What's wrong with finance
economist.com
economist.com
This is rather an understatement. Most neoclassical models (the dominant strain of economics, despite its demonstrated failure to predict crises) basically assume that the financial sector doesn't exist.
This is why most economists' reaction was "nobody could see it coming" and their policy recommendation response to the crisis was "even more of the same, please" (deregulation, desupervision and de-facto decriminalization).
Then they wonder why people don't respect them any more.
"Hope", as such, does not come from the school of behavioral economics. That was getting trendy even before the crisis hit and did not help at all. Personally, I can think of only one economist who is making models that accurately model the behavior of financial institutions in the macro-economy - Steve Keen, who is resurrecting and extending upon Hyman Minsky's instability hypothesis.
The rational conclusion from this is that mainstream academic theory - i.e. not people like Keen - is a source of collective stupidity.
See e.g.
http://www.telegraph.co.uk/finance/economics/8089832/We-cant...
When untrained people can predict the future more accurately than trained experts, the training of those experts has negative social value.
Sometimes they are right.
Excerpt From: Anonymous Hedge Fund Manager, n+1and Keith Gessen. “Diary of a Very Bad Year.” HarperCollins, 2010.
This in contrast to mainstream people who talk about economics, who have been predicting hyperinflation for years now.
There were many academics who warned that austerity policies would be a drag on the economy for years. There were people in academics warning about a possible housing bubble.
The aftermath of the financial crisis seems to have been handled remarkably well though, don't you think? At least in the US the economy is doing fairly well and the deleveraging was handled admirably.
Unfortunately, that ignores: - the labor participation rate is dropping steadily.. because long term unemployment is up. - the Fed has pumped $1T (yes, trillion) into the market each of the last 5 (6?) years. - wages have been stagnant and have only now reached 1998 levels. - education - previously a ticket into the middle class and beyond - has been devalued by poor standards but simultaneously the price tag has increased dramatically.
And that means -- if I might be prophetic for a moment -- that it's all going to happen again.
Hell no. It was used as an excuse to shovel money into the pockets of the ultrawealthy.
>At least in the US the economy is doing fairly well
By what measure?
Because if you're going to count employment, you should factor out the people who used to have decent middle class jobs and are now scraping by working at walmart.
I don't think bubbles need a complex financial system to form (the famous example of the tulips). And a society can sustain any bubble. A bubble only really hurts if it is combined with high leverage, as it was in 1929 and as it was in 2007.
The mechanism by which this leverage is achieved doesn't really matter, it is the over-reliance on debt we should focus on. That people leveraged themselves through mortgages financed by CDO^2, by a shadow banking system (p2p loans) like in China, or by good old banking loans is a technicality.
One can blame the financial industry but the problem is really the addiction of society to leverage. Banks are merely the drug dealer.
I live in the UK and I am always perplex when I see how natural it is for people here to mobilise all their financial resources, bury themselves into debt through all the means possible in order to bid as much as they physically can on a house. And this is encouraged by the government who pushes for 100% LTV loans. And when confronted they always respond "it is fine, the property market only goes up, we just need to get on the ladder". Sure...
Governments are doing exactly the same. The rise of public debt since the 60s should be absolutely alarming. We have reached war time levels of indebtedness. How will this not result in a financial collapse?
One can blame bankers and speculators but I think this is missing the big picture here.
The tulip bubble was small and did not have knock on effects for the Dutch economy, and for what it's worth, there was a futures market for tulips in 1637. Complex financial systems are not new.
>I live in the UK and I am always perplex when I see how natural it is for people here to mobilise all their financial resources, bury themselves into debt through all the means possible in order to bid as much as they physically can on a house. And this is encouraged by the government who pushes for 100% LTV loans.
Guess who gets the government to push loans on people?
People take loans and buy a house because they're told by those above them that it's "the responsible thing to do". This message is echoed around the media as well.
>One can blame bankers and speculators but I think this is missing the big picture here.
No, that is the big picture. They are the ones who benefit from an over-leveraged economy and they are the ones who are pushing for it.
Ordinary people certainly aren't dying to drown themselves in debt, just as they weren't the ones pushing for student loans. In five years time they won't be the ones pushing for the student loan book to be privatized either, but guess what? Someone out there is salivating over it.
The government is buying electoral support with Help to Buy schemes and Right to Buy extensions; the fact the banks also like it is incidental.
I think of the Right to Buy as being a bit like giving away the family silver in return for a few transient votes, and in doing so committing your children to a future where they'll have to rent expensive stainless steel cutlery.
Or to put it in other words, when someone is saddled with a property and a family they are more likely to go "yes masta, right away masta".
A) No, they're not.
B) Home ownership doesn't solve the shortage problem. Actually, it can exacerbate it because it gives landlords an opportunity to gouge you. Building more council housing might help, but is that on the table? No. Banks wouldn't want that. That's rental income that is not being diverted to their pockets.
>The government is buying electoral support with Help to Buy schemes and Right to Buy extensions;
This is just the most palatable way of giving help to the banks. If electoral support were what they were really after, they would build more homes to offset the shortage.
>the fact the banks also like it is incidental.
You misspelled 'central'.
Help to Buy is tiny in the scheme of banks' balance sheets, huge in the scheme of the household finances of those wishing to join the majority of Britons in owning their own home.
Renters have limited security of tenure in a sense which can be very apparent: even if you meet all the conditions of rental, you can be kicked out of your own home when the landlord decides their interests lie elsewhere.
Tenants do not own the property - the landlord does (or the bank that provides the landlord's mortgage).
You seem to be saying that tenants don't have a right to call somewhere home, which is exactly my point.
If financing (of some kind or another) is available for housing, education or health care, prices go up. In the case of housing nobody saw this as a problem: the house my parents built appreciated 10x before we sold it, and even people who were stuck buying a postage stamp sized house in California for $1M believed they were going to sell it for $5M.
At some point you have to starve the beast, that's the one thing that works.
It is astonishing how much capital is kicking around doing nothing. There is this continuous drumbeat that we can't upgrade rural America to optic fiber for instance, although Apple has the cash to do it and surely it has to be a better investment than negative interest rate bonds.
There are lots of reason why it doesn't happen and it is not that "fiber is too expensive", rather it is that Frontier can make $135 a month already selling me two phone lines and two 1.2 Mbps DSL connections and that Apple has cozy relations with wireless carriers who wouldn't want any competition for their $10 a GB money party.
So far as the cost, when you consider the effect on property values, income and stuff, the eye-popping numbers for what it costs to wire a house really are not that much, particularly when you realize services can be offered over them for 50+ years.
Often those eye-popping numbers are offered as a bluff by providers who don't want to serve an area. If you work in the IT field, $20,000 to get cable at your house pays itself back and you can put it on your HELOC if you don't have it an cash.
The problem here is not just a lack of competition but it is the competition for capital against bling-bling LTE phones and harvesting old copper wires and other things that make money quicker.
It is generally the case that government redistributes money from urban areas to rural, largely because rural areas subsidize urban areas in other ways. For instance, Silicon Valley would not have the stream of young labor that it has if there weren't places where people could afford to raise children.
Wireless should actually be the future for less dense rural areas, something like Google balooon anyways. How else can we even think of serving the Alaskan outback? Heck, I have family who just live an hour north of Spokane WA, and there best option up until a few years ago was satellite.
But if there's no financing for housing, builders are realistic about their chances of selling something that's that expensive, stop building, and prices go up due to the lack of supply.
I don't think you can call this a failure of academics, it seems more like next on a long bucket list of questions to answer.
As an aside -- some of the explanations of M-M and CAPM are wrong, which is straight up first semester finance.
http://www.debtdeflation.com/blogs/minsky/
But frankly trying to model every damn individual is a fools errand. Keen limits himself to "classes", like workers, bankers and business owners.
The problem is that the control system is now using a non-negligible amount of the power generated by the plant.
Most economic models make the basic assumption that this is not the case. This makes them not very useful.
However, they have a lot of social inertia when it comes to getting listened to.
Economy, circulatory system.
Finance, bone marrow.
25 standard deviations has to be an exaggeration? I fail to see how any model could ever be that far off the mark.
>25 standard deviations has to be an exaggeration? I fail to see how any model could ever be that far off the mark.
It's easy to be that far off the mark. E.g. assume a normal distribution for a fat-tailed distribution.
I wonder if he's been reading "Life among The Econ" by Axel Leijonhufvud. http://www.econ.ucla.edu/alleras/teaching/life_among_the_eco...
Economist worth their name had predicted the crisis and way more. There are good serious economist out there, but do not look for them in the media, including the Economist.
It is economists in the media and power institutions who failed to predict the crisis, on record, because most of them are not as stupid as the look when they talk.
That is, if you get to chat with them personally, you realize they know pretty well what is happening. They have the biggest amount of intelligence resources in the world, and again they use to be very smart. But they can't say what they know in public as a word for them could bankrupt entire nations.
In the inner circles in meetings in Switzerland cities they are really worried about what is happening, but then in public they say everything is ok.
Keynesianism had become the non sense dogma of today economist on media and Universities. If Keynes were alive he would not approve what is being called Keynesianism today, as you can see if you read Keynes.
Economics has the remarkable property that if you can see the future coming better than your peers, you can profit off it. So conversely, whenever somebody claims in retrospect that they saw the future coming it should be asked why they didn't profit.
Even if you can easily see the inevitable correction coming, it's difficult to say when it will happen. A powder keg still needs a spark to take.
I wonder if there's a way to "far-short" a stock. Like, if you think the stock in question will "eventually" go up to $1k, you can buy now and sell when it does. But if you think it'll "eventually" drop to $10, you can't easily trade on that, right?
Maybe the way to go is to buy everything _but_ that stock (via overlapping index funds?), then sell once the stock drops to $10 and reevaluate from there? I don't know.
Who says they're not?
It's the one undeniable evidence of predictive success there is in the market.
Of course, that might be stupid from a PR perspective. Which is terrible.
I truly believe the root of all of these problems is over investing in financial instruments like equities, which in turn give power to financial industry, economists, and CEOs.
It is a face saving measure by the people actually responsible, namely Pension Funds and Government Policy makers in that order.
Pension Funds were chasing returns... and finance types depend on Pension funding at many levels. Pension funds own 95+ percent of the stockmarket shares overall and in some cases closer to 100%. Shareholders elect the board who appoint the staff. Further Hedge Funds do not hedge their own money exclusively. They sell to outside people, ultimately again mostly coming from Pension Funds.
Government agencies like Alan Greenspan had the option to use their blunt tools to control matters via interest rates and perhaps policy changes. They chose not to do so.
To me it is like a Railway Tycoon shouting "faster faster.." to the train drivers and then blaming the driver of the day when a massive accident happens. Even if the driver is reckless... who hired they guy and gave guidance to ignore the warning signals ??
Pension funds only started chasing returns after the crisis.
Why did they do that? Because the government made a policy decision to drop interest rates like a stone.
Why did they do that? Because the too big to fail banks were sitting on a pile of mortgages without sufficient collateral because of a popping bubble that they created and they couldn't withstand the potential onslaught of defaults.
They were exposed and insolvent and in danger of being destroyed unless quick political action was taken.
Fortunately, for them, quick political action was taken and they were saved from facing the consequences of their actions. We had to deal with them instead.
The sub funds that Pensions invest in get rewarded according to Alpha... the amount the sub fund exceeded the main stock price movement.
How is that not chasing returns??
They weren't taking outsized risks in order to chase an outsized gain - "chasing returns" as you put it.
2008 changed all that.
Once government debt yields dropped to zero (done to save the bankers' hides), in order to still maintain the same returns which they needed, they started chasing returns.
This was more done out of desperation than greed. They had made promises pre-crisis that presumed the economy would continue as normal - exactly what economists and bankers of the time promised us would happen.
The only non pension funds who own anything substantial are governments. Private holdings are vanishingly small.
Who do you think owned the shares in the banks that took all the risks? 99% Pension Funds. Even if the Pension Funds had 85% as Government Bonds, from the rest they still owned 99% of the banks and hedge funds and private equity.
Holding bank shares is a suckers' game, however. Real money is made in bonuses:
http://www.cbsnews.com/news/study-bank-bonuses-far-exceeded-...
Control is more important than holding a share certificate entitling you to a residual claim on profits.
http://www.pewtrusts.org/~/media/Assets/2014/06/PensionInves...
By far, the largest uptick in the shift from low risk bonds to higher risk assets like equities was in the 80s, but it's been happening longer than that. You could make a claim that there has been an increased shift to alternative assets since the crisis, but you didn't, and the uptick isn't massive anyway.