Summer Essays – July 2010
Don’t walk in the woods any more than you have to these days. Don’t get sick until September, when medicalpractitioners’ vacations end.
The Girl with the Dragon Tattoo
really is as readable as they say, and the movie is evenbetter. The Sharpe series by Cornwell is the easiest read ever and a painless way to pick up some Napoleonic history.
War and Peace
is the most self-indulgent, overwritten work ever. There is, though, a great 600-page novel lurkinginside it. 4,300 clicks on my Kindle! Have a good summer!
I mentioned in last quarter’s
that UBS had
red the inestimable Gary Brinson at the peak of the 2000 bullmarket. This turned out to be incorrect, as Gary was not
red. He and UBS had agreed to his withdrawal for a varietyof personal and other reasons some considerable time earlier. No negatives were meant to be applied to Gary. Quitethe reverse. Being
red for standing one’s ground for a good cause is always an honorable activity in my opinion.My apologies.
Finance Goes Rogue (But Volcker Wins a Round!)
My previous argument in the
debate*was that the 3% of GDP that was made up of
nancial servicesin 1965 was clearly suf
cient to the task, the proof being that the decade was a strong candidate for the greatesteconomic decade of the 20
century. We should be suspicious, therefore, of the bene
ts derived from the extra4.5% of the pie that went to pay for
nancial services by 2007, as the
nancial services share of GDP expanded to aremarkable 7.5%. This extra 4.5% would seem to be without material value except to the recipients. Yet it is a formof tax on the remaining real economy and should reduce by 4.5% a year its ability to save and invest, both of whichdid slow down. This, in turn, should eventually reduce the growth rate of the non-
nancial sector, which it indeed did:from 3.5% a year before 1965, this growth rate slowed to 2.4% between 1980 and 2007, even before the crisis.This bloated
nancial system was also increasingly deregulated and run with increasing regard for pro
t and bonuspayments at all cost. Thirty years ago, Hyman Minsky could have told you that this would guarantee a major
nancialbubble sooner or later and at periodic intervals into the inde
nite future. This unnecessary explosion in the sizeof the
nancial world has been a clear example of the potential for dysfunctionality in the capitalist free marketsystem. I have not been a great fan of the theory of rational expectations – the belief in cold, rational, calculatinghomo sapiens; indeed, I believe it to be the greatest-ever failure of economic theory, which goes a long way towardexplaining how completely useless economists were at warning us of the approaching crisis (with a half handful of honorable exceptions). But it would be a better world if their false assumptions were actually accurate ones: if onlyinformation
owed freely, were processed ef
ciently, and were available equally on both sides of every transaction,we would indeed live in a more ef
cient and probably better world. The problem that information is asymmetricalin the
nancial business is a serious one. One side of the transaction, say an institutional pension fund, is often at themercy of the other, say the prop desk of a talented and mercilessly pro
t-oriented investment bank.The problem of asymmetrical information is compounded by the confusion between the roles of agent and counterparty.I grew up in a world where stocks and other
nancial instruments were traded by the client with a high degree of trustin the agent. Millions of dollars traded on a word, without a tape recording. Somewhere along the way, without anyformal announcement of the change, the “client” in a trade mutated into a “counterparty” who could be exploited.Steadily along the way, the agents’ behavior became more concerned with the return on their own trading capital thanwith the well-being of their clients. One of my nastiest shocks in 45 years was the realization one day in 1985 that wehad been ripped off by our then favorite broker on one of the early program trades we were doing. We had supposedwe had developed a trusting relationship. We had certainly done many incentive trades that were successful from ourpoint of view. Perhaps, with hindsight, our strong incentives might have merely motivated them to rip off some otherclient.