering what would our economy be like if we neutralized risk altogether. Not with derivatives; they are an extenuation of risk. Risk in sheep’s clothing. Because if no risk then no growth is not a problem, right? Can’t we ingenious humans come up with a no risk economy?
I’m not able to visualize a no risk economy:
1. Making certain all risk takers were given a padded landing would be almost impossible and might offer too much encouragement to innately stupid plans. Yes, we seemingly do that now but still, risk taking with expensive consequences for failure can be a good thing in certain instances.
2. There is too much under lying chaos in the universe for anyone to be able to foresee all options. Allowing some risk takers to fail and suffer the consequences is just going to be a natural outcome of this chaos. The questions is which risk takers do we allow to suffer losses and which do we not?
“The questions is which risk takers do we allow to suffer losses and which do we not?”
I believe that question has already been answered. My question is doesn’t TBTF make the word “risk” a misnomer?
Can the “masters” of the universe pay to legislate the laws of conservation of mass and energy?
Have you considered smoking a joint and chilling out for a while? it might all make sense after 5 minutes staring at the wall, but then it also won’t seem like it’s worth thinking about anymore.
I’ve been tee-totaling. You noticed; recognized the symptoms.
Interesting. Makes you want to re-examine the meaning of “entropy”.
“Gain in entropy always means loss of information, and nothing more”.
– G. N. Lewis writing about chemical entropy in 1930
When I was a kid, there was a game we would play at parties called “shoosh, pass the secret”. We would arrange chairs in a circle and sit facing each other. The hostess would write something on a piece of paper. Then she would pick one of us and start the game by whispering what she had written into his/her ear. Then he/she would repeat the secret into the ear of the kid to his/her left. Then the second would repeat to the third, and so on until the secret made its way around the circle. The last kid would have to stand and repeat it out loud followed by the hostess reading what she had written. What started as “pepperoni pizza” would end as “scrambled eggs with blue cheese”. The larger the circle, the wilder the transformation. Always made for good laughs.
The commoditization of all the participants in the mortgage lending process makes it easy for the banks to control outcomes – which is what they did leading up to the meltdown. From shoddy origination to cherry-picking appraisers that make the values needed to make the loan. Nothing has changed today. Originators and appraisers and their products are simple commodities to them and it doesn’t matter who originates or values the property or the experience of either. The banks have their automated valuation systems that they believe in far more than the products produced by the human participants that are supposed to be their eyes and ears on the ground. They believe this so they can turn originators and appraisers into their ATM’s and a profit center for them. This was a good video. As long as banks control the process another housing bubble is just around the corner – and any other bubble they wish to create.
The point Bhide makes about corporate central planning is very important. Any hierarchical structure will have problems with information flow from bottom to top, whether it is a government, a corporation or a family. Decisions made within groups who are hierarchically organized will, necessarily, be based on a small subset of the total information available to the group as a whole, and that information may well be biased in a particular direction (by sycophants and yes-men, for instance). Hierarchical structures, like rules-of-thumb, can be useful and efficient if applied in the proper place and way, but they are also quick to cause problems if they are improperly used or applied without a high degree of awareness.
Because we tend to assume that capitalist, corporate hierarchy is a “natural” way for social relations to be organized, we find such awareness difficult to maintain. But as Bhide explains, if left to their own devices these hierarchical financial entities will homogenize and liquefy everything in their path. That may be good for suits’ bank-accounts, but it’s highly destructive for the rest of us.
Closely tied into the problems inherent in information flow in hierarchical systems is the problem information flow in totalitarian hierarchical systems. Which is what corporations are. As people such as Chomsky and Robert Anton Wilson liked to point out; the further down the totem pole you go, the more terrified everyone is of making a mistake or having a mistake revealed. Problems are papered over, giddy enthusiasm over sober analysis, corner cutting takes place to achieve ever expanding production or sales quotas….
What applies to corporate central planning also applies to state bureaucratic planning as well; Bhide mentions Department of Agriculture type planning in the early part of the video. This is why in the U. S., State and county administrators are better located to make decisions. They would however, need clear, concise and well documented rules and too often even when locals are empowered they don’t have those well written rules. For this whole situation and the mess we are in – say just looking at the regulation of farming and the attendant commodities market that flows out of agricultural production – we can look to Congress as the perpetrator of the crime. Our current system of commodities subsidization empowers only relatively larger operators – the typical farm is now a $6 million/yr operation and usually involves 5,000 plus acres ( or thousands of feed animals on small acreage)- this flies in the face of careful growers nurturing each bud and calf and lamb. Smaller operations would yield higher quality products and we would all be better off. Supposedly the farm subsidy program is intended to promote smaller farms (less than 600 acres) but that seldom happens due to high costs of production. We can in practice incorporate a food subsidy program which would take care of that situation but we lack the political will to turn the need for food into a given right. This is similar to a different type of problem with medical care, the resources are available to have all people covered under a national health insurance program but the political elite in this country are at least 75 years behind in their education, training and vision.
Vision is the key word here and no one in the circle of ruling elites (Congressional Committee chairs, residents at 1600 Pennsylvania Ave.(especially the current occupant) and the attendant advisers-all are stuck with outmoded world views that are resistant to change.
Bhidé seems to hit some of the same notes that Adair Turner does here:
Turner’s pre-crisis delusions include:
• Financial activity and innovation axiomatically beneficial
• Financial deepening limitlessly beneficial
• Credit growth essential to nominal demand growth
There seems to be an unexamined assumption on both Turner’s and Bhidé’s parts, however, that endless growth of demand and consumption are a good thing. There seems to be a rump group of commenters here on NC that are more than willing to challenge that assumption.
confusing issue (growth) because there is the growth of financialization versus the growth of social good/goods and they intertwine; then (for me) there is always the big danger lurking out there which is the growth of toxic industrialization; better to have the growth happen in CO2 and environmental cleanup – so social growth… blablablah.
Confusing indeed, and in “emerging” economies it drives a wedge into the left as the progressive developmentalists square off against the environmentalists and defenders of indigenous peoples, who are fighting to preserve their traditional ways of life.
Both sides, of course, claim the mantle of Marx.
Dodd Frank and everything else make perfect sense to anyone familiar with Veblen’s Absentee Ownership (1923). You really can throw everything after Veblen out the window. I don’t think he would change a word if he were alive and writing today. In addition to being absolutely correct he was devastatingly funny, and I think it helps to get a few laughs while you find out how and why you are being screwed.
You cannot change power relations with reasoned criticism and I don’t think women with pikes will work any more- so Eighteenth Century, n’est-ce pas?
“If you read Hayek carefully his critique of central planning isn’t based on mis-aligned incentives or lying and corrupt central planners… He’s not attacking the mal-intent of bureaucrats. He’s attacking the lack of information.”
Well how convenient, and exculpatory. There’s never any malicious intent or, in legal jargon mens rea, on the part of bankster thieves and sociopaths. Never!
Why does it not surprise me that Hayek would think that way?
Um, did you manage to miss that most of Hayek’s critical writing was in the 1930s and 1940s? There actually was a code of conduct among the elites in advanced economies that curbed significant corruption. The general level of official conduct was a hell of a lot better than what you see today.
You also seem unable to appreciate that the point Bhidé is making is far more devastating. Corruption can be contained to not-destructive levels by vigilant oversight. If that was the problem with central planning, it would be possible to remedy it. But the problem of lack of critical information means centralized planning is inherently flawed.
Well actually, I did not “manage to miss that most of Hayek’s critical writing was in the 1930s and 1940s.”
But I likewise did not manage to miss this part of the interview either:
John Authers: Now let’s bring that to the current situation where we’re sitll in the recovering stage from this remarkable financial crisis that came to a head in 2008. That was built around a mortgage market that plainly failed… How does this critique of central planning apply to that very liquid mortgage market that we saw.
Bhidé: To make mortgages liquid, to make anything liquid you have to impose on them a collectivization akin to central planning….
Then Bhidé goes through his explanation of how in the mortgage-making process running up to the 2008 crisis important information was lost, and it was the loss of this information which caused the crisis. Then he concludes:
Bhidé: [T]here are studies that show people who were actually, personally involved in making those mortgages who thought they were terrific and they personally exposed themselves to the mortgage market… They were simply mistaken. And what the mortgage market has done is to conjoin what might be individual mistakes and make it one giant mistake….
So not only does Bhidé use Hyek’s philosophy on central planning and information loss to conjure up an explanation for the crisis which leaves the people who caused it free of any ill will or intent, he even goes to the point of exculpating the perps by declaring the crisis was just “one giant mistake.” No foul.
And where does Bhidé make the argument that “centralized planning is inherently flawed?” In fact, he makes the very opposite argument. To wit:
John Authers: The argument is often made from the point of view of moral hazard from too big to fail. Are you actually saying we need to split up the big lenders? The mortgage market is even more concentrated now than it was in ’08. Is that what you’re talking about?
Bhidé: I don’t care whether it’s a small bank that makes a mortgage or whether it’s a large bank that makes a mortgage. I’m much more concerned with how that mortgage is made.
And what can I say to the claim that in the 1930s and 1940s “There actually was a code of conduct among the elites in advanced economies that curbed significant corruption?” I’ve read a good bit of history, and I certainly can’t find any evidence of those halcyon days. In fact, those were the decades when the elites in advanced economies committed some pretty atrocious acts.
No he is NOT exculpating the perps. He is silent on the motivation of the perps. You are projecting.
Bhide is criticizing the REFORMERS who see “skin in the game” as a sufficient remedy. This is widely believed to be a solution to the problem of too much risk taking.
And Bhide’s notion of having regulators force banks (the type with banking charters) to evaluate risk on a case-by-case basis in reg exams and discourage liquid markets would end the state subsidization of the casino and shrink it radically in size.
You simply don’t grok how astute Bhide is. What is looting? Levering up enterprises that are or probably do have official support. That’t they way execs and insiders can steal on a huge basis. Turning banks into public utilities severely limits the damage the bad guys can do.
This gets you to the same end point (limiting the damage the bad guys can do) and FAR FAR more effectively (guys who run public utilities and who eat their own risk cooking for the most part won’t be able to buy much in the way of political favors. Hedgies even now aren’t a big or effective lobbying group and cutting their funders down to size and limiting the liquid markets they can play in.
It would be nice to punish the baddies but it is much more important to get them out of the driver’s seat. And the appeal to Hayek gets the right on the page of utility banking.
Bhide is simply finessing a debate that we have lost (and he is under NO illusions as to the conduct of industry incumbents). Jamie Dimon should go to jail. Is that ever gonna happen? No. But you’d rather continue to curse the darkness than light a candle and find a way out.
These authors have done some extraordinary work on instability in “homogenized”
systems, though their mathematics is a little beyond me:
I suppose it’s intuitive that credits issued without credit analysis are apt to be
trouble, but that was not the authoritative line in 2006 and isn’t really the
authoritative line today.
This speech by Sornette concentrates more on financial system dynamics
than on their origins in a “perpetual motion machine” economics and may
be more congenial to some here: http://www.ted.com/talks/didier_sornette_how_we_can_predict_the_next_financial_crisis.html
There’s a great deal of material on Sornette’s ideas available on the web
at various levels of depth. I’ve just linked a couple that might be of
interest to the investor or businessman for whom the chronic large-scale
volatility has become a chronic headache.
BTW, his presentation’s very clear in excellent English.
there are many problems with this entire edifice of intellectual asphyxiation and the so-called thinkers fail both to perceive the full spectrum of reality they purport to observe or the catalyst that money (and hierarchy) can represent as a reality-transforming force for ehanced individuation.
the so-called “information” at the local level is not always worthy of inclusion in a top-down construct. Our favorite whipping boy, the southern Jim Crow economy, is a case in point. A civil war followed eventually by a top-down hierarchy was enforced to obliterate the traces of it. Yet there are certainly situations where top-down hierarchies only oppress.
The value structure that observes and makes the moral judgment is, itself, a creation whose provenance includes, at least as one catalyzing element, the centuries-long financial deepening. Yet that water, to continue the metaphor, can drown the swimmers when taken to a blind extreme.
The topic is nuanced and complex, a dialectic of gnostic perception and group super-ego formation, and money is in the middle of it like a catalyst in a chemistry experiment. These professor and “thinkers” don’t see any of this, and so their theories are reductive destructions of the very information they purport to cultivate.
It’s not that I object to intellectualizing, it’s that my standards are relatively high. The theory should be, like good art, something that hangs together and forms its own irrefutable force of persuasion both through its definitions of the energetic forces at work and its mastery of their expression in an intelligible and self-consistent presentation. But it rarely is. Usually it’s just kind of funny.
As a practioner, wmeone who lent money then had it returned, both I and my smarter peers would agree with Prof Bihde. Lending is a business of home cooks or chefs and not cooks. Market liquification is okay if the ingredients, underwriting, is sufficient. If bank due diligence is vaulted into the primary position in lending then the rest follows…..including decreasing the size of banks.