Crybaby bankers (21 April 2009)

Be sure to sharpen your pitchforks before reading Gabe Sherman's New York magazine schadenfreude-fest about pouty investment bankers, who from behind the cloak of anonymity complain about how unfair life has suddenly become for them. It turns out the bankers are "angry" because they are having to pay higher taxes and because their plutocratic bonuses seem to be a thing of the past. As Sherman notes, "In a witch hunt, the witches have feelings too" -- but then, one could sympathize with the witches because they were singled out unfairly by an unruly mob of religious bigots. The fury at the bankers, in their callous cluelessness and their reckless endangerment of the global economy in pursuit of an extra Hamptons mansion or two, seems altogether justified and rational. The bankers aren't some misunderstood group of well-meaning citizens; they are a group that prided themselves on their sharklike mercilessness and tenacity in extracting every last bit of advantage for themselves, and they would smirk when they rehearsed the exculpatory excuse that such single-minded greed had the inevitable by-product of economic efficiency. They were wrong about that, and they should probably get as much forgiveness as they would give us if we were opposite them at the bargaining table.

When bankers were capitalism's winners, they had no problem lording it over everyone else; it seems appropriate they taste the full sting of loserdom. Sherman writes that Wall Street bankers, analysts, and traders "had believed Wall Street was where the winners of American capitalism went. Now they were feeling shamed for their work." To which I would say "good" -- only the rest of the article makes it clear that they are a group incapable of feeling shame.

What I found most irritating is the expression of overclass entitlement in such complaints as this:

“No offense to Middle America, but if someone went to Columbia or Wharton, [even if] their company is a fumbling, mismanaged bank, why should they all of a sudden be paid the same as the guy down the block who delivers restaurant supplies for Sysco out of a huge, shiny truck?” e-mails an irate Citigroup executive to a colleague.

This is a good reminder that those cretins at "elite" schools really do think they are better than you, regardless of what they or you do -- or rather that whatever they do is inherently more important and valuable because of their pedigree. As Sherman puts it, "they see themselves as the fighter pilots of capitalism," to which Time blogger Justin Fox replies, "Actually, they may more closely resemble the bumper-car drivers of capitalism, spending more time tangling with each other than doing anything useful."

From the sound of the people whining to Sherman, the bankers lost sight of the principle that meritocracy have some clear relationship to merit. Instead they assert a marketocracy and claim that it amounts to the same thing. One banker declares, "The truth is, the market determines what people are worth." Um, that's not the "truth" as in being some fundamental law of society. That's an ideological precept that has been concocted to rationalize drastic income inequality. And do bankers really want to start measuring what people are "worth" by the money they make, by market performance, at this juncture? Considering all the value banks have destroyed, that must mean the investment bankers are actually "worth" less than nothing -- they owe society several years of their working lives, by that sort of accounting. The "truth" is that people who work for no other reason than money will take as much as they can get at all times, unless some greater authority sets a limit. Will that limit seem arbitrary to them? Of course. But the amount at which they would feel content will always be arbitrary as well, since it is always at least one dollar more than whatever they are currently receiving. Listening to investment bankers' advice on compensation would be like canvassing for ideas about drug-law reform in the parking lot at a Dead show.

Sherman recounts how Wall Street came to gobble up a greater percentage of the corporate profits earned in the U.S. economy, which supplied them with the firepower to press for more financial deregulation. He quotes economist Simon Johnson, who's article on the subject in the Atlantic is essential reading: "“The system as a whole became unstable because Wall Street developed this disproportionate influence. It’s an entire system of belief they had to create." That belief system involved the idolatry of deregulated markets (which basically render them less transparent) and risk-spreading procedures which maximized the cut for middlemen -- which is essentially what investment bankers are. But the ideology they espoused claimed that this process was generating economic efficiency, not profits for parasites. Perhaps at the dawn of the financial free-for-all, bankers worked harder to find better ways to allocate capital, but by the end they were merely rent seekers who felt entitled to their cut by virtue of their pedigree, by a sort of plutocratic fiat. Their hard work went into what Johnson has labeled "tunnelling" -- insiders funneling money out of legitimate enterprises because they know the end of the bubble is near.

In short, the New York article succeeded in accomplishing its goal with me; it made me disgusted and angry. Ryan Avent implies that there might be something irresponsible in this:

Personally, I find this all very disconcerting. A round of all-out class warfare would be good for no one, and I generally agree with the idea that markets ought to set compensation levels. The brazenness with which executives are disregarding public concern over these issues is just adding fuel to an already uncomfortably hot fire.

I don't agree that "markets" (in practice, often boards of directors) set compensation levels appropriately -- it seems like a market for lemons, at this point, and is ripe for reform. And if it takes class-warfare rhetoric to steel the resolve of politicians to do something, than articles like Sherman's are probably valuable. The problem is that financial journalists do little complaining about executives' brazenness during ordinary economic times, when political action might actually work as preventive care rather than triage.

Reinflating the housing bubble (5 Feb 2009)

Georgia senator Johnny Isakson's amendment to the stimulus package, which passed the Senate yesterday, is a stupid idea -- call it the Realtor Creation Act, and heaven knows we need more Realtors. The amendment doubles the existing unnecessary subsidy to new-home purchasers from $7,500 to $15,000, and intends to encourage more activity in the housing market and speed recovery in that sector, which remains afflicted with a massive inventory overhang -- we built too many houses, and the vacancy rate is at a record high. Of course, in practice, this is a tax giveaway to the upper middle classes -- the sort of people who already can afford to buy houses rather than rent -- and encourages the same sort of dangerous real estate speculation that helped create the recession we're in.

Calculated Risk is skeptical that the historical precedent for this -- a 1975 giveaway to home buyers that supposedly boosted sales -- holds water. And economist Dean Baker explains that the proposal is probably going to be far more expensive than advertised:

Isakson puts the cost of his tax break at just $19 billion. Let's break the Washington rules and try a little arithmetic. Even with weakness in the housing market, it is still virtually certain that we will sell close to 5 million homes in 2009. The overwhelming majority would qualify for the full credit. So, we get 5 million times $15,000. That sounds a lot like $75 billion. And this is before we get to any gaming. It's hard to see why tens of millions of people wouldn't figure out a way to buy a house from a friend or relative and get their $15k. If we can get one-third of the country's homes to change hands (lots of jobs for realtors) that would be good for $375 billion.

Economist Tyler Cowen says "boo to the Republicans" for generating the proposal, arguing that "the supply of homes is relatively elastic right now. The tax credit will subsidize the new buyers without propping up the price of homes. Demand will go up, supply will go up, price will stay more or less on the same trajectory, and banks won't be any healthier. The subsidy goes to new home buyers and why should we be helping them above all others?"

Brian Beutler laments that this sort of policymaking is the "benefit" of bipartisanship:

I suppose if we wanted to, we could build upon the Isakson amendment by suspending environmental regulations and setting aside money for construction workers to build more Kaufman & Broad communities, and coal-fired power plants. That might even technically count as great stimulus, but with Democrats fully in charge the hope was that the money could be spent both in great quantity and in ways that, at the very least, didn’t help entrench the habits that got the country in this mess in the first place. But I guess that’s bipartisanship for you.

Those who thought Obama would usher in a new regime of ideas and end the pandering to the suburban bourgeoisie are finding out they were wrong, and really, this should be no surprise. Obama didn't campaign as a progressive urbanist, even if his life experience suggested he might govern as one.

Anyway, housing economist Ed Glaeser (no progressive -- you can find him on today's WSJ editorial page calling for more tax cuts) in this TNR book review, details the distortions of the subsidized lending schemes that Isakson wants to extend:

The popularity of subsidizing borrowing has led some to advocate a new round of federally subsidized lending, perhaps at an interest rate of 4.5 percent, aimed at pushing housing prices back up. But nothing is going to bring back the boom days of 2006. On average, housing prices go up between 3 percent and 5 percent when interest rates fall by 1 percent. A big loan program that pushes lending rates down to 4.5 percent would probably lead to a price boom of less than five percent. Such a modest impact would be barely noticeable in markets that have lost more than one-fifth of their value in the last year. It certainly would do little stem the tide of foreclosures. Housing in America is a $20 trillion market. It is no more plausible that the government will be able to bring housing prices back to bubble-like prices than it was for Herbert Hoover, or Franklin Roosevelt, to bring stock prices back to their 1929 levels.
I doubt that the government should try to make housing more unaffordable to ordinary Americans, even if it could manage that trick. Higher prices would just mean more overbuilding in places such as Las Vegas, which already have a glut of homes. In almost all cities, prices are still far above 2000 levels. Why is unaffordable housing now a national desideratum? The most recent housing boom made some of America's most economically dynamic and beautiful places unaffordable to ordinary Americans. Higher housing prices made it difficult for young and middle-income families to get by in America's costly coastal regions. There is much to like about housing's return to reality, not least its increased affordability, and much to dislike about artificially trying to make homes expensive.
Moreover, credit subsidies can be quite regressive. The Home Mortgage Interest Deduction is poorly targeted toward lower-income Americans who are on the margin between renting and owning; its benefits go mainly to the rich. In markets where housing supply is more or less fixed, subsidizing borrowing just pushes up prices, which means capital gains for existing homeowners, not increased housing affordability. In more flexible markets, the deduction encourages over-building and over-borrowing.
In the midst of today's housing crash, certainly, subsidizing borrowing looks particularly foolish. The government essentially encouraged Americans to leverage themselves to the hilt and bet on housing markets. Now a lot of those erstwhile owners have lost everything. Why exactly does it make sense to subsidize gambling on home prices?

Glaeser then details how homeownership subsidies basically mean that the government is encouraging us to live in single-family homes. That means when we make attempts to expand home ownership, it leads to more inefficient, energy-wasting, low-density development, perpetuating the stranglehold of suburban anomie for yet another generation.

The "atmosphere of craven conformity" (30 April 2008)

This post is not about high school or hyper-brand-conscious hipsters but investment bankers. In a FT editorial yesterday, former investment banker Abigail Hofman blamed the current financial crisis on the culture of the banks. First and foremost, she argues, that culture is about greed:

Investment banks are all about making money. At the extreme, this means making money for employees not shareholders. The big revenue producers are revered. It is not considered prudent to upset them by asking too many questions. The subprime meltdown is a perfect example of the "emperor has no clothes" phenomenon. These were complex products, yet obfuscation was considered acceptable. Bank chief executives should have asked more questions. I suspect they saw the juicy profits and hoped underlings understood the risks.

But then in the next paragraph, she goes further, denouncing the "cult aspect" of investment banks: "If you work on Wall Street or in the City, you toe the party line. Despite lip-service to 'diversity', diversity of thinking is not encouraged." As a result, no one asks difficult questions or challenges the logic of various practices that are bringing in money. No one wants to blow the whistle, derail the train.

It's hard to see how it could be any other way, as asset bubbles in general require a uniformity of opinion, a sustained and unwavering effort of belief to keep them inflating, and investment banks seem to need asset bubbles to make the outsize profits they have become accustomed to since the 1980s. The discipline of staying on message, of not undermining the optimism that obviates risk, seems essential to the business model. And from there it filters out, through the business press via various quoted analysts interpreting the steady stream of economic reports, and then into the general-interest press, helping sustain consumer confidence. A climate of critical thinking and skepticism is not particularly conducive to money-making, to the Ponzi scheme-like nature of selling risk down the daisy chain. The wrong sorts of questions are only likely to jeopardize your opportunities -- critical thinking seems more often than not to undermine opportunities rather than exploit or discover them.

This is because the "logic" of asset bubbles can't bear careful scrutiny, so the energy that might otherwise go into critical investigation is instead invested in ideology, into explanations for why we shouldn't be skeptical: "the internet has birthed a New Economy and Everything Is Different," "We all need to belong to the Ownership Society, and home prices will never drop."

Another way to put this: Investment banks are haunted by entropy, by the sense that investment opportunities inevitably unravel, face diminishing returns, run into natural limits. Lockstep conformity militates against this entropy, generates a solution for something unsolvable. Capitalism, then, is this logic writ large, which is perhaps why America is the most congenitally optimistic place in the world and a place where there reigns an overarching conformity, masked by the quotidian kind of individuality that we trumpet as freedom. That kind of individuality -- the rebellion of self-fashioning within the larger context of a stable consumerist system -- comes at the price of surrendering the kind of critical thinking that Hofman laments the absence of in the banking world.

Necessary bubbles (14 Jan 2008)

Last year, Slate business columnist Daniel Gross wrote a book called Pop!: Why Bubbles Are Great for the Economy. Needless to say, this doesn't seem such a great title given our current economic climate and the growing sense even among people who aren't business-news junkies that the burst real estate bubble will cause a lot of economic misery for all of us. You don't have to read WSJ to notice the alarming depreciation of your retirement savings, as stocks have lost a huge chunk of their value in recent weeks. And you don't have to be on a Bloomberg terminal to notice how expensive food and gas are becoming, or to notice how certain neighbors are failing to keep up on their home maintenance, or are even around anymore. No wonder consumer confidence is battered. Though Gross is a bit tongue-in-cheek in celebrating bubbles (as if this was a job he had taken on assignment) his assessment of the impact of the then-not-fully-popped housing bubble seems a touch short-sighted: "So far its salutary effects include the creation of a huge number of jobs and the inflow of investment into long-neglected urban areas." That was true at the time, but now those jobs are vanishing, and blight is returning to those areas in the form of foreclosures.

Obviously, bubbles cause inflated asset prices, which eventually come back to earth, painfully, leaving a giant crater that causes all sorts of collateral damage. But some of Gross's points about the origin of bubbles (government subsidies and favorable legislation) and their upside can't be dismissed: Some of the paper assets created during the frenzy do spur real infrastructure investment, as with the build out of fiber-optic networks that are only now paying dividends with the advent of "cloud computing." And past bubbles promoted widespread shifts in the way ordinary people work, travel, or communicate. In short, bubbles built the railroad and the information superhighway. Gross also argues bubbles build a "mental infrastructure" for comprehending new technological possibilities, new ways of doing business. The "creative destruction" enacted by the inflation and subsequent undoing of bubbles is presumably a small price to pay for progress. Indeed, by highlighting alternative energy as the next big investment boom, Gross suggests that bubbles will save us all from global warming.

In the most recent Harper's former VC honcho Eric Janszen puts an apocalyptic spin on this thesis, claiming that the American economy has replaced the business cycle, the bugaboo of economies past, with a hyperaccelerated bubble cycle. Along with this shift, what are sometimes called the FIRE industries (finance, insurance and real estate) have supplanted traditional manufacturing as America's economic base. Now that the housing bubble has popped, these industries are in grave trouble, and the usual remedies -- rate cutting, currency deflation, tax cuts, an influx of foreign investment (think, sovereign wealth funds buying into U.S. banks) -- are not so easily implemented when interest and tax rates are already low and inflation is rising and foreigners are filled to the brim with dollar-denominated assets. Hence we need a new bubble to bail us out, and Janszen too points to alternative energy. But rather than highlight the infrastructure and paradigm-shifting legacy such a bubble would supply, he directs our attention to the "$20 trillion in speculative wealth, money that inevitably will be employed to increase share prices rather than to deliver 'energy security.' When the bubble finally bursts, we will be left to mop up after yet another devastated industry. FIRE, meanwhile, will already be engineering its next opportunity." In other words, the middlemen create fictitious value while extracting real profits for themselves, and then let government step in and clean up the mess when the fictions are revealed.