"The Art Of The Banking Controversy In Uncategorized on April 20, 2009 at 7:21 am
Also published on the Atlantic Monthly’s Business Channel.
Now that we are well into the depths of a recession, banker-bashing is all the rage. In addition to being fashionable, these “arguments” have an air of credibility about them, given the dire context in which they are made. As a result, the debate over regulating the financial sector is being recontextualized by portraying Wall Street as little more than a vacuous pig-pen. This view is informed by a grand equivocation, which lumps together all of finance under one roof, somewhere on Wall Street, where bankers convene and discuss how they can further redirect the world’s resources towards their pockets. And the shapeless anger that follows from this view has consumed not only the main stream media, but bloggers as well.
Brad Delong takes the view that both compensation and profits in the financial sector are wholly unjustified. Matthew Yglesias agrees. Another even more dubious theory, also espoused by Matthew Yglesias, is that those in finance are morally inept. (You can find Conor Clarke’s response to Yglesias here). Together, Delong and Yglesias employ straw men, false dichotomies, equivocation, conflate coincidence and causation, and in general treat a complex subject with glib answers that suggest the authors have no concern with getting it right, or have just finished reading Schopenhauer’s, “The Art of Controversy.”
Summary Judgment
In a sparsely worded opinion, Justice Delong condemns all of finance, finding the Economist’s piece on the likely pitfalls of blaming the wealthy for the current downturn an unconvincing defense to the charges. In structuring his opinion, Delong provides us with only two avenues through which we may prove our worth:
The rise in [financial sector] profits [as a share of domestic American corporate profits] from 20% to 40% would have been justified had finance produced (a) better corporate governance and thus better management, or (b) more successful diversification and thus a lowered risk-adjusted cost of and a higher risk-adjusted return to capital.
To say that profits can be justified only by satisfying exogenous factors strikes me as bizarre, especially coming from an economist. To say that there are only two such factors is simply ridiculous. There is no mandate which financial institutions must satisfy, other than the law, in order to prove their worth. The fact that Mr. Delong would like to see more emphasis on corporate governance and diversification does not create the presumption that profits earned at financial firms were somehow unjustified. Investors and clients are not in the business of making charitable contributions to financial institutions. If they paid financial institutions for services or products, they believed that they were getting good value in return at the time.
One sensible explanation for the rise in financial sector profits is that investor appetite was voracious during the relevant period. This was due at least in part to an influx of capital available for investment from the Middle East and elsewhere, which was itself due to record commodity prices, and a period of seemingly unbounded asset appreciation, each of which skewed the market’s appreciation for risk. Note that this explanation would not satisfy Delong’s demand for the justification of such profits. That is, Delong suggests that the mere existence of lawfully earned profits which the market elects to create through the demand for goods and services is insufficient. After all that happens, he, or some other economic Tsar, gets to determine which are justifiable and which are not.
Similarly, Yglesias writes:
Could it really be the case that so many people were naive enough to trust their monies to institutions that were only claiming to have brilliant investment models? Well, it seems to me that it could.
If we assume that financial institutions were merely feigning the existence of “brilliant investment models,” whatever that means, are we to simultaneously believe that these institutions were unaware of their inadequacy? After all, to accept Yglesias’ argument is to believe that Wall Street was not drinking its own Kool-Aid, but only selling it to others. This theory is quickly debunked by considering the glowing counterexample of Bear Stearns. Employees up and down the spine of corporate governance were married to Bear in the form equity. When Bear’s equity got wiped out, so did its employees, who held approximately one third of the company’s stock.
Despite Delong’s and Yglesias’ pronouncements to the contrary, the goings-on of Wall Street are not an elaborate ruse fashioned by the well-connected to deplete the world’s “precious bodily fluids.” That said, something has gone disastrously wrong. But indulging in argumentation that amounts to little more than hand waving will not help anyone to understand what happened, and more importantly, what policies should be implemented to prevent it from occurring again."
Posts
“After all, to accept Yglesias’ argument is to believe that Wall Street was not drinking its own Kool-Aid, but only selling it to others. This theory is quickly debunked by considering the glowing counterexample of Bear Stearns. Employees up and down the spine of corporate governance were married to Bear in the form equity. When Bear’s equity got wiped out, so did its employees, who held approximately one third of the company’s stock.”
The above doesn’t follow:
“What responsibility does he take, as chief executive officer, for the failure of Enron?
“I have to take responsibility for anything that happened within its businesses,” says Lay. “But I can’t take responsibility for criminal conduct of somebody inside the company.”
“This is what I call the Elmer Fudd defense — that I went to work every day and was paid $6 million a year and had a Ph.D. in economics — and somehow, despite all of this, I didn’t know anything that was going on. It’s laughable,” says Bill Lerach, a lawyer who sued to stop document shredding by Enron’s accountants. Now, he’s leading an investor lawsuit against the company, its bankers, its accountants and Lay.
“What was he doing every day in his office? Reading comic books? This man was the CEO of the company,” says Lerach. “He had an obligation to be informed about what was going on in that business every day in every way. And he utterly failed to do it.”
And:
“Prosecutors have tacitly conceded the effectiveness of Lay’s use of what is known in legal circles as the “idiot” or “ostrich” defense. The indictment handed down against him was narrowly drawn, consisting of seven counts of fraud and conspiracy, compared with the 35 counts leveled against Skilling and the 98 against former Chief Financial Officer Andrew Fastow, who is set to testify against Lay and Skilling under a plea bargain that limits his prison term to 10 years. Confined almost entirely to Lay’s actions during the last few months of 2001, the indictment accuses him of misrepresenting Enron’s condition as it careered toward insolvency.”
Of course, he was convicted.
As for Bear:
“The disintegration of the funds cost investors $1.6 billion and set in motion a series of cascading collapses, resulting in the write-down of more than $350 billion in losses and the demise of Bear Stearns itself.
“Perhaps the greatest irony yesterday was that these most networked of men, who were tuned into their Blackberries day and night, are being prosecuted through their own incriminating emails to one another.
In its indictment, the government uses email messages confiscated from both their home and work accounts to make the case that Cioffi and Tannin knowingly misled investors about the funds’ impending crackup to save their own jobs and reputations – in Cioffi’s case, going so far as to withdraw $2 million of his money from one of the funds, even as he reassured investors.
“If I can’t [turn the funds around] I’ve effectively washed a 30-year career down the drain,” Cioffi says in a June 9, 2007 email with the collapse imminent, according to the indictment.
The two are the first traders to face criminal charges in connection with the sub-prime mortgage crisis in a case that is likely to be a bellwether of the government’s ability to prosecute those who used highly complex financial transactions. ”
And:
“SEATTLE, April 8, 2008 /PRNewswire/ — Hagens Berman Sobol Shapiro filed a
third complaint today against Bear Stearns (NYSE: BSC) on behalf of current
and former employees, claiming the company violated ERISA laws concerning the
management of the Employee Stock Ownership Plan (ESOP).
Today’s lawsuit, filed in U.S. District Court in New York by plan
participant Rita Rusin, seeks to represent all employees that invested in the
ESOP from December 14, 2006 until the present.
The lawsuit claims the company’s failure to adequately manage the plan and
its investments resulted in the depletion of hundreds of millions of dollars
in retirement savings and anticipated retirement income for plan participants.
“We’ve received calls from employees looking for help,” said Hagens Berman
managing partner and lead attorney Steve Berman. “They are upset that Bear
Stearns didn’t warn them that the company stock might be in trouble.”
Berman also noted that the firm has received calls from current Bear
Stearns employees, afraid the company could retaliate against them if they
participate in the legal action. “I urge any employee who wants to speak up to
do so without fear,” Berman noted. “There are very strong laws that protect
employees when they come forward on cases such as this.”
Hagens Berman filed its first suit against Bear Stearns on March 24, 2008
after the company announced JPMorgan Chase & Co. was purchasing Bear Stearns
for $2 per share, 90 percent less than the company’s market value the week
prior.”
I don’t accept the Kool-Aid or Stupidity Defense, but all I’m asking for are through investigations into allegations of Fraud, Collusion, Negligence, and Fiduciary Mismanagement. Is that so much to ask for?