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Book Discussion: ECONNED: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism

BDBlue's picture

[Welcome, Ms. Smith -- lambert]

As I mentioned to lambert and Ms. Smith, when I first proposed this discussion I knew two things: 1) that I wanted to encourage as many people as possible to read the book and 2) that I'd want to discuss the book with others. I had no idea the author herself might stop by. No pressure.

The book is definitely worth reading and should be as widely read as possible because, as Ms. Smith notes in the book, "[t]he economy is far too important to all of us to leave to experts" especially when those experts' opinions are built on faulty assumptions and twisted for ideological reasons. And I do have lots of things I'm interested in discussing and I'm sure I'm not alone.

I don't want to hijack the discussion or direct where it goes, but I will throw a few thoughts out there to try to get us started.

First, I'll start with where the book starts and where it ends because I think there are two incredibly key points that are the crux of everything else in the book. One of these CMike already noted and that's, from page 6,

We need to implement economic policies that treat finance as the handmaiden of commerce, not its master.

And from page 308,

Only when we, the public, are able to call the underlying realities by their proper names - extortion, capture, looting, propaganda - can we begin to root them out.

We're not going to get to the first unless and until we can see reality and speak about it truthfully. It's quite clear from the capture of all three branches of our government as well as our media, that the public is on its own to a large extent when it comes to efforts aimed at seeing our reality clearly. We're not going to get help from our elites.

Which brings me to another issue raised by the book, the great extent many of our elites behave as sociopaths (if not outright psychopaths). From busting Mexican banks like pinatas to screwing over every investor they can get away with, there never seems to be any thought or empathy for the effect their economic activity has on others, not even ostensible clients.

The underlying sickness probably has many causes and the book highlights one of the main ones - the underlying economic philosophy of "free markets" that focuses on individuals, when we are social creatures even in the markets we create, and the increasing use of economic models, which optimize output, as the framework for political and social policy. When, of course, people are more than their outputs and a healthy society recognizes that. When you only measure people by their economic output, you skew their own views of themselves, which is how the Masters of the Universe come to believe they are worth every penny of their eight or nine figure salaries and fail to recognize they are essentially nothing more than welfare recipients. And, of course, if you're really that special, there's no need to concern yourself with the fate of the "losers".

One of the added problems in terms of propaganda that the book identifies is how anyone who uses the phrase "free markets" to mean something more moderate is seen as endorsing the most radical version of libertarian ideology. I would argue that we've seen with Obama that the opposite is also true. Some neoliberals use people's willingness to assume that when they use the "free market" language they mean the more moderate view to hide the fact that they, instead, mean the more radical one.

So I think that's one of my first issues - how do we propagate reality and take back our country from sociopaths (especially with the economic knife to our throat, as they continually threaten to tank the economy) or, hell, even identify the sociopaths in the first place before we put them in positions of incredible power?

Reading the early part of the book with the takedown of neoclassical economic theory reminded me of the discussion of the gas tax during the 2008 campaign*. During the campaign, Clinton proposed suspending the gas tax on consumers and raising the revenue from oil companies. Obama countered with a signed statement from, IIRC, 200 economists that said the proposal wouldn't work. This latter narrative seemed to carry the day despite the fact that the same proposal had been done in Illinois and, in fact, had passed savings onto consumers.** That result led lambert to say "It works in practice, but does it work in theory."*** While originally taken from another context, this statement seems to nicely summarize modern economics, which is more interested in theory and reaching some fantasy perfect world of equilibrium than actually improving our real world. And theory is used to shut down policy ideas or objections to proposed policies that are much larger and of a lot more consequence than some gas tax holiday. Like free trade, for example. Never mind your little prosaic concerns about how you're going to earn a living once your company can pay someone in a developing country 1/10th what they pay you, our models show free trade is good for the economy (of course, that doesn't mean it's good for most people in the economy). To make matters worse, we're seeing the faulty ideas of economics now used to support other neoliberal policies such as Obama's education policy. There's no empirical evidence that "free markets" - using a mix of charter and public schools - actually improves public education, but that's what they're doing and selling it with the same buzz words "free market" that they use to sell every other neoliberal policy.

Again, I return to propaganda - how do we combat what's become an analytical pass, the use of the phrase "free market" as if that's always an inherent good (or even true, if there were really free markets, I would never be a customer of Verizon)?

Then there's the larger, systemic issue, which is cutting off our over-dependence on debt. When I read Ms. Smith's discussion of the need to increase the cost and lessen the availability of debt, I thought of Andrew Bacevich's interview with Bill Moyers where he tied our foreign policy problems to our need for access to credit. And that brought me back again to a post on naked capitalism about how tied in our policy makers are to the banks, in part, because wars require credit (I cannot seem to find the link this morning). So our foreign policy crisis is intimately tied to our domestic policy crisis.

I don't know how to reduce Americans' need for debt from the issue of stagnating wages. Debt essentially replaced wages to maintain an American middle class. Just as speculation via leverage on Wall Street replaced real economic activity and investment. We're basically debt slaves at this point and it's not just the "losers".

Which brings me back to "extortion, capture, looting, propaganda" and making finance the handmaiden of commerce, not its master. The book offers several excellent ideas on how to start moving in that direction in terms of Wall Street, but it seems to me that none of them are even seriously being considered by our elites or discussed in the media. How do we breakthrough the propaganda bubble and break the capture on our government to end the looting and extortion?

I don't know, but talking about it honestly is an important first step, which Ms. Smith has done in her excellent book.

So what parts of the book caught your attention (I've only scratched the surface) and how do we translate knowledge into a broader discussion within our society and, ultimately, action?

* This thread is NOT going to be used to re-litigate the primary or even this issue from the primary. I only used the example because it's how I got to the bigger issue - practice v. theory.

** Note the fascinating update where the author responds to readers, including apparently the criticism that he isn't an "economist".

*** lambert informs me that this quote is "from Adam Gopnik's Paris to the Moon. Gopnik puts it in the context of the (sadly, now useless) New Yorker's system of fact-checking -- the French simply didn't get the concept. But a theory checker, well... And so, Versailles is, duh, French! No wonder all the projection...."

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BDBlue's picture
Submitted by BDBlue on

and it didn't even cover the need for better regulatory and legal framework, the various methods of fleecing being used on Wall Street, or potential connections between this book and The Shock Doctrine.

As with so much writing, if I'd had more time it would've been shorter.

BDBlue's picture
Submitted by BDBlue on

she mentions that Keynesians had no response to Friedman's analysis of stagflation in the 1970s. So we have a crisis - stagflation - and Friedman has a ready analysis and solution to implement in the face of the crisis. The other side had nothing. That's what made me think of The Shock Doctrine. Along with the banks using the most recent crisis to dig deeper into the political system.

Submitted by lambert on

alien4

However, it's not clear how to detach the parasite from the guy's head, given that it's sunk its tentacles clear into the brain, the body organs, etc.

yves's picture
Submitted by yves on

I think that captures the spirit of the book well. Having said that, tackling propaganda is likely to be a tough slog. I've become attentive to how often economists and economic journalists use the expression "free markets" assuming it's motherhood and apple pie, of course, we all think markets are great, right? But free markets, particularly in policy debates, is often code for "markets with no rules" when well functioning markets DO have rules!

I think this takes a lot of chipping, both on the level of facts and use of language.

BDBlue's picture
Submitted by BDBlue on

Personally, I think "extortion, capture, looting, propaganda" makes an excellent chant, although the elites' minds would probably be able to focus more if the chanters are holding pitchforks and torches. Speaking of which, why aren't there people out there with pitchforks and torches? Is it because the looting is so convoluted people aren't sure who to be angry at or is it some sort of learned helplessness?

yves's picture
Submitted by yves on

I recall how disappointed I was at the horrid turnout at Showdown in Chicago, maybe 2500 people. Of course, it was the winter, but there were quite a few community groups behind this effort.

Richard Kline, NC's resident polymath, has said his reading of history is that protests in America have long been working class affairs, the 1960s the big exception.

Now, I think you have a lot of people who are tired (physically), the workweek is really lone, and frankly afraid. Student debt, other debt, can't afford to lose a job, can't afford a black mark. What happens if you are on a video at a protest, or worse arrested in a society where tons of employers do background checks before hiring?

Moving money into smaller banks is one step. Another (suggested by a Congressman, but not publicly) is to stage runs on banks as a form of protest. You wouldn't want to take down a bank. but say to do it on a city or state level to demonstrate it can be done.

Submitted by lambert on

I've always remembered an admiral's answer to the question"How will we know that the aircraft carrier is obsolete," which was "When it fails in war."

It seems to me that from the perspective of the banksters, what the rest of us are experiencing as a catastrophic failure is in fact, a roaring success. Surely we can agree that another crash is coming, and quite possibly a series of crashes, until we've fallen all the way to the bottom of the stairs, and the system is no longer sustainable? That would be "fails in war" for the financial system.

It doesn't really seem like protest is an adequate response to that evolving process. And since propaganda plays such a large part in the world as we know it, it would seem that protest would be very easily integrated into the propaganda. Look what happened to our political access bloggers! (There's also the argument that Versailles wishes for and encourages violence, since it's the only thing they understand. I'm sure that they couldn't be happier if some on "the left" responded to the teabaggers windowbreaking tit for tat, for example.)

Now, one could argue under the "worse is better" mindset that the reason people don't protest is that they still have something to lose, and that when we've fallen down a few more stairsteps that won't be the case anymore. That's a very painful state of mind to encourage.

I go back to this quote from De Tocqueville that I think is still true:

Americans of all ages, all stations of life, and all types of disposition are forever forming associations... In democratic countries knowledge of how to combine is the mother of all other forms of knowledge; on its progress depends that of all the others.

The "knowledge of how to combine" hasn't been lost, but it's being applied in seemingly non-political ways. It just seems to me that there's a space for quietism and withdrawal from all forms of engagement with the system, that if applied on a mass scale, would have greater effects than any protest could have. For instance, the best answer to the propaganda really is to turn off the teebee. One obvious campaign would be to turn off the teebees in airport lounges and waiting rooms, for example.

It seems to me, again, that happiness is the key. Can a life lived under the banksters bring happiness? Increasingly, no. This should be obvious to anybody who takes a moment to reflect. Well, what would? I'd say that enabling rent seeking behavior is one such thing. Rent from cable? Get rid of cable. Rent from an auto loan? Pay it off or get different transportation. Rent from commercial software? Go open source. And so forth. Ultimately, that would erode a great many bottom lines.

This is an incoherent non-rant, I agree!!

UPDATE Assume that another crash is coming; I'm also thinking, how to prepare for it. Growing food, sharing with the neighbors... That's political, yes? No?

BDBlue's picture
Submitted by BDBlue on

for optimizing your life? Sounds pretty powerful and very political, however it's done. In fact, lambert, when I read the paragraph on page 109 after the break, I wrote in the margin "lambert - happiness is the point" because it's been your mantra for some time and I think that should be the underlying idea. Because it is a powerful - and empowering - idea, particularly with regard to one's standing vs. corporations.

Submitted by lambert on

The paragraph I think you mean on 109:

One of the fundamental problems with economics is that it is difficult to parse out political consideratiosns from those that economists would like to see as "economic" [autistic?] which in this case means limited to technocratic concerns. However, that narrow a view is simply impossible. Economists love to twiddle with models to prove the existence of optima, but that begs the question of what is society trying to optimize? Most individuals have richer goals than simply making money and buying goodies. Yet the combination of the propensity of economists to focus on greater output as the main measure of success, plus their disproportionate influence on policy means that their worldview has, over time, framed the objectives of collective action.

As long as that action is mediated through the market (which is, oddly, or not, the goal of both legacy parties, see under HCR.)

Submitted by lambert on

... what the blogosphere does, and the econoblogs have done a great job of doing it -- in terms that its audience can understand.

Not so the blogs that cover "politics" (and should be covering "political economy"). I'm rather at a loss to see how to counter a positively Goebellsian level of propaganda. (I knew there was a lot wrong, but until I read your book, I didn't realize it was all wrong, all the way down to "free markets"* as taught in the universities who gave all of our functionaries their credentials).

I'm feeling a disconnect between the kind of scams written about in the book (I like the script in Appendix A), which I think you believe have been adapted to the meanest understanding, and which I can barely get my mind around. How do people think like that? And how to we convey to ordinary citizens that the people running the show do think like that? The deliberate complexification and obfuscation seem to be key, but people seem willing to put up with it, if it comes from authority.

I remember playing whack-a-mole on WMDs in the run up to Iraq. That was effortful, and at that time the political blogosphere was more effective. This story, however, makes WMDs look like... Fisher-Price toys. It's very hard to appreciate the scale of it.

NOTE What was it Ghandi said about Christianity? It would be nice if they tried it?

BDBlue's picture
Submitted by BDBlue on

about all the efforts to sell markets was the turning of the judiciary. Of course, I knew about Easterbrook and Posner and all the rightwing appointees, but I had no idea there was an entire program set up aimed to turn the judiciary into a bunch of Friedmanites. That it wasn't just ad hoc appointments.

I'll give the bastards this, they're very thorough.

Submitted by lambert on

Funding!

And if funding-raising is the ground we have to fight on -- a la the access bloggers -- then we lose, by definition. Yes? No?

yves's picture
Submitted by yves on

The idea that economics is political has been airbrushed out. You have all these right-wingers suspicious of control by elites, yet the very ideas they spout come from an economics elite (and the right wing political types have also have a more intellectual policy arm than in the past). "Political economy" has come to have Marxist overtones, which means you don't say that in polite company.

In France, they've started to stress the autistic aspects of mainstream econ thinking, that might be a starter.

emilianoZ's picture
Submitted by emilianoZ on

I think Taleb wrote about that. I cant find it now.

letsgetitdone's picture
Submitted by letsgetitdone on

If the economists were to concern themselves wth dynamics they'd have to quickly get into consideration of non-economic variables that impact their favorite economic ones. If they didn't do that they wouldn't be able to make sense of the development of the economy over time. For years economists ignored technology, knowledge, politics, culture, and values, and they get away with it because of they deal with statics and not dynamics. Economists who have gone further like Kenneth Arrow (in later years) and Brian Arthur have found themselves wandering into Complex Adaptive Systems Theory and areas that are far away from classical economic models.

yves's picture
Submitted by yves on

The hard part is also that the big financial firms, the JPM, Goldman, Barclays level players, control the global debt markets. By policy (well maybe more by neglect), we've shifted a lot of activity from traditional banks to financial markets (securitization). That concentrates power in their hands. So a lot of the TBTF programs are unrealistic. Now that the financial markets are so concentrated, I don't see any way back from here (the minimum costs of being in that business are so high you can't attract new entrants, and you can't realistically break up that particular business, the one that gives the banks so much power). So the only solution is to regulate that aspect of the business heavily, and even a lot of the aggressive reformers are not going in that direction.

BDBlue's picture
Submitted by BDBlue on

are part of that loaded gun to our heads though, aren't they (or did I misunderstand the extortion part)? If so, how do we unload that gun or at least un-cock it so that we can regulate them more heavily? Setting aside the issue of capture in terms of political contributions, I think there's also a real fear among politicians that the Masters of the Universe will smash the place up to avoid tighter controls.

yves's picture
Submitted by yves on

I wish putting more activities on exchanges would work. But that isn't a viable idea. If you have something illiiquid (like a house, say), is putting it on an exchange going to change anything? No. The problem is that in illiquid markets, you really need market markers. And you need more end buyers and sellers to increase liquidity. Putting something on an exchange does not automagically create more end buyers and sellers.

But I do see going after credit default swaps as a big possible improvement. They are just a terrible product, no social value (the few legitimate uses come at too high a social cost). That would reduce connectedness.

For the rest, you need intrusive regulation. The crucial capital markets functions need to be regulated like utilities. The EU has more nerve, the are starting to take on Big Finance.

DCblogger's picture
Submitted by DCblogger on

if the business model is a fail, and we don't bust them up, then when they do ultimately fail, does that not make the fall out all the more worse?

a Russian friend of mine told me in 1989 that he was not worried that the West would bail out Gorbechev and keep communism running a few more years, that there wasn't enough money in the world to bail out the Soviet Union. Don't we have a similar situation with the Goldman Sachs et al?

yves's picture
Submitted by yves on

You can take the mega-banks, like JPM and Citi and Deutsche and make them separate out their capital markets operations from everything else. But they are still effectively TBTF. That is what a lot of people miss.

These firms control the global debt markets. By some measures, the shadow banking system is at least as big as the conventional banking system. The shadow banking system (securitization, repos, credit default swaps) have become crucial to commerce. What got bailed out in the crisis was the CDS and the repo markets, not conventional banking.

And there isn't any ready way to break up those markets. We can strangle CDS, as I recommend, that would help. But pretending that a new Glass Steagall is the answer is naive. We rescued the investment banks last time, remember?

Submitted by jawbone on

We're in a real pickle.

The first I heard of credit default swaps was from Bernard at the now closed Moon of Alabama blog. He was very helpful in bringing the less econ educated along. I've been watching what's happened with a sense of helpless alarm. Our Dems, as well as Repubs, seem to be in thrall to the FI part of FIRE.

This may have been one of the first times I encountered the CDO concept. I think Collateral Debt Obligations are about the same thing. Bernard railed incessantly against the naked CDO/CDS. He thought they should be outlawed and declared null and void. I really miss his voice in the blogosphere.

Thank you for your time and responses today. Please keep your blog around, OK?

emilianoZ's picture
Submitted by emilianoZ on

In Chapter 2, you describe how economics borrowed notions from physics such as equilibrium. You seem to suggest that though those ideas do not work at all for finance they seem to apply to goods markets. Can you give us an example of that? What goods or commodities seem to be in equilibrium to you? How do you recognize a state of equilibrium for a market?

yves's picture
Submitted by yves on

The analysis in economics is a static analysis. They just show markets can clear at a specific point in time.

As the engineers like to rant, static analysis is trivial, what counts is dynamics.

I wasn't able to go after that book (space and perhaps reader tolerance for the denser parts of the argument), but I'm not overwhelmed with the equilibrium assertion in goods markets either. I think you might argue a weaker form, that when goods markets get too far away from an equilibrium price (price is too high or too low), various forces step in to take advantage of the mispricing.

Submitted by gmanedit on

is Chapter Three of George Brockway's The End of Economic Man: Principles of Any Future Economics (reader reviews at http://www.amazon.com/End-Economic-Man-P...).

I haven't read your book yet (regular reader at your blog), but have read Brockway. Very accessible for someone like me who has trouble with numbers. Are you familiar with this book? (For all I know, it's in your bibliography.)

Submitted by lambert on

(besides breaking the Internet's architecture).

There's no way anybody other than the original author can fix them.

yves's picture
Submitted by yves on

Not having read Brockway's book, I can't opine, but I'm not certain I buy that physics is value free either. Contrary to what laypeople are told, even scientific theories we take as "proven" are not proven to the degree we think they are.

Submitted by Lex on

We need to implement economic policies that treat finance as the handmaiden of commerce, not its master.

This raises a question that i've been asking a lot recently (i especially like to ask it of the free marketeers who never bother answering) and asked on another thread. Does the market serve as a means to raise capital for industry/commerce or does industry/commerce serve as a means for the market to extract capital?

I think that it's supposed to be the former but has become the latter (thanks, Jack Welch you SOB). I'm no economist, so maybe i'm dead wrong or asking the wrong question.

It does, however, relate to the point about propaganda. Reasoned truth will only defeat propaganda over a very long time line, and will often only emerge from the ashes when propaganda finally fails. So do "we" need to develop a counter-propaganda message?

Could slogans like "Make the market serve industry" be more effective than trying to explain that we are in fact dealing with a perversion of free markets or the phrase being a code word for something much more sinister?

I've tried an idea with one experimental subject a few times: i ceaselessly call him out for being an economic liberal/neo-liberal, which is true regardless of his self-description as "conservative". If it's the economy, stupid, then can the weaponized word "liberal" be used against the people who weaponized it?

Unfortunately, i haven't read the book yet.

yves's picture
Submitted by yves on

You are right re the priorities increasingly being reversed. The point of capital markets is supposed to be MAINLY so companies can get funding. Then secondary trading (trading after the company sold its stocks or bonds) is necessary for investors (as in they need an exit for the paper they bought).

Now somehow the purpose of markets has become to promote/preserve the markets themselves, and to keep asset values rising. That was never supposed to be the aim of financial markets. One of the notions that the industry keeps pushing is that more liquidity is better. Really? Who does that idea serve? it's usually never proven or documentable, but is a way of financial people to stem regulation or push new complicated products of dubious value. For instance, credit default swaps are touted for promoting liquidity. Huh? They don't promote liquidity of bonds, which is where people raise money, they in fact probably detract from the liquidity of bonds (as in people will use CDS rather than bonds). And in a crisis CDS drain liquidity.

letsgetitdone's picture
Submitted by letsgetitdone on

Thanks BD Blue. This quote:

Only when we, the public, are able to call the underlying realities by their proper names - extortion, capture, looting, propaganda - can we begin to root them out.

A lot of people are calling for a change in our political vocabulary, saying that the left-right frame is not adequate to describe what is going on. I support that since the left-right frame has never been enough to describe the vaious factions in American politics ad what they believe. But certainly part of the vocabulary needed to describe reality is the old vocabulary Yves uses above. We shy away from that vocabulary, because of a desire not to appear moralistic, or shrill, or naive; but in doing so, we are losing the opportunity to tell the truth about what has been going on.

Submitted by jawbone on

especially the housing portion. Libs made the lenders offer all those subprime mortgages.

He seems to have recovered from his appearance before Congress where he admitted perhaps the Magic Hand of the Marketh had not cured all problems, that he'd thought bankers were rational actors and maybe they weren't all the time....

All is seems to take was a few more large bonuses to make all right with his world. And Repug and FOX talking points....

What can we do about this? People who think as he does?

yves's picture
Submitted by yves on

Maybe the blaming the victim meme is the one to go after.

We had housing policy since the 1960s that favored home ownership.

We also had a subprime bubble in the 1990s that corrected itself with no systemic damage.

Greenspan airbrushes out that if you look at household debt v. GDP, it rose gradually in the 1980s, rose more rapidly in the 1990s, and starting in 1999, went on a moonshot. That ain't the result of subprime lending, folks.

People need to pull out charts and hammer on it. It was a consumer debt explosion across the board, not just mortgages, and it started well before the subprime mania.

And why was supbrime such a disaster? BECAUSE FOR EVERY $1 IN BBB SUBPRIME BONDS, THERE WERE $10 OF CREDIT DEFAULT SWAPS WRITTEN ON THOSE BONDS. And worse, the CDS (per my post on Michael Lewis' The Big Short) not only kept the subprime party going two years longer than it would have otherwise, it also drove demand for the very worst mortgages. The CDS were FAR more integral to how bad the subprime mess turned out to be than housing policy.

Submitted by lambert on

... that it was the demand for debt (created by people who profited from writing it, and even from when the debts went bad!) that created a demand for the subprime mortgages, and not the other way round? This is in the book, but I'm sure I'm not explaining it precisely enough.

yves's picture
Submitted by yves on

It takes five minutes even with people who are market savvy. No joke, a Wharton grad who is now a financial journalist and interested in that angle explained it to one of the subprime shorts (Kyle Bass) and the guy did a slap in the forehead.

The strategy I described in Ch. 9 required some actual cash bonds. The firm Magnetar and its imitators needed some BBB subprime bonds (note these are a tranche of a normal subprime bond and represent only 3% of total value) to created their CDOs. They needed insurance from monolines and monolines would not guarantee a pure synthetic CDO (one made only from credit default swaps).

Their program was pushing the pipeline to generate more supbrime loans...just to get that 3% risky slice.

And the use of the CDO enables BBB risk to be sold at AAA prices. CDS prices dictate the price of actual bond issues. So the Magnetar trade was ALSO keeping BBB subprime bonds artificially cheap (by dressing it up to look like something completely different) at the same time they were increasing demand for it.

Submitted by lambert on

... so I wrote a long one." -- Pascal

Is this the sort of thing a drug dealer would do? I'm looking for simple, real world analogies, on the principle that at bottom, all cons have a similar and well understand architecture.

yves's picture
Submitted by yves on

I had wanted to debunk that Taibbi post, saying all cons are the same. It wasn't one of his best pieces.

In fact, it is dangerous because it suggests we can find the abuses easily. That in turn encourages only superficial investigation of the chicanery. We have to accept that what went on is not easily understood, it takes time and effort to unpack some of the destructive behaviors. I've spent over three years trying to understand CDOs better. It is simply not easy to get any decent information about them, most of the market G2 is tradecraft known only to insiders. I've gotten further down the curve ONLY by being able to debrief some market participants at length. And even then, I know only a couple of structures, ones that were particularly germane to the crisis.

Submitted by lambert on

I didn't mean that all cons were the same con, I meant that there are known cons that reoccur through history (as in Ur (?)).

That said.... "tradecraft known only to insiders." Yikes! (And the word "tradecraft" reminds me of a LeCarre novel...)

Submitted by jawbone on

stick to reality. Blogs like yours make the world of economics much more comprehendable to us with no background in the area. Thnx.

Yves, commenter Stoat responded to my invitation to drop to chat with you here at Corrente with this:

stoat
yves smith is unfailingly smart, well-informed and comprehensible.

how do you beat that?
Today, 2:24:49 PM

danps's picture
Submitted by danps on

Hi Yves. Your site is one of my regular stops, and my first one for financial news. I excerpted your post on Lewis earlier today because it was just about the only one to take on the flattering light Lewis shines on his protagonists.

For whatever reason (and I could go on and on about it but I won't) there's a scary tendency for financial/economic reporting to get locked into a narrative very quickly. That in turn tends to marginalize anything that doesn't agree with the narrative, and in some cases (like the major players in the Deep Capture story) leads to outright ridicule/demonization of those who don't go along.

That's one of the main reasons I value Naked Capitalism so much - the writers there are much more likely to buck the prevailing take on things. Keep up the great work - I suspect you're being read by lots of folks like me who lurk but don't often comment.

emilianoZ's picture
Submitted by emilianoZ on

In Chapter 6, you talk about unsophisticated investors such as some school districts in Wisconsin who were fooled into buying CDOs. Do you think such investors have learned their lesson and will not buy products they do not understand again or are there indications to the contrary?

yves's picture
Submitted by yves on

It's too early to tell, disasters like that come to light well after the fact.

The problem is there is a tremendous amount of both corruption and just plain lack of sophistication in the muni investing market. Most hire advisors. The advisors have an incentive to recommend complicated products to justify their fees. Why would you need to hire someone fancy to be told you really should just issue a 20 year fixed rate bond (advisors were also involved in all the scandals like Jefferson County, where municipalities funded with floating rate debt and then used swaps to switch to fixed rate).

three wickets's picture
Submitted by three wickets on

Hello yves. Thank you for visiting. A macro question for you. Japan is currently running their public debt at 200% of GDP. They have other problems, but that level of debt hasn't necessarily been catatrosphic for their economy, and their trade surplus is probably not the only explanation for that. The US is now approaching 100% of GDP debt levels. Can our public debt extend further out like the Japanese without deep reprecussions on our recovery or solvency as a nation.

yves's picture
Submitted by yves on

I think they concern re public debt levels in a country that issues its own currency IN AND OF ITSELF is overdone. I think the debate around debt levels is misframed.

Borrowing to fund productive investment isn't a bad thing. If the borrowing was serving to lessen the pain of deleveraging (which can easily turn into a vicious cycle as it did in the Great Depression) that would be one thing. But we see no deleveraging occurring in the economy overall. The debt is being issued increasingly to validate the outstanding debt (particularly in the case of banks). We need more restructuring of the bad debts and reform. We are getting neither. So in this case, the increase in public debt looks to be throwing good money after bad.

DCblogger's picture
Submitted by DCblogger on

Yves, have you sensed any interest in your work from some of the more reality oriented investment newsletters? I am thinking of Grants Interest Rate Observer and that sort.

yves's picture
Submitted by yves on

I only get newsletters randomly when hedgies send them to me.

Having said that, Bridgewater is well respected. One of my buddies is keen on Stephanie Pomboy and Joanie McCullough. Joanie in particular is on to market/accounting games and is a brutally pointed writer.

DCblogger's picture
Submitted by DCblogger on

of your interest in them than their interest in you.

I read the financial trade press from time to time, Investment News in particular, and I sense no understanding that their industry is fundamentally broken. In autumn of 2008 they were all in racial scapegoating mode, community reinvestment act and all. I don't see that so much nowadays, but I see no recognition that fundamental changes must be made within the industry.

yves's picture
Submitted by yves on

One of my buddies forwards her newsletters to me occasionally and scolds me that I can't blog about it. She is independent, or in a very small shop, not sure which.

letsgetitdone's picture
Submitted by letsgetitdone on

Hi Yves, Thanks for visiting Corrente and chatting. I've noticed that you've been covering providing space to Randy Wray, Marshall Auerback, and Rob Parenteau. Do you have disagreements with the MMT school in the area of theory, and, if so, what are they?

yves's picture
Submitted by yves on

MMT really does tell you how the system works with floating currencies. People get really offended when they see some of the conclusions (like in the discussion with Spain, that if you require the private sector and public sector to delever at the same time, you need a massive increase in exports to keep the economy from contracting massively, and it is not obvious how you have that happen).

MMT shows you choices. People don't like seeing the tradeoffs it reveals.

Now some of the MMT folks IMHO go too far in opposing what they see as overdone theology re lowering government debt levels. They are right to say that when (when, mind you) the private sector is deleveraging, some increase in public debt is not an awful thing, indeed the alternatives are much worse. I think if they approached the problem that way, and pointed out the private sector deleveraging, they'd have lot more acceptance of the argument many of them make.

letsgetitdone's picture
Submitted by letsgetitdone on

You think the theory is pretty sound but that its advocates sometime overstate the practical implications. Is that a reasonable interpretation of your view?

yves's picture
Submitted by yves on

They get so busy arguing with what they call debt vigilantes that they sound indifferent to debt levels, which is not the case. Too many people engage in black or white thinking, and by attacking the debt vigilantes, the MMT types wind up being seen as if they are endorsing the opposite view, which is not the case. Opposing one extreme does not mean you like the other extreme.

emilianoZ's picture
Submitted by emilianoZ on

In the book you describe the change in culture in investment banks, how traders or salesmen started boasting about "ripping someone's face off" as Partnoy puts it. Morgan Stanley did this for instance with the Banamex stuff. But Morgan Stanley is still here. How do you explain that costumers do not punish the banks that ripped them off? Do they have no choice or do they not care?

yves's picture
Submitted by yves on

People are trained to fall for social cues. If someone acts sincere, they think he is sincere.

Derivatives salesmen are very good actors.

And the more sophisticated investors hate admitting to themselves that they were had, it's easier to blame bad luck of some sort.

Plus investors are under performance pressure. If everyone in your peer group shows better short-term returns by doing something you know to be stupid....you will get hassled and maybe fired for being a Luddite and sitting on the sidelines. All the incentives are to follow the lemmings.

BDBlue's picture
Submitted by BDBlue on

I once represented some boiler room brokers and while they did rip off a fair number of truly innocent people, there were also a fair number of folks who knew what they were investing in (or at least suspected) but thought they'd simply not be one of the folks who got screwed on the end. Basically, they thought the brokers would take care of them, get them into the stock, manipulate the price up and then get them out of it before it crashed. They thought they were special, that the people who lost out when it crashed would be people other than them. In part, they thought that because they were wealthy and, therefore, special (fwiw, doctors, who think of themselves as smart and special, seemed to be the best scam targets for a stock scheme). But the brokers were also very good at making their clients think that they had a special relationship with them that others didn't share. Sure, the brokers would screw a client, but they'd never screw a friend. In the end, of course, they screwed everyone because that's how these things work.

BDBlue's picture
Submitted by BDBlue on

As someone who has been on both sides of the regulation equation - representing the regulated and the regulator - I've come to respect that no matter how you draft regulations, people will find new and exciting ways to both avoid them and/or violate them. I'm also reminded of something a securities lawyer I used to work with would say "fraud is a visceral concept", meaning that if the SEC thought the client ripped somebody off, then they'd find a way to take action regardless of exactly what the regulations said.

yves's picture
Submitted by yves on

Look at the nonsense we are having with credit card regulation. All sorts of new restrictions were imposed, yet you see the big card issuers coming up with new ruses to reinstitute many of the bad practices with new fees that are permissible under the new rules that accomplish much of the same thing as the old fees did.

Maybe we need an Elizabeth Warren rule (not that she proposed this, mind you). "You can have any kind of credit card agreement provided the annual rate does not exceed X (or X over some rate) and you can put the entire agreement on two sides of a single page in 12 point typeface". She had noted that credit card agreements in 1980 were one page long. They are now 35 pages when you include all the riders.

three wickets's picture
Submitted by three wickets on

As I understand it, moral hazard is risk taking without accountability. Would seem the only accountability that can matter to security traders is either immediate impact on compensation or the breaching of laws and regulations. We hope for the latter with the current financial reform, but there seems to be no movement on executive compensation. Is compensation reform a lost cause in your mind? Because if moral hazard if always backstopped by other people's money or govt bailouts, there won't be change in behavior.

Submitted by lambert on

[Thanks, Yves, for coming. This is great. Thanks BDBlue, for putting this together. Maybe we could do it again, since I think we're going to have more questions thatn answers...]

Is finance a feminist issue, and if so, why? [I don't mean personal finance, but the global system of finance as described in ECONned]

Riggsveda's picture
Submitted by Riggsveda on

Hi Yves, and thank you Correntians for putting this together.

One of the reasons I've enjoyed following you so much, Yves, is that you have a fearless attitude toward the conventional wisdom of your field, and a willingness to describe what is right in front of your face. My question to you is: if we cannot break the backs of the monopolies that got us into this mess, what realistic alternative do we have to living in a feudal estate? Barry C. Lynn, who introduced me to the concept of monopsony, stated that it's (in great part) our failure to enforce anti-trust laws, combined with the rise of the Chicago school during the Reagan period, that led to the failure of the financial market. The growing consolidation of so-called "free markets" via mergers and acquisitions over the last decades has given enormous power to the financiers who engineered them, which in return allowed them to concentrate political power to change the law and how it was enforced. That power allowed them to craft new corporate entities that shielded them from any responsibility for their actions, and create the economic philosophical justifications that freed them from any common-sense regulation. It seems that without the destruction of our current monopolies we will never break the hold those in power have to influence law in a way most profitable for themselves. Yet what was it that happened when the financial giants began to crumble in 2007? Our own government colluded in engineering and even forcing more mergers, which left us even more at the mercy of "too big to fail" excuses. What do you think ? If the break-up of the banks is an impossible goal, how on earth can we ever regain the power they have stolen from us?

Submitted by lambert on

Why don't you drop in with some crossposts? Gotta go, seriously, but good to see ya, good to see ya,

DCblogger's picture
Submitted by DCblogger on

don't be a stranger!

BDBlue's picture
Submitted by BDBlue on

I couldn't help noticing how many of the fathers of neoclassical economics had the words "Nobel Prize" in front of their names and I was wondering if you had any thoughts on how the Nobel has been used to give economists more gravitas than they might otherwise have as a profession.

Also, I was wondering if you've seen any indication that the profession is rethinking the way they do business in light of the financial collapse. Watergate literally changed the way lawyers were trained (even if the torture scandal makes me wonder if it was enough), but as an outsider, I see no signs that the economics profession is engaged in any kind of soul searching.

emilianoZ's picture
Submitted by emilianoZ on

In the book, I think you start talking about "money markets" without defining them. Can we have a short description: what they are, their characteristics, their importance, who participates in them and why?

Submitted by lambert on

Yves, you introduced me to William Black, and his concept of accounting control fraud.

Why do you think that Black's thinking hasn't made it into the mainstream? I can think of at least one liberal economist with a very large bully pulpit, who hasn't given him so much as a mention. Is the corruption so pervasive that even the mention of it in the wrong context would lead to systemic failure?

BDBlue's picture
Submitted by BDBlue on

Thanks to everyone who participated (and please feel free to continue to participate, I'll leave this stickied). I want to particularly thank Ms. Smith for coming by and for giving us so much to think about with her book and her blog.

CMike's picture
Submitted by CMike on

[I wish I could have been here earlier. I haven't finished ECONned yet, but, in my defense, I am reading it closely. Maybe it's for the best I wasn't here because I am going to go on a tangent by taking issue with an example Yves Smith uses to illustrate one particular theme of hers among the several she develops in her book. With that said, I will go ahead and post my bone of contention. Note: I've taken the liberty of referring to Yves by her first name, which I would be comfortable doing if I was commenting at her blog, though it feels a little awkward doing so here. I don't address Yves directly, as if she's reading this, because I assume she's long, long gone by now and I didn't want it to sound like I'm expecting a reply from her.]

Early in Chapter 2, Yves blames the machinations of speculators for driving the barrel price of oil up to $147 in July of '08. She asserts those 89% of economists, surveyed by the WJS in May '08, who blamed the then rising oil prices on market fundamentals didn't know what they were talking about; that they had led themselves astray by relying too much on the core of their discipline's methodology, i.e. simplified models.

I happen to agree whole heartedly that economists do lead themselves astray because of this reliance. As an example, the unshaken faith of most credentialed economists in the merits of free trade, based on the theory of comparative advantage, borders on the delusional at this late date. But I don't think it's clear economists were wrong in the conclusions they came to, to explain the cause of the rise of oil prices in '08.

The author directs some particular scorn at Paul Krugman and the model he relied on to conclude that market fundamentals caused the sensational run-up in petroleum prices. There's a problem here because Yves seems to be asserting her view as if it were today's established conventional wisdom. Actually, the jury's still out on what caused the rise of oil prices in the first half of 2008. However, barring a discovery of massive new reserves, we are going to have a verdict in this case once world oil consumption levels are back at their previous highs and on the rise from there.

In explaining her view, Yves rejects both of the "central arguments" Krugman used to explain how the spot price for a barrel of oil got to $147/bbl. As to what she labels his "first" argument, Yves seems to have misunderstood what Krugman was saying. The professor claimed that if the rise in the price for oil was not due to the consumption levels by end users then there would have been evidence of a build up of "excessive inventories." Yves countered that, in fact, China was stockpiling diesel and the United States was adding to its petroleum reserve during the first half of 2008. The problem here is that, when Krugman pointed out that there was no evidence of "excessive inventories" being stored, he was referring to any which might have been stored for the purpose of manipulating oil market prices.

When governments buy a strategic resource and store it for strategic reasons or to guarantee themselves the ability to maintain industrial planning time schedules and cap future expenses they, like other end users, will impact the spot market price of oil but they are not trying to manipulate it. Governments like to have their own stored supply of hydro carbons as insurance against future interruptions of supply that could lead to civil unrest, say, or limit the military options available to its policy makers during a crisis.

By the way, at 70,000 barrels/day the U.S. was adding to its strategic reserve at a rate that would only accumulate one day's quantity of total world oil consumption every 1200+ days and then the U.S. suspended those purchases in May, '08.

Yves cites Bart Chilton as a person who authoritatively declared conclusions that the early '08 price rise "were the result of supply and demand relied on 'deeply flawed data.'" However, if we follow the footnote for this claim we end up at a July, '09 WSJ article that reads in part:

In a contentious report last year, the main U.S. futures-market regulator pinned oil-price swings primarily on supply and demand. But that analysis was based on "deeply flawed data," Bart Chilton, one of four CFTC commissioners, said in an interview Monday.

The CFTC's new review, due to be released in August, adds fuel to a growing debate over financial investors...

The review also reflects shifting political winds. Under Chairman Gary Gensler, appointed by President Barack Obama, the CFTC is departing from the more hands-off approach it took under its previous head, a George W. Bush appointee...

The U.K.'s Financial Services Authority has found no evidence that speculators are behind big oil-price swings, people familiar with the matter said Friday. This view, made by the overseer of one of the world's biggest financial markets, contrasts with an opinion piece published in The Wall Street Journal two weeks ago, by French President Nicolas Sarkozy and U.K. Prime Minister Gordon Brown, who said governments need to act to curb "dangerously volatile" oil prices.

Yves cites George Soros and references other commodity trading experts who, at the time, claimed "the skyrocketing prices to be at least in part the result of speculation, not merely supply and demand." The source offered for this is a May, '08 article:

In an interview with The Daily Telegraph, Mr Soros said that although the weak dollar, ebbing Middle Eastern supply and record Chinese demand could explain some of the increase in energy prices, the crude oil market had been significantly affected by speculation.

"Speculation... is increasingly affecting the price," he said. "The price has this parabolic shape which is characteristic of bubbles," he said.

Now it may be that a necessary condition, that must be present to conclude that there is a bubble, is that when a commodity's price over time function is drawn on a graph that it be in a "parabolic shape." However, that shape is not a sufficient basis on which to conclude the price for a commodity is the result of a market bubble. The same article goes on and Soros is quoted saying some things that didn't seem to advance his thesis that speculators were causing the bubble:

At just over $130 a barrel, the price has doubled in around a year, causing misery for motorists and businesses.

However, Mr Soros warned that the oil bubble would not burst until both the US and Britain were in recession, after which prices could fall dramatically.

"You can also anticipate that [the bubble] will eventually correct but that is unlikely to happen before the recession actually reduces the demand.

"The rise in the price of oil and food is going to weigh and aggravate the recession."

Yves also claims a spiraling feed back loop repeatedly caused OPEC to raise its asking price for a barrel of oil because the organization had "moved away from pricing based on the spot market and used formula prices based on a weighted average of futures prices. Thus, contrary to what Krugman said, future prices were...according to the Oxford Institute for Energy Studies, 'the heart of the current oil-pricing regime.'"

I'm not following. If OPEC will not sell when the spot price is below this weighted average then OPEC has to lower the amount of the supply it's offering the market until the spot price rises to the level OPEC will accept. As far as I know, throughout the period of the price run-up in '08 the OPEC supply to the world market was increasing. (See the Production chart on frame 8 in this 48 frame British Petroleum pdf. 2008 OPEC production was up for the year unlike that of other producers.) Whatever the basis OPEC relies upon to create its initial ask price, the market supply clears only at a price point at which consumers and investors will buy all of the supply offered.

Well, the proof will be in the pudding. Yves passes on a Jeroen Van der Veer quote from an April '08 Washington Post article when oil was around $110/bbl. Van der Veer, chief executive of Royal Dutch Shell, said, "The fundamentals are no problem. They are the same as they were when oil was selling at $60 a barrel." That was the price oil was trading for back in March of '07 when the world consumption rate was, by my extrapolation from the BP numbers, 1.2% or so lower than when Van der Veer made this comment. According to the article (my emphasis):

Shell's Van der Veer said he expects a crunch in energy markets in 10 or 15 years. "The easy oil and easy gas will not be sufficient," he said.

So, is it Yves' contention that as the economy recovers we will not be seeing any spikes in the oil price like the succession of ones that occurred throughout the first half of 2008 if the markets for oil futures are properly regulated? I'll give the bruised Paul Krugman the final word here. This is from a February 22, 2010 blog post of his with the header, "The Oil Bubble Controversy, Revisited:"

...Oil prices did spike to triple-digit levels in early 2008, then drop sharply. But think about the fact that right now, with the world economy still seriously depressed, oil is at $80 a barrel. This suggests to me that high oil prices are largely caused by fundamentals.

And it also suggests that resource constraints will be an issue if and when we do get a full recovery.

Brian.Nelson's picture
Submitted by Brian.Nelson on

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