The technocratic compulsion is very seductive to a lot of people (including, I think, our President-elect). I can't tell you how often I hear "if we just had one smart person to clean up the mess..." But it never works. Just think about this auto czar idea being trial-ballooned this week. Even if you could find someone brilliant enough to perfectly discern and synthesize the diverse buying interests of a hundred million consumers, he can never have the right incentives sitting in that government job. Pretty soon he has group A insisting that he needs to mandate more fuel economy and group B that he needs to protect union jobs and group C that he needs to save jobs in Michigan in preference to Ohio and group D advocating for Ohio over Michigan and... you get the point. All rolled up with the incentive problem that if he actually solves the problem at hand, he will be out of a job, so you can bet the problem is never fully solved.
My wife read the Michael Lewis article and comes back to me and says "I can't imagine how you can read that and still oppose government intervention and increased regulation." I said, "why?" Sure, people screwed up and did stupid stuff, but no defender of capitalism promises that won't happen. Besides, what regulation would you propose? "I don't know, but someone smart should have been watching them."
And that is what the argument usually boils down to - someone smart should have been watching them. But lots of smart people were watching all the time. You can see one such person featured in Lewis's article. Guys run all over Wall Street looking every day for some single digit basis point spread they can make money off of. But untold wealth was just sitting there for someone who was willing to call bullshit on the whole CDO/CDS pyramid game. These guys playing this game were searching for people to bet against them.
And despite this, despite untold wealth as an incentive, and companies looking for folks to take the other side of their transactions, only a handful saw the opportunity. Thousands of people steeped in the industry with near-perfect incentives to identify these issues ... did not. What, then, were our hopes of having some incremental government bureaucrats do so? Usually, after this kind of crisis, there are lines of pundits and writers ready to suggest, with perfect hindsight, new regulations to avert the prior crisis. But, tellingly, I have heard very few suggestions.
Back in the 1980's, everyone was freaked out about junk bond-financed hostile takeovers, greenmail, leveraged buyouts and the like. Since, while this activity has not disappeared, the wackiest of this behavior has really died down. Do you remember that act of Congress and subsequent regulation that really curtailed this behavior? Yeah, neither do I. The fact is that, if they are allowed -- and if they are not shielded by taxpayer-funded bailouts from the consequences of their actions -- individuals learn from their excesses. Or they go bankrupt.
Posted on November 12, 2008 at 11:11 PM | Permalink
Here's one guy who called bullshit. There are some great quotes in that article.
Posted by: dsm | Nov 12, 2008 11:39:18 PM
It's a matter of position. As you observe, the government sinecure isn't it. If a single smart guy COULD fix GM's problem, he would be Chairman of GM.
GM's problems stem, in large part, from government meddling, from enabling unions to use "bargaining" methods that should mandate their disbandment and barring from the marketplace to safety and pollution standards that appear to have been pulled out of some congressional staffer's nether regions.
Adding another bureaucracy to the mix surely can't help.
Posted by: Mark Alger | Nov 13, 2008 6:55:41 AM
You're overstating your case here. The issue with Wall St is that its risk-management models are faulty. They are based on the assumption that asset returns are normally distributed, when Taleb and Mandelbrot among others have noted that asset returns are, in fact, not normally distributed.
You are correct when you state that regulators have neither the ability nor the incentive to solve Wall Street's problems but it is nonetheless incorrect to say that Wall Street had a lot of smart people who could have exploited weaknesses in the "CDO/CDS pyramid game." Call it whatever you like but Wall Street's ability to price and manage risk simply has fallen short. You can't take advantage of that which you cannot accurately assess.
What Wall Street needs is not more or different regulation. What it needs are better tools with which to quantify and manage risk.
Posted by: Dave | Nov 13, 2008 7:40:18 AM
Wall Street succumbed to hubris. The tools were bad and they were too confident.
The story is that someone actually did his homework. Nothing else. The loans were bad. Someone understood that the loans were bad. Everything else follows.
How brilliant do your analytical tools have to be to figure out that garbage sliced and diced into tranches can't be anything but garbage? Only a fool believes that gold can be spun from straw. Wall Street was preaching that gold could be spun from crap.
Posted by: stan | Nov 13, 2008 8:39:01 AM
A lot of intelligent guys were selling stuff that they knew as little about as the Realtor selling houses and claiming real estate always goes up. It was too easy to sell and make money than to worry about the underlying problems of what they were selling. I'm sure some, maybe many, of them suspected that all was not well; but I presume a lot told themselves, "I'll get out before it gets bad."
Posted by: ElamBend | Nov 13, 2008 10:22:44 AM
The problem with Wall Street's risk management tools is that they were based on the idea that asset returns are normally distributed. If you want more detail on what this means and what alternatives there are this is a good place to start your reading: http://www.nature.com/nature/journal/v456/n7219/full/456173a.html
The fact remains that a lot of nominally intelligent people--MBAs from Harvard and the like--got it wrong, perhaps because their professors--economists and financiers--relied on bad assumptions about asset returns. Or perhaps just because of cultural/institutional inertia at the banks. Who knows. But those who followed conventional wisdowm here have egg on their face.
Posted by: Dave | Nov 13, 2008 10:43:43 AM
Kevin Drum might start with this from Byron York:
On May 23, 2006, as a jury in Houston deliberated the case against top Enron executives Kenneth Lay and Jeffrey Skilling, a little-known regulatory agency in Washington, the Office of Federal Housing Enterprise Oversight (OFHEO), released a study with the dryly bureaucratic title “Report of the Special Examination of Fannie Mae.” The document received far less attention than the news from Enron, but its conclusions were stunning. In meticulous detail, it outlined a culture of corruption at the Federal National Mortgage Association — better known as Fannie Mae — that rivals the most serious corporate scandals in recent years. In this case, however, the main players are Washington insiders — some of them prominent veterans of the Clinton administration — and the scandal’s effects could ripple through Congress for years.
Read the whole thing, Mr. Drum.
Posted by: Flash Gordon | Nov 14, 2008 10:16:07 PM
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