The Greenspan Moment?

Paul McCulley of PIMCO coined the term Minksy Moment to describe the point in a credit cycle or business cycle when investors have cash-flow problems due to spiraling debt they've incurred in order to finance their speculative investments. It's at this point that mass sell-offs begin due to the fact that nobody else can be found to bid at the current high prices. The collapse of the housing bubble in 2007 is a perfect example of a Minsky Moment.

A Minsky Moment is a nice description of how a bubble collapses. But after the financial crisis happened in 2008, I believe there should be another "moment" named: it's the moment that policy makers, economists, bankers and politicians forget how fragile all economies are. It's the moment they forget the lessons of history (and all the bubbles from Tulip Mania to the dot-com crash). It's at this point, when the regulations put on the financial industry by the survivors of previous panics, are unwound. It's the point at which a new generation--which has enjoyed the long-run economic benefit their ancestors helped ensure--end up making the same mistakes their grandparents and great-grandparents made. It's the moment at which people arrogantly believe that monetary policy (or some other force) can stave off depressions. It's the moment that arrogance overtakes rational economic analysis (and knowledge of history). Going forward, I propose this moment be called the Greenspan Moment.

50-years after the Great Depression (from 1931-1981) the country experienced another major financial crisis (the S&L scandals). 70-years after it, politicians repealed Glass-Steagall. And 80-years after it, the country stood on the precipice of another depression.

Will this happen in the future?

Looking back at all the financial panics and crashes in history, I'm guessing yes. We can expect Ben Bernanke to be very heavy-handed with monetary policy in the future. He'll do his level best to control asset bubbles and dampen irrational exuberance. There will be new financial regulations instituted such as counter-cyclical leverage ratios at banks. Bernanke's eventual successors will probably also have lived through the Great Recession and they'll continue the vigilance against asset bubbles, shadow banking and deregulation. But then, at some point in the future (50- or 60- or 80- or 100-years from now) there will be a Greenspan Moment. It will be the moment when the lessons are forgotten, regulations are relaxed and the next crisis happens. Mark my words it will happen. And it needs a name. I only hope that, after the next Greenspan Moment, celebrated economists don't once again forget the lessons of Keynes and fiscal spending.

Stimulus Questions

Nobel Prize-winning economist Paul Krugman recently opened up his blog for questions from the readers. He answered a few and the entire Q&A is online and it's educational for those who have questions about the stimulus, the recession, health care, etc. He's a smart man, and his answers are obviously well-thought out and intelligent. Go read what he wrote.

But, unfortunately for me, he didn't answer the question I asked, so I asked my question again, but this time I asked it in the comments section of Brad DeLong's blog (Professor DeLong is an equally intelligent economist) but alas, no answer, yet.

So I suppose I'll write my question(s) here and see if anybody stumbles across it in the future and can shed light on some of these issues for me.

Firstly, regarding the stimulus: Government spending in WWII is what pulled the United States out of the Great Depression. It proved Keynes correct and validated most (if not all) of his theories that fiscal policy could fill the output gap between real GDP and potential GDP during a recession (or depression). However, the world looks very different today than it did in the 1940s and I'm not concerned about the short-run equilibrium of AS-AD or of the effects of the stimulus on real GDP. My questions concern the Long Run Aggregate Supply Curve (Potential GDP).

The "stimulus" of WWII set the stage for long-run economic prosperity in the United States, but the postwar boom here was also fueled by interest payments the United States received from England and Germany. In fact, there was interest earned on interest in some cases, as we loaned money to Germany who had to pay war reparations to England who was in debt to the United States. In addition to these interest payments from other countries, the debt that funded WWII's spending was largely internal debt--meaning the United States went into debt to its own citizens for the most part. But now, however, there is a much larger percentage of US debt owned by sovereign funds (some estimates claim sovereign purchases of US debt has reached nearly 40%).

In the end, my questions are: What does this mean for the long-term recovery? Will potential GDP be lower because a large portion of government debt is given to foreign countries? Does this lower "I" or "G" or neither? Does it matter? Will the new, lower LRAS slow immigration and investment in the US and re-direct capital and resources to growing economies? Will the US, after this collapse, emerge from the crisis much the same way England did from WWII--meaning a sort of economic decline that lasts for a decade or more, accompanied by eventual replacement as the world's economic superpower, while foreign countries like China and India rise? Did Christie Romer include the sovereign purchases of our debt and the interest-on-interest we earned after WWII in her multiplier calculations for the ARRA? Is there an automatic offset to the sovereign funds and interest-on-interest by the TYPE of spending in the ARRA?

What I mean by that is: Keynes proposed that stimulus spending should be spent on useful things if possible, but completely wasteful things if necessary. He proposed burying money in mineshafts so that workers would be hired to dig it out. And WWII's stimulus spending was really no different than wasteful spending because in the end, as Bruce Bartlett so aptly put it:

"WWII proved to be an effective stimulus that, economically speaking, consisted of 100% waste. If the war hadn't broken out, the US could have enjoyed the same economic benefit of the stimulus by building all the tanks, planes and bombs and simply dumping them into the ocean."

So, will there be natural offsets in the ARRA on the "interest and sovereign fund" issues because of economically useful stimulus spending? And, again, how much of this was calculated by the ARRA's creators? And, finally, as I asked Dr. DeLong... what is the air-speed velocity of an unladen swallow?

Reaching Escape Velocity?

As I'm currently out of work, I went to the annual CFA networking day here in Philadelphia, last Friday. Most of the exhibitors said they were currently only hiring "replacements" (people who had retired, moved on, etc.) so it wasn't a great day for me professionally so, as usual, I was more interested in the speakers and the panel discussions.

The keystone speaker this year was Tony Crecsenzi, Senior VP at PIMCO. He began his speech by talking about the economy and the chance that it will reach escape velocity from the recession by 2011. He outlined the pros and cons of the Fed's actions, the TARP and what effects the stimulus will have, all without giving his opinion. Then he asked for a show of hands from the audience (about 250 CFA Charterholders and Candidates) if they thought the economy would reach escape velocity by 2011 without further stimulus. Only two people said yes, the rest of us said no--that we'll need more stimulus.

This may, or may not, be surprising to most people, but it was surprising to me. Most of the CFAs and MBAs I know are fiscal conservatives--typically against government spending. However, CFAs are usually more quantitative in nature, with a higher degree of financial literacy than most (even over MBAs) so perhaps they understand the economy in a much more detailed way than the average financial industry worker.

Crescenzi finished his speech by highlighting a drag he forsees on the growth of the economy in 2010 and 2011 -- the expiration of the Bush tax cuts -- and perhaps a bright spot for further stimulus. Without further stimulus, he believes the economy won't reach escape velocity by January 1, 2011 (when the Bush tax cuts expire). But the mid-term elections (he believes) typically see the ruling party lose seats in Congress. With the economy still dragging by then, the tax cuts will have to be extended (an unfavorable proposition for Democrats) so perhaps it will force them into action on a second round of stimulus. Well, fingers crossed I guess. I need a job sometime before 2011.

Here are the guts of Crescenzi's speech if you're interested.

Wal-Mart vs. FEMA

I read this not-very-interesting research paper today that compared Wal-Mart's response and FEMA's response to Hurricane Katrina.  The reason why this paper isn't particularly interesting is because, as we all know by now, FEMA's response was just awful.  In fact awful is probably an understatement.  It might even a little generous.  Actually, if all Wal-Mart did was ship half a carton of Ramen noodles to New Orleans, they would still have beaten FEMA's response by a mile (FEMA's head, Michael Brown, apparently didn't realize that many of us would consider waterboarding of displaced 9th Ward residents an "ineffective response").

All kidding aside, you can read the report if you want but I'm sure you won't find it enlightening. What you may find dis-enlightening, however, is the report's conclusion... that the government is incapable of responding to disasters and therefore FEMA should be replaced by Wal-Mart. Ummm... what?  

I've written about this type of cynical assumption before - that conservatives in power purposefully wreck the government then turn around and point at the wreckage as proof the government doesn't work. Horwitz's paper does exactly that.  It celebrates the Wal-Mart response as proof the private sector should be allowed to run everything and that the government should step aside.  

It's typical that Dr. Horwitz, a conservative professor who has previously blamed the entire financial crisis on Fannie/Freddie and the Community Reinvestment Act (both of which are debunked Republican talking points), would leave no room in his conclusion for managing FEMA properly. He doesn't care that governments in other countries work just fine or that the government's response to 9/11 worked well. As a free market champion Dr. Horwitz's response to any governmental failure is proof the government doesn't work rather than proof this government doesn't work.  So his concluding proposal is for future administrations to seriously consider more outsourcing to private companies rather than for future administrations to fix the wreckage Bush created.  

Strangely, what's missing from Horwitz's report is the examination of the millions the Bush administration doled out to private companies like Bechtel, Halliburton and Gulf Stream Coach, all tasked with rebuilding New Orleans. Where, I wonder, is the report on the private sector's efficiency regarding the rebuilding effort?  Well, perhaps Horwitz is happy to see free market efficiency at it's finest -- after all, what's more profitable or efficient than for Bechtel to take piles of money without actually y'know doing anything with it? That's the absolute pinnacle of profitability. That's a free lunch. Money for nothing. Arbitrage. All hail the efficiency of the private sector...  

...in the meantime, please just look the other way on accountability, since none of these private companies will be held accountable for not actually doing anything with taxpayer money. 

Truly Useless Information

Free Exchange has an interesting post today about Insidious MBAs.  It adds to the general sentiment in the comments from my last post on the subject -- namely that MBA students arrive at B-School with no morals (or an amoral world view). 

Shortly after the Enron debacle [my professor] asked me how business schools could better teach ethics to help reduce such behaviour in the future. I told him you cannot teach ethics to MBAs. By the time you're an MBA student (typically mid to late 20s) you're either an ethical person or you're not. No business school class can make you realise embezzling money is wrong if that's your inclination.

I agree with that sentiment but will add that MBA professors are definitely trying their hardest to turn out highly moral individuals. Nearly all our professors dispense lessons and teach with an almost heavy-handed approach to morals.  The types of books we're given to read (especially in the more qualitative classes like HR, Management, Leadership) when not conveying direct strategic lessons often extol the benefits of highly virtuous management.  Gentle, magnimous management styles are encouraged and case studies back up the benefits of leading in such a way.  The benefits of corporate social responsibility and the stupidity of trying to defraud customers or shareholders is a constant, constant, constant drumbeat. 

Professors should be applauded for their work in this regard, but what if examining bad moral decisions isn't enough? Mark Thoma points to the problems with financial engineering and says MBAs and Financial Engineers may not be learning enough (or enough of the right stuff) as it is. As his post notes, and as Nassim Taleb has famously decried in his book The Black Swan, our Financial Engineering program teaches Black-Scholes up the yin-yang but little else, but Black-Scholes is a formula that doesn't translate beyond academic mathematics -- it simply doesn't work in the real world.

So the FE students and the brave few MBAs who took this class have spent four months studying their brains out for nothing. This, despite the fact that our derivatives professor admitted to the class yesterday that, as a former engineer, he's quite familiar with Nyquist Sampling, Brownian Motion and Mandelbrot's fractals and could probably teach them. 

Why he hasn't adjusted the program until now is probably because there has been no demand on Wall Street for quants with knowledge of these theorems. I recall an old Jack Welch speech from a few years ago to a bunch of students about how the market shapes what kind of MBA students the b-schools churn out.  If the market wants quants who only know Black-Scholes, then that's what the b-schools will deliver. Why would academia bother to teach them something different when Wall Street only wants Black-Scholes disciples?  Students won't get hired, paid a ridiculous salary and be able to give a portion of their piles of money back to the school if their skill sets don't match what Wall Street wants.

I suppose I might be one of the last MBA students to learn Black-Scholes. It would seem the financial world is changing and with it, B-School curriculums will change as well.  This is obviously disheartening to me for more than a few reasons, but it's mostly frustrating because I could have completely skipped derivatives (which has, by far, been the most difficult and challenging class I've had) and still earned an MBA in Finance. Derivatives is an elective course for us MBAs, and only a required course for the FE students.

So I could have easily graduated without putting myself through learning a difficult skill set I'm never going to use not just because it's out-of-vogue but because it's also completely useless.

Awesome.  None of this is helping me study for the derivatives final I have in two weeks.  

Highbrow Blogging

So I saw this blog readability site the other day (hat tip: JES) and at first I was happy about the props it was giving my writing skillz, but then I became concerned. I started wondering what kind of rating system it's using and what my rating should mean to me. 

JES and others haven't been happy with their ratings and, to be honest, at first I was hoping for a Double Doctoral Degree Rocket Scientist rating. So I conducted thorough analysis of the software (and by 'thorough analysis' I mean 'drank beers while watching tv') and concluded that the readability test works perfectly well. The system rates blogs based purely on readability and doesn't rate content at all (which should have been obvious to me since it's called a blog readability test).

Anyway, after realizing this, my rating concerned me because it could be a sign that my posts are not as clear and concise as they should be. To test my hypothesis I ran the blogs of Brad Setser and Felix Salmon (smarty pants, finance bloggers I follow) through the rating system to find out whether or not I was right. 

Nearly all of Setser's post require a Master's in finance or economics to properly comprehend, and a healthy portion of Salmon's require the same. But their blogs were rated as High School and Junior High respectively. To me, these ratings undoubtedly proved the system was rating writing style and not blog content.  

What does this mean for me?  Well, Setser and Salmon boil down exceedingly complex financial arcana into readable articles that high schoolers can understand. I turn fart jokes into scholarly dissertations. Setser and Salmon write about derivatives, leveraged financial intermediaries, fixed income arbitrage and illiquid securities while, most of the time, I'm just trying to find excuses to write the name Dick Butkus. 

I suppose I could find my blog's rating flattering. On one hand, it shows I'm in rarified Joycean air -- Finnegans Wake, after all, was nothing more than a 650-page fart joke gone horribly wrong.  But on the other hand, how many freakin' people have actually ever read Joyce? Sure we all like to lie and say we have, but we haven't. Nobody has. And the few who have are usually insufferable. Anyone who's read Finnegans Wake cover-to-cover is so bitter at having lost numberless hours to reading and trying to decipher Joyce's fart-joke prank that they have to act like it's scripture afterwards to save themselves from psychosis.  

Is this the future of my blog? Are these the type of readers I have? Am I reading way too much into this readability test?  Who knows... but on a more serious note, what do you think Dick Butkus's blog looks like?

Amoral MBA Students

MBA students, perhaps not to anyone's surprise, are cheaters.  MBA students cheat on the GMAT's so they can get into top B-Schools.  MBA students also willingly admit to cheating once they're in B-School, and MBA students obviously act amorally and immorally once they're out of B-School.  

Keep this in mind as I present the results of an informal, professor-administered poll taken in my Derivatives class this Tuesday.  The class discussion began with talk of everything that's been happening lately, as usual, and the professor believed illegal actions will eventually come to light regarding actions at the Wall Street firms (pressuring ratings agencies, exchanging favors for good ratings on toxic CDO's etc.).  Some students expressed anger at the immorality of it all, others questioned whether anything illegal had actually happened or whether it was simply irresponsibility that caused it all.  In light of the class discussion, the professor presented a class with the following situation:

You work somewhere in the finance industry nine months from now, and I present you with an opportunity to make $5 million.  However, you have to do something illegal to get the $5 million. The chance you'll be caught for doing this illegal act is 50%. Further, the maximum sentence you'll receive is four years and the chance of receiving the four years is also 50%. No matter what happens, if you're caught and sentenced to three years, you'll still get to keep the $5 million.  Would you do it?

Almost everyone in class raised their hands.

Here are the demographics of the class, as best I can guess.  It's a mixed class with both MS and MBA students since Derivatives is an elective for MBA-ers.  The class size is roughly 90 students, all ranging in age from 26-34 (my best guess).  The mix is approximately 50% Asian and South Asian, 40% American (all races) and 10% other (from the accents I'm guessing Russian, German, South American and Latin American).  Males comprise about 70% of the class.

There were little demographic differences among those who raised their hands, at least as far as I noticed, other than the few married women who didn't.  If you must know, I also raised my hand, but it's not a static answer for me. I'm on the upper end of that age range and four years is a long time for me to be rotting in a jail cell.  I've got friends and family I love dearly and wouldn't want to miss seeing.  I'm also certain that if I figured out who exactly I'd be damaging with my immoral / illegal actions, I might not follow through.  I find it's a lot easier to answer "yes" to a question of an illegal act when the question is asked in a void, but it's also much tougher to actually follow through on that act in real life.  

All this is beside the point, however. MBA Students (and MS - Finance students) are supposed to be smarter and (I suppose) less immoral than rest of the world.  I imagine the results of this poll would skew quite high if given to the population at-large, but the class this poll was asked of are supposed to be future leaders -- future leaders of large corporations that will hold the financial well being of tens of thousands, or even hundreds of thousands of workers' lives in their hands.  

All the students wrote essays to gain admittance to school, and all their essays discussed the "good" they'd like to do in their future career as well as the unique and interesting career paths they believe that earning an MBA will open for them (management consulting and investment banking, at the time the essays were written, are unique?).

Anyway, nearly all the students I know are in B-School to make more money.  There are few non-profit, humanitarian types in the program but for the most part we're all here just to earn larger paychecks. That's it. Plain and simple.  

So basically, 90% of MBA students are not just generally a bunch of cheats but also liars since their admissions essays were anything but honest!  And yes, I'm completely comfortable extending generalizations to every B-School and MBA student in the country after the completely unscientific and informal polling I conducted at mine.  I wonder if, when they're reading the admittance essays, the adcoms aren't just looking for the most riveting piece of fiction they can find since we all lied about our future hopes to save the whales and the rainforest? Well, maybe after we make our first $100 million we'll have whaletanks installed in our mansions and rainforest terrariums installed in our million dollar greenhouses, thereby following through on the empty promises we wrote in our essays.

All this pretty much got me wondering whether financial gain attracts the amoral / immoral or whether the amoral / immoral are attracted to financial gain?  I have to admit that I give the professors a lot of credit for trying their hardest to sway us and the HR Profs do an especially admirable job in this respect, but if the students are already money chasing cheaters, what difference can a few enlightened lectures make?  

Anyway, in the wake of the meltdown and news items claiming MBA degrees are no longer worth it, I'm really starting to think I should have earned my Master's in something less sleazy, more honest and more respected....  like law!  Hey, at least I'd have a job next year prosecuting all those immoral MBA-ers who caused this mess.