Invisible hand of morality

I enjoyed writing my MINT column for Tuesday on the rise of socialism among millennials and how capitalism – both ‘arms-length’ and ‘arms-around’ varieties – brought about this love for socialism. The MINT column was triggered by ‘The Economist’ cover (16th February 2019) and the ‘leader’ on the topic. While researching for the topic, I came across a paper by Amar Bhide titled, ‘An accident waiting to happen’ written in 2009. It is a well-written paper – both cogently and passinately argued.

In my MINT column, I argue that both arms-length capitalism and relationship capitalism (citing an example from India) had failed and the common reason for that failure is that morality has disappeared from both forms of capitalism. The common belief stemming from a faulty reading of Adam Smith’s ‘Wealth of Nations’ was that morality was not required. Self-interest was both necessary and sufficient to drive collectively beneficial outcomes. It is quite possible that Adam Smith never meant it that way. I had covered that in an earlier blog post. The visible hand of morality was the foundation or pillar of capitalism. My argument and Amar Bhide’s arguments are not mutually exclusive.

In his paper, Amar Bhide argues that the crisis of 2008 was a case of humans lacking in humility (excessive belief in mathematically determined probabilities) and failing to factor in the law of unintended consequences. He argues that tight securities market regulations (investor protection laws; insider trading rules, etc.,) created arms-length capital markets in which nobody had a stake and hence, managers looked after themselves. No single shareholder was powerful enough or interested enough to stop excesses of managements.

Similarly banking or financial deregulation, he says, enabled banks to take on risks that they otherwise would not have. He cites abolition of inter-state banking, repeal of Glass-Steagall, proprietary trading, etc. Federal Deposit Insurance encouraged banks’ excessive risk-taking: moral hazard. Ho brw come economists ignored moral hazard in this matter? With deposit insurance, depositors were not interested in monitoring risk-taking by banks.

He writes:

In the narrative offered by Rajan and several other economists, exogenous technologies played a deterministic role, inexorably forcing changes in regulation and financing arrangements. But technology might, instead, have facilitated relationship banking…. The outcome was not predetermined. In fact, in the story that I have told here, the increased share of securitized financial assets was driven mainly by the beliefs of financial economists and regulators. [Link]

His conclusion is pithy, sharp and correct:

Economics has underpinned securitization through its embrace of mathematical models to the exclusion of other perspectives, and through a complementary tendency to ignore the downside of liquidity and arms-length relationships. Regulation has brought this way of thinking into the world of practice in two paradoxically related streams: by increasing the scope and effectiveness of the New Deal securities acts and subsequent rules that fostered the growth of arms-length transactions in corporate control; and the progressive dilution of New Deal banking acts, which nurtured and protected long term relationships. This is the complicated story that may explain why developments in mortgage banking, of all things—traditionally the plodding, conservative bread-and-butter of depository banking—should have led to the implosion of the world economy.

I also chanced upon two of his op.-eds. One calls for the end of the Federal Reserve (as we know it) and the other faults the IMF for encouraging reckless lending by banks in foreign currencies to emerging sovereigns. Who, in their senses, could disagree with his (and his co-author’s) arguments?

Notwithstanding all of these, I could not resist pointing out in my column that the love of socialism is misguided and that humans were once again falling back on lazy answers. In this regard, the article I had cited in my MINT column on the case for wearing fur and leather was very thoughtful. The costs imposed on societies by misguided and/or uninformed do-gooders are substantial. I encourage you to read it.

I would also like to recommend reading a blog post I had written little less than six months ago.

Whose sufferance?

This is not a long article but makes some important points. It is about technology taking over our lives. AS always, it is an outcome of ‘means’ becoming the ‘end’. Technology was the means to a comfortable life. But, because we chased it too hard, technology has become the ‘end’ in itself and it is now dominating our lives.

IF you are not convinced about the conflation of ‘means’ and ‘ends’, read this paragraph by George Dyson:

The search engine is no longer a model of human knowledge, it is human knowledge. What began as a mapping of human meaning now defines human meaning, and has begun to control, rather than simply catalog or index, human thought. No one is at the controls. If enough drivers subscribe to a real-time map, traffic is controlled, with no central model except the traffic itself. The successful social network is no longer a model of the social graph, it is the social graph. This is why it is a winner-take-all game. Governments, with an allegiance to antiquated models and control systems, are being left behind. [Emphasis mine; link]

This warning by a MIT professor in 1970 was very prescient:

While Minsky believed that A.I. might solve the world’s problems, he also recognized how it could all go drastically awry. In an interview with Life magazine in November of 1970, Minsky warned: “Once the computers get control, we might never get it back. We would survive at their sufferance.” In one of his more famous premonitions, he posited, “If we’re lucky, the [machines] might decide to keep us as pets.” [Link]

The reference to the work of Arthur C. Clarke, ‘Childhood’s End’ is interesting. One should check it out.

Perhaps, this tribal community in Nagaland, in its own way, is showing us the way?

Stuff that caught my attention (STCMA) – 15th February 2019

Who would have thought that ‘The Economist’ would be forced to write a leader on the love of the millennials for socialism. I think, once again, the diagnosis is correct. But, the solutions are hackneyed. Capitalism has gone to extremes. Share buyback, financed by debt, and its brazen link to executive compensation are just an example.

Pity that an astute observer like James Mackintosh twists himself too much to exonerate or minimise share buyback. It is hard to understand how one has to be mutually exclsuive about these things. That is, one can be critical of share buybacks and one can also be critical of the other stuff that he writes. Why does it have to be EITHER/OR?

This is incredible. The story is about how some of the corporate bonds that the European Central Bank bought went bust barely a year later. Had it happened in India, all hell would have broken loose and the Reserve Bank of India would have either had to close down and then be reinvented or the entire management and the Board would have had to resign. But, there is barely an eyelid batted in Europe. They preach governance to us. Read these extracts:

Scores of banks and bond investors were freely lending to investment-grade rated companies on not particularly onerous terms back in 2016. Yet the ECB determined that jostling its way to the front of this queue would boost investment and create jobs. What it did create were immediate pricing distortions, with companies able to issue negative-yielding bonds for the first time — charging investors for the privilege of lending to them. …

This QE bezzle was sometimes dramatically revealed even while central bank bond-buying was in full swing. Months after the ECB bought Steinhoff’s bonds in 2017, it had to dump the position at half face value amid an accounting scandal at the retailer. [Link]

I do not think Indians are paying attention to what is happening in Italy although folks of Italian origin continue to make the news in Indian politics. Mateo Salvini, one of the two Italian Deputy Prime Ministers,spoke about seizing the gold reserves from the Bank of Italy. Again, had the Government in India spoken like this, the so-called elites will have concluded that India was doomed forever.

In the meantime, the other Deputy Prime Minister did meet anti-government protesters in France:

Italy’s Deputy Prime Minister Luigi Di Maio said he met leaders of France’s “yellow vest” anti-government movement on Tuesday, an encounter likely to further test already strained bilateral relations. [Link]

Interesting, isn’t it?

For economists who see ominous patterns in the world of numbers, one figure — 18 — is giving pause for thought. Last year, China, the world’s second-largest economy, accounted for 18 per cent of the global economy — just like Japan on the cusp of a decade of stagnation, and just like the Soviet Union shortly before it collapsed.

“In different ways, the USSR and Japan both stumbled when they faced the need to generate growth from more bottom-up, entrepreneurial, service- and network-oriented activities,” says Arthur Kroeber, managing director of research company Gavekal Dragonomics. “Despite a strong record of bottom-up dynamism, China is now moving in a much more statist direction.” [Link]

That leads to interesting political battles too:

Last month, the son of 1980s reformist leader Hu Yaobang warned that the USSR’s demise was due to overly centralised power and over-reliance on a planned economy, in a pointed swipe at Mr Xi. The son of reformist leader Deng Xiaoping has similarly warned that the country’s aggressive international stance could lead to danger. [Link]

The Free Exchange blog in ‘The Economist’ argues that a world without Facebook will be a better place. It might be hard to quarrel with that, even for FB users.

Michael Jensen’s legacy

(1) This link takes us to the work by Alex Edmans of London Business School, showing how CEOs release news in the month in which his share sale takes place. He and his co-authors do control for many other factors.

(2) This paper shows corporate stock buybacks and executives’ share sales are linked.

I got the link to the article by visiting his home page. Click on the Jan. 18 paper. A good summary of the paper is here.

(3)  In turn,  I was led to the HBR article from this blog post.

(4) While you are at it, do not miss this FT Alphaville post which is also linked in the above blog post by Jesse Felder.

In a way, this shows up the inadequacy of Michael Jensen’s work. Or, to put it differently, the law of unintended consequences is always operational and tha the road to hell is paved with good intentions.

Or, third, it proves my point that whatever starts as MEANS to an END becomes the END in itself. That is what Sapiens always do.

Postscript: let us not forget what makes debt-financed share buybacks feasible: ultra-low interest rates of central banks done in the name of supporting the economy

Rate cut dissent

If Andy Mukherjee is right that India’s financial stress is spreading, then why should one be surprised that RBI cut rates? Shouldn’t one be surprised about the dissent in the meeting? Credit Suisse research says that financial system stress is slowing the economy.

Viral Acharya’s reply at the press conference does not mirror any of the frantic distress signals that Andy is writing about:

I think this issue has come up quite a bit over the last six months I would say starting with the default of IL&FS. We have looked quite carefully at the data and our assessment is that since the peak of the stress in the short-term commercial paper markets in September and October, things have eased quite comfortably, they have eased especially for the better quality NBFCs and HFCs. So I think what is happening is that the liquidity conditions that had been extremely in surplus mode post-demonetisation have finally reached some normal level so that mutual funds and others who are providing capital to these entities are finally doing quality sorting themselves. I think that needs to be allowed to happen but nevertheless we remain watchful and if we think that there are extremely healthy borrowers who are also struggling with the funding, then we would consider that. [Link]

Heartache recalled

Siddharth Vaidyanathan pens a lovely piece in ‘Cricket Monthly ‘ (ht: Amol Agrawal – who else?) on the India-Pakistan cricket test match at Chepauk Stadium in Chennai in January 1999.

I was one of the many who went back home speechless and heavy on that day. But, it was a great cricket match. I can say that dispassionately now after twenty years.

I remember speaking to Harsha Bhogle the previous night over phone. He said that India’s two best batsmen were at the crease and if they got out, the match was over. They were Rahul Dravid and Sachin Tendulkar.
Rahul did get out to a beauty from Wasim Akram. Saurav was dismissed by an umpiring howler. My dad gave up and left the ground at lunch time. The excitement started after that. Mongia and Sachin made batting look so easy. But, the end was not what we were all looking for. The tail choked. Anyway, one has to concede too that Wasim and Saqlain were a class act in that match.

Read the well-written article with a lovely touch in the end.

Recommended reading – 10th Feb 2019 edition (part 2)

We need positive change to avoid climate hell. Can we? Colour me sceptical.

This is grim stuff:

Total student loan debt rose 161% for people aged 60 and older from 2010 to 2017—the biggest increase for any age group, according to the latest data available from TransUnion.

Between 2010 and 2017 people in their 60s, like most other age groups, accelerated their borrowing in nearly every category, according to the TransUnion data.

Seniors are finding they have to work longer, holding onto positions younger adults might otherwise receive. They’re relying on credit cards and personal loans to pay for basic expenses. People 65 and older account for a growing share of U.S. bankruptcy filers, according to the Consumer Bankruptcy Project; unlike most consumer loans, student debt is rarely dischargeable in bankruptcy. [Link]

The DNA kit can and did unravel families. What will happen if it becomes ubiquitous in India? Absolutely fascinating reading.

A fiction explores the dark side of Sweden. FT has a book review on it.

A friend forwarded this Brookings blog post on ‘joyless growth’ in India, China and in America. I think it is mostly right.

Jason Gay thanks Katelyn Ohashi for her perfect and joyful 10 in the floor gymnastic exercise. She deserves it every bit. Watch the 2 minute video embedded in the article.