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Senior Vice-President for Research and Innovation, Professor of Theoretical Physics, Michigan State University

Friday, February 15, 2013

The City and The Street

Michael Lewis writes in the NY Review of Books.

Early 1990s, hanging out in Manhattan with some friends in the derivatives business, one of them an Oxbridge guy who had been at graduate school at Harvard: when I used the then new term "financial engineering" in conversation he burst out laughing. "Is that what they're going to call it?" he asked, incredulous. "It's just bollocks."

See also The illusion of skill.
NYBooks: ... If you had to pick a city on earth where the American investment banker did not belong, London would have been on any shortlist. In London, circa 1980, the American investment banker had going against him not just widespread commercial lassitude but the locals’ near-constant state of irony. Wherever it traveled, American high finance required an irony-free zone, in which otherwise intelligent people might take seriously inherently absurd events: young people with no experience in finance being paid fortunes to give financial advice, bankers who had never run a business orchestrating takeovers of entire industries, and so on. It was hard to see how the English, with their instinct to not take anything very seriously, could make possible such a space.

Yet they did. And a brand-new social type was born: the highly educated middle-class Brit who was more crassly American than any American. In the early years this new hybrid was so obviously not an indigenous species that he had a certain charm about him, like, say, kudzu in the American South at the end of the nineteenth century, or a pet Burmese python near the Florida Everglades at the end of the twentieth. But then he completely overran the place. Within a decade half the graduates of Oxford and Cambridge were trying to forget whatever they’d been taught about how to live their lives and were remaking themselves in the image of Wall Street. Monty Python was able to survive many things, but Goldman Sachs wasn’t one of them.

The introduction into British life of American ideas of finance, and success, may seem trivial alongside everything else that was happening in Great Britain at the time (Mrs. Thatcher, globalization, the growing weariness with things not working properly, an actually useful collapse of antimarket snobbery), but I don’t think it was. The new American way of financial life arrived in England and created a new set of assumptions and expectations for British elites—who, as it turned out, were dying to get their hands on a new set of assumptions and expectations. The British situation was more dramatic than the American one, because the difference between what you could make on Wall Street versus doing something useful in America, great though it was, was still a lot less than the difference between what you could make for yourself in the City of London versus doing something useful in Great Britain.

In neither place were the windfall gains to the people in finance widely understood for what they were: the upside to big risk-taking, the costs of which would be socialized, if they ever went wrong. For a long time they looked simply like fair compensation for being clever and working hard. But that’s not what they really were; and the net effect of Wall Street’s arrival in London, combined with the other things that were going on, was to get rid of the dole for the poor and replace it with a far more generous, and far more subtle, dole for the rich. The magic of the scheme was that various forms of financial manipulation appeared to the manipulators, and even to the wider public, as a form of achievement. All these kids from Oxford and Cambridge who flooded into Morgan Stanley and Goldman Sachs weren’t just handed huge piles of money. They were handed new identities: the winners of this new marketplace. They still lived in England but, because of the magnitude of their success, they were now detached from it. ...


LondonYoung said...

Relevant note: in the U.S. it is observed, now and then, that the bailouts of the financial system turned a profit for the "taxpayer" and it was only bailing out the auto industry that lost money. However in Europe it is a very different story. European banks, left and right, are still wards of the state and countries like Ireland are drowning in debt incurred to finance their bailouts.
I think this important contrast doesn't get much airtime because nobody likes the fact that the american bank bailouts made money - they just wanna say the bankers were unjustly enriched (which of course they were, but that does not change the fact that the U.S. treasury was made whole by its banks while the Europeans were not).

HughLygon said...

"...the bankers were unjustly enriched (which of course they were..." But they can't be blamed. Doing what's right and good is an abstraction. The concrete reality is "Will I be working with my kind of people?" and "What are my peers making?" What is more unambiguously value producing than machining? But would you want to work with machinists? And so the native inequality of people and the acquired inequality of class still goes unaddressed by politicians still content to moralize. Grow up!

Richard Seiter said...

The contrast between the financial and auto industry bailouts is interesting. It seems clear (based on my limited economic knowledge) that one was a liquidity crisis (the banks) while the other was the collapse of an unsustainable business model (the auto companies, in particular their pension funding and health care costs compared to what they can afford and remain competitive). I have some concern that maintaining low interest rates right now is a hidden bailout of the financial industry and will have substantial costs in the future.

Do you have any thoughts about why the European experience is so different?

One thing I like about the Michael Lewis quote above is he addresses one of my primary grumbles about American financial/business culture right now. The tendency towards socialization of costs and privatization of benefits (resource extraction and associated environmental cleanup problems provide fertile ground for observing this).

Tertius Lydgate said...

The Treasury has an infinite supply of dollars. Making a profit for the Treasury is nonsensical.

LondonYoung said...

Cool, let's use those dollars and take tax rates to zero ;-)

LondonYoung said...

Low interest rates: I think low rates WILL have substantial costs in the future. Banks benefit when the fed is actively cutting rates - so the 2008 actions really helped them. But sustained low interest rates (i.e. below the rate of inflation) like we have now are, I suspect, better thought of as part of financial repression of all creditors in favor of debtors (like the UST).

IMHO, the European experience was different because their accounting standards and regulations allowed their banks to be more leveraged and engage in riskier practices. The U.S. regime pre-Dodd-Frank was already pretty tough. Note that one problem U.S. politicians have faced in prosecuting Wall St. banks is that most of the worst performing mortgage securities were registered offshore and sold to europeans - largely beyond U.S. law.

Tertius Lydgate said...

Yes, federal taxes could be eliminated or made negative (stimulus!). What do you think gives value to USD?

Tertius Lydgate said...

Yes, I agree that tax obligations give the USD value, and the Fed/Treasury controls net supply. However, endogenous horizontal credit expansion through banking is important to consider as well.

Secondly, do you really think that people will respond to inflation by consuming instead of saving? I feel it is more likely that they will seek alternative savings, and then only if the inflation is extreme. Inflation does not change the reality of impending age and retirement -- look at Japan.

SethTS said...

Russ Roberts invited Cathy O'Neil (of mathbabe.org ) to EconTalk. Makes for interesting listening:


j_mct said...

Per the article, the NYRB has been putting out articles like that since it's existed. In addition the the 'Wall Street guys are so crass' angle it also has references to the supposed cultural sophistication of Europeans, which really cannot survive any contact with actual Europeans. One could take that article, change some particular references, and it would be a close match to some NYRB article that might have been published in 1966. The NYRB is like that. The article's supposition that Londoners, whose town was the world capital of banking and finance for about 250 years didn't do or know anything about finance or being financial until the awful tacky Americans somehow corrupted them is a bit rich too. NYRB readers like it rich though.

Per banks bailouts, yes the Treasury did in the end make a profit on basically every NY finance type bailout, or investment in some cases, Wells Fargo wasn't anywhere close to bankruptcy at any time, in the case of AIG and to a lesser extent, Citigroup, amazingly so. At the time though, the profit wasn't a sure thing, which is why the govt did it, since no private entity would have. So the 'Wall Street got special treatment' people obviously do have a point. In any reckoning about bailouts to financiers though one has to count Fannie Mae and Freddie Mac. I think if one includes F&F the govt most assuredly lost money, and it's tab still isn't quite settled. F&F aren't usually included since the 'narrative' demands that all the unpleasantness was caused be greedy immoral NYers. The greedy and immoral NYers were certainly at fault for places like Bear Stearns going under, just because there was a housing boom and bust doesn't mean that Bear Stearns had to lose money, they didn't lose any money during the internet bubble, their going under on mortgage securities was entirely their own fault. But the nasty NYers did not cause the housing boom and bust, that was caused by greedy and stupid Washingtonians. F&F was entirely a Washington thing, and in the end, that's where the big losses are, which is exactly where one would expect to find them given the housing boom and bust was caused by greedy stupid DCers, which it was.

The point of the 'narrative' is that all those greedy stupid private sector people need minding by the wise and virtuous public sector people in DC, lest the people suffer. The whole thing looks like SOB. Every time public sector types cause a disaster, they always find some private sector types they can blame it on, 'blame shifting' is a recognized political skill that public sector types have in abundance relative to private sector types, and the public sector types usually succeed. They most certainly did this time around, 'too big to fail' was not created by the latest regulations, it was expanded, F&F were the original TBTF entities. People were making the 'privatized profit, socialized losses' observation, correctly, about F&F when Richard Nixon was president. Now, if F&F aren't wound up, which right now it looks will not occur, we will have eight F&F's. It always seemed funny to me about the Dodd Frank bill was who Dodd and Frank are. One could argue that the guy who ran Lehman Bros, even if he lost most of his money, was left with too much with the bankruptcy, but one cannot argue that he was still influential as to what happened in the world afterwards, he was gonzo. That's so private sector. One cannot pin all the blame for the housing boom and bust on Dodd and Frank, or the Democrats alone, but in DC when you screw up royally at regulating finance, they'll put you in charge of the reform effort! That just expands the idiotic regulation that caused the disaster in the first place! So it seems 'the narrative' worked.

HughLygon said...

Venting? "That just expands the idiotic regulation that caused the disaster in the first
place!" Is government to blame in all economic disasters? "...which really cannot survive any contact with actual Europeans" Hear, hear! But the US is still an outlier politically, and Americans are FAT. Fat people cannot be taken seriously.

j_mct said...

No the govt doesn't cause all economic disasters, it didn't cause the dot com bust, for instance, but the fed'l govt did cause the house boom and bust in the US, no matter what NYC bien pensant NYRB readers and writers think. NYC bien pensants don't need a financial crisis to think that banksters suck, they always think that. Per Europeans, I guess I should have said more culturally sophisticated than Americans, which wouldn't survive contact actual Europeans, since aren't more culturally sophisticated than Americans. NYC bien pensants seem to think that all Euros are Jacques Barzun and they're not. Making fun of NYC bien pensants has been a sport ever since they existed, here's an example of a master at it. https://www.youtube.com/watch?v=Omu_bePQ4Lc .

HughLygon said...

The "life of the mind" attracts both idiots and the idiot children of the rich like Barzun. Regression to the mean I guess. Why don't the "productive" banksters have a voice as loud as the bien pesants? They only need to be heard by people who count.

HughLygon said...

I just started getting the NYRB. Looks even more crass than the LRB. I use the LRB to start fires.

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