Krugman: The Madoff Economy
nytimes.com
nytimes.com
This strikes a chord with me. Stop chasing money. Chase changing the world.
And as for the high incomes of money managers, it seems reasonable to pay someone a lot to manage a huge fund. So much is at stake that it would be a false economy to hire someone cheap.
All you have to do is make sure the giant losses occur just 1 year out of N. It doesn't matter that the one year's losses wipe out the other N-1 year gains; you've already collected your fees and quite possibly retired, and there's no claw-back of your cut.
A reasonable aim of financial technology is to ameliorate the risks that could obscure or destroy truly productive activities. But the same tools can easily be used to do the opposite, construct net-wealth-destroying strategies which enrich only money managers.
To cook up such a strategy purposefully is a crime, and the classic ponzi scheme is the blatant extreme case. But many other strategies based on collecting fees during the upswing of an unsustainable bubble, while being insulated from the downswing, are close cousins of the full ponzi. That the loot is laundered through ostensibly legitimate investments (like mortgage securities this time around) is a convenient consensus cover story; it helps even the perpetrators believe they are providing valuable investment services rather than just a scam.
This view doesn't indict all investment activity/funds as being similar to ponzi schemes. But an awful lot of this most recent financial-services boom appears to have been like a ponzi skim.
(Despite the truth I see in this column, I would not trust Krugman's suggested solutions, which are likely to be heavy on new regulation. Ultimately capital has to learn to protect itself, with novel compensation schemes that disincentivize the 'year N explosion' pseudo-ponzi strategies.)
That seems unavoidable. It's the same in most industries. You have to pay top baseball players high salaries, even though there's no guarantee they'll do well after you hire them.
To cook up such a strategy purposefully is a crime
Is it, actually?
But the degree matters. If looting and destruction is occasionally rewarded, it can be a manageable expense. If it dominates the industry, even if not via conscious malice, we've got problems. What if every high-paid 'top baseball player' for 10 seasons running was a bust? Then something in scouting or compensation would have to change, a lot.
Is it [a crime], actually?
Yes. A manager who promises investors the possibility of positive return, but knows he has purposefully designed things so that the investors are guaranteed to ultimately lose, while the manager gains, has at the very least engaged in criminal fraud.
So to pull off net-losing strategies within the law, a manager should deceive himself as well as his investors. Fortunately for this class of managers, a whole industry of external rationalizations was spawned by the potential profits.
But the value of baseball comes from entertaining, not from winning, so I'd rather put it this way:
There would be something very wrong if you would suddenly realize that every game you saw in the last ten years had unconsciously bored you to death.
I don't think the case of day trading is covered by the baseball player analogy.
This is probably net true, but maybe there is a also a flip side: do these products exhibit some negative price elasticity? (i.e. a fund that charges high fees and pays it's managers highly may actually be more attractive than one that is cheaper but otherwise identical). Given the intangibility and the expectationary-nature of the product, it is possible.
The underlying issue is the dilution rate of the dollar. From 1998 to 2008 the money supply was diluting at ~10% a year. With the money supply growing that fast, and CD's are paying only ~3% a year, holding anything other than dollars seems like a good idea. So people speculate in stocks, gold, oil, real estate - anything that dilutes at a lower rate than dollars. But most people aren't good at speculating, so they lose money.
No government running a sound money system should be diluting at 10% a year. It's simply inexcusable.
Since the expectation (integral of probability density times outcome) of such games can be net-negative, he might be. It depends on how prevalent those games are.
There's another angle, too. What matters for the economy as a whole is not one player's expected outcome, but the sum of the expected outcomes over all the players.
http://fora.tv/2008/10/21/Richard_Kovacevich_Evolution_of_th...
It's not Ponzi, but it's not in the interest of investors (unless their money's in short-term enough to miss the implosion).
Is this the case?
Luckily the government isnt crazy enough to promise extraordinary returns on your social security contributions, however once the funds run out for the current recipients, watch our forced contribution be raised sky high to keep paying it out.
Bad times ahead. But thats the predetermined path for a Ponzi scheme, no matter what the size.
It isn't exactly out of our capacity to do. We just have to stop blowing things up and destroying wealth.
This is a statement one might expect from a pure juvenile. No, Mr. Krugman, the investment industry serves a viable purpose, in deep contrast with a Ponzi scheme. There are good and bad methods in the investment industry, but Ponzi schemes, in every instance, are indelibly insolvent, unproductive, and unprofitable.
A Ponzi scheme is defined as an operation "that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business. "
In 2007, the dividend yield of the S&P 500 was 1.5% People were not buying stocks to obtain the cash flow of a real business. People bought stocks under the assumption that eventually they could sell to someone else for a higher price.
But that's not the point. The point is that Krugman's objects of comparison share almost no correspondence. Even Lehman Brothers was substantially profitable when brought down by one class of securities, the creation of which was largely a government affair. It is important for everyone to understand that Krugman is the worst kind of shill.
It's a big part of it, and the rest of the industry was operating in much the same way.
Buying an asset with the expectation that it will increase in value...
People expected the asset to increase in price. The only way an asset can increase in price is if new buyers are willing to pay more money for it. If this increase in price corresponded to an increase in the underlying cashflow, that would be healthy. But the price of stocks were increasing at a far greater rate than dividends were increasing. Therefore it was not healthy at all.
Another way of putting it: if you bought a share a S&P 500 ETF, and knew you could never, ever sell it, what kind of dividend yield would you demand? I would demand at least a 5% dividend, maybe more. By that metric, the S&P in 2007 was overpriced by about 70%. That premium is based on the idea that someone else would be willing to pay that price or more.
The S&P is not really a ponzi scheme. When a ponzi scheme is big enough, and it is legal, we have a new name for it: money. S&P stocks were essentially trading as private currencies. See my longer comment on this here: http://www.newmogul.com/item?id=2587
It is important for everyone to understand that Krugman is the worst kind of shill.
He is a shill, but it's important to criticize him for the right reasons. The elephant that Krugman misses is that from 1995-2008 the dollar was diluting at ~10% a year. When that happens, holding any asset other than the dollar - stocks, real estate, gold, oil - starts looking like a great idea.
(And a point that Kling might make but Krugman tends not to: much of the financial-sector ponzi-ism was propelled by government policy, which inflated the housing bubble with tax benefits, Fed-lowered interest rates, government-sponsored mortgage-underwriting, and regulatory favoritism for dubious mortgage-lending. And policy which then further insulated finance institutions from existential risk with the implied promise -- now delivered -- of giant bailouts.)
However, I very rarely submit the articles I find that I like. My fear is that the ensuing discussions tend to be very much about ideologies and create lots of heat, but little light - they're about 'firm beliefs' rather than something that can ever really be proven in an internet discussion forum. These sorts of discussions, in my opinion, attract people that want to talk about politics and economics, which are sort of low-hanging fruit - everyone, not just hackers, has opinions on them. Also, there is so much written about those topics that it would be extremely easy to crowd out hacker/startup topics with economic ones, even restricting economics/politics postings to relatively good ones. My gut feeling is that if these articles prosper, this site will, with time, decline. Your site, your call though - if you say economics and or politics go, I will no longer comment or flag them. Maybe I'll even submit a few of my own.
BTW, one of my favorite articles of Krugman's is this one:
It's better just to flag what you don't like. Personally, I find this article to be both insightful and important.
This is the sort of phrase that makes Zeus start sharpening his thunderbolts.
Heh, I suppose I get a bit wrapped up in it. Living in the middle of the Tirolean Alps, and not speaking much of the local language (German), I don't really interact much with hackers outside of this site, or pretty much at all in real life, which is less than ideal - I'm a fairly social person. Hopefully we'll be back in Italy in a few months and things will improve.
> But this economic crisis is not only a once-in-a-lifetime event, but it has tremendous consequences for start-ups.
Sure, but plenty of real, serious economists are still discussing the great depression too, so I am quite sure that there will be enough discussion about current events to last at least a generation. This article wasn't really all that directly related to startups, either. I thought it was pretty evident he wasn't talking about plain old stocks and bonds, but a lot of the wackier things going on (CDO's, CDS's, hedge funds, etc...). Even there, though, he was doing it in sort of a facile way that probably doesn't add much to the debate.
At some point, a public person decides to make politics part of his brand. That's a business decision. The results of that decision is that whenever they write, whatever the topic, politics gets inserted into the stream.
Personally I thought it was a poorly-worded and easily constructed essay based on class warfare and ignorance of the value of managing risk. (Which is odd given Krugman's occupation) All securities are risky. People make lots of money managing that risk for their clients. Every now and then Wall Street blows up and investors get screwed.
Nothing much to see here, except Krugman's dancing on the grave of hundreds of billions lost to the tune of "I'm with the little guy"