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November 12, 2012

Giving Wall Street types more credit than they deserve
Posted by Patrick at 11:51 AM * 75 comments

In a post I find myself wishing everyone would read immediately, actually-numerate scientist-blogger Chad Orzel gets exasperated over how frequently journalists credit finance people—like Mitt Romney, or the speculators who caused the housing collapse—with being “numbers guys.”

You would think that the 2008 economic meltdown, in which the financial industry broke the entire world when they were blindsided by the fact that housing prices can go down as well as up, might have cut into the idea of Wall Street bankers as geniuses, but evidently not. […] It’s not hard to see where it originates—Wall Street types can’t go twenty minutes without telling everybody how smart they are—but it’s hard to see why so many people accept such blatant propaganda without question.

Look, Romney was an investment banker and corporate raider at Bain Capital. This is admittedly vastly more quantitative work than, say, being a journalist, but it doesn’t make him a “numbers guy.” The work that they do relies almost as much on luck and personal connections as it does on math—they’re closer to being professional gamblers than mathematical scientists. This is especially true of Bain and Romney, as was documented earlier this year—Bain made some bad bets before Romney got there, and was deep in the hole, and he got them out in large part by exploiting government connections and a sort of hostage-taking brinksmanship, creating a situation in which their well-deserved bankruptcy would’ve created a nightmare for the people they owed money, which bought them enough time for some other bets to pay off.

Yes, there are some genuinely data-driven traders, but as Orzel points out, they’re very much a minority in the actually-existing finance industry. The idea that Finance Guys (and they are, very much, mostly guys) have some kind of super-numerate insight into money and economics is, basically, a big con perpetrated by a privileged class that wants the rest of us to believe it’s far more essential than it actually is.

Orzel’s ultimate point is to those of us who’ve been boggled over the many reports that Romney and his team weren’t just faking last-minute confidence but, rather, genuinely expected to win—despite the fact that every single credible poll said that they probably wouldn’t. As Orzel says, no, this is precisely the common failure mode of guys like this:

They make “gut” decisions all the time, and slant their projections in a way that justifies what they want to do. When one of their bets come through, they rake in huge amounts of money; when it doesn’t, they chop up the company and sell the pieces to cut their losses. And when a disaster that thousands of other people see coming a mile off blows up in their faces (the housing crash, or last Tuesday’s election), they’re left utterly flabbergasted.
I’m not sure how many more disasters it’s going to take before journalists get out of the habit of treating Wall Street types like they’re the super-geniuses they claim to be, but the sooner the better.
Comments on Giving Wall Street types more credit than they deserve:
#1 ::: Steve Halter ::: (view all by) ::: November 12, 2012, 12:23 PM:

Many of them (finance guys, corporate overlords) are unable to grasp the effects of randomness upon their lives. They say, "See all my decisions have been right--you can tell by all the money I have." Unfortunately, their numbers are gut based and in the next coin-flip decision, they may very well lose a large portion of that money.
In much the same vein, I was always very bemused by the hyper efficient corporations that Michael Crichton often had within his novels. While they may very well exist, I've never seen any first hand.

#2 ::: Lydy Nickerson ::: (view all by) ::: November 12, 2012, 12:57 PM:

From 1986 until 1994, I worked for a mortgage company that closed loans in 50 states. This was back when companies like IBM and ATT were relocating their people every 2 years. So I got to work with a lot of people moving from one place to another. People moving from Texas to California were hurting big time. They were not just losing the equity they had in their home, they were paying twenty, thirty, forty thousand dollars to get out of the home they absolutely had to sell, and buying a home three times the price and half the size in California. Property values in Manhattan were doubling every couple of months. Other markets were doing other odd things. It became very clear to me during that 7 years that real estate always operates on a boom-bust cycle. Now, if I could figure that out...

#3 ::: Christopher Wright ::: (view all by) ::: November 12, 2012, 01:10 PM:

"Wall Street Coyote... SUUUUUPER GEEEEEENIUS!"

#4 ::: Larry S ::: (view all by) ::: November 12, 2012, 01:21 PM:

I work in finance on the technical side. I can tell you that 90% of the brokers and traders are clueless about the numbers. Hell they are mostly clueless about how their desk works. You will get 10 answers from 10 brokers/traders if you ask them how it all works.

There are some really, really smart people in finance. Most of them are not that. It's about networks and relationships mainly. Who you know, what sports team you like, what the latest internet thing you can show your customers that is what drives it when you get out of the OTC markets.

A lot of it is throwing out stuff and seeing what sticks from a business perspective. Also and this is a big beef I have personally most of it is short term thinking because the bonuses come on the quarter so everything is done in light of "how much money can I get in 3-4 months" not "how will i do in a year".

Lydy @#2:

The MBS markets were always a little sketchy I thought. The amount of money passing through those markets made it ripe for the bust that happened. I recall seeing Lehman and others go under and the markets scrambling to remove all their risk and positions related to those firms in like a 24 hour period before markets officially opened.

#5 ::: The Raven ::: (view all by) ::: November 12, 2012, 01:26 PM:

There's a reverse problem; there's a lot of times when the knowledge of real "numbers guys" isn't recognized. The science of climate change—an extraordinary statistical achievement—is perhaps the most egregious example of this, but I think also of the rejection the work of economists like Paul Krugman and Christine Romer and Keynesian economics more broadly. Of Keynesian economics Daniel Davies has recently written, "I think people are underestimating quite how well-tested Keynesian theory is, by now, in the Popperian sense."

Returning to the original point, in the same article, Davies makes an argument that sometimes there aren't any numbers (see Davies' fn2) and the belief that there are leads to specious results; one ends up, like the Romney campaign, seeing one's own prejudices in random data.

#6 ::: rea ::: (view all by) ::: November 12, 2012, 01:33 PM:

@The Raven @ 4 one ends up, like the Romney campaign, seeing one's own prejudices in random data

As usual, there is an xkcd about this:

http://xkcd.com/904/

#7 ::: The Raven ::: (view all by) ::: November 12, 2012, 01:36 PM:

Rea, #5: did you know that Nate Silver started out in sports journalism?

#8 ::: Serge Broom ::: (view all by) ::: November 12, 2012, 01:50 PM:

Lydy Nickerson @ 4... Now, if I could figure that out...

I have it all figured out, thanks to my science of Psychohistory - emphasis on 'psycho'.

#9 ::: Kevin Riggle ::: (view all by) ::: November 12, 2012, 01:59 PM:

It's worth noting that there's a distinction between "Wall Street types" like Mitt Romney -- who trade on gut instinct and personal connection -- and the actual quants, who really are very numerate, and know exactly what the risks look like. (There's some anecdote about how it used to be that MIT physics PhDs went into science or R&D and now they all go into finance, which isn't entirely accurate but will do for illustrative purposes.)

Why the "Wall Street types" don't listen to their highly-paid, highly-trained, highly-intelligent quants is really quite beyond me.

#10 ::: Lee ::: (view all by) ::: November 12, 2012, 02:01 PM:

There used to be a piece of common wisdom concerning the stock market: "Past performance is no guarantee of future performance."

I wonder if people still say that, and if they realize that this is also true of people who claim extraordinary expertise with the stock market and similar gambling entities.

#11 ::: Alec Austin ::: (view all by) ::: November 12, 2012, 02:02 PM:

If Romney and his team were actually numerate and technologically capable, any of the multiple design & process-oriented failures surrounding their roll-out of Project ORCA wouldn't have happened.

Seriously, beta-testing your (complex, with a non-obvious UI) product on election day is just madness.

#12 ::: eyelessgame ::: (view all by) ::: November 12, 2012, 02:04 PM:

I despair of teaching people how math works.

When the author of 'Outliers' was being interviewed a few years ago, the expatriate Brit doing the interview was incensed that he should claim that part of his succcess was due to luck. "I resent the idea that my success is due to luck. I came here," he said, "a man with a British accent, to become a television newscaster. Do you have any idea how risky a move that was?"

With no awareness of what he had just said.

#13 ::: Nancy Lebovitz ::: (view all by) ::: November 12, 2012, 02:12 PM:

#9 ::: Kevin Riggle

I've read The Quants. You don't necessarily want someone who knows math but not the markets.

If the book is correct, there were too many guys (again mostly? entirely? guys) who thought you could bet on one thing going up and another thing that ought to go down if that first thing doesn't and look like a genius for a few years.... but then the market is weirder than you imagined and both your bets go wrong and you hemorrhage money.

Less giddily, Thorpe (the fellow who invented card-counting) had a gut level understanding that things could go wrong and the younger generation tried to coast on his ideas without really understanding them.

See also Goodhart's law: Any shortcuts to actually understanding what's going on (business people understand money! we can trust past results! we can trust credentials!) is likely to eventually get bitten by whatever was left out.

#14 ::: Lizzy L ::: (view all by) ::: November 12, 2012, 02:16 PM:

I enjoyed Orzerl's post, though it ain't news.

No, Wall Street financiers are not Masters of the Universe, no matter how easy it is for them to believe their own hype. Now, if only contemporary journalists could be persuaded to pay attention to the counter-narrative. Unfortunately, contemporary journalists appear to be extraordinarily gullible. Or perhaps it's just that they really really want the Wall Street mythology to be true, because the people who pay their salaries also really really want it to be true.

#15 ::: Bruce Cohen (Speaker To Managers) ::: (view all by) ::: November 12, 2012, 03:09 PM:

Lizzy L @ 14:

I suspect a lot of the gullibility of the "journalists" (they're really more like stenographers) who report on Wall Street stems from the unwillingness to do their own research; they get most of their information from interviews and press releases. This comes in part from the great stress placed on the press in general as newspapers and other traditional outlets downsize to cut costs as their readership declines; the more stories you can write in a given period of time the more competitive you are as a reporter and the more likely you are to keep your job, and research takes time.

I've had considerable dealings with industry analysts in the high tech sector over the last 20 years or so, and as far as I can tell, they have exactly the same failings as the brokers$. They pick the companies and products they think will be winners based on gut feeling, and then find rationalizations to back up their guts¥.

$ My first pass at typing that word came out "borkers" which I think is appropriate.
¥ Yes, entrail divination continues to be used in the modern world.

#16 ::: clew ::: (view all by) ::: November 12, 2012, 03:27 PM:

LTCM had and listened to math geniuses, and may not have been as sensible about the markets as anyone in the 1970s-1990s; and still, crash!

#17 ::: clew ::: (view all by) ::: November 12, 2012, 03:28 PM:

Der. 'May have been as sensible'. Was thinking that it's obvious now what their error was, but hindsight is like that.

#18 ::: KayTei ::: (view all by) ::: November 12, 2012, 03:33 PM:

I think part of my concern with the stock market, generally, is that people seem to view it as a form of gambling, which makes them feel like they don't have to exercise ordinary prudence.

I feel like we need to start nailing some of these cowboys on failing in their duty of care to their clients and employers. And where they don't have a duty of care, we need to establish one. It won't help everything, but I feel like it might help limit the scope of the problem, which is significantly a problem of cultural tolerance.

#19 ::: Serge Broom ::: (view all by) ::: November 12, 2012, 03:36 PM:

Lizzy L @ 14.. Wall Street financiers are not Masters of the Universe

Thank goodness for that. Some of them I'd rather not see garbed like Dolph Lundgren.

#20 ::: Larry S ::: (view all by) ::: November 12, 2012, 04:43 PM:

clew @16: LCTM was also heavily leveraged into some high risk markets. In a sense they had to be heavily leveraged in order to do what they did. This meant that if things went bad, which of course they inevitably will, the fund would be decimated. This is what happened.

The markets, be they equities, fixed income, currency, or whatever are a mix of numbers and the human side. Problem is a lot of the people running it don't trust the technology for all sorts of reasons both right and wrong.

#21 ::: Kevin Riggle ::: (view all by) ::: November 12, 2012, 05:53 PM:

KayTei @18: I mean, the stock market is a form of gambling -- in that you are paying money now in return for a potential payoff later -- except it's one that (in theory) has a positive expected value rather than a negative expected value. It's also a form of gambling which we believe has a positive value to society.

There's nothing wrong with making a risky bet, as long as you're willing to lose it. The Wall Street firms bet more than they could lose, and the government had to step in. Now, that said, the Wall Street bailout made a pretty profit for the Federal government, so it's not so clear-cut an issue as "the taxpayers ended up shouldering the debt with nothing to show for it".

Nancy Leibowitz @13: "Knowing the market" amounts to "gut instinct". Of course things could go wrong -- things could always go wrong. The problem is not that things went wrong, the problem is that when they did, they nearly took the country with them. "The housing market can never go down" wasn't driven by the quants, that was driven by "gut instinct".

As to gender balance on Wall Street -- among my friends (who are mostly back-office quant or tech types), at least, it's pretty even. Outside of my friends it probably skews male, but it's still not nearly the old Good Ol' Boy's club.

What's the right way to limit the risks banks take on while still allowing them to do their job (which is to take risks with a positive expected value overall)?

#22 ::: Nancy Lebovitz ::: (view all by) ::: November 12, 2012, 07:12 PM:

How competent your gut is depends a lot on what it's stocked with-- how much experience, how much good sense, how much detailed knowledge.

I expect there are people who could look at the quants' math, and those people's guts would go "ow-ow-ow" because their gut feelings would react immediately to the lack of concern for things going wrong. Unfortunately, the math was so complex and the idea of hiring mathematicians and physicists was so shiny that the few people with the right instincts didn't have enough authority to deal with the problem.

#23 ::: Bill Stewart ::: (view all by) ::: November 12, 2012, 07:23 PM:

I used to work with a bunch of physics PhDs. Some of them were doing actual physics, though more were applying physics-type math to network problems. One of them left in 1987 to become a quant (oops, but fortunately he didn't get laid off 3 months later when the market crashed.)

Another wanted to go become an actual physics professor; the first job he applied for, he was one of the top three of 600 applicants for a job at a small state college, and the next year he actually got that job after the top guy bailed on them. Physicists don't become quants just because they want the money and excitement of Wall Street, it's where they go slumming if there aren't academic jobs around.

And one of the big reasons that "knowing the market, not just the numbers" matters is that the models all rely on independence or correlation of events, and the numbers don't always reflect the underlying correlation of events except in rare circumstances, e.g. mortgages failing are pretty much independent noise as long as the average housing price doesn't drop more than 20%, but if it does you find that there's a strong correlation between all of them, so that tranche that Moody's rated as AAA is really just as junky as the tranche they rated Junk--. So if they're just following the numbers, quants can make a reasonable profit on the not-quite-random fluctuations, unless the bottom falls out of the whole game.

#24 ::: Fragano Ledgister ::: (view all by) ::: November 12, 2012, 07:34 PM:

What amazes me is that there's some serious mathematics phobia in the world of journalism. I do mainly qualitative research, but I had to do stats (and learnt my stats from one of the top people in quant pol sci). I have a lot of respect for the people who can actually make the numbers sing, and there's an awful big difference between them and the Wall Street Masters of the Universe.

#25 ::: Bruce Cohen (Speaker To Managers) ::: (view all by) ::: November 12, 2012, 07:37 PM:

As far as the math of stock market speculation goes, before he died Benoit Mandelbrot wrote a book titled "The Misbehavior of Markets: A Fractal View of Financial Turbulence" in which he took the marketeers to task for using the wrong mathematical models of risk. His arguments certainly looked reasonable to me (I'm not a mathematician or physicist, but I do know a fair amount of math for an engineer). His primary thesis was that the models that the market uses to estimate risk are based on normal distributions of the probabilities of events, whereas the appropriate models are power laws, which have much longer tails and much more dangerous outliers.

So far as I know, the entire quantitative establishment has ignored his work, on the theory that he didn't know what he was talking about. Even if he was wrong, that's hardly a rational way to analyze conclusions which, if true, can have serious consequences for the global economy.

#26 ::: Bruce Cohen (Speaker To Managers) ::: (view all by) ::: November 12, 2012, 07:53 PM:

Here's a frightening thought: the next big financial crisis may not be caused (directly) by the ignorance and arrogance of the MOTU, but by their computers. High-frequency trading, where computers request quotes hundreds or thousands of times a second, and can respond to changes in stock prices with buy or sell orders in a few milliseconds represent a significant fraction of the market network traffic today. When they start issuing tens of thousands of requests a second and respond in microseconds over custom-built communication networks designed to be a few microseconds faster than the common carriers, they'll probably represent the majority of the traffic.

All it takes is one bug, or even just an incompatibility between the algorithms of two different traders to create unstable market behavior. You may remember that in August what was supposed to be a limited beta test of a high-frequency trading system slipped its leash and ended up costing the company running it over $400 million.

#27 ::: chris ::: (view all by) ::: November 12, 2012, 08:22 PM:

Why the "Wall Street types" don't listen to their highly-paid, highly-trained, highly-intelligent quants is really quite beyond me.

Understanding things is a skill. Convincing people to believe you is another skill. Real life isn't like a completely balanced point-based RPG, but still, time spent developing one skill is not spent developing the other.

On top of that, if you understand things thoroughly enough to make qualified and hedged rather than sweeping and absolute statements, to some people that makes you *less* convincing.

they’re closer to being professional gamblers than mathematical scientists.

Actually, I would bet (ha!) that of Wall Street brokers, professional gamblers, and mathematicians, the Wall Street brokers are the least like the other two. Although it may depend on what you're gambling on.

#28 ::: P J Evans ::: (view all by) ::: November 12, 2012, 09:08 PM:

25
That idea's getting some serious attention now. The statisticians are looking at the historical records of market performance and saying that it really is fractal. See 'Beware the Long Tail', in Science News (5 November 2011).

#29 ::: Lee ::: (view all by) ::: November 12, 2012, 09:41 PM:

Kevin, #21: What's the right way to limit the risks banks take on while still allowing them to do their job (which is to take risks with a positive expected value overall)?

We had a functional answer to that during the decades between 1930 and 1980, in the existence of banking regulations which pretty solidly prescribed the amount and types of risk a bank could take on, and yet the banks flourished.* Those regulations were systematically demolished between 1980 and 2000, with results which should have been entirely predictable. Deregulation is what got us into this mess, and yet Wall Street continues to yell for more deregulation as a solution. To which I say, the hell with that -- let's see some RE-regulation!


* We also had Savings & Loan Associations -- remember those? They were deregulated starting in 1978, and it took about a decade for the entire industry to go glub, at a hefty cost to the taxpayers. You'd think someone would have taken the warning to heart.

#30 ::: Lee has been gnomed ::: (view all by) ::: November 12, 2012, 09:42 PM:

Probably for a suspiciously-formatted link.

#31 ::: KayTei ::: (view all by) ::: November 13, 2012, 01:05 AM:

Kevin @ 21

I get it. But it's the difference between taking stupid risks and taking informed risks. And an informed risk isn't just "this seems like a pretty good gamble and I think it will probably pay off," but includes "and it's within my client's risk tolerances, which may or may not allow for a high degree of uncertainty."

Put it another way - you can make conservative bets or risky bets, or mix it up. But when people assume it's all gambling, and start taking lots of really risky bets because "it's all the same" and when nobody's paying attention to the odds because they're too focused on the high payouts at the other end of a long shot? That's a problem. A duty of care would require folks to pay attention to the odds, and also to their client's specific circumstances, before deciding what bets to place. When their professional licenses are on the line, people pay attention to that sort of thing.

#32 ::: Dave Bell ::: (view all by) ::: November 13, 2012, 01:58 AM:

When the professionals running things such as pension funds rarely do better than the average of the markets, it strongly suggests that they don't have any understanding of the underlying merits of what they trade. It is likely that the Venture Capitalists (and TV programs such as Dragons' Den indicate they are not infallible) are the geniuses of the financial world, because they investigate carefully where they put their money.

#33 ::: SamChevre ::: (view all by) ::: November 13, 2012, 08:33 AM:

Lee @ 29

We had a functional answer to that during the decades between 1930 and 1980...

This is just fractally wrong. With stable inflation, and stable exchange rates, the 3/6/3 rule worked fine. It stopped working when inflation rates started rising in the early 70's; the late 70's deregulation was an an attempt to cope with the resulting mess.

#34 ::: C. Wingate ::: (view all by) ::: November 13, 2012, 09:02 AM:

re 32: What it suggests to me is that they are the average of the markets. It wouldn't surprise me at all to find that mutual funds and other such huge professionally managed portfolios own well over half of the entire market. And you know, there an old rule that says you can't be blamed for doing badly when everyone else got burned the same way, but you can be blamed when you strike out on your own and get burned.

#35 ::: paul ::: (view all by) ::: November 13, 2012, 10:10 AM:

There's another factor at work as well, I think: the whole point of the finance industry is to know something your counterparty doesn't. Either because they haven't done due diligence or because you've deliberately constructed an opaque instrument or you have special inside information, or you have contacts and power to make your preferred outcome happen regardless of events. At the very least, if you don't believe that, you don't trade.

#36 ::: Caroline ::: (view all by) ::: November 13, 2012, 10:11 AM:

Dave Bell @ 32 and C. Wingate @ 34: A few years ago I read a very informative book called Naked Economics. One thing I learned from that book is that no matter how you pick stocks and try to time the market, over any reasonable period of time you won't do better than the market average. It's a statistical fact. This caused me to start investing in index funds that track the market as a whole -- and to treat anyone who claimed to consistently outperform the market with great suspicion.

Venture capital is a whole different kind of investing -- statistics of large numbers don't really apply. (Or that's how it seems to me, anyway. Not a finance expert here.)

#37 ::: Larry S ::: (view all by) ::: November 13, 2012, 10:33 AM:

Paul #35: It goes beyond that. A large part is to not know who you are buying/selling from to prevent a competitive advantage.

In my time I've seen it's less a distrust of the math but more a "i know better" thing. For all the risk taking unless something is happening they think will make them money they will ignore it at best. I've seen this a lot with new tech or tech that is hard to understand.

#38 ::: Lee ::: (view all by) ::: November 13, 2012, 12:39 PM:

SamChevre, #33: I disagree based on the history of the S&L crash, but am willing to be convinced. Is there any evidence you can lay hands on quickly?

#39 ::: Lori Coulson ::: (view all by) ::: November 13, 2012, 01:22 PM:

Wall Street is the reason I keep my savings in government securities -- if things go sufficiently pear-shaped that that is not a good strategy, I suspect I'll have more to worry about than money.

If it's good enough for Alan Greenspan, it's good enough for me.

#40 ::: SamChevre ::: (view all by) ::: November 13, 2012, 01:54 PM:

Lee,

It's a pdf, but I think this history from the FDIC is a good summary.

#41 ::: guthrie ::: (view all by) ::: November 13, 2012, 02:10 PM:

As an aside, what is it with the paranoia or hatred of PDF's? People have been typing "warning, PDF" or suchlike for quite a few years now, as if PDF's are more evil the microsoft or will take over your computer and join it to a botnet or something. Never mind that often people don't do the same thing when linking to an online document written in MS word or other program like that.

Is there anyone who doesn't have Acrobat reader on their computer?

#42 ::: C. Wingate ::: (view all by) ::: November 13, 2012, 03:26 PM:

Oh, this version of the S&L implosion is much more entertaining. I was right in the midst of it all, at least as a customer: I got an account at Chevy Chase right after they started offering checking. They were, by the standards of those things, conservatively run, which I think means really that BF Saul II wasn't innately a crook. The Levitts at Old Court and a fellow named Klein at Merritt between them took down the state deposit insurance fund, in no small part because the S&Ls who weren't run by megalomaniacal pigs saw the handwriting on the wall and bailed out for the FSLIC, which was in turn taken down as described in the FDIC paper. The Levitts came to stand for banking greed, at least in these parts, on a par with Imelda Marcos and Tammy Fay Bakker.

This is why I see no reason not to regulate the hell out of banks, and to severely confine their business. There are a lot of good operators, and then there are those like the Levitts who were beyond what parody could possibly dare to depict. The collateral damage of letting the market deal with the latter is simply too high.

#43 ::: C. Wingate throws a Twinkie to the gnomes ::: (view all by) ::: November 13, 2012, 03:27 PM:

Hey, if it worked for the Levitts...

#44 ::: albatross ::: (view all by) ::: November 13, 2012, 03:41 PM:

C Wingate, Lee, Etc.:

In general, bailouts imply strict regulation, if you don't want to run a system where the taxpayers cover the bad bets of the bankers from time to time. And the deposit insurance stuff worked okay in the financial meltdown, right? I mean, the big problem was not with banks collapsing and taking their customers' money with them, but rather with very large and shaky banks/financial companies having large and hard-to-assess exposures to other shaky banks, so that it was hard to decide whether a given bank was safe to lend money to. The biggest banks/financial companies in the crisis were given overt and hidden bailouts, under the "too big to fail" theory.

Now, IMO, too big to fail means either too big to exist, or so big and systemically important that it should be taken over by the government and run as a public utility. I'm no expert, but I do not understand why Citibank and Goldman and the rest get to continue doing business with a de facto US government guarantee on their debts, but without enormously tighter regulation. Indeed, it seems to me we'd be better off breaking those huge banks up and using antitrust or financial laws to keep them from re-forming.

#45 ::: Bruce Cohen (Speaker To Managers) ::: (view all by) ::: November 13, 2012, 06:56 PM:

One of the worst aspects of the deregulation of banking and investment is that the gamblers aren't required to have enough money to back their losses. So if they guess really badly, nobody in the system can cover the bets, which is basically what happened in 2008, when several trillion dollars of losses from bets on bad mortgage instruments had to be covered.

#46 ::: Dave Hemming ::: (view all by) ::: November 13, 2012, 06:57 PM:

This is an odd one, as I've met Chad and his wife - although they weren't married then - despite being UK based.

Usenet has a lot to answer for.

#47 ::: Jacque ::: (view all by) ::: November 13, 2012, 07:32 PM:

Kevin Riggle @21:

Friend of a friend back in the '80s played the stock market very successfully. He had a very simple algorithm:

1. What are the possible gains?
2. What are the possible losses?
3. Can you afford the losses?

If the answer to 3 is 'no', you don't bet. The answer to 3 is NOT "can't possibly lose!"

#48 ::: chris ::: (view all by) ::: November 13, 2012, 08:48 PM:

Venture capital is a whole different kind of investing -- statistics of large numbers don't really apply. (Or that's how it seems to me, anyway. Not a finance expert here.)

They don't beat the market either -- as a class. Some get lucky, beat the market and get on the cover of adoring business magazines. Thousands go bankrupt in obscurity and shift the real costs of their operations onto their innocent counterparties. All hail the awesome power of the free market.

#49 ::: P J Evans ::: (view all by) ::: November 13, 2012, 09:08 PM:

41
They tend to be large files. People on dial-up, or with other kinds of slow connection, prefer knowing before they click on links.

#50 ::: abi ::: (view all by) ::: November 14, 2012, 01:37 AM:

guthrie @41:

I'm not on dialup, but I find them annoying because I need to confirm the download, and then take the extra step of figuring out whether to keep or delete them. It's just more cognitive effort than opening and closing tabs.

More generally, I try to cater to other people's dislikes without necessarily trying to adjudicate whether they're reasonable or not. I don't know if you were intending to come across as judgmental (rather than simply curious) in your comment, but that's the effect your comment had on me.

#51 ::: albatross ::: (view all by) ::: November 14, 2012, 09:27 AM:

Guthrie #41:

Additionally, PDFs can be used as a vector for attacking peoples' computers. I gather this is not all that uncommon when you're trying to selectively install keyloggers or other malware on activists' computers--put out a PDF with some kind of payload that takes over Acrobat Reader and then installs the keylogger, and you magically get to spy on the computers of a whole bunch of people who are downloading documents on Chinese human rights abuses in Tibet or something.

The annoying thing about this is that PDF files are the standard way to transfer big documents around, despite the exploits. However, it's not a bad idea to find an alternative PDF viewer instead of counting on Acrobat Reader, and it's a very good idea IMO to set your browser to download PDF files, rather than opening them automatically.

#52 ::: Terry Karney ::: (view all by) ::: November 14, 2012, 09:42 AM:

One of the things a moderate amount of reading has shown me is the "market" is anything but free.

It also makes it plain that what happened wasn't, "Banking" so much as bilking. The "banks" weren't making money on putting money to work, they were making money on sales.

Anyone who was paying attention should have known there was a disaster coming. I did, back in 2005. If I'd had a small fortune, and known about things like, "default swaps", etc. I could have made a big fortune.

Because I saw a television ad. From that ad (telling people the way to get out of renting was to buy a negative amortization loan, with a three year lag time to the ARM phase), and from Alan Greenspan touting ARMs, I knew 1: there were a lot of loans guaranteed to fail and 2: the "numbers guys" were clueless, and possibly had ill intent.

Sam Chevre: It's possible that the deregulatory waves in the 70s/80s were attempts to deal with some systemic problems, the evidence on the ground is the solution was worse.

The problem with such things is the experiments can't have a control negative. We don't know what doing nothing, or doing something else would have done.

I do know that when the parallel sort of deregulating was done, a fairly similar metastasis of the banking sector; to what happened in the S&L sector, took place.

A type of failure which hadn't been seen in the time of the regulation. I know (because I was alive in them. I recall lending rates in the 17-21 percent range. My family bought a house in 1976), that I think the solution is worse than the problem; esp. with the "austerity" being touted to fix the fallout.

#53 ::: SamChevre ::: (view all by) ::: November 14, 2012, 09:48 AM:

the deregulatory waves in the 70s/80s were attempts to deal with some systemic problems, the evidence on the ground is the solution was worse.

I would absolutely agree.

I disagree with "we had a working system"; I don't at all disagree that "once we messed with it, it was even worse."

#54 ::: Terry Karney ::: (view all by) ::: November 14, 2012, 12:44 PM:

I think the system was working. There were a lot of other things going on; the oil embargo, the delayed costs of VietNam, the backlash adjustments to Nixon's price controls.

Was the banking system too inelastic? I don't know, but I do know the deregulation of banks (not S&Ls) didn't really take off until Clinton (and the repeal of Glass-Stegal), so it's hard for me to say, "It was broken", when it recovered before the tinkering; and exploded afterwards.

Esp. because there are extant historical examples of that same pattern, Holland, in the time of Tulips, and then England in the latter Victorian era. Their markets went from making/selling THINGS, to selling "investments", and then they collapsed.

I wish I could remember the book which was detailing it (No, it wasn't McCauley).

#55 ::: Jim Macdonald ::: (view all by) ::: November 14, 2012, 12:47 PM:

Reinstating the New Deal wouldn't be a bad idea. And after that, next time someone wants to "deregulate" make them explain why this time that'll work.

#56 ::: Barry ::: (view all by) ::: November 14, 2012, 01:03 PM:

SamChevre:

"I disagree with "we had a working system"; I don't at all disagree that "once we messed with it, it was even worse.""

I would assert that, at least in the S&L fiasco.

From my understanding, the problem in the late 1970's (before deregulation) was that the inflation of the late 60's onwards had killed many S&L's, through no fault of their own. The business of an S&L was to loan money at fixed nominal rates over long terms, while taking in deposits which were withdrawable upon demand. Let's say that a S&L had loaned out their deposits at 5% for 20 or 30 year mortgages, while paying 3% on those deposits. When an inflationary period hits, their real loan rate could be negative, and people withdrew their money to invest in things paying over 3% nominal (such as real estate).

The way that I heard it was that in 1980 this was estimated to need a 50-70 billion $ FDIC bailout of depositors. The Reagan administration decided that the way to cure that was to deregulate, and let S&L's move into higher-yielding investments to make up their losses. Apparantly there is no risk-reward trade-off in right-wing economics.

Two of the effects were (a) riskier investments sometimes led to serious losses, putting the FDIC deeper into the hole, and (b) the deregulation include (probably deliberately) looser ownership restrictions, allowing real estate investors to own S&L's, which they promptly looted to fund real estate games.


This took a $50-70 billion problem and turned it into at least a $250 billion problem.

#57 ::: albatross ::: (view all by) ::: November 14, 2012, 02:49 PM:

Terry:

The usual quote used to respond to that idea comes from Keynes: "Markets can remain irrational a lot longer than you and I can remain solvent."

That is, many people can see that a bubble is inflating, but that doesn't mean that you know when or how the bubble will deflate. Sometimes it can go on for a very long time overinflated, while you lose money betting against it time and again.

#58 ::: C. Wingate ::: (view all by) ::: November 14, 2012, 03:08 PM:

re 56: This is accurate about the pressures on the S&Ls, but the way things fell apart was a bit more complicated. Real estate guys could own S&Ls long before the 1980s, I think actually from the beginning. It actually made a great deal of sense that way, because it helped them to fund customers, and the extremely limited nature of the business kept temptation at bay. The problem, as Barry points out, is that when interest rates started to run away (in large part because the Fed pushed them that way to push back against inflation), the S&Ls couldn't compete, and started to bleed money. If someone at that point had stopped to think where this was going to end, they could have skipped right to the correct solution, which would have been to kick them all up to full-fledged banks and merge away or close those which weren't viable, using the FDIC to do the clean up. What happened instead was that the piece ways action in that direction left open a series of regulatory holes and other differentials, which existed in large part because S&Ls couldn't act like banks and therefore didn't need the same level of supervision. Now they could so act, and weren't supervised. Also, the fatal scent of "get rich quick" was heavy in the air. The FDIC was never seriously threatened in this, but the much smaller S&L insurance pool was taken down in two steps, first with the state pools, and then the FSLIC; S&L owners went crazy because crazy was in the air.

Some aspects of deregulation I think were OK and even necessary. There was no way that the banks could have survived the Fed's interest rate hikes without more flexibility in setting interest rates than they had. (One can question whether those hikes were a good idea, but that's a separate issue.) OTOH the removal of the wall between retail and investment banking was and is a big problem. One of the points of that barrier was, after all, that an investment bank that went bad could be left to fail without involving the FDIC. And surely one of the lessons here is that forcing the banks to do ordinary business simply both makes supervision both less of a burden and more effective.

I am convinced at this point that there's going to be a crisis, who knows how many years off, revolving around student loans. The only thing that makes it not as bad is that it seems to be free from the "get rich quick through wheeling and dealing" curse, so the money doesn't pour into in with the same abandon. But there is no way that the current pattern is sustainable, and the perpetual indenturement of current loans can't last. And when it pops, the college costs bubble will have to pop with it.

#59 ::: Caroline ::: (view all by) ::: November 14, 2012, 03:21 PM:

Re: warning for PDFs:

Back in the 90s, Acrobat Reader would pretty often crash Windows machines, in my experience. It was a reliably buggy program back then. I always figured that's why people started warning for PDF download links.

I think the habit's stuck around because it's nice to know in advance that the link you're clicking on is a link to download a file, for workflow reasons (as abi mentions) if nothing else.

#60 ::: Terry Karney ::: (view all by) ::: November 14, 2012, 08:48 PM:

albatross: That's why I said if I had the money...

I did some reading on the people who made money on the crash... The leverage of being on the winning side of a CDS, or the more insance CDO (which were just bundled CDS) was in the range of orders of magnitude, for a fixed annual cost.

So for a 3 tenths of a percent you could be entitled to all the insured funds. All you needed was the couple of million a year to pay the rate. A fund that had a couple of billion could do that, so long as the investors were willing to take the up-front losses.

And by 2005, anyone who was looking at the details (as I was seeing the big picture) could have seen the writing on the wall. A few did. They made tens of billions on a couple of hundred mill.

If you are rich, you can make a fortune.

#61 ::: P J Evans ::: (view all by) ::: November 14, 2012, 08:57 PM:

60
By early 2006, the real estate market was slowing noticeably; I'm surprised that people on Wall Street didn't notice that. Out here in the real world, people certainly did.

#62 ::: Tom Whitmore ::: (view all by) ::: November 14, 2012, 11:31 PM:

Hey, I can predict that the same sort of thing is happening with modern first editions, particularly with respect to (name a genre). Right now, there are some amazingly inflated prices that people are willing to pay because they believe someone else will, in a year or two, pay a lot more. Look at any book published since 1980 that's being offered for over $500. There's a serious chance that bubble effects are a major component of the price.

I'd push that "1980" back to "1940" for a small consideration, and back to 1900 for a larger one. The Modern Firsts market is a classic bubble.

My rule about collectibles: "Never spend more for something than you'll get back from the pleasure of owning it." That's the only way I know of not to lose. The art lies in predicting the pleasure/cost ratio.

#63 ::: Nancy Lebovitz ::: (view all by) ::: November 14, 2012, 11:49 PM:

#60 ::: Terry Karney

If you are rich, you can make a fortune.

If you are rich and have better sense and more information than most of the people around you, you can make a fortune. In other words, you probably won't.

#64 ::: Bruce E. Durocher II ::: (view all by) ::: November 15, 2012, 12:04 AM:

Tom: the weekend after Zelazny died, I was at a con where one of the vendors was offering the first edition (the one that was pulped accidentally) signed of Nine Princes in Amber for $1,700.00. I wasn't tempted--but it was nice to at last see one not in a catalog photo.

#65 ::: Tom Whitmore ::: (view all by) ::: November 15, 2012, 01:55 AM:

Bruce Durocher @64 -- that's a book I've owned three copies of. One I bought for half the cover price from Charles Brown at Locus just when it was published (and that copy got passed around a lot before the paperback got published). One I found in the Salvation Army bookstore in DC (x-lib, passed on to a Seattle collector who Really Wanted it, for not very much). And the third I bought at a Boskone for cover price, long after it was out of print, and I made a nice profit on it several years later.

I still think he didn't need to write any more books in the series after the first (which I said before the second was published). Everything I needed to know was in the first one. But -- I still wanted to read more. I just wish he'd done a better job with the "more".

#66 ::: chris ::: (view all by) ::: November 15, 2012, 08:38 AM:

By early 2006, the real estate market was slowing noticeably; I'm surprised that people on Wall Street didn't notice that. Out here in the real world, people certainly did.

IIRC, some people did, but they were sneered at, and in some cases fired, for their negative attitude.

IMO, the first lesson of the crisis should be: Never demand a positive attitude from someone whose job is prediction. If a disaster really is coming you need to know about it and shooting the messenger is suicidally stupid.

The man who doesn't believe in bears will be the first one mauled. Ditto bear markets.

#67 ::: Jacque ::: (view all by) ::: November 15, 2012, 12:08 PM:

C. Wingate @58: And when it pops, the college costs bubble will have to pop with it.

But that would be a good thing, right? Us J. Random Populace who refuse to get student loans could maybe afford a college education again? Or would it just mean that the universities' financing would collapse?

#68 ::: C. Wingate ::: (view all by) ::: November 15, 2012, 03:22 PM:

Jacque, it could go a lot of different ways. The big question is whether the colleges are going to need to or be able to respond to the potential loss of revenue. I think the ivies and their relatives won't have to budge, but the composition of their student bodies will go back more towards what they looked like before WW II. (If their prestige suffers a bit for that, so much the better.) I don't know what leeway other schools have to cut costs; surely schools like GMU and GWU which have pushed up their standings by hiring prestige faculty will be forced to give that practice up to survive. I imagine that, as usual, the smaller liberal arts places will go through another round of closings. I'm sure there will be tremendous pressure on the big status-seeking public schools to do what it takes to keep admissions up by cutting costs somehow (GMU again, and UMCP especially). But I think that the end result is going to be to push a lot of people out of college because they are too poor and can't get a scholarship. This may not be all bad, because it would crimp the credentials creep that has blocked the non-college-educated out of a lot of jobs, but clearly a lot of those who could benefit from a college education would lose the chance to get one.

#69 ::: Jeremy Leader ::: (view all by) ::: November 15, 2012, 04:20 PM:

Somewhere recently I skimmed an article about the UC (University of California, includes Berkeley, UCLA, and quite a few other sizable, prestigious public universities).

The first point I recall was that until the 1960s, the UCs were essentially free (they charged no tuition, and only minimal fees). Pretty much anyone who got accepted could afford to attend. Apparently Governor Reagan didn't like the problems caused by Berkeley students (and faculty), and so did all he could to reduce state funding to the UCs. Today, the UC "fees" have risen to rival tuition at private universities.

The second point was that one of the Regents of the UC system is also one of the largest investors in the Apollo Group, the largest for-profit higher-education company, owner of Phoenix University among others.

I don't expect the coming changes in higher education when the student loan bubble pops to be good for society as a whole.

#70 ::: abi ::: (view all by) ::: November 15, 2012, 04:26 PM:

Jeremy Leader @69:

The article for your first point might have been this article that I Parheliated last month.

It makes no mention of the Apollo Group, however. So maybe not.

#71 ::: C. Wingate ::: (view all by) ::: November 15, 2012, 04:53 PM:

Well, the situation at UMCP back when I was there in the late 1970s was that anyone with a pulse and a high school diploma could get in, and they were very cheap. They then failed something like half the freshman class in the first semester, because they didn't make allowances for the quality of the people coming in. What this meant was that if you were an in-state student, and you were up to the work, you got a good education for cheap; and people in the various fields knew what schools within the school were solid (CS, physics, geology, some engineering fields, journalism....). We also go a lot of out-of-state kids from the NYC area whom their own public universities didn't have the capacity for. The problem was that the metric that desirability is measured in became the number of people you turned away, and since they effectively didn't turn away anyone, that came to be viewed as a problem. So the solution was to go to competitive admissions and cut the student body by the 8,000 freshmen that used to drop out on their own. They also went on the building spree that was part of the status-seeking process. Some of that was necessary: the CS department in particular was badly wedged into a building that wasn't really up to dealing with 1964 computing, never mind 1980. But they also built themselves a shiny new gym, and a shiny new arts center, and a shiny new basketball court, and a lot of shiny new dorms-- and they kept all the old buildings too, except for one dorm and Cole Field House. And fees went up, so that while UMCP is still a lot cheaper than the comparable private schools, it isn't dirt cheap, as it used to be. In my day, if you had the stamina, you could work an evening job and pay for college with it. They've likewise gone on a perpetual fund-raising campaign, so that every few months I get a call from some student begging me for a donation. But in one respect it has worked: it has become a very competitive place to get into.

#72 ::: Jeremy Leader ::: (view all by) ::: November 15, 2012, 05:34 PM:

Abi @70: That's definitely the article I'm thinking of. I thought I had read something else that connected Blum to Apollo, but a quick web search now doesn't turn up any evidence of that, other than that his firm partnered with other firms that are involved with Apollo, which probably doesn't mean much.

I apologize for (unintentionally, but sloppily) propagating misinformation.

#73 ::: Cat ::: (view all by) ::: November 15, 2012, 08:03 PM:

#68: the ivies and their relatives won't have to budge, but the composition of their student bodies will go back more towards what they looked like before WW II. (If their prestige suffers a bit for that, so much the better.)


Education for the children of the 1%? Not sure how that's a good thing...

#74 ::: C. Wingate's remark sleeps with the gnomes ::: (view all by) ::: November 17, 2012, 08:51 PM:

re 763: Well of course in that sense it isn't good, but if the appearance of competitiveness suffers because people decide not to try, it could only "help" Harvard's reputation shrink a bit towards something less distended.

#75 ::: Jim Macdonald ::: (view all by) ::: November 18, 2012, 02:47 AM:

#74 ::: C. Wingate

-- I don't see your remark either in the moderation queue or in the spam bucket, so I think your remark is pining for the fjords.

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