February 8, 2009 § 2 Comments
Some (Brad De Long ) are saying this is terrific.
My brother recommends this from Edward Luce of the FT. I agree: it is the best short thing I have read on current American politics:
The article with [comments]
Major recessions are characterized by something novel. Opacity and pseudo-objectivity created the crisis today.
The history of socialism is the history of failure—and so is the history of capitalism, but in a different sense. For the history of socialism is one of fundamental failure, a failure to provide incentives and an inability to coordinate information about supply and effective demand.
[this is a major piece of ideology. As corporations have grown, they duplicate or replace similar complex mechanisms in government. The critique of Hayek and others that Government is unresponsive fits the large corporations, which are also bad incenting machines and control rather than coordinate, just as Hayek said earlier of governments. This failure to apply a similar critique as that to governments to corporations is a sign of ideology and filtering at its worst.]
The history of capitalism, by contrast, is the history of dialectical failure: it is a history of the creation of new institutions and practices that may be successful, even transformative for a while, but which eventually prove dysfunctional, either because their intrinsic weaknesses become more evident over time or because of a change in external circumstances.
[ the failure of capitalism, like the sometime failure of markets, is not for either intrinsic, but due to their inability to cope with corporations and their market controlling and capital controlling tendencies, which lead to increased concentration of wealth.]
Historically, these institutional failures have led to two reactions. They lead to governmental attempts to reform corporate and financial institutions, through changes in law and regulation (such as limited liability laws, creation of the FDIC, the SEC, etc.). They also lead market institutions to reform themselves, as investors and managers learn what forms of organization and which practices are dysfunctional. The history of capitalism, then, is the history of success through dialectical failure.
[he is saying that capitalism can self correct but socialism can’t. so far, since they both favor large scale organization – corporations and government – and teir combination- the failure s symmetrical. In both cases elites capture the process, benefit, and then collapse it (see Joseph Taintor Collapse of Complex Societies)]
History rarely repeats itself. There are some standard patterns in economic recessions, but major recessions are characterized by something novel. If only this were not the case: economists have devoted a great deal of attention to learning the lessons of the Great Depression that began in 1929, not least Ben Bernanke. As a result, we are unlikely to make the errors of monetary policy made by the Fed in that era (of tightening money when it should have been loosened); or the errors of fiscal policy made by the Treasury (such as raising taxes when they should have been lowered);
[ this is put here, I assume, in order to cut off the possibility of taxing those who got extraordinarily rich in the recent phase.]
or the errors of ideological tone made during the 1930s, when anticapitalist rhetoric frightened many potential investors from making new investments. In all of these respects, we have learned from the past.
We should attend to what is new and especially problematic about the current downturn and why it may not respond to policies modeled on avoiding the errors of the past.
[lets see what he has to say.]
Unfortunately, initial conditions are too different from case to case to simply apply some historical template that would permit us to fully understand what is currently happening, let alone how to deal with it.
Instead of explaining why this recession (or depression) is just like the others, we should attend to what is new and especially problematic about the current downturn and why it may not respond to policies modeled on avoiding the errors of the past.
What is old and what is new in the current economic downturn? Major recessions typically begin
[ the idea of begin is ambiguous. Obviously regulatory changes and the nature of alrge systems, and the wide use of computing contributed as causes earlier]
with a rapid change of prices in the market for some asset or comm
odity; that price decline then affects financial institutions (banks), leading to a decline in the availability of credit, and then to a decline in commercial activity. Usually, then, localized crises in capitalist societies are reflected in the financial sector. When the crisis reaches the financial sector, it becomes a more general crisis.
This time, too, there is an underlying commodity bubble, namely in housing. But it has had much wider ramifications, because financial institutions have become interconnected in two unprecedented ways. First, once distinct financial services became interconnected: banking, credit, insurance, and the trading of derivatives have become interlinked because they are conducted by the same companies. Second, financial institutions are more connected across national borders, so that there are entities across the globe that invested in toxic American-made instruments and are suffering as a result (including municipalities in Norway that invested tax revenues in American collateralized debt obligations, now worth 15 percent of their face value).
The financial system created a fog so thick that even its captains could not navigate it.
[good metaphor but, instead f a shipwreck, it paid off for those at the top and their clients. Intentiaonal? Probabaly.]
What we have is not so much the crisis of some underlying commodity that gets reflected in the financial system, as a crisis caused within the financial system itself. The most important bubble of the last decade or so was not of the housing sector, but of the financial sector, a bubble reflected by the 20 percent of S & P 500 profits that were made in the financial sector.
[bravo yes, the real inflation was in financial instruments. ]
Some of the causes of our contemporary crisis are well known by now. There were governmental errors: monetary policy that was too loose; government monitoring agencies that were too lax; and government policies specifically intended to encourage home ownership among African-Americans and Hispanics that had the unintended but quite anticipatable effect of extending mortgages to those who lacked the ability to repay them.
[This is probably false in essence. The runups forced house prices higher than they would have been, hence a poor person who could afford a modest house had to pay approx 30% more for that house than if there had not been such speculation. When the poor person bought the house, and then lost it, much of the increase went to the broker, the bonds speculator, and in many cases the lender.]
There were perverse alignments of market incentives, incentives that put personal interests at odds with corporate interests, and corporate interests at odds with the public interest. There were principal-agent problem within firms, where traders were remunerated with bonuses for selling collateralized debt obligations without regard to the long-run viability of the underlying assets. Rating agencies were corrupted because they were paid by the sellers of the goods they rated, offering unreliable evaluations that redounded against the purchasers of mortgage-backed securities. Large profits were made by companies that packaged and sold mortgages and mortgage-backed securities without needing to be concerned with their ultimate viability. It turns out that intermediation of risk reduces the incentives for adequate risk management: so long as risk is intermediated, from a mortgage loan broker to a commercial bank to an investment bank to an investor, there is really no incentive, at each stage of the game, to have adequate risk-managing policies in place.
[this is a good description.]
These factors have received a good deal of attention. But they are not the whole story, and certainly not the most original part of the predicament. What seems most novel is the role of opacity and pseudo-objectivity.
[again, inresting and accurate]
This may be our first epistemologically-driven depression. (Epistemology is the branch of philosophy that deals with the nature and limits of knowledge, with how we know what we think we know.) That is, a large role was played by the failure of the private and corporate actors to understand what they were doing.
[was there such innocence? Some like Daily Reckoning, seemed to know what was happening.]
Most heads of ailing or deceased financial institutions did not comprehend the degree of risk and exposure entailed by the dealings of their underlings—and many investors, including municipalities and pension funds, bought financial instruments without understanding the risks involved. We should keep this in mind when we chastise government agencies such as the SEC for failing to monitor what was going on. If the leading executives of financial firms failed to understand what was taking place, how could we expect government regulators to do so? The financial system created a fog so thick that even its captains could not navigate it.
Diversification and complexity, which are both supposed to reduce risk, turned out to have unintended and unanticipated negative consequences. The purported virtues mutated into vices.
[because events were too highly correlated to balance each other. But the idea that balance can mitigate risk fails to realize that a zero sum game minus fees is not a good proposition.]
Recognizing the novel element of the present crisis means that getting out of it will require
more than wise monetary and fiscal policy.
[but the underlying issue is that the economy does not make enough stuff people want to buy. Our whole productive capacity is deteriorated.]
Getting us out of the current mess requires calling into question several cultural patterns that have driven our corporate economy in recent decades. These are belief in the virtues of diversification and complexity, which are both supposed to reduce risk,
[ which they just do not. Magic.]
and in the virtue of accountability, which is understood as rewarding performance based on ostensible measures of objectivity. Each of these has turned out to have unintended and unanticipated negative consequences. The purported virtues have mutated into vices.
The diversification of investment, which was intended to reduce risk to institutional investors, ended up spreading risk more widely, as investors across the country and around the world found themselves holding mortgage-backed American securities of declining and indeterminate value. There was a belief in the financial sector that diversification of assets was a substitute for due diligence on each asset, so that if one bundled enough assets together, one didn’t have to know much about the assets themselves.
The creation of securities based on a pool of diverse assets (mortgage loans, student loans, credit card receivables, etc.) meant that when markets declined radically, it became impossible to determine an accurate price for the security.
There was also the fallacy of diversification of activities within the firm. This was predicated on the belief that the more areas you are financially involved in, the more protected you are from loss in any one area. But the unintended consequence of this is that the more areas you are involved in, the less you know about them, and the more subject you are to unexpected and unanticipated shocks, especially when the assets decline in tandem.
The diversification of financial firms, which was supposed to create efficiencies and synergies, ended up spreading contagion, as investment banks and other financial institutions such as AIG (once a successful insurance company) were brought down by divisions specializing in real estate or in derivatives.
The complexity of newly created financial instruments, which were supposed to use mathematical sophistication to diminish risk, ended up creating opacity—an inability of any but a few analysts to get a clear sense of what was happening. And the creation of arcane financial instruments made effective supervision virtually impossible, both by superiors in the firm, and by outside regulators.
As Niall Ferguson has put it, ‘Those whom the gods want to destroy they first teach math.’
[this is deep, actually. The role of the mathematizing of society. See Mirowski, Machine Dreams]
The cult of "accountability" was related to diversification. As companies grew larger and more diverse in their holdings, new layers of management were needed to supervise and coordinate their disparate units. From the point of view of top management, the diversity of operations means that executives were managing assets and services with which they have little familiarity. This has led to the spread of pseudo-objectivity: the search for standardized measures of achievement across large and disparate organizations. Its implicit premises were these: that information which is numerically measurable is the only sort of knowledge necessary; that numerical data can substitute for other forms of inquiry; and that numerical acumen can substitute for practical knowledge about the underlying assets and services.
A good deal of our current economic travails can be traced to this increasing valuation of purportedly objective criteria,
so denoted because they can be expressed and manipulated in mathematical form by people who may be skilled at such manipulation but who lack "concrete" knowledge or experience of the things being made or traded. As Niall Ferguson has put it, "Those whom the gods want to destroy they first teach math." The paradigm—and the precursor of our current crisis—was the rise and fall of Long Term Capital Management, founded by two of the fathers of quantitative options financing, Myron Scholes and Robert C. Merton. Knowing a great deal of math, but not very much history, they developed trading models that radically underestimated the risk entailed in their financial speculation, leading to a dramatic collapse of the company in the summer of 1998. But the phenomenon is more widespread. Attaching a number creates a belief that the information is more solid than is actually the case. That is what I mean by "pseudo-objectivity." In each case, it is a response to what (to recoin a phrase) one might call alienation from the means of production, the attempt to substitute abstract and quantitative knowledge for concrete and qualitative knowledge.
The shibboleth of linking pay to performance created tremendous incentives for CEOs, executives, and traders to devote their creative energies to gaming the metrics.
The cult of "accountability" was linked to key innovations that turned out to have unanticipated undersides. One was the shibboleth of linking pay to performance, which put a premium on schemes that purported to measureperformance. This tended to produce "hard" numbers that seemed reliable bu
t were not. It created tremendous incentives for CEOs, executives, and traders to devote their creative energies to gaming the metrics, i.e. into coming up with schemes that purported to demonstrate productivity or profit by massaging the data, or by underinvesting in maintenance and human capital formation to boost quarterly earnings or their equivalents.
Two milestones in the process of creating the fog of finance were the transformation of Wall Street investment banks from private partnerships to publicly traded corporations (beginning with Salomon Brothers in 1986), and the repeal of the Glass-Steagall Act of 1933 through the Gramm-Leach-Bliley Act of 1999. The former created tremendous incentives for risk-taking, since the firms no longer invested using the money of their top executives, who instead were remunerated based in large part on the amount of business the firm conducted, creating incentives to increase business by producing ever more complex and opaque financial instruments, such as collateralized debt obligations, swaps, etc. Then along came Gramm-Leach-Bliley, which opened the door to unlimited contagion, so that when one financial sector turned downward, it took the rest with it.
Looking ahead, the sort of government regulation and private re-organization that will be most beneficial will focus on these epistemological problems. Some of this goes under the rubric of transparency: making the asset holdings of financial institutions more publicly visible in order to reduce the problem of counterparty risk. Equally desirable would be transparency through the reduction of complexity, which includes avoiding intra-institutional contagion through greater limits on the ability of financial institutions to engage in an open-ended variety of financial activities. It means, in short, the reformulation of something like the Glass-Steagall Act, which would separate savings banks, investment banks, insurance and brokerage from one another.
Over and above government action, private individuals and firms should make decisions with these epistemological considerations in mind. That would mean avoiding firms that are "too complex to manage" in Amar Bhidé’s memorable phrase. Companies should not expand beyond the ability of top management to comprehend the firm’s actual activities. That will mean smaller and less diversified firms. Investors may want to ask the question: is this firm so big, or engaged in such diverse activities that its management doesn’t understand the activities in which it is involved? (And by understand, I don’t mean simply the ability to read a current balance sheet, but rather to understand the underlying dynamics of the products or services being provided.) If not, decide to invest elsewhere.
Without financial institutions that people have faith in, a fiscal stimulus is unlikely to have much of a multiplier effect.
[So, then what?]
This message has not yet taken hold among public policy makers. There is much talk about monetary policy and fiscal stimulus. But without financial institutions that people have faith in, a fiscal stimulus is unlikely to have much of a multiplier effect. It is widely assumed that people will have faith in financial institutions if the Treasury injects capital into them. But the problem is not just that major financial institutions are short on operating capital: it is that recent experience seems to show that they are incapable of prudently managing the capital they have. In short, economic actors believe that other economic actors don’t know what they’re doing. Nor is the problem merely one of isolating "bad assets"—it is of a system that createsbad assets because of misaligned incentives and the fog created by opacity and pseudo-objectivity.
Confidence cannot just be conjured out of air. Nor can it be created with injections of capital or fiscal stimulus. It will be rebuilt to the extent that financial institutions take actions that lead us to believe that they know what they are doing. And they are more likely to know what they are doing if they are smaller, less diversified, and less engaged with financial instruments that are too clever by half.
Some recent policies seem likely to exacerbate the problems I’ve outlined. Take the Treasury’s encouragement of institutional consolidation through amalgamation. Bank of America was encouraged to take over Merrill Lynch; and JPMorgan Chase took over Bear Stearns, and then bought the assets of Washington Mutual. Whatever the purported advantages of these takeovers, the creation of ever larger and more diversified companies makes it more likely that these firms will be plagued by the epistemological problems noted above. The Treasury has created more firms that can’t really be understood (or whose riskiness can’t be assessed)—not by their managers, not by government regulators, and not by investors.
To speak of a crisis of financial epistemology may sound abstract, but it has had very concrete and disastrous consequences. Understanding this underrated aspect of our current crisis is a prerequisite for getting us out of the hole we’ve dug ourselves into.
Jerry Z. Muller is a history professor at The Catholic University of America and the author of "The Mind and the Market: Capitalism in Modern European Thought" (2002). His course "Thinking about Capitalism" has just been released by The Teaching Company.
Editor’s note: Amar Bhide has asked that it be noted that some of the ideas in this essay draw upon his articles, "An accident waiting to happen," which appeared on his website, and "Insiders and Outsiders," which appeared on Forbes.com.
The referenced article..
I’ve included this because it is interesting. He likes tech and markets, and wants more economic activity in the corporations and less in the banks.
What Was Really Wrong?
The 2008 financial crisis is rooted in seriously flawed theories and regulatory structures.
¶ Modern economic theory assumes that all risks can be reduced to known probability distributions that are common knowledge – everyone knows what the true probability distribution is. The assumption is crucial for building mathematical models; but it bears little resemblance to reality and sustains the dangerous belief that diversification eliminates risk and thus the need for case-by-case judgments.
In a 1994 article ("Return to Judgment," Journal of Portfolio Management) I challenged a 1974 claim (in the same journal) by Paul Samuelson that investors should construct passive market portfolios and "throw away the key."
Unfortunately the use of models based on the same flawed assumption continued to expand and lots and lots of keys got thrown away. Valuing securities taking into account the vagaries of specific circumstances – trying to get a handle on "unsystematic" risk – finance professors taught, was a wasted effort.
In March 2002 someone who was writing a survey for the Economist about the future of capitalism asked me to offer a prognostication. Capitalism, I emailed him, was in great shape – except in the financial sector because of the pervasive belief that diversification was a substitute for due diligence.
"I think the financial system faces a much sharper change from the trajectory its been on since the early 1980s — much more so than in the other elements of the modern capitalist system (e.g low taxes, deregulation, cost conscious managers, privatization, cross-border trade and investment) that I think are here to stay. Of course if the financial sub-system really starts unraveling, the other elements may also be affected.
"One reason for expecting a sharp change is simply that trees don’t go to the sky. The growth in the value of financial assets (and in the incomes of bankers) has far outstripped the rate of growth of the real economy (and of other working stiffs). The inevitable mean-reversion is already in place witness NASDAQ and VC returns. Heck one of these days, we might even see the S&P trade at a reasonable P/E."
"But that’s not the main dimension of the system that’s out of whack. In fact, I think the absurd valuations themselves may be a symptom of flawed assumptions about agency problems. To simplify: when a "principal" provides capital to an "agent" he faces two kinds of problems — that the agent is a crook and that the agent has bad judgment. I don’t see too much of a direct problem on the crookedness side–the rules of the game haven’t made outright stealing any easier over the last few decades. The systemic problem lies in the lax control over errors of judgment. This has arisen because of the mistaken belief that diversification (and well aligned incentives) can substitute for the control of bad judgment through due-diligence and oversight. Everyone has bought into the belief — investors, intermediaries and implicitly (through the promotion of market liquidity) regulators — that diversified portfolios make the problem of bad judgment disappear. Actually, diversification complements due-diligence and oversight; relying on diversification as a substitute exacerbates the problem of bad judgment. Incentives to cheat also may increase — many fraudulent schemes start out as cover-ups for mistakes.
¶ A regulatory apparatus, first established in the Great Depression, has underpinned the breadth and depth of U.S. stock markets. But, it has also have severely impaired corporate governance. For instance, rules prohibiting insider trading and requiring disclosure encourage trading by keeping the casino honest; but, placing special burdens on insiders, discourages stockholders from accumulating control positions or even serving on the boards of directors. Inevitably boards comprise individuals who don’t have a significant economic stake in the company.
Takeover threats may deter flagrant abuses but aren’t a substitute for informed oversight by insiders. In banks and other financial service firms, even that threat is absent because regulations (and highly leveraged capital structures) make hostile takeovers practically impossible.
(I had discussed the trade-off stock market liquidity and governance in a 1993 article in the Journal of Financial Economics, and then in several more popular pieces in the Harvard Business Review, the Financial Times and the New York Times and in a Royal Society of Arts lecture. My 1988 doctoral dissertation had shown that the much feared corporate raiders curbed only the extreme cases of mis-governance, and that too, just the problem of over diversification).
¶ The unintended consequences of Depression Era rules on banking have inflicted even more damage than did the stock market rules.
In principle the case for bank regulation was strong. The rules protected depositors from imprudent bankers — and bankers from jittery depositors. Before this, the fear of bank runs made depositors and lenders inordinately cautious: Mortgage loans, for instance, rarely exceeded half of the value of the property. The creation of the FDIC both ensured the safety of deposits and also freed bankers from the challenge of earni
ng the confidence of depositors. Bank examiners became the main restraint.
The switch initially produced good side effects. Banks lowered down payments on mortgages, making home ownership more affordable. Regulators also provided the cover needed to pursue innovative risk management strategies. In the ’70s for instance, banks started using futures to hedge the risks of making long term loans with short term deposits. Without deposit insurance — and the reassurance of state supervision — even sophisticated depositors would shun banks that traded futures. Paltry passbook rates simply wouldn’t compensate for the risks.
Eventually however, more complex and dangerous innovations flourished under the regulatory canopy. Regulators apparently succumbed to the idea that if a little financial innovation was good, a lot must be great. Banks directly or indirectly enabled instruments that were far outside the regulators’ capacity to monitor.
Banks’ CEOs weren’t on top of things either. Freed of both stockholder and depositor restraints, banks (and their financial next of kin) became sprawling, unmanageable enterprises whose balance sheets and trading books are but wishful guesses. CEOs famously frolicked on golf courses and at bridge tournaments while their businesses imploded because they didn’t know any better.
¶ President Clinton says the collapse was triggered by the absence of good investment opportunities outside housing. In my view the system was an accident waiting to happen and anything could have triggered it. If we want to identify a particular trigger, I would vote for the knock-on effects of the rapid advances of the Chinese economy: As Ned Phelps and I wrote in 2005, China increased its capacity to produce modern goods for international markets more quickly than it increased its capacity to consume such goods. This created a "savings glut’. But if the Chinese saved, someone had to borrow. And the borrowing had to be channeled through a financial system that could screen for creditworthiness and guarantee repayment. The US financial system offered the illusion of such a capacity but in fact buckled under the amounts that passed through it.
¶ Besides the financial costs to taxpayers and the global economic slowdown, the dysfunctions of the financial system have exacted a serious toll on the legitimacy of providing great rewards for great contributions. Finance certainly contributes to prosperity, but the vast wealth secured in recent years by a small number of financiers does not map into a commensurate increase in their economic productivity: they haven’t created or financed new industries or turned around failing companies. Rather they have used subsidized borrowing to leverage the returns of questionable schemes, secure in the knowledge that if things go wrong the authorities will step in, trying to shore up asset prices or prop up failing counterparties. The sharp rise in income inequality at the top of the scale owes much more to reverse Robin Hood regulation than to a small decline in personal income tax rates.
¶ The haste with which Congress is being railroaded into passing a $700 billion bailout is disquieting. The establishment tells us that unless we act immediately, catastrophe awaits.
But on what theory or evidence? And consider the source – the very same crowd that didn’t see it coming.
And what’s the worst case consequence of no bailout?
The Dow falls, 1000, 2000, 3000 points? So what – financial markets fluctuate? (After word: The Dow in fact did fall precipitiously after the bailout was passed. Would the Dow in fact have fallen more if there had been a more measured and thoughtful response? Did shouting "fire-marshals!" in a crowded theatre really help? )
We enter a deep recession? That’s more serious – but take a deep breath. The US did endure a very serious recession in the early 1980s. Unemployment and interest rates were in double digits. But that was, most would consider, a necessary cost of wringing out inflation and restructuring the old economy. There was no quick fix.
As against this possible downside, we have the near certainty that that a hasty $700 billion bailout will be mismanaged or worse. For some people, is this an opportunity to rake it in or what?
¶ Neither presidential candidate has offered a plausible long term fix.
McCain rails against greed – but that’s not a strategy.
Obama, like many others, favors bringing the regulatory system into the 21st Century because "old institutions cannot adequately oversee new practices."
Sounds great, but which agency has the capacity to spare? Bank examiners continue to struggle with traditional lending, and the Fed hasn’t yet mastered the problem of central banking in a globalized economy. And, adding capable regulatory staff to oversee fiendishly complex innovations and institutions – and then keeping them from going over to make the big bucks on Wall Street – isn’t like recruiting baggage screeners at airports.
A Modest quasi-libertarian proposal
¶ Rather than trying to keep up with the never ending proliferation of innovations, it is time regulators pulled commercial banks back into traditional lending. Let’s instead revive the radical idea of narrow banking and tightly limit what banks (and any other entities that raise short term deposits from the public) can do: nothing besides making loans and simple hedging transactions that examiners who don’t have PhDs in finance can monitor. And, certainly, no willy-nilly diversification or Rube Goldberg financial supermarkets.
¶ Anyone else: investment banks, hedge funds, trusts and the like can innovate and speculate to the utmost, free of any additional oversight. But, they would not be allowed to trade with or secure credit from regulated banks, except through prudent, well secured loans. This simple, "retro" approach would protect depositors, limit the risks of financial contagion, allow the FDIC and Fed to focus on their primary responsibilities, and not require new agenci
es or more regulators. Less, would in fact, be more.
¶ Unfortunately the panicky response to the crisis is moving us even further away from narrow banking – witness the conversion of Morgan Stanley and Goldman Sachs into bank-holding companies to be regulated by the Fed. This is wrong-headed – if the Fed couldn’t control the tangled mess at Citicorp how is it going to cope with more Too Big Fail and Too Complex to Manage mega-banks?
(I made the old argument for narrow banking in a presentation at a conference held at the council on Foreign Relations in November 2007 and then in a New York Times op-ed (forthcoming). My critique of mega-banks is in a Forbes.com op-ed.)
Some Good News
¶ Until very recently many scholars and financiers claimed that the "sophistication" of the US financial system was a prime cause of US prosperity. If this was really true – and the system is shorn of its refinements – we would have much to worry about.
But is it?
¶ Certainly a modern economy needs sound financial basics – stock markets, banks, insurance companies, venture capitalists, commodities exchanges etc. But there is no evidence, that all the bells whistles that have been developed over the last couple of decades are have created value.
¶ In fact the claims in favor of increased sophistication are implausible on their face. Can we really believe that a financial sector that accounted for more than a fifth of the profits of the S&P 500 (and that does not include the profits of the hedge funds) have produced improvements in mobilizing or allocating capital of that magnitude?
¶ More likely, innovators and entrepreneurs in the real economy prospered in spite of the talent and funds that were taken up by the expansion of the financial sector. So if the financial sector shrinks back to the "basics" so much the better for long run prosperity.
¶ Also encouraging, even if there is a recession: Our Venturesome Economy (TM !) has demonstrated a capacity to develop and deploy innovations that sustain our long run prosperity in good times and in bad. Personal computers recall took off in the dark days of the early 1980s. But we mustn’t let the ill-will generated by bad financial innovations lead to policies that harm innovators in the good economy! Clean out the stable, but please keep the horse.
(This was written on September 30th 2008 (before the bailout). I believe its all still valid.)
As I said to a friend who was contemplating investment in a dodgy "emerging" market: "Giving your money to twenty thieves is no better than giving it to just one."
 "Return to Judgment," Journal of Portfolio Management, V 20, N 2: pp. 19-25, Winter 1994.
 "The Hidden Costs of Stock Market Liquidity," Journal of Financial Economics, V 34, 1993: pp. 31-51.
 High cost of liquidity, Financial Times, December 13, 1994
 Fair Stock Markets: The Hidden Cost, The New York Times, January 22, 1995.
 The hidden costs of investor protection: lessons from the US," Royal Society of Arts Journal, V CXLII, N 5452, July 1994: pp. 27-34. (from lecture delivered to the Royal Society of Arts, London April 13, 1994)
 Published in "The Causes and Consequences of Hostile Takeovers," Journal of Applied Corporate Finance, V 2, N 2: pp. 36-59, Summer 1989.
See for instance Robert Litan’s Ph.D. Dissertation: An Economic Inquiry Into the Expansion of Bank Powers.
And from his websitge..
The slides from my book talks (which you may download for your personal use) provide more detail about the modern system, but really, you should read the whole book! (available at Amazon, Barnes and Noble, Borders, and your fine neighborhood independent book store).
""Amar Bhidé provides a fresh and reassuring perspective on America’s technological position in an increasingly global economy. Anyone interested in our economic future and especially our technology policies should read this book."
Lawrence Summers, Harvard University, Former Secretary of the U.S. Treasury
[I am afraid this might tell us more about Larry than it does about the economy.]
"The strides made by China and India, notably their unexpected technological advances, have made America anxious, prompting calls to double federal spending on basic research. In The Venturesome Economy, Amar Bhidé draws on his unmatched knowledge of the mechanisms of innovation to show the benefits to us of Asia’s advances and the errors in the techno-fetishism that grips Washington officialdom. This book deepens radically our understanding of how the global economy functions."
Edmund Phelps, 2006 Nobel Laureate in Economics
[this hints that there is more than just technical effeciency. I’d like to know what. ]
"In The Venturesome Economy, Amar Bhidé takes on the increasingly noisy chorus of critics worried about the effects of globalization on the national economy. He demonstrates that the application and commercialization of technology is far more important than whether the underlying science originated at home or abroad. The winners will be those countries and businesses that have the insight and energy to apply innovations effectively. This is an optimistic and important message."
Donald J. Gogel, president and CEO of Clayton, Dubilier & Rice
[more economics for winners. Seems very limted]
Pasted from <http://www.bhide.net/>