Incentivising malpractice

The mind-bending complexities of the new financial technology combined with the modern practice of incentive payments that reward employees for particular deals practically invites malpractice, whatever the pious institutional statements about the priority placed on client relationships and an ethical culture. In fact, rewards for successful proprietary transactions, inherently speculative and often in conflict with client interests, will tend eventually to color the overall atmosphere and the reward systems in banks, even beyond the trading rooms.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 216). Public Affairs. Kindle Edition.

The emphasis was mine and that is the key part of that comment.

Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.”

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (pp. 216-217). Public Affairs. Kindle Edition.

… concerns about regulatory complexity are common and not limited to financial regulation. Pictures of the thousands and thousands of pages of federal regulation are grist for election campaign mills. I cringe, like others. But then I also cringe a bit when I receive, each year, the eighty or so pages explaining precisely my rights and the policy limitations in my “simple” household insurance policy.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 218). Public Affairs. Kindle Edition.

Volcker-William Sharpe conversation

I found myself sitting in the audience next to William Sharpe, a 1990 Nobel laureate in economics whose “Sharpe ratio” has become a widely accepted measure of risk-adjusted returns for fund managers. I nudged him and asked how much this new financial engineering contributed to economic growth, measured by GNP. “Nothing,” he whispered back to me. It was not the answer I anticipated. “So what does it do?” was my response. “It just moves around the [economic] rents* in the financial system. Besides it’s a lot of fun.” (Later, at dinner, he suggested the possibility of small ways in which economic welfare could be advanced, but I felt I had already gotten the gist of his thinking.) 

Source: Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 206). Public Affairs. Kindle Edition.

Here we are, a decade after the crisis, and the scurrying lobbyist chipmunks are nibbling away in the name of efficiency and simplification (good, in itself), but with the ultimate aim of weakening the new safeguards.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 209). Public Affairs. Kindle Edition.

I am sure Tim Geithner and Larry Summers would have been content if I disappeared. The potential for conflict in policy approaches was real.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 212). Public Affairs. Kindle Edition.

In my view, ‘Keeping at it’ was a good book but not a great book. He is a master of understatement. Mr. Volcker’s transparent sincerity, simplicity, impeccable integrity came through. But, he was not going to make scathing statements or judgements on any one. That is a testimony to the man’s character but that also makes the book somewhat duller. One has to pierce through his statements to understand what he left it for readers to figure out. One example is the comment on Geithner-Summers above.

We rent digital books and don’t buy them

Katharina Pistor rightly raises the alarm on Facebook’s cryptocurrency. Central bankers’ silence is, one hopes, a sign that they are studying it deeply.

Yanis Varoufakis (May 2019) writes that the stellar returns achieved by Greece’ stocks and bonds since 2012 are part of the problem. He is right. There is a gap between economic reality and financial returns. Greece is not the only place it is happening. But, it could be one of the more extreme examples. He forgot to zero in on the principal source of the problem: reckless monetary policy pursued by the developed world.

Wall Street Journal comment on the appointment of Christine Lagarde is a very good read. It is politicisation of the European Central Bank. Not that Draghi was much different. The comment notes that markets are cheering her appointment but that markets would regret it. Well said. The cheer is because it means continuation of reckless monetary policies.

Adam Tooze’ review of the book, ‘1931’ by Tobias Straumann made for very interesting reading. My friend Ajit Ranade suggested that I read a blog post by his friend on the book. I did so. It is well written. The post makes a good point about how Jews were made the scapegoats by the Nazi party when they were actually in the forefront of defending Germany’s interests in the peace conference and that the German foreign minister was Jewish, etc.

As to the take-aways from the book, I am not sure that there are neat answers to avoid a certain march of history, except in hindsight. Colour me sceptical on humans’ ability to solve the problems they create. They are good at creating problems but not that good at solving them. Most of the time they solve themselves or plain luck and humans take credit.

It is hard to quarrel with the motherhood statement made by the blogger here:

Economic orthodoxy must always take second place to the need to make sure individuals, communities and businesses are able to work and earn a decent return on their investment (labour in the case of individuals, capital in the case of businesses).  [Link]

One important take-away from Adam Tooze’ review is that democratic politics (local politics) can come in the way of doing the right thing in terms of global obligations. This is but a variant of Dani Rodrik’s ‘Inescapable Trilemma’. The review also reminded me of what I had not read yet: John Kenneth Galbraith’s account of the Great Depression.

This FT Edit made for very disturbing reading, especially for someone like me who has gotten used to reading stuff on the Kindle App in my iPad. I did not know that I am renting books and not buying them outright. As the Edit says, this is duplicitous. The Edit says that, in this regard, the revival of paper-based books is a good thing. I have to agree.

Sucheta Dalal in Moneylife has a good article on the corporate cleanup underway in India. She thinks it has been overdue. I hope she is right that it is being pursued with earnestness.

The importance of knowing history

Again, a brilliant episode from Paul Volcker’s ‘Keeping at it’:

That evening, I learned something more about the power of Connally’s political instincts. After a formal dinner in a grand palazzo at the top of one of Rome’s seven hills, he stood and, seemingly extemporaneously, extolled the triumphant achievements of ancient Rome, of Italy, of modern European civilization.

We ministers of finance bore responsibility for bringing the world’s monetary affairs, and indeed humanity itself, into greater harmony. The impact was electric.

Once viewed as a crude Texas bully insensitive to the need for international cooperation, Connally seemed to reveal himself as an erudite, if forceful, global statesman. Within four weeks, an agreement was reached.

Connally was the guy famous for telling Europeans that dollar was America’s currency but Europe’s problem. The episode that Volcker refers to was in the early Seventies just after 15th August 1971 when America suspended the gold window and wanted to devalue the dollar.

The Bretton Woods agreement was still in force and Europeans were reluctant to accept a revaluation of their currencies. It was in that context that this incident took place. 

The importance of knowing history, for men and women in public affairs, cannot be overstated.

Volcker on Iacocca

Lee Iacocca passed away on 2nd July 2019. As a young management graduate in the Eighties, I read his book on how he turned around Chrysler Motors, with awe and admiration. I was reading the book, ‘Keeping at it’ by Paul Volcker on my flight to London today. What he had written on the turnaround of Chrysler made for interesting reading:

The government’s backbone in demanding the sale of Chrysler’s executive planes over the persistent complaints of the new chairman, Lee Iacocca, helped resonate with the public.* A well-designed “K-car” was just coming into production and Chrysler became competitive. All of the creditors, including the US Treasury, ultimately could make millions: the new loans extended in the crisis included warrants for new stock. Those warrants (contracts that give the owner the right to buy stock at a set price over a certain time period) surged in value as the company recovered.

Iacocca, a flamboyant master salesman, pleaded with the new Reagan administration to cancel the warrants, arguing that they were essentially an unearned and undue reward. He didn’t win. Chrysler ended up paying more than $300 million to buy back and cancel warrants held by the Treasury. My wife sent me a little typewritten note, enclosing an ad for Don Diego cigars featuring a handsome Lee Iacocca, cigar in hand. The note read: “Would you give a loan to this man?” My handwritten reply: “Not willingly!”

What is interesting to us in this narrative is how the bailout was structured. It is not a lesson just in the case of bailouts. It is a general lesson. Government support or subsidy or bailouts must involve reciprocal obligations and accountability on the part of the beneficiaries.

It happens during the day

Chanced upon the review of three books by Quinn Slobodian in ‘Boston Review’. The three books are ‘dark’ in his view, especially the first one, he reviews: The Age of Surveillance Capitalism: The Fight for a Human Future at the New Frontier of Power by Shoshana Zuboff.

He takes exception to her comments on how media influences behaviour:

One could ask whether her description doesn’t flunk the Cultural Studies 101 test by failing to acknowledge that the media’s designers don’t dictate directly its use and consumption. We hear a great deal about what companies “aim” to do through baroque projects of “behavioral modification,” but, as with the Cold War brainwashing techniques she references, we have little evidence that these efforts work—except for generating ever greater contracts for those pronouncing their own effectiveness. [Link]

But, let us listen to the testimony of Jim Balsillie, former CEO of ‘Research in Motion’ (remember Blackberry?):

Second, social media’s toxicity is not a bug — it’s a feature. Technology works exactly as designed. Technology products, services and networks are not built in a vacuum. Usage patterns drive product development decisions. Behavioral scientists involved with today’s platforms helped design user experiences that capitalize on negative reactions because they produce far more engagement than positive reactions. [Emphasis mine]

Third, among the many valuable insights provided by whistleblowers inside the tech industry is this quote: “the dynamics of the attention economy are structurally set up to undermine the human will.” Democracy and markets work when people can make choices aligned with their interests. The online advertisement-driven business model subverts choice and represents a foundational threat to markets, election integrity and democracy itself. [Link]

Indeed, the comment about on-line reminds me of advertising itself. I just did a blog post on it yesterday.

More importantly, very powerful lines above. The point to note here is obvious: it is not the subversion of the tech. platforms by populists, demagogues, far-Right and other extremists that is the issue. The platform is the subversion.

That is why it was disappointing to read that Stanley Druckenmiller, otherwise an intelligent man, criticise the Trump Administration’s consideration of anti-trust investigations of the tech. companies in the USA.

So, Zuboff is not exactly wrong. It is ‘dark’ for the rest of us because we don’t know (or cannot be bothered to fathom) how the ‘rich’ and the ‘connected’ operate. Looks like that is the stuff of the second and, even more so, the third book reviewed.

The second book he reviews is Darkness by Design: The Hidden Power in Global Capital Markets by Walter Mattli. A key paragrph from the review:

Mattli shows how the shape of financial governance—and lack thereof—was pushed by a small elite of investment entities. The advantages gained by those able to make costly investments in computerization began to concentrate wealth at the upper end of exchange’s members, including the “national commercial and non-U.S. ‘universal’ banks” that deregulation had allowed to enter. By 2000, the twenty-five second-tier firms had less than 10 percent of the market capitalization of the top ten. Household name titans such as Barclays, Credit Suisse, Citigroup, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, and JP Morgan dominated. 

The third book he reviews is Katharina Pistor’s The Code of Capital.

In fact, he summarises it very well:

Katharina Pistor’s The Code of Capital is also an urgent tract. The difference, in her telling, is that the law doesn’t always ride a white horse. It comes as often to perpetuate injustice as redress it.

Further, the following statements are both profound and true. In other words, the State is the protector – or it ought to be – and the villain. The problem is, in other words, the State is captured and hence, aids the evasion of taxes by the rich whom it supposedly has to now bring back into its tax net!:

The concentration of wealth and its evasion of state attempts at its capture through taxation also do not happen by escaping law or the state, but through the law and the state—through projects of legal “encoding,” to use Pistor’s dominant metaphor.

Quinn Slobodian highlights a few things from Pistor’s book that ought to be of interest to those in Finance. Very few would even be aware of them:

Pistor introduces us to new sites and conventions created to offer protection for capital mobility and insulation from democratic states, places with their own acronyms, where PRIME Finance (Panel of Recognized International market Experts in finance) protects PRIMA (the Place of Relevant Intermediary Approach convention).

So, the point is that it is not about shining light on people operating covertly, in darkness, outside the pale of law. There is collusion. There is capture. State and the law have facilitated it.

Perhaps Pistor’s book is similar to the one by Brink Lindsey and Steven M. Teles: ‘The Captured Economy‘. I have begun reading it.

Alan Krueger and ‘mind fixers’

Gary Greenberg’s review of the book, ‘Mind Fixers’ by Anne Harrington is not just a review but also an indictment of the profession of psychiatry. He indicts Anne Harrington for not indicting the profession enough for not acknowledging the limitations of what it knows about psychiatric illnesses and the vastness of what it does not know yet, of the origins of psychiatric illnesses. In other words, the psychiatric professionals have a psychiatric problem or two: hubris and denial. Well, in that, they have a much larger company: the entire humanity.

That this book review caught my attention today in the aftermath of the sad and sudden death of Prof. Alan Krueger in the United States is entirely coincidental. He took his own life apparently and that he was suffering from mental depression. I had listened to him twice in Singapore during the Annual ABFER Conferences in the last few years. He was a good looking man and appeared confident and positive. He had done quite a bit of empirical work and was on the Council of Economic Advisors for President Obama. His suicide and his depression actually proves the point Gary Greenberg makes.

We do not know much about mental illnesses and we refuse to admit it. That is so typical of us.

I seldom agree with Martin Sandbu’s economics because of his steadfast refusal to allow empirical evidence to influence his pet theories of policy prescriptions for the post-crisis economy in the world.

But, I will readily concede that he has written a very good and a very apt tribute to Alan Krueger. Martin Sandbu focuses on Krueger’s work on minimum wage. It had re-shaped the pet, ideological views of many that a higher minimum wage necessarily lowers employment. It is not the case. Alan Krueger took interest in questions of economics that had a public policy dimension and public utility. That makes his demise all the more sadder and untimely. There are many useful links in Martin Sandbu’s piece. One of them is this.

President Obama had reportedly said, in his moving tribute, that Alan Krueger had a smile even when he was critical – something for all of us to keep in mind.

Also, the last paragraph of the article is very important:

“If someone has positively shaped your life and work, let them know,” Susan M. Dynarski, a professor of public policy, education, and economics at the University of Michigan, wrote on Twitter. “No one is too famous or accomplished to be lifted by your kind words.” [Link]