The End of the Financial World as We Know It | Hacker News Reader

The End of the Financial World as We Know It

nytimes.com

75 pointstortilla78 comments

These oligopolies [the rating agencies], which are actually sanctioned by the S.E.C., didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it.

We've heard a lot in recent months about how the current crisis proves that "unfettered capitalism" doesn't work and that libertarian political philosophy is (intellectually) bankrupt. Libertarians, we are told, are running scared.

The quote above is one small example of why this claim is rubbish. The banking and financial sectors have been heavily regulated for at least 70 years; this has created the kind of cartel virtually impossible to form in a free market. And what happened to the SEC is so common it has a name: regulatory capture, the capture of the regulatory agency by the special interests of the industry being regulated.

There's plenty of blame to go around: the global financial crisis has many causes. Laissez-faire capitalism isn't one of them.

Laissez-faire capitialism doesn't exist outside of flea markets. Reality is that many industries are monopolies or effective oligarchies: banking, telecommunications, insurance, pharmaceuticals... The idea that these companies working in heir own self interest will counterbalance each other is nonsense. That's why we need regulation. The problem occurs when the regulated do the regulating, whether by infiltrating the government, bribing congress, or actually writing the laws. And I will acknowledge that there is and has been a more than adequate supply of bad regulations.

Also we need vigorous antitrust enforcement so that the failure of no one company can bring down the economy. AIG come to mind, but also the telcos, oil companies, and Rupert Murdoch,

Consumers regularly counter act companies. Brands are so valuable that companies fight to protect them. The best examples of monopolies are almost exclusively backed by government regulation.

For the examples you site about companies too big to fail: firstly no company is too big to fail. Secondly, those industries would be more competitive without regulation, subsidies, the SEC, and the FCC.

Finally, it makes your whole comment hold less weight when you single out Rupert Murdoch while commenting on an open forum on the internet. Communication and broadcasting tools have never been more competitive and free.

> Consumers regularly counter act companies.

So why can't consumers get e.g. cheaper text message rates?

Because the FCC auctions off portions of the wireless spectrum, and various municipalities control where you can build cell towers, and so a hypothetical telecom startup devoted to the cheaper text message rates must jump through a lot of bureaucratic red tape just to setup the basic infrastructure. Most startups won't bother while there's low-hanging fruit in the unregulated Internet market.

I'm not sure I buy the whole "truly free markets will save us all" argument, but the particular text-messaging argument has a very simple explanation in terms of government monopolies and the cozy relationship between entrenched players and the government.

> auctions off portions of the wireless spectrum

http://en.wikipedia.org/wiki/Tragedy_of_the_commons#Modern_s...

> municipalities control where you can build cell towers

http://en.wikipedia.org/wiki/Externality

Certain the tragedy of the commons is a real issue, but the FCC and the spectrum control is too far in the regulated direction.

Again, I'm not certain that free markets are the answer. It may be that telecom is fated to suck, and the regulated alternative sucks less than the complete laissez-faire one. But I am fairly certain that telecom sucks at least in part because of regulation.

Like free email? Like open wifi networks to send GB of data?

And the other reply is right. The space is incredibly regulated. You'd be arrested for trying to compete in the restricted spectrum.

This consumer talks on my prepaid voice account and saves lots of money over texting. Or I use the email I already pay for to send people text.

Substitution sometimes works just as well as attacking any one product's pricing model.

What if the consumer dies of a bad pharmaceutical purchased on the free market before getting to change vendors? What if his house wiring (done without codes or regulations) burns him and his home in his sleep before he gets to send out the correction signal to the market?

Hominem ūnīus librī timeō.

My point about brands was that this kind of thing is VERY bad for the companies at fault and they work hard to avoid it. Another point about regulation is that is actually doesn't solve much. Not only do people die from drugs both from failures in testing despite regulation, but they also die from NOT taking drugs because of delays in the regulator process.

Most business take pride in what they make. Most people look for that, and look for recommendations from peers. That system is remarkably effective.

I would not argue the effectiveness of that system, but can you honestly say we should not regulate who can fly an airplane or drive a car, practice heart surgery or design bridges and buildings? Do you think an unfettered market with no regulation of these things is a good idea?

Depends how much people care about who they go to for heart surgery.

The free market would eventually fix all these problems, albeit after a period of suffering and very likely, many deaths. Industry standards and associations would crop up after a string of failures, and consumers would eventually move towards firms that are endorsed by the industry standard bodies. eg. chartered accountants.

Regulations are just there to try and avoid the transition period of pain (and death).

Industry standards and associations would crop up after a string of failures, and consumers would eventually move towards firms that are endorsed by the industry standard bodies. eg. chartered accountants

Sounds remarkably similar to where we are.

> The free market would eventually fix all these problems

Saying that doesn't make it true, it's a belief, not a fact, keep that in mind.

After a bit of thought, most calls for regulation are unfounded.

I would start by emphasizing that things that can kill lots of people should be regulated. Cars and planes and buildings fall in that category. But how?

An airline should be forced to get insurance for the risk of bad pilots. That might be enough to align incentives and protect people from risk. It is a slightly irrelevant issue as laws will be passed within our lifetimes that mandate a human must _not_ fly a commercial airplane. Only robots.

Driving is similar, but much easier, so more people can do it. It's harder from a robotics front, but will also be solved soon. I've worked on robot cars.

Heart surgery is where it gets interesting. By mandating a certain level of quality, you essentially place a price floor above the market price on medical care. That means a lot of people don't get it. Would you rather have a shoddy operation or none at all? As desperate times often demonstrate (e.g. delivering a baby outside a hospital by necessity), people want shoddy care over none at all.

So licensing doctors is bad. Private accreditation is enough. I will trust a doctor that has received a credential or accreditation from an institution I trust. I certainly trust Harvard more than I trust the AMA or HHS.

You should read Capitalism and Freedom by the way. Milton Friedman is an excellent author. He makes this issue crystal clear.

I will give it a read, thanks for the suggestion.

Most business take pride in what they make.. And some didn't/don't:

By the 1930s, muckraking journalists, consumer protection organizations, and federal regulators began mounting a campaign for stronger regulatory authority by publicizing a list of injurious products which had been ruled permissible under the 1906 law, including radioactive beverages, cosmetics which caused blindness, and worthless "cures" for diabetes and tuberculosis. The resulting proposed law was unable to get through the Congress of the United States for five years, but was rapidly enacted into law following the public outcry over the 1937 Elixir Sulfanilamide tragedy, in which over 100 people died after using a drug formulated with a toxic, untested solvent. The only way that the FDA could even seize the product was due to a misbranding problem: an "Elixir" was defined as a medication dissolved in ethanol, not the diethylene glycol used in the Elixir Sulfanilamide.

http://www.calcompnutrition.com/natural-cures-kevin-trudeau....

http://www.ripoffreport.com/searchresults.asp?q1=ALL&q4=...

Medicine and media today are very different. Also, stories like this get lots of attention. They skew perception about instances of events like this. Regulation's side effect is often inaction or inactivity. You don't really hear much about that.

Many real elixirs are killing people right now, by not getting on the market fast enough to save lives because of the lengthy FDA approval process. You don't hear about that.

> Consumers regularly counter act companies. Brands are so valuable that companies fight to protect them.

There are many kinds of businesses that exploit faults in the public and market, yet don't even have any relationship with branding. Companies have better resources and access to more information about the areas they function in than the public does (whether as individuals or groups), and many businesses don't market to the public at all, even if they deal with the public. Debt collection firms, for example, have all of these features.

The public does have a mechanism to counteract the actions of companies, and that's representative government and regulation. It's obviously imperfect, but it is the mechanism the public has.

Regulatory costs do raise the barrier to entry and push the market towards fewer, larger firms.

> The problem occurs when the regulated do the regulating, whether by infiltrating the government, bribing congress, or actually writing the laws.

It's poor form to not mention that said problem always occurs.

It's also poor form to not mention that all of the monopolies/oligopolies mentioned were created and/or maintained by govt action.

Regulation is one of those govt actions. Regulation gives Walmart an advantage over every Mom&Pop because even at its best, regulation is a fixed cost that Walmart can spread over more transactions. At its typical, Walmart gets a deal that no one else gets.

Really, really, really real free markets never seem to exist, though. So the whole "if only" game doesn't seem like a worthwhile one to me - if there's a failure, it's never, ever, about the market actually failing, it's that it just wasn't free enough?

Sorry, back to the drawing board then, and design a system that works in the real world. It's probably not too far off from what we have now, and should be reasonably free, no doubt about that, but it should be designed to muddle along with the muddly creatures that comprise its actors, rather than some sort of idealized system that will never come to fruition. Those apes tend to have both collectivist and individualistic tendencies, and ignoring one in favor of the other is a bad idea.

What, you mean I can't just project my Platonic ideology onto the real world have it work exacty as I envision?

The devil you say, David!

I think the discussion is getting lost here. We recognize that the current system is a partially-free, but heavily-regulated structure. Now the question is, what were the weaknesses in the system? What were the points of failure?

Leftists are saying that the problem was that the system was too free. Libertarians are saying that the main problem lies with the corruption and inefficiency of regulation. Neither point is trivial, neither point can be dismissed as ideological rhetoric.

There are those libertarians who will always blame the government for every problem until we live under Rothbardian anarchy. You may think that position is idiotic, and you are welcome to do so. However, the leftists who blame every problem on "the unfettered free market" sound equally idiotic to my ears in a world with regulatory agencies with multi-billion dollar budgets and hundreds of thousands of pages of rules controlling trillions of dollars of capital every day.

So, don't dismiss all claims of misregulation even if some of the critics are unhinged. After all, if something is wrong there, we would expect it to have large effects. My old firm spent at least a seven-figure number each year to comply with regulatory rules, and it wasn't very large.

Oh, I agree completely that some on the left make plenty of bad statements of their own and are altogether too ready to blame markets for various things. I'm sort of a centrist and believe that many things need to be worked out by trial and error. This means that people basically need to be free to try, but that, in some cases, errors also need to be dealt with, and sometimes, the government is the most efficient way to deal with them. Often, local governments are preferable to farther away/bigger ones, but some issues are also dealt with best on a larger scale.

I think a major problem is that governments are large, monopolistic, and tend to copy each other. How do you know what really works if you don't have different models to look at?

We see some competition between governments in areas like the European Union that have free trade and free movement. This has resulted in tax rates being lowered and business being liberalized across the EU. However, the European Union cooperates on some things, such as financial regulation, so we won't see any competition between different models there.

I think the US is much too large in terms of people, GDP, and land area to be efficiently governed by one entity. The law is crusted over with special interest regulation and really needs a rethinking. However, I doubt that is likely to change any time soon.

And I agree with you that trial and error is a good way of proceeding. The problem is that the visibility and the severity of an error are not always correlated. It is easy to fix visible problems but not get closer to an efficient model.

> I think the US is much too large in terms of people, GDP, and land area to be efficiently governed by one entity.

I've felt that way for a while now. People need to feel they have sovereignty, so "states" should never get too large. Also, as Taleb said in The Black Swan about mergers: the lower diversity means that when one fails, it's catastrophic. Instead of 300 million people trying to decide on Red or Blue, we could have 50 states that catered to every style, much as in Europe.

> tend to copy each other

Sure. We've found a model that works pretty well, and a whole lot better than various recent experiments, so it's a fairly safe bet. Who wouldn't want to copy that?

> US is much too large in terms

Difficult to say. It's not run worse than plenty of smaller countries, and has one huge advantage: it's an ironclad free trade area.

You should read some John Dewey if you haven't, his philosophy meshes well with your's.

I think the problem is not regulation, but that regulations are almost always implemented after something has gone wrong.

Regulations should be more dynamic. If it looks like someone has found a loophole, they shouldn't be afraid to plug it before it becomes a problem. But they should also be more active in modifying and "optimizing" existing regulations, so long as they don't do it too often.

There is also a disconnect (related to your comment) between what the left (and centre) are accusing, and what libertarians defend against.

The left are simply claiming that this was caused by market liberalisation. Increasing market liberalisation would make it worse. The free marketeers are then countering by saying it was never totally free. You can't use that situation to judge anything.

I appreciate that you're basically defending me here, but your distinction between libertarian anarchists and leftist socialists is a false dichotomy. As governments grow more socialist, socialists blame society's growing problems on capitalism; libertarians blame them on socialism.

I think the question of more or less regulation independent of what that regulation is is basically meaningless. It'd be much better if that extremely abstract argument was much less common than a real look at the specifics.

I think Lewis' point is that regulation we have today has gotten into a position of disguising real risk when it should be exposing risk so it can be fixed quickly. If we don't have failure and risk then the market can't work. The liberals want more regulation while the libertarians want less. If we had regulation that could drop MBIA's triple A score when it started doing more risky investments, or a SEC that investigated fraud when someone basically handed them all the facts that they needed to validate then wouldn't those problems be contained to a much smaller impact?

What I hear Lewis saying is that we are over-regulated with ineffective regulation. All the institutions are there, but they don't really do anything to protect the markets from financial meltdowns like these. If you're still asking what are the weaknesses of the system, and what are the points of failure I'm not sure you read the article.

>> Really, really, really real free markets never seem to exist, though.

What, pray tell, do you think the black market is?

they're not free since they have constraints. Those constraints bring prices higher. there is no free flow of information either in black markets

Really free markets do exist and have existed in many times and places, and they work really well. The reason they work well is because they have the proper incentive structure to realize good outcomes (as judged by the participants in the market). The "if only" game is worthwhile because it allows us to see the outcomes of different incentive structures without running costly (and sometimes fatal) social experiments.

Our financial system is a wreck; it's time to change tack. If you want to sail with the wind, it helps to know which way it is blowing.

Markets with greater freedom don't have as many shitstorms as markets with less freedom. Example: Chile, the most capitalist country in Latin America, and the one with the most economic freedom, is also close to being the richest per capita (...I have my doubts about Argentinian GDP reporting) along with the similarly free Costa Rica. Sure, Chile has a lot of mineral wealth, but so do a lot of other Latin American countries.

Learn economics.

Libertarians and socialists seems to be the internet equivalent of cowboys and indians.

Sure, it's been about a week since we played. Ready, set, go!

  [insert the same discussion as always here]

your argument is fallacious: Basically saying: Look there was SOME government regulation. The market failed, so it is the fault of regulation. less regulation is the solution.

While if you flip the coin you can have: The industry was not regulated enough. Recently there has been a trend to de-regulation, and letting the market free to do what they want to do, and this let us to this huge mess. The markets are made out of people, that have a herd mentality, and only view their short term interest, while ignoring the long term ones.

And there are many experiments to prove this: (insert many experiments done on how people would rather have 5$ today, then $20 if few weeks, even though the later is a much better deal).

While you fail to mention the fact that the government is not forcing anybody to actually acknowledge the rating agencies ratings, and to invest by them.

If the market was smart, why didn't reconginze the problem with the ratings, and avoid it?

Another thing that libertarians fail to mention is that in the late 20s, early 30s, a lot of this regulation, or agencies, didn't exist!! Yet the market failed to protect against themselves, and we had the great depression.

Please explain that!

No, his argument isn't fallacious, but yours is a straw man.

He is NOT saying that regulation was the problem, and he's not saying that less regulation will solve the crisis. He's saying that blaming libertarianism, free markets and "unfettered capitalism" is a fallacy - simply because the financial market is neither of those.

the argument sounds very similar to communist apologetics saying: "blaming communism on the Soviet collapse is a fallacy, simply because the Soviet Union (and all the communist nations) were never real communist countries like Marx and Engels intended".

The crisis existed largely because existing regulations were loosened, and those that weren't were laxly enforced against people who were gaming the system. The markets in the late 1800s and 1920s were both largely libertarian, free, and unfettered -- and both failed pretty miserably, which is why we have (flawed) institutions like the SEC now.

I don't know what you mean about the trend for deregulation -- the amount of regulation and spending on enforcement has significantly increased in the past 8 years. So if anything, we are more regulated now than we have ever been.

Communism would have worked if people didn't try to game the system too. If your philosophy isn't robust enough to deal with the sharp intrusions of reality, complaining about reality isn't the solution.

You're just like Enron that always blamed government regulation of the market. Check out this documentary Enron: The Smartest Guys in the Room: http://en.wikipedia.org/wiki/Enron:_The_Smartest_Guys_in_the..., it's nice to learn from history. I agree that government regulation can be as dangerous as out of control police force, but libertarians (similar to communists) are completely oblivious (sometimes on purpose) of how absurd their idealistic word is and lack basic understanding of human nature.

Article summarized by this quote from it:

"... nothing has been done to change that, or any of the other bad incentives that led us here in the first place."

The headline is a little misleading.

<i>Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O’Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup’s chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower had stood up and said "this business is irresponsible and we are not going to participate in it," he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.</i>

And yet that's exactly what upper management at Goldman and JPMorgan did. Goldman never bought massive quantities of ABS CDOs for portfolio. Chase never originated a single option ARM. Not all of Wall Street was so cravenly focused on short-term profits.

Is this a joke?

Uhh ... you do realize Blythe basically INVENTED the CDS right?

Maybe I am misunderstanding what you are trying to say, but ALL of the big investment firms were in on this. In fact, the system would not have failed if any one of the investment banks had not played their role.

If you are a quant we can get into arguing the fatal flaw of uncleared counterparties. But from my perspective when everyone is a counterparty, and EVERYONE was, there is nowhere to run when things go bad.

Could you clarify what you mean for me please?

Incidentally, the quote is correct, the heads of everyone from Bear to Goldman would have been summarily dismissed if they had failed to play their roles. All because of the 'innovation' of one, as it turns out, not so bright quant at JPMorgan. Astounding isn't it?

I wasn't talking about CDS, and I am aware that Blythe Masters is credited with inventing the CDS while at JPM. I think it's still too early to tell if CDS are good or bad on the whole. Ultimately, they're just insurance contracts, which have been around for hundreds of years. But that's another discussion.

I'm talking specifically about subprime. JPM and Goldman explicitly decided at the very highest levels of management to remain uninvolved in certain areas of the subprime mortgage market. Chase did originate subprime loans, but it did not securitize them and for a long time, did not make a market in subprime bonds. Chase also stayed away from certain areas of alt-A lending, in particular option ARMs, which have become one of the most toxic forms of mortgage debt. Also, JPM didn't purchase billions upon billions of subprime bonds and subprime-backed CDOs, like Merrill, UBS, Citi, and other banks did. That's why JPM has taken "only" $6bn in writedowns over the past 18 months, vs. over $30bn each for Citi, Merrill, and UBS. And yet Jamie Dimon remained CEO of JPM through the mortgage lending boom, despite staying away from its most lucrative areas.

You might find the following article interesting: http://money.cnn.com/2008/08/29/news/companies/tully_jpmorga...

What an incredible year and a great article.

It's hard to imagine a scenario where 12 months ago I would have imagined an editorial in the New York Times with the title, "The End of the Financial World As We Know It."

It's called "yellow journalism." This crap sells right now, and the major news outlets are all over it. Remember all of the "dirty bomb" fearmongering a few years ago?

I agree with you in general but disagree about this piece. I think it's much better than you describe, for two reasons: Lewis is a fabulous writer, and the article is more truth-telling than fear-mongering.

you need this kind of articles to change the system, make sure senators or entrepreneurs see the problem and act upon it.

Hyperbole and invective are the domains of politicians who use them to great effect. No need for it in a balanced press (wishful thinking).

It seems clear to me the SEC has failed as an institution. I tend to agree with the author that the revolving door policy whereby ex-regulators become bankers for the banks they were previously regulating is no longer acceptable.

No matter what the government (or anyone) does, the same process will repeat itself over and over again.

http://en.wikipedia.org/wiki/Tulip_mania

maybe. it would be interesting to see what trends occur in vastly different cultures than the western individualistic, self-centered one.

for example, the Great Law of the Iroquois states, "In our every deliberation, we must consider the impact of our decisions on the next seven generations."

i am completely ignorant of Iroquois economy and lifestyle otherwise. nonetheless, the optimist (or perhaps sci fi reader) in me imagines a (near?)-future in which people are motivated not simply be money, but also by joy, inclusiveness and sustainability.

the effectiveness of rules depends on cultural context (or complete domination of free will).

Actually, I think a slightly different process will appear each time. Different enough that people will not recognize it for what it is except in hindsight. Since regulation is most effective as a reaction to a problem, perhaps we should accept that there is very little we can do to stop these sorts of things and concentrate on preparing ourselves to weather the storms when they appear.

The best indicator? "This time it's different."

-1980's Leverage Buyout Craze (RJR Nabisco) coupled with junk bonds

-Dotcom Bust

-Day trading

-Too much leverage (Long Term Capital Management and repeated today)

-Mortgage back securities

-People making 50k per year buying 500k homes

continued at: How to Repair a Broken Financial World http://www.nytimes.com/2009/01/04/opinion/04lewiseinhornb.ht...

So, apparently (according to the article), the bond raters are paid by the bond issuers. How in the world is that not a conflict of interest? There must be some "pro" for the financial world being this way?

The pro is, if you are an insider, your ass is subsidized by everyone else.

So, it is cost effective to lobby, bribe, and generally deal underhandedly to get that subsidy. Times like the recent bailout is when your investment in underhandedness pays back handsomely.

I completely agree. How can anyone look at this fact and not see it as totally undermining the intent of bond raters?

Phase 4, "Winter": http://en.wikipedia.org/wiki/Decline_of_the_West#Phases_of_r...

article summary: the world is full of sheeple.

It's the end of the world as we know it.

God bless REM

Flagged, not hacker news.

I hearby declare anything written in whole or in part by Michael Lewis to be Hacker News. May God have mercy on your soul.

I'll try digging up his shopping list.

I'll be the first person to upvote it.

"Michael Lewis (an author so talented that, as they say, his shopping list makes gripping reading)"

http://www.bmacewen.com/blog/archives/2005/11/michael_lewis_...

I thought this paragraph in the guidelines was clear enough, but I've added another sentence to make it more explicit:

"Please don't submit comments complaining that a submission is inappropriate for the site. If you think something is spam or egregiously offtopic, you can flag it by going to its page and clicking on the "flag" link. (Not all users will see this; there is a karma threshold.) If you flag something, please don't also comment that you did."

http://ycombinator.com/newsguidelines.html

Funny. Most of the time when I make this comment I get 5+ upvotes just for it, because I generally make it quite accurately on articles that are judged not desirable by others too (and the article is usually killed soon after).

I'll refrain from making it in the future if it hurts your HN experience, so this will be my last comment on the topic.

I still maintain that this article is irrelevant to this site, btw. This is reddit/r/business material - i.e. grandiose, inflammatory politico-financial opinion pieces that will result in no significant change of anything whatsoever, but get lots of upvotes and a plethora of comments that look like they make a lot of sense (until you read the response to each comment and find that someone else is making just as much sense with the exactly opposite view).

Imho, this is a fantastic waste of this site - and I shall continue to flag this kind material whenever I find it.

Edit: I'll just add that on occasion even this kind of post that you appear to dislike does generate a useful outcome, e.g.: http://news.ycombinator.com/item?id=417744

Reply on news.ycombinator.com