Greed and Stupidity

What happened to the global economy? We seemed to be chugging along, enjoying moderate business cycles and unprecedented global growth. All of a sudden, all hell broke loose.

There are many theories about what happened, but two general narratives seem to be gaining prominence, which we will call the greed narrative and the stupidity narrative. The two overlap, but they lead to different ways of thinking about where we go from here.

The best single encapsulation of the greed narrative is an essay called “The Quiet Coup,” by Simon Johnson in The Atlantic (available online now).

Johnson begins with a trend. Between 1973 and 1985, the U.S. financial sector accounted for about 16 percent of domestic corporate profits. In the 1990s, it ranged from 21 percent to 30 percent. This decade, it soared to 41 percent.

In other words, Wall Street got huge. As it got huge, its prestige grew. Its compensation packages grew. Its political power grew as well. Wall Street and Washington merged as a flow of investment bankers went down to the White House and the Treasury Department.

The result was a string of legislation designed to further enhance the freedom and power of finance. Regulations separating commercial and investment banking were repealed. There were major increases in the amount of leverage allowed to investment banks.

The U.S. economy got finance-heavy and finance-mad, and finally collapsed. When it did, the elites did what all elites do. They took care of their own: “Money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves,” Johnson writes.

In short, he argues, the U.S. financial crisis is a bigger version of the crises that have afflicted emerging-market nations for decades. An oligarchy takes control of the nation. The oligarchs get carried away and build an empire on mountains of debt. The whole thing comes crashing down. Johnson’s remedy is clear. Smash the oligarchy. Nationalize the banks. Sell them off in medium-size pieces. Revise antitrust laws so they can’t get back together. Find ways to limit executive compensation. Permanently reduce the size and power of Wall Street.

The second and, to me, more persuasive theory revolves around ignorance and uncertainty. The primary problem is not the greed of a giant oligarchy. It’s that overconfident bankers didn’t know what they were doing. They thought they had these sophisticated tools to reduce risk. But when big events — like the rise of China — fundamentally altered the world economy, their tools were worse than useless.

Many writers have described elements of this intellectual hubris. Amar Bhidé has described the fallacy of diversification. Bankers thought that if they bundled slices of many assets into giant packages then they didn’t have to perform due diligence on each one. In Wired, Felix Salmon described the false lure of the Gaussian copula function, the formula that gave finance whizzes the illusion that they could accurately calculate risks. Benoit Mandelbrot and Nassim Taleb have explained why extreme events are much more likely to disrupt financial markets than most bankers understood.

To me, the most interesting factor is the way instant communications lead to unconscious conformity. You’d think that with thousands of ideas flowing at light speed around the world, you’d get a diversity of viewpoints and expectations that would balance one another out. Instead, global communications seem to have led people in the financial subculture to adopt homogenous viewpoints. They made the same one-way bets at the same time.

Jerry Z. Muller wrote an indispensable version of the stupidity narrative in an essay called “Our Epistemological Depression” in The American magazine. What’s new about this crisis, he writes, is the central role of “opacity and pseudo-objectivity.” Banks got too big to manage. Instruments got too complex to understand. Too many people were good at math but ignorant of history.

The greed narrative leads to the conclusion that government should aggressively restructure the financial sector. The stupidity narrative is suspicious of that sort of radicalism. We’d just be trading the hubris of Wall Street for the hubris of Washington. The stupidity narrative suggests we should preserve the essential market structures, but make them more transparent, straightforward and comprehensible. Instead of rushing off to nationalize the banks, we should nurture and recapitalize what’s left of functioning markets.

Both schools agree on one thing, however. Both believe that banks are too big. Both narratives suggest we should return to the day when banks were focused institutions — when savings banks, insurance companies, brokerages and investment banks lived separate lives.

We can agree on that reform. Still, one has to choose a guiding theory. To my mind, we didn’t get into this crisis because inbred oligarchs grabbed power. We got into it because arrogant traders around the world were playing a high-stakes game they didn’t understand.

(The New York Times)

A Speech to the Delegates

My fellow Americans, it is an honor to address the Democratic National Convention at this defining moment in history. We stand at a crossroads at a pivot point, near a fork in the road on the edge of a precipice in the midst of the most consequential election since last year’s “American Idol.”

One path before us leads to the past, and the extinction of the human race. The other path leads to the future, when we will all be dead. We must choose wisely.

We must close the book on the bleeding wounds of the old politics of division and sail our ship up a mountain of hope and plant our flag on the sunrise of a thousand tomorrows with an American promise that will never die! For this election isn’t about the past or the present, or even the pluperfect conditional. It’s about the future, and Barack Obama loves the future because that’s where all his accomplishments are.

We meet today to pass the torch to a new generation of Americans, a generation that came of age amidst iced chais and mocha strawberry Frappuccinos®, a generation with a historical memory that doesn’t extend back past Coke Zero.

We meet today to heal the divisions that have torn this country. For we are all one country and one American family, whether we are caring and thoughtful Democrats or hate-filled and war-crazed Republicans. We must bring together left and right, marinara and carbonara, John and Elizabeth Edwards. On United we stand, on US Airways, there’s a 25-minute delay.

Ladies and gentleman, I never expected to be speaking before you today. Like so many of our speakers at this convention, I come from a hard-working, middle-class family. I was leading a miserable little life, but, nevertheless, overcame great odds to live the American Dream. My great-grandfather fought in Patton’s Army, along with Barack Obama’s great-grand uncles’ fourth cousin once removed.

As a child, I was abandoned by my parents and lived with a colony of ants. We didn’t have much in the way of material possession, but we did have each other and the ability to carry far more than our own body weights. When I was young, I was temporarily paralyzed in a horrible anteater accident, but I never gave up my dream: the dream of speaking at a national political convention so my speech could be talked over by Wolf Blitzer and a gang of pundits.

And today we Democrats meet in Denver, a suburb of Boulder, a city whose motto is, “A Taxi? You Must be Dreaming.”

And in Denver, we Democrats showed America that we have cute daughters who will someday provide us with prestigious car-window stickers. We heard Hillary Clinton’s ringing endorsement of “the weak-looking thin guy who’s bound to lose.”

We heard from Joe Biden, whose 643 years in the Senate make him uniquely qualified to talk to the middle class, whose family has been riding the Acela and before that the Metroliner for generations, who has been given a lifetime ban from the quiet car and who is himself a verbal train wreck waiting to happen.

We got to know Barack and Michelle Obama, two tall, thin, rich, beautiful people who don’t perspire, but who nonetheless feel compassion for their squatter and smellier fellow citizens. We know that Barack could have gone to a prestigious law firm, like his big donors in the luxury boxes, but he chose to put his ego aside to become a professional politician, president of the United States and redeemer of the human race. We heard about his time as a community organizer, the three most fulfilling months of his life.

We were thrilled by his speech in front of the Greek columns, which were conscientiously recycled from the concert, “Yanni, Live at the Acropolis.” We were honored by his pledge, that if elected president, he will serve at least four months before running for higher office. We were moved by his campaign slogan, “Vote Obama: He’s better than you’ll ever be.” We were inspired by dozens of Democratic senators who declared their lifelong love of John McCain before denouncing him as a reactionary opportunist who would destroy the country.

No, this country cannot afford to elect John Bushmccain. Under Republican rule, locusts have stripped the land, adults wear crocs in public and M&M’s have lost their flavor. We must instead ride to the uplands of hope!

For as Barack Obama suggested Thursday night, wherever there is a president who needs to tap our natural-gas reserves, I’ll be there. Wherever there is a need for a capital-gains readjustment for targeted small businesses, I’ll be there. Wherever there is a president committed to direct diplomacy with nuclear proliferators, I’ll be there, too! God bless the Democrats, and God Bless America!

(New York Times)