Sunday, March 22, 2009

How Wall Street has got the US government by the ****s

I'm yet to read an article by Matt Taibbi where he doesn't drop the F-bomb somewhere -- but when it's the sixth word in the article, you know he's upset.

And with good reason. He goes into gory details of what happened at AIG and how a AAA-rated company let itself be submerged by toxic instruments, how those instruments were enabled by laws passed by people like Phil Gramm (by the way, lets stop blaming the Bush administration over this crisis: many of the crucial legislative and regulatory changes occurred on Clinton's watch), how much influence firms like Goldman Sachs have over policy (a large number of Fed and Treasury officials have been their alumni), and most of all, how Wall Street is using the crisis to line its own pockets. Go read it.

(I had no major expectations of Obama, but I must say I'm pretty disappointed so far. He seems to have no coherent vision of what to do about all this, and the recent 90% tax on bonuses must count as the rankest and most useless form of populism.)

Question for any economists reading this: Once upon a time, you decided whether or not to buy a stock by comparing its price with the earnings of the company, estimating the dividends you would get, and comparing with other investment options. Somewhere along the way, the goal of investment changed into something rather different: buy a stock in the hope that its price will rise, and sell it. It doesn't matter if it is ridiculously overvalued: if the market is going up, buy. What exactly was wrong with the old model, and how many mutual fund managers actually looked into the strengths of the companies in their portfolios before putting their customers' money into them? I can see that, in boom times, such a cautious strategy would "underperform" -- that is, Rediff Money would not list your mutual fund among the top ten that "outperformed" the Sensex by vast amounts that year. But does nobody think of the long term? (And I'm not even getting into derivatives, futures, hedge funds, and so on.)


Anonymous said...

I am an economist and know very little and care even less about the stock market. And I am not even an exception: I am aware of two much much more distinguished economists, Steven Levitt (Chicago) and Ariel Rubinstein (NYU), who have expressed similar sentiments. Levitt's blog, in fact, had a guest post by two of his colleagues, Doug Diamond and Anil Kashyap, explaining the financial crisis. Levitt's opening lines in that post speak for many of us: As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven’t got the foggiest idea what this all means.

You want to talk to people studying financial markets. While this set has a non-empty intersection with the set of economists, it is not a subset - among people studying financial markets can be found quite a few physicists, for instance. And the majority of economists aren't particularly interested in financial markets, though that's what many non-economists seem to think.

I suppose this sort of thing happens in other subjects too :-)

Rahul Siddharthan said...

Anonymous: I don't think Levitt would say he "cares even less" about the stock market. I can't imagine a molecular biologist reacting to news about a superbug, say, declaring that he "knows very little and cares even less about medicine". He may know very little, and may never contribute to designing a drug against the bug, but there would be much that would interest him. Or her.

Non-economists read about Summers advising the president, and read Krugman's fulminations in the NYT, and read about Friedmanian capitalism and a Keynesian stimulus and so on, and naturally assume that the subject is of interest to economists :) After all, if losses of hundreds of billions of dollars and a stimulus of perhaps over a trillion dollars does not interest economists, what on earth would interest them?

Anonymous said...

Okay, my last word. One, when you talk about molecular biologists, you have already narrowed down the field quite a bit, haven't you?

Two, would Levitt use those specific words? May be, may be not. Incidentally, what makes you think that *every* molecular biologist would react to the discovery of a superbug in the way you postulate?

Three, regarding what economists do and what they are interested in, the answer is many things. Some of us have quite broad interests within Economics; other are quite narrow. As elsewhere, we are also quite diverse.

Regarding your polemical question what on earth would interest them? - let me tell you this. In 1988, the future Nobel prize winner, Robert Lucas published a famous paper "On the mechanics of economic development" where he laid out the central issues and suggested that "once one began thinking about them, it was difficult thinking about anything else." Those issues, mind you, were and still are, more important than the current problems in financial markets given the number of people living in absolute poverty even now. Our country has a fairly large share of them. So did all economists (even within India) begin working on economic development or even taking interest in such issues? The answer is obvious, though Lucas's paper did, as all great papers do, generate a huge subsequent literature. We all have our interests and what appears very important to you is not necessarily so to others.

Rahul Siddharthan said...

Anonymous: and now my last word :) Many scientists would say that breadth of interests is essential in science and is what marks great scientists from good ones. I assume the same is true in economics. The current crisis is a concern for 90% of the lay people out there, who are hungry for expert and disinterested opinions and do not know where to find them, so it is startling to hear that some economists do not "care" about it. Most finance industry people are far from disinterested.

Anonymous said...

Well it seems that a lot of physicists are culpable for the wall street debacle according to NYT -
They Tried to Outsmart Wall Street

Ramanan said...

Well the crisis was not because of stocks but because of other things available and created in the market like repackaging home loans and selling it to investors. They kept accumulating it and couldnt sell it to anyone than thats when they became toxic.

The good old model of looking at company earnings doesnt work at all. So everything is wrong with that. Fund managers try to beat an index and the simple strategy of calculating P/Es and investing based on that doesnt work - it may just beat the index by fluke.