Monthly Archives: September 2008

Nostalgia For iBanking Literature

Wolfe isn’t the only novelist to capture the pulse of finance. With Bombardiers, Po Bronson stole fire from Joseph Heller, Thom Jones, sat in a closet–yes, he did, with REM’s It’s the End of the World playing on repeat–and emerged with a hypnopompic literary style, thundering with wraparound dolby sound effects. I assure you there is wisdom in this. It captures spirit of the last week better than any article I read in all 2000 pages of the New York Times. Listen to this one sentence alone:

It was a filthy profession, but the money was addicting, and one addiction led to another, and they were all going to hell. 

 Or perhaps more prophetically: 

When the sun didn’t come up and instead their tower was socked in by clouds and fog, the other world existed even less than usual; they could not see the streets below, or most of the shorter buildings, and they were one of the few spaceships in the sky. The next attack could come from anywhere. The economic forecasts were useless. The fundamentals were ignored. The Federal Reserve was unpredictable. Money supply meant nothing in a global market. The Yanks followed the lead of the Japs, and the Japs followed the Krauts, and the Krauts followed the Yanks. They waited for instructions from the top, but their standing instructions were to sell first and not wait for instructions. Nobody knew where the market was going, but those that knew less than others lost their shirts and had their eyes ripped out and were made to swallow. In the mornings, there was always a chance to make it back. Later, the government would bail them out.

That was written in 1995. Attorney Generalissimo Cuomo wasn’t even at HUD yet.

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Wolfe’s on Greenwich Time

I can’t think of another novelist whose opinion on social matters is sought out like an oracle’s. (Could it be because he’s the last great hope for social realism in literature?) Imagine newspapers calling up Philip Roth and asking him about hedge funds. Would anyone care? Anyhow, here’s the oracle of social realism in today’s Times

The Masters of the Universe are smarter than the people they left behind at the investment banks. Their hedge funds have blown up here and there, but unlike the investment banks, they are still very much in business. They have hurriedly pulled themselves into defensive positions inside their shells, like turtles. Their Armageddon, if any, will not come for two more days, which is to say, Tuesday, Sept. 30.

Most hedge funds open up a crack on Sept. 30, Dec. 31, March 31 and June 30 to give investors the chance to “redeem” their investments, meaning take their money out. These moments are called gates, like a series of gates in a prison. The gate is the limit, the fixed percentage of your money, that the fund will allow you to take out at one time. Even with these strict caps on withdrawals, some funds may end up nothing but shells.

Shed no tears for the Masters of the Universe, however, not that your correspondent actually thought you might. Most of the young Masters already have their own personal nut free and clear. “Nut” is the term for the amount of money you need salted away in weather-proof investments in order to generate enough interest to live comfortably in Greenwich on Round Hill Road, Pecksland Road or Field Point Road in a house built before the First World War in an enchanting European style, preferably made of stone featuring the odd turret, with a minimum of five acres around it and big enough to be called a manor. Every Master of the Universe knows the number.

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Obama is the Next Bush

So says the always respectable, if heretical Steve Landsburg. He writes: 

McCain is not Bush. This came as a surprise to me. I’d been assuming, in my ill-read, uneducated way, that McCain had been complicit in most of the great travesties of the Bush administration and the execrable Republican Senate. I’ve learned that’s largely untrue. He voted (to my great surprise!) against the prescription drug entitlement, against the Farm Security Bill, against milk subsidies, against Amtrak subsidies, and against highway subsidies.

Obama, by contrast, is in many ways a continuation of Bush. Like Bush (only far more so), Obama is fine with tariffs and subsidies. Like Bush, he wants to send jackbooted thugs into every meatpacking plant in America to rid the American workplace of anyone who happens to have been born on the wrong side of an imaginary line. Like Bush, he wants a more progressive tax code. (It is one of the great myths of 21st century that the Bush tax cuts made the tax code less progressive; the opposite is true. If you are in the bottom 38% of taxpayers, you now pay zero income tax—and therefore have an incentive to support any spending bill that comes down the pike.) Like Bush, he wants more regulation, not less.

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Culpable Rating Agencies

S & P, Moody’s & Co., and Fitch–a portfolio manager tells me I shouldn’t overlook the culpability of these rating agencies for misjudging and then cloaking the risk involved in the sub-prime mortgage market. By law, investment banks and other financial entities would have been prohibited from adding so many risky mortgage-backed securities to their books. Pension funds, banks, money market funds, and insurers can only buy debt rated “investment grade” by a Nationally Recognized Statistical Ratings Organization (NRSRO). The SEC doles out this “recognition” and S&P, Moody’s, and Fitch are the only rating agencies so recognized. Since these rating agencies assessed the sub-prime packages as top shelf debt–AAA-the banks took the bait and swallowed the hook. When the debt was finally downgraded, the crunch followed. 

You would think that independent rating agencies would have every incentive to provide reliable information. But that would assume there was an open market for rating agencies, one without any barriers to entry. Unsurprisingly this is not so. According to Forbes

Regulators have long kept other agencies from competing with Moody’s, S&P and Fitch, despite their supporting roles in high-profile blowups like Enron and the 1997 Asian financial crisis. How? By requiring that only firms that the Securities and Exchange Commission designates as Nationally Recognized Statistical Ratings Organizations can be the final word on credit quality. Since the NRSRO designation is the only one that matters to world’s largest investors and financial institutions, Moody’s, S&P, and Fitch essentially have a lock on the trillions of dollars in debt issued each year…In order to be considered for the designation, the SEC requires a firm to be “nationally recognized” as an “issuer of credible and reliable ratings” by “the predominant users of securities ratings.” But since predominant users, like pension funds, are required to use NRSROs, smaller firms have a hard time meeting the “nationally recognized” threshold.

Yeah, go figure…

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Hedge Fund Managers Deserve Their Salaries Because They’re Smarter

The ever insightful Richard Posner writes

I do not think that the government does bear much responsibility for the crisis. I fear that the responsibility falls almost entirely on the private sector. The people running financial institutions, along with financial analysts, academics, and other knowledgeable insiders, believed incorrectly (or accepted the beliefs of others) that by means of highly complex financial instruments they could greatly reduce the risk of borrowing and by doing so increase leverage (the ratio of debt to equity).

Posner fails to consider a host of contributing factors originating from government sources: the moral hazard Freddie and Fannie create, perverse tax incentives (starting in ’97) to overstimulate investment in housing, and the Clinton administration’s policies (again, starting in ’97) to increase home ownership among the poor. Still, the venerable Judge has a point. If all these mortgages were suspect, then why did all those Ivy Leaguers on the trading desks eat them up? Shouldn’t their 150 IQs have included a bullshit detector? Quoth the Seventh Circuit Judge:

It should be noted that because of the enormous rewards available to successful financiers, the financial industry attracted enormously able people. It was not a deficiency in IQ that produced the crisis.

But are they able enough? And were the rewards high enough to attract the most able? The New York Observer has been the first to buttonhole Tom Wolfe and ask him what he thinks of the current crisis. (It’s about time someone got a hold of him, fer Christ sake. Whenever there’s a Wall Street story, a thousand reporters invariably trundle out references to the Bonfire of the Vanities and the Masters of the Universe.) Wolfe has a peculiar theory about the failure of investment banks–it’s brain drain, he says. Instead of turning into cubicle donkeys, the best and the brightest in finance have all found their way to hedge funds, leaving space at the trading desks for all the second-raters out of Harvard. Herr Wolfe:

 there’s nothing as second-rate as investment banks. Every smart and ambitious young man—and forget young women because they don’t play any role in this—wants to be in a hedge fund. And I’d be surprised if the hedge funds implode, they’re just smarter. … What bright guy wants to be an executive for a firm like Lehman Brothers, where you have to hold the hand of disgruntled employees, you hold the hand of disgruntled directors, you’re constantly nice and wearing the right clothes? That’s for real second-raters. … It’s only the bottom of the barrel that’s left in these companies. The new Wall Street is Greenwich, Conn. You don’t need these big glass silos full of people. Look at the number of employees. Lehman? 28,000! And a Greenwich hedge fund can handle the same amount of money with 20 employees. 

And just for kicks, Wolfe adds, “Did I mention to you I’m pimping out my cars?”

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Left-Wing Moral Intuitions Involving Sanctity & Authority

Jonathan Haidt’s research into moral psychology possesses many virtues. I recommend any of his papers on gut reactions and moral judgement for a mind-quake inducing aha. (Turns out Hume was closer to the truth than Kant.) But besides delineating five types of moral judgement–recoiling from harm to others, unfairness, disobedience, despoiling the sacred, and disloyalty–Haidt outlines a theory for political psychology. As he sees it, conservatives have different settings from liberals along these five moral dimensions. The liberal cares more about preventing harm to others and upholding fairness than he cares for authority and the sanctity of sacred spaces. Liberals also care less about in-group loyalties. On the other hand, the conservative amps up his authority, in-group bias and sanctity settings. So Haidt says. But I have to say Haidt’s taxonomy of political psychology lacks the power of his research into morality. Haidt writes:

morality is not just about how we treat each other (as most liberals think); it is also about binding groups together, supporting essential institutions, and living in a sanctified and noble way. When Republicans say that Democrats “just don’t get it,” this is the “it” to which they refer.

If Haidt thinks that left-wing ideologies are without any sense of the sacred, then I offer this video to refute him. One horse laugh is better than 10,000 syllogisms.

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Obama’s and McCain’s Soft Thinking

On the underlying causes of the current crisis, Obama says in the New York Times

“The problem that we have in part has to do with wages and incomes that have been flat. And so homeowners and ordinary families out there have been working very hard, but it’s tough for them to pay the bills and stay afloat with rising gas prices and health care.”

The moronic argument he is offering could be summarized in this way: because the government didn’t redistribute wealth over the last twenty years, subprime mortgages failed. A more progressive tax scheme would have prevented this. Now I can’t find one economist who has proposed this argument or finds it convincing. 

Meanwhile, McCain’s perspicacity shines in all things economic. He intends to reward Attorney Generalissimo Cuomo with Cox’s job at the SEC. According to the same Times article: 

Mr. McCain, who has been trying to distance himself from the Bush administration while proposing to continue many of its economic policies, tried Sunday to strike several bipartisan notes. In a separate interview on “60 Minutes” on CBS, he mentioned that he would like to seeAndrew M. Cuomo, a Democrat who is the attorney general of New York, take over as chairman of the Securities and Exchange Commission from Christopher Cox, whose ouster he has called for.

How wonderfully delicious! Only in American politics does a man who helped orchestrate a crisis get rewarded with a position to regulate it. Consider this graph from Russ Roberts. The Case-Shiller Home Price Indices measure the nominal value of the residential real-estate market in the US. 

Roberts notes that during both the Clinton and Bush presidencies, the government intervened in the housing market to increase home ownership among low-income buyers and raise the overall rate of home ownership. And as he points out, the run-up in housing prices coincides with the government’s interventions led by the work of our man in Albany, Attorney Generalissimo Cuomo. (He served as Clinton’s Secretary of Housing and Urban Development.)  Sez Roberts of the irrationally exuberant housing bubble: 

“It may have begun in earnest in 1997 with Andrew Cuomo, at the time the head of HUD, encouraging the GSEs to become more active in the subprime market. Is that causation or just correlation for the graph? I am looking forward to reading and learning more this week.”

Fun game: without assaulting reason, try to find a way for Obama’s theory to fit the data on the graph. As a bonus, try to rationalize hiring Cuomo to head the SEC.

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