Das is Worried: 'Crunch Porn' on Financial Publications, Including Roubini

The author of the best and most interesting book ever written financial derivatives ( and dare we we say about 'finances', period?), has written a new blog entry in which he reviews and comments about several new financial books. Fabulous writing, as usual, from Das.

In the process he also makes fun of Roubini...

Satyajit Das is currently a risk consultant and author of the great, fantastic, must read "Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2010, FT-Prentice Hall)". 5 stars.




Mr. Das is very worried. He says that the 'publisher led recovery', which he calls "crunch porn" or, more kindly, "crash lit" has entered a new and more dangerous stage and economists have begun to hold forth on the problems. "

Keynesians, Monetarists, Cavaliers, Roundheads and Vegetarians are stirring to give their own views of reality and putative solutions. Worryingly, at least two of the books are now in the Best Seller lists for Business Books".

"A key characteristic of the emerging tidal wave of books is the fact that almost everyone saw the writing on the wall, predicted the crisis and now moreover have solutions that can ensure that this was the crisis to end all crises. Unfortunately in the prediction stakes no economist can claim the prescience of Pope Benedict XVI. According to Italian Finance Minister Giulio Tremonti (as reported on Bloomberg News (20 November 2008)), the Pope, then merely Cardinal Joseph Ratzinger, in an article written in 1985 predicted that "an undisciplined economy would collapse by its own rules". It is unclear which crisis the Holy Father was predicting, but given papal infallibility, probably all of them.

In the wonderfully titled "This Time is Different", Carmen Reinhart and Kenneth Rogoff expand on their recent academic papers and empirical work on "eight hundred years" of financial crises. Marshalling a mind numbing array of statistics and data, the authors find similarities between financial crises. Their conclusion is that the cause is excessive debt accumulation by government, banks, corporations or consumers. The combination of excessive leverage and short-term debt lies at the heart of the problem.

If you are unsurprised at the predictable conclusions, "This Time is Different" provides solid empirical support for the intuitions. The book misses an essential point "This Time is Different" depends on identifying the correct base precedent that is being used for the economic state being studied.

The interesting part of the book is the evidence of what happens after a financial crisis. The authors show that severe financial crises share the following characteristics:

• Declines in real housing prices averaging 35% over six years.
• Equity prices fall an average 56% over 3.5 years.
• Unemployment rises an average of 7% during the down phase with average length of four years.
• Output falls more than 9% over a two-year period.
• Government debt increases an average 86% in real terms, as a result of the collapse in tax revenues, counter-cyclical fiscal policy efforts and spiking interest rates.

So much for a ‘V’ shaped recovery! But "this time is different".

To prevent future crisis, Mrs Reinhart and Mr Rogoff propose a new global financial regulator and improving the IMF (Mr Rogoff’s former alma mater where he was once chief economist). Puzzlingly, they are not optimistic about their reforms: "The persistent and recurrent nature of the ‘this-time-is-different’ syndrome is itself suggestive that we are not dealing with a challenge that can be overcome in a straightforward way."

Raghuram Rajan, Professor of Finance at the University of Chicago Booth School of Business and former chief economist at the IMF (there seem to be a lot of those going around!), did warn about the risk of the global financial crisis. His early warnings led to the economist’s version of a duel at dawn (only with irony and sarcastic epigrams) at a conference held at Jackson Hole.
In "Fault Lines" Professor Rajan’s focus is on deep-seated problems in the global economy, including the absence of income growth, employment, health care and the problems of global capital and trade imbalances. Bravely, he argues that the over borrowing that caused the problems was an entirely ‘rational’ response to a deeply flawed economic and financial system. He also identifies growing inequality as a theme in the problems. He argues that these "fault lines" are the real problems rather than a group of greedy bankers taking irrational risks.
The "Fault Lines" position on bankers is at odds with "13 Bankers", co-written by Professor Simon Johnson and James Kwak, a former McKinsey consultant. Expanding on their earlier Atlantic Monthly piece "The Quiet Coup", the authors outline the thesis that big banks, especially in America, have used their economic power to gain political power.

The economic power of the banks derives from their growing importance in the broader economy as measured by share of corporate earnings and stock market capitalisation. This economic strength is then leveraged using lobbying, campaign contributions and the transition of staff between Washington and Wall Street.

"13 Bankers" sees a conspiracy in this arrangement and also considerable danger. Like all good conspiracy theories there is some validity in the argument.

Suggestions of political influence and a palpable lack of transparency in recent government actions to bail out banks have emerged. There are allegations that the Henry Paulson, the previous U.S. Treasury Secretary, may have "pushed" Bank of America to consummate its controversial acquisition of Merrill Lynch when it sought to withdraw after additional losses came to light. The "closeness" between banks and government officials and regulators that has been exposed is increasingly part of the problem in dealing with the real issues.

The thesis in "13 Bankers" is similar to the work of Mancur Olson, the American economist. In his books ("The Logic of Collective Action" and "The Rise and Decline of Nations"), Olson speculated that small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The policies result in benefits for the coalitions and its members but large costs borne by the rest of population.
Over time, the incentive structure means that more distributional coalitions accumulate burdening and ultimately paralysing the economic system causing inevitable and irretrievable economic decline. Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, may illustrate Olson’s thesis. Active well funded lobbying efforts and "regulatory capture" is impeding necessary actions to make needed changes in the financial system.

"13 Bankers" is grounded in a traditional American fear of a financial oligarchy, dating back to the fights between Thomas Jefferson and Alexander Hamilton over the "Bank of the United States" and Franklin Roosevelt’s Depression-era regulation of finance. While American banks may certainly be powerful and highly influential, the case for a conspiracy is not entirely convincing.

Bankers are keen to pick the pockets of anybody including each other. The highly nuanced differences in the positions of individual banks are unlikely to be consistent. Bankers agree and disagree with each other on about the same number of issues. One online commentator noted the intersection between Wall Street, Constitution Avenue and Main Street was best named: "Confusion Corner".

In addition, the potential risks of such a powerful clique are not fully explained. Large banking and other industrial complex dominate many nations and economies with not always negative consequences.

The authors’ remedy is to cap the size of banks as a percentage of the economy. This may not be effective without reform of campaign finance rules, restrictions on political appointees to many positions, reform of the central banking system and other measures.

Nouriel Roubini (who had inherited the mantle of "Dr Doom" from Henry Kaufman) also predicted the global financial crisis. In case you didn’t know this, statements like the following ensure you are left in no doubt: "Roubini’s prescience was as singular as it was remarkable: no other economist in the world foresaw the recent crisis with nearly the same level of clarity and specificity." The problems of joint authorship and reference to only one of them presents challenges within the English language.

In "Crisis Economics", Professor Roubini with co-author Stephen Mihm take a distinctly Minsky line in analysing the global financial crisis. They argue that financial crises are the result of a confluence of historical and economic factors. Building on Hyman Minsky’s "stability is itself destabilising" hypotheses, "Crisis Economics" blends economy theory, behavioural economics and agency theory to try to explain the present crisis. The authors conclude that financial systems are inherently fragile and prone to collapse. Interestingly, while it is wary about the value of theories, statistics and mathematical economics and finance, "Crisis Economics" argues that crises are not only predictable, preventable and, with the Roubini/ Mihm brand medicine, curable.

Professor Joseph Stiglitz’s "Freefall: Free Markets and the Sinking of the Global Economy" and Robert Pozen’s "Too Big To Save: How to Fix the U.S. Financial System" focus less on the cause of the crisis than on solutions.

Professor Stiglitz believes that the origins of the present crisis lie in neo-liberalism and its fascination with free markets and de-regulation. Correcting these problems, Professor Stiglitz produces an extensive list of policy reforms. On the way, the author launches into often abrasive attacks of the government actions to date.

The analysis of the causes of the crisis is not original. His criticisms of policy actions range from insightful to assertions that need supporting facts. "Freefall’s" call to action disappointingly ends rather tamely in a serious of well-worn prescriptions for stronger regulation (by the same apparatus that caused the problems) to correct market failures. Somewhere, Professor Stiglitz finds the time to argue for a less materialistic society and adoption of something akin to Bhutan’s measure of Gross Domestic Happiness ("GDH").

"Too Big To Save" is light on causes (thankfully) and long on lengthy lists of proposals. The proposals themselves focus on analysing alternative models for government stakes in banks, new board structure for large financial institutions, jurisdictional issues over systemic risks and the securitisation of loans. None of the proposals are startling or differ much from that offered by others. Some are in the process of being implemented.

Both "Freefall" and "Too Big To Save" tend to telesis ascribing events to innate, inexorable facts. Reality is far more nuanced than such a simple view of history. Perhaps this why economists generally tell you tomorrow why what they forecast yesterday didn’t happen today.
Both books also embrace regulation and regulators freely whilst being critical of regulators as lacking in skills and beholden to special interests. The faith in government activism is perverse. It fails to consider why a new set of rules will necessarily be more effective and existing regulators will be able to deal with complex issues well above their pay grades. This is particularly the case when the same regulators failed in the very same tasks in the lead up to this crisis. This dissonance is striking.

In "ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism" Yves Smith, the creator of the Naked Capitalism website, provides an edgy and interesting antidote to the other books on offer. It is an anti-economics economics book that explores the failures of the discipline itself as revealed by the global financial crisis.
Ms Smith argues, consistent with Professor Rajan, that the proximate causes (excessive leverage, global imbalances and model failures) are symptomatic of deeper financial problems. "ECONned" focuses on a central issue - the role of economists as policy-makers and the weaknesses of economic thought. The thesis is that economists, some in key policy making roles, relied on dogma ignoring the dangers that eventually led to the financial crisis. The book’s coverage of the sequence of errors, misrepresentations and rationalisations of poor outcomes and instability is revealing.

"ECONned" is strongest in its coverage of the role played by economists in the crisis and the flaws in the widely used financial models and concepts that created the conditions for the crisis.
The books, with the exception of "This Time is Different" which lurches around a space time continuum that would have made Dr. Who giddy, are primarily American in focus. For the main part, the world ends appears to end at the Atlantic and Pacific Oceans (Mexico and Canada are American off-shoots in any case). American exceptionalism extends to financial crises or it must seem to the reader.

The style of these books varies. The tone is mostly the desiccated drone (reminiscent of John Cage’s experimental work from the 1960s). Some are deliberately academic in tone to achieve the correct type of unreadability. One assumes that they are weapons deployed in the dawn duels between economic scholars.

"This Time is Different" is not wholly successful in condensing its stupefying density of data and facts into an accessible tract. The book favours the repetition of minimalist music. Aaron Brown (who authored a less than complimentary review in the Wilmott Magazine) noted that the book uses the word "inflation" 154 times, "default" 220 times and "crisis" 253 times. It also repeats the title phrase "This Time is Different" from time to time in a form of economic incantation.
"Freefall" reads like a 19th century pamphlet with equal measures of vitriol, self-righteousness and broad prescriptions. "13 Bankers" and "ECONned" are written intelligently with the non-technical layman, rather than the "econo-wonk", in mind.

It seems that the global financial crisis is the economist’s moment in the sun. They are busily "solving" the problem, sometime with pet theories or, more often, rehashing old ones. Unsurprisingly, there have been spats between economists with allegiances to different camps. Most notable fights include Paul Krugman versus Stephen Roach, Martin Wolf versus Niall Ferguson etc. If Friedman had been alive, then it would have been Milton versus all comers. If Keynes had been alive, then the jousts would have at least been witty and cultured. No modern economist can touch Keynes and John Kenneth Galbraith for pungent wit.

Most economists, it seems, believe strongly in their own superior intelligence and take themselves far too seriously. In his open letter of 22 July 2001 to Joseph Stiglitz, Kenneth Rogoff identified this problem: "One of my favourite stories from that era is a lunch with you and our former colleague, Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, "Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?" I responded something to the effect of "Well, he was arguably the greatest Federal Reserve Chairman of the twentieth century" To which you replied, "But is he smart like us?" Economists have delusions of adequacy and a related assured self-confidence that they bring to any problem.

Rogoff went on note that in one of Stiglitz’s books – "Globalisation and its Discontents": "… I failed to detect a single instance where you, Joe Stiglitz, admit to having been even slightly wrong about a major real world problem. When the U.S. economy booms in the 1990s, you take some credit. But when anything goes wrong, it is because lesser mortals like Federal Reserve Chairman Greenspan or then-Treasury Secretary Rubin did not listen to your advice." Rogoff concluded that Stiglitz was "… a towering genius. Like your fellow Nobel Prize winner, John Nash, you have a "beautiful mind." As a policymaker, however, you were just a bit less impressive."

Writing in his preface to Benjamin Graham’s "Intelligent Investor", Warren Buffet observed that: "…not only does a sky-high IQ not guarantee success but it could also pose a danger…I therefore urge the relevant regulatory bodies of the United Studies and Canada to incorporate an IQ test into their securities licensing exams. … nobody would be allowed to work in the financial markets in any capacity with a score of 115 or higher. Finance is too important to be left to smart people."

One could add economics should definitely never be left to economists".

Link to Al Books Reviewed:

Carmen M. Reinhart & Kenneth Rogoff (2009), This Time is Different: Eight Centuries of Financial Folly; Princeton University Press, London




Raghuram G. Rajan (2010) Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton University Press, London




Simon Johnson and James Kwak (2010), 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown; Pantheon Books, New York




Nouriel Roubini and Stephen Mihm (2010), Crisis Economics: A Crash Course in the Future of Finance; Penguin




Joseph Stiglitz (2010), Freefall: Free Markets and the Sinking of the Global Economy; Allen Lane, London




Robert Pozen (2010), Too Big To Save: How to Fix the U.S. Financial System; John Wiley, New Jersey




Yves Smith (2010), ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism; MacMillan