http://www.wilmott.com/blogs/satyajitdas/index.cfm Knowns & Unknowns In Derivatives/ Financial Products en-us Fri, 24 May 2013 02:55:20 --0100 Thu, 09 Aug 2012 07:59:00 --0100 BlogCFC http://blogs.law.harvard.edu/tech/rss blogs@wilmott.com blogs@wilmott.com http://www.wilmott.com/blogs/satyajitdas/index.cfm/2012/8/9/Tilting-at-Windmills Richard Duncan (2012) The New Depression: The Breakdown of the Paper Money Economy; John Wiley, Singapore Simon Lack (2012) The Hedge Fund Mirage: The Illusion of Big Money and Why It?s Too Good to be True; John Wiley & Sons, Inc, Hoboken NJ In Miguel de Cervantes? Don Quixote the hero seeks to fight windmills that in his imagination are giants, despite the warning of his servant Sancho Panza. In English, the phrase ?tilting at windmills? has come to be associated with attacking imaginary adversaries, based on a heroic, romantic and ultimately incorrect logic. Both The New Depression and The Hedge Fund Mirage share something of the Knight of La Mancha?s mis-placed idealism. Richard Duncan is a practitioner, who has over three books ? The Dollar Crisis, The Corruption of Capitalism and his new work The New Depression ? sought to diagnose the ailments of the global economy. Mr. Duncan?s consistent and oft repeated argument throughout his trilogy is that the problems are caused by the over-extension of credit. Mr. Duncan is, of course, not the first or alone in this pre-occupation. The rapid expansion of credit presaged both the Great Depression and 2007-2008 economic problems. Between the mid 1920s and 1929-30, debt as a percentage of US GDP increased from about 160% to 260%. In the run-up to the current crisis, debt to GDP reached over 350%. Mr. Duncan attributes the credit growth to the demise of the gold standard. The end of the Bretton Woods system of fixed exchange rates and the de facto gold standard via the dollar?s link to gold, Mr. Duncan argues led to a rapid build up in debt and global imbalances, exemplified by persistent current-account deficits. The explanation may well be broadly correct. However, it is inconsistent with the fact that a large expansion in credit took place in the 1920s when most currencies were linked to gold. Mr. Duncan?s analysis relies on an extension of Irving Fischer?s theorem on the relationship of money supply and prices: MV=PT or money supply times the velocity of circulation equals the price level times the number of transactions. Mr. Duncan replaces ?M? with ?C? the total credit in the economy with V becoming the turnover of credit. Mr. Duncan argues that the increase in C and some increase in V led to a steep rise in asset prices that led to the current problems. Mr. Duncan identifies the process whereby banks lent money against the collateral of overvalued asset prices, reinforcing prices rises, until the game of musical chairs ended. Few would disagree with the proposition. It lies at the heart of the now fashionable Minsky analysis of the financial processes underlying boom and bust cycles. Like Irving Fisher?s equation, Mr. Duncan?s revised formulation is a self evident truth; the amount of money spent equals the value of goods and services purchased. At the ?crisis attribution? level (all books on the crisis need a pantomime villain), Mr. Duncan blames policymakers who presided over this rapid growth of credit. The thesis is one that has been well argued before elsewhere, perhaps more persuasively. In this slim volume, Mr. Duncan does not delve beyond the surface of the argument and his imaginary enemies. The reality may be more nuanced. Western economic systems require continued growth. The period of stagnation in the 1970s following the oil price shocks promoted a major policy shift including deregulation of crucial industries such as banking and hence credit creation. Credit became a way of driving growth, in conjunction with more market based economies. Increased debt in small doses may be useful in promoting growth. But over reliance on credit is more dangerous, even if it is inevitable if economic history is any guide. The global monetary system is remarkably ad hoc, underpinned by economic theorems that are conjectural and unproven. As identified by Belgian-American economist Robert Triffin in the 1960s, the use of the dollar as the global reserve and trade currency required the US to run large trade deficits to meet the world?s demand for foreign exchange. As a self serving President Johnson argued: ?The world supply of gold is insufficient to make the present system workable?particularly as the use of the dollar as a reserve currency is essential to create the required international liquidity to sustain world trade and growth?. The complexity of the international finance may make it difficult to manage completely or successfully. Arguably, like the gold standard that preceded it, the Bretton Woods system was flawed at the outset as well as in its abandonment. Mr. Duncan?s conclusions are problematic. In The Dollar Crisis? published in 2002, he predicted a dollar implosion, as a result of a huge global imbalances and the credit bubble. The dollar remains in relative good health, despite the efforts of policy makers. Mr. Duncan?s prognosis is romantic, although he eschews an idealistic call for a return to the gold standard. Seeing no realistic prospect of private consumption or investment driving real growth, he urges continued fiscal stimulus. Rather than encouraging private consumption or public spending, Mr. Duncan proposes an American solar energy initiative to create a new era of growth and prosperity. This is keeping with a previous suggestion of a $3trillion US government investment in unspecified ?21st century technologies over 10 years?. The New Depression proposed program would cost perhaps $1 trillion over ten years, and reduce the cost of energy by 90%. Mr. Duncan?s approach is based on his view that conventional stimulus policies will create hyper inflation (which ignores the very low creation of credit and its lower velocity), depression or both. It is difficult to assess whether the proposal is realistic. An obvious query is whether Mr. Duncan, a financial market professional, has the right disciplinary credentials for promoting such renewable energy initiatives to boost growth potential. In any case, like the authors? earlier recommendations of a rising minimum global wage, which has perhaps more to commend it, the chance of adoption is low. The chance of a reversal of the monetary policies of recent years to restore financial integrity is also unlikely. Politicians of every persuasion like the illusion of control that power over money gives. While abandoning this power may be sound policy, it is unlikely that policy makers will willingly embrace it. As conservative politician William Buckley Jnr. knew: ?Idealism is fine, but as it approaches reality, the costs become prohibitive?. A different idealism permeates The Hedge Fund Mirage. Simon Lack, a former hedge fund profession, provides an insightful, if not original, critique of the industry. Mr. Lack?s thesis is simple, if distressing for investors ? hedge fund returns are not all they are cracked up to be. He presents his claim provocatively: ?if all the money that?s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good?. Mr. Lack?s argument is that hedge fund returns are grossly overstated. A typical hedge fund makes most of its larger percentage return early in its history when it is small. This means that a small percentage loss in later life when it is much larger can lead to a loss in dollar terms than gains to that date. The dollar gain or loss argument is important although it has been made before. Author Richard Bookstaber in A Demon of Our Own Making argued that percentage returns can be misleading. In its first 18 years, Julian Roberston?s Tiger Fund generated returns of 30 percent per annum. In its last two years, the fund made losses of 50 percent. Taking the losses into account, Tiger returned 25 percent per annum over its life. Starting life in 1980 with $10 million, it had $22 billion under management by 1998. The fund?s highest percentage returns were on a small dollar base. The losses came from a larger base (a 50 percent loss on $22 billion is a loss of $11 billion). Tiger may have lost more dollars than it made over its life. Mr. Lack outlines familiar arguments. Historical returns exclude funds that fail or no longer accept new investment -survivorship bias. Only funds with a successful track record report performance?backfill bias. The difference between the best and worst performing funds is large, placing a premium on fund selection. Funds of funds add cost which detracts from return. Most really good hedge funds are closed to outside investors. Controversially, The Hedge Fund Mirage claims hedge fund managers have taken the largest share of the investment profits (over 80%). Mr. Lack indulges in some sensational hyperbole (essential these days to gain media attention and sell even a modest number of books earning the author less than the minimum legal wage in Sudan). But for the most part, the book reaches sensible if unremarkable conclusions, highlighting the importance of fund selection, avoiding indexes and averages, the importance of risk management and avoiding any invitation from Mr. Madoff and his ilk to invest. For investors seeking alpha, high average returns are meaningless, like a comfortable average ambient temperature where your feet are in the oven and your head is in the refrigerator. Unlike Mr. Duncan, whose prescriptions have not budged the needle on the Richter scale, The Hedge Fund Mirage has extracted a predictable, earth shaking response from the hedge fund industry, through its lobby group -Alternative Investment Management Industry (?AIMA?). In a series of opinion pieces, articles, a 24 page ?research paper? and ?commissioned? academic research, the AIMA has sought to highlight methodological, mathematical and factual errors. Mr. Lack probably can?t believe his luck as the AIMA?s rabid attacks have provided that most useful fuel for book sales ? controversy. Financial Times journalist Paul Murphy drew the analogy to Mel Gibson?s The Passion of Christ, whose success at the box office was guaranteed by the fact that the film managed to upset every Christian group who took up arms against the work. The AIMA criticism is also framed in ancient Aramaic, borrowing from The Passion of Christ. The central controversy is based on the appropriate measure of returns - dollar weighted or time weighted. The AIMA have resorted to that great modern invention - global best practice standards, which advocate time-weighted data for assessing hedge fund performance but dollar-weighted return for private equity assets. The detailed data used by Mr. Lack is not explicitly outlined making it difficult to independently assess the competing claims. Both sides to this arcane controversy have sought the idealistic high ground. It is useful to remember writer Aldous Huxley?s observation that ?idealism is the noble toga that political gentlemen drape over their will to power?. Whilst amusing, the exchange, which may have to do with livelihoods (hedge fund managers and Mr. Lack?s advisory business), does not advance greatly the debate regarding hedge funds, their performance and role in financial markets. A confluence of events may have boosted hedge fund returns. Initially, small funds and state managers may have benefited from regulated inefficient market. Macro funds high returns have been the result of the growth of emerging economies, the end of communism in Eastern Europe, world trade and deregulation of financial markets. Some hedge fund managers are undoubtedly exceptionally skilful. Soros, Tudor Jones, and James Simons, an ex-mathematics professor and former code breaker, have outstanding records. Others undoubtedly boost performance using investment Viagra, leverage and investment in illiquid or complex securities. Some managers have sought an information edge, testing the boundary of insider trading and market abuse. In reality, hedge funds occupy an artificial evolutionary niche in financial markets. Their existence is heavily reliant on the restrictions placed on normal investment vehicles. The ability to short, use leverage and focus on absolute returns defines hedge funds. But increasingly, their existence has also become a way of charging higher fees. As one manager candidly admitted: ?a hedge fund is just an excuse to charge two and twenty; they do not do anything else very different?. The Hedge Fund Mirage does not address these issues. It also does not explore the issue of the feasible size of hedge funds and their broader influence on financial markets. Whatever the truth or dare of these arguments, The Hedge Fund Mirage provides a welcome and wry antidote to the hilarious and excessively serious hagiographies about hedge funds and hedge fund managers ? see Sebastian Mallaby?s More Money Than God and Maneet Ahuja?s The Alpha Masters. Most authors and journalists behave like pre-pubescent girls in the presence of Justin Bieber when near these Lords of Money. They suffer from a phenomenon first diagnosed by John Kenneth Galbraith: ?Nothing so gives the illusion of intelligence as personal association with large sums of money. It is also alas an illusion?. Perhaps in a concession to his American ancestry, the Singapore resident Mr. Duncan is more earnest, believing that he can influence policy. True to his British heritage, Mr. Lack recognises that most hedge-fund books are written by ?proponents?. He recognises that the industry won?t change any time soon. The books are examples of a new emerging sub-genre in financial literature - Quixotic Tracts. The primary characteristic is an impractical idealism, lofty and romantic ideas and belief in extravagantly chivalrous standards of behaviour. The ideas in both books ? sensible economic management and efficient investment behaviour- are probably beyond the human race in its current stage of evolution. © 2012 Satyajit Das Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money Book Reviews Thu, 09 Aug 2012 07:59:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2012/8/9/Tilting-at-Windmills http://www.wilmott.com/blogs/satyajitdas/index.cfm/2012/8/7/Personal-versus-Personalities Jonathan Fenby (2012) Tiger Head, Snake Tails: China Today, How It Got There and Where It is Heading Robert Frank (2011) Who Repo?d My Jet: the manic millionaires, and why they?ll lead us to the next boom and bust John Coates (2012) The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust Personal ? relating to an individual or what serves the interest of that individual. Personality ? distinctive assemblage of qualities which defines an individual, frequently in modern life conflated with celebrity. These three books deal with the ?personal? and ?personality? in the financial world. In an increasingly crowded list of books purporting to explain China, Jonathan Fenby?s Tiger Head, Snake Tails is a standout, providing very personal insights into the Middle Kingdom rarely found elsewhere. Mr. Fenby is in an excellent position to write about the subject, having been the Editor of the South China Morning Post in HK for many years. His resistance to the newspaper following an overt pro-China line as demanded by the owner may have been a factor in his contract not being renewed. He continues to be closely involved with China, heading a team at the research service ? Trusted Sources. His direct knowledge and immediate experience provides the substance that defines the work. Most books on China are polemical tracts, rooted in Sino-philia or Sino-phobia, sometimes both simultaneously. Sino-philia believes in the Chinese ?model?. For example, The Economist asserts that: [Chinese leaders make] ?rational decisions that balance the needs of all citizens over the long term?. Francis Fukuyama and Nancy Birdsell believe that ?China can avoid the delays of ?a messy democratic process? because the bureaucracy at its upper levels is capable of managing and coordinating sophisticated policies?. Sino-phobes fear that China is hell-bent on conquering the world, capturing its resources and enslaving its peoples. They hold China accountable for everything, including the unsolved death of Marilyn Monroe and the mysterious forces behind the assassination of an American president in Dallas. The discussion and binary opinions are driven by the fact that economically and politically China is being called upon to play a central role in the world. The debate is focused on what the world requires rather than what China sees as its own interests and a realistic assessment of its abilities. Treading a nuanced path, Tiger Head, Snake Tails develops the thesis of an emerging country, seeking to deal with complex problems of economic development, social structure, political system and the unshakeable legacy of its history. Nothing illustrates this better than Chinese income levels. Despite its status as the world?s second largest economy, China ranks 98 out of 181 nations in the World Bank?s ranking of GDP per capita. Based on forecasts, wealth per capita in 2016 will be only equivalent to US$13,700 against $57,300 for the US and US$48,000 for Germany. This does not take into account the massive income inequalities in China, where a large portion of the population lives on less than US$1.25 a day. Mr. Fenby outlines China?s challenges, giving detailed examples and evidence. For example, to test the sustainability of its debt fuelled investment model, Mr. Fenby examines the Chinese Railway system, now one of the most extensive in the world. The Ministry of Railways employs 2 million people, has its own 70,000 strong police force and a court system employing 7,000 staff which includes judges with no legal training. It leader ?Liu Zhijun- was a cadre, whose major qualification was that he was Deng Xiaping?s bridge partner. The very fast trains are based on design by Kawasaki of Japan. The Chinese have ?indigenously re-innovated? the technology and now compete with Kawasaki to build high speed trains throughout the world. The route structure is erratic. The first super-fast train route puzzlingly connected Guangzhou and Wuhan (where Liu hailed from) rather than one in the more obvious North East. The trains were found to be faulty and their speed (rated at 300 KPH) has been throttled back in the interest of safety. A large number of faults have been discovered, including bridges built of gravel and garbage rather than cement. Liu himself and his deputy were dismissed for corruption and bribery. During this period, Chinese Railways debt tripled to around US$300 billion. The example is not isolated. Mr. Fenby painstakingly documents the endemic inefficiency, environmental abuse, lack of intellectual property rights, weak economic and managerial foundations of the economy, lack of rule of law, absence of rights, injustice, corruption and social problems. Mr. Fenby?s analysis highlight that any view of China through the prism of Western constructs is flawed. Central to China is the role of the Chinese Communist Party (?CCP?), which Mr. Fenby compares to the secretive, insular world of imperial rule that dominated China throughout much of its history. As Richard McGregor documented in his work The Party, the CCP plays a vital part in every aspect of Chinese life. CCP cells make most important decisions in all enterprises, even those that are publicly owned and have significant foreign shareholders. China?s economic, social and political systems are the product of its own history, as interpreted by the CCP. The central belief is that the fate of the CCP and China are intrinsically the same. Fear of instability and uncertainty form the background to every decision of a leadership that despite its outward appearance is deeply insecure. Comprehensive and provocative, some readers may find the organisation of the book idiosyncratic. Some may find its density challenging. But the book?s detail and richness is its strength, eschewing pat simplistic explanations. The text will reward carefully reading and re-reading. Tiger Head, Snake Tails is an antidote to the shallow narratives about China found in airport shops, which frequently form the basis of policy debates at least on TV chat shows and in business circles. Robert Frank, a journalist for the Wall Street Journal and author of the Richistan, takes the personality route. Who Repo?d My Jet is a slim volume of stories about people who belong to the nouveau rich whose wealth ?mansions, cars, private jets etc- was eviscerated by the events of 2008. Mr. Frank has compiled a well written, breezy set of tales whose dominant theme seems to be: got rich, mainly through luck and a generous dose of borrowed money, mistook the source of success as genius, spent too much money on various toys mainly to impress who knows whom, became overextended in business, investments, personal lifestyle or all of the above, then the bank called the loans in causing the entire pack of cards to collapse. While diverting and at time entertaining (the description of Aspen?s annual Gatsby Party and phrases like seasonal homes which are ?cruise ships on land?), Who Repo?d My Jet suffers from the shallowness of its analysis, paralleling the people portrayed. Mr. Frank?s attempt to develop an over-arching theme ?that the rich are important because they manically create wealth, booms and busts- is not convincing and the evidence he relies on does not support the conclusions. The book lacks the power of the apocryphal short exchange between F. Scott Fitzgerald and Ernest Hemingway. Included in The Crack-Up, compiled by Edmund Wilson. as entries from his notebooks, Fitzgerald is quoted as saying: ?The rich are different from you and me?; to which, Hemingway responds: ?Yes, they have more money.? Who Repo?d My Jet is Schadenfreude stretched thin. The Hour Between Dog and Wolf is about explaining the trader?s personality via his biology. It wades into the ?nurture versus nature? debate, trying to relate risk taking behaviour in financial markets to neurobiology, in particular to testosterone levels of traders. The author John Coates is a former trader at Goldman Sachs, Merrill Lynch, and Deutsche Bank who has earned a doctorate in neuroscience from the University of Cambridge. His thesis is simple. Male traders perform better when they have elevated testosterone levels. As prices increase and decrease, traders experience chemical changes. Euphoria caused by boosted testosterone levels from successful trades drives higher risk taking. Losses or reversals increase levels of the defensive steroid cortisol leading to risk-aversion. While a provocative and well argued thesis, Dr. Coates? arguments are thin as the experimental data relied on is limited at this stage. Dr. Coates also draws a distinction between the masculine world of risk-taking traders and the more feminised world of asset managers. The evidence presented is less than convincing. Most importantly, the analysis disregards environmental and cultural factors, documented by ethnographers such as Dr. Karen Ho in Liquidated. This includes matters such as incentive structures, risk control systems and peer performance pressures. Dr. Coates? thesis is not all encompassing. For example, cautious investors and traders also make and lose money, suggesting that biology cannot be the only driver. John Maynard Keynes?s ?animal spirits? may not be so easily reduced to a series of simple chemicals and their effects on humans. The book proposes positive steps that banks and fund managers can take to manage risk. Some of the proposals are well known - changing bonus systems and implementing mandatory cooling-off periods. Dr. Coates proposed hiring more women and older men. But Dr. Coates is coy about the potential for artificially manipulating the biology of traders and investment managers to improve performance. It is not hard to imagine a future where traders will need to have their supplements ?uppers and downers (in the old parlance)- at hand to improve trading, similar to the experience of competitive sports where drugs have become relatively commonplace to improve performance. It is also not hard to imagine internal risk mangers and regulators insisting on regular monitoring of hormone levels as part of the compliance regime, with attendant cheating. This is not far fetched. Already, organisations are adopting unusual initiatives to gain a critical edge. A trader at Steve Cohen?s SAC Capital was allegedly forced by his boss to take female hormones and wear articles of women?s clothing at work, leading to a sexual relationship between the men, one of whom was married. The bizarre behaviour was to eliminate the trader?s aggressive male attitude, making him a more obedient and detail-oriented trader. One suspects that neurobiology of the business cycle and all things financial and economic will become a burgeoning field. Like Freakonomics, the quack application of a discipline or cognitive construct to everything and everybody may be entertaining but it may be too simple to provide a complete explanation. However, it does offer a convincing excuse to losses akin to the dog ate my homework ? ?it was beyond my control, it was my hormone levels!? Whether personal or personality driven, these books share complicated titles. Tiger Head, Snake Tails refers to a Chinese saying with complex multiple meanings. The ?tiger head? is the popular views of China but the ?snake tail? details of how the country operates on the ground, which will shape its future. The Hour Between Dog and Wolf refers to a French expression that denotes twilight: ?entre chien et loup?. It is an ambiguous light, in which it is difficult to distinguish between a dog and a wolf. In Dr. Coates? interpretation, it is the time when it is difficult to distinguish whether a trader has become over confident and is taking unreasonable risks. At least, Who Repo?d My Jet does not need any explanation. © 2012 Satyajit Das All Rights reserved. Satyajit Das is author of Traders, Guns & Money and Extreme Money. Book Reviews Tue, 07 Aug 2012 08:16:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2012/8/7/Personal-versus-Personalities http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/12/14/School-for-Economists Nicholas Wapshott (2011) ?Keynes/ Hayek: The Clash That Defined Modern Economics?; Scribe Melbourne John Mauldin and Jonathan Tepper (2011) Endgame: The Debt Supercycle and How It Changes Everything; John Wiley, New York To borrow from David Letterman, there might be no business like show business, but there are many businesses like economics. There is Classical Economics, Neo-Classical Economics, Keynesian Economics, Austrian Economics, Monetarist Economics etc There are also different types of economists ? academic economists, professional economists (generally policymakers like central bankers), market economists. No wonder economist John Kenneth Galbraith observed that: ?economics is extremely useful as a form of employment for economists?. Economics, one is tempted to add, also provides periodically useful fodder for journalists and business authors. These two books provide interesting perspectives on the profession as much as on the subject of economics. Journalist Nicholas Wapshott previously authored ?Ronald Reagan and Margaret Thatcher: a Political Marriage?. Using the same basic conceit, he posits a conflict between the ideas of John Maynard Keynes and Frederich Hayek around the time of the Great Depression. The present demand for solutions to the Great Recession, Mr. Wapshott argues, gives this debate contemporary relevance. Solid and engagingly written, ?Keynes/ Hayek? suffers from a basic problem ? the major protagonists rarely engaged with each other. Hayek?s puzzling failure to debate Keynes on the subject matter of ?The General Theory? deprives the book of the central conflict and drama that the book?s subtitle claims. Economics seeks to understand how production and financial systems work or should work. It evolved out of political science and philosophy and its social agendas and value systems. One of economic theory?s preoccupations was the business cycle, especially painful and disruptive boom and busts. Capitalism created wealth and progress but at high social cost. Classical economists tried to understand how economies periodically purged excesses in recessions. The 1929 stock market crash was the final phase of the long boom of the jazz age. Led by the U.S., the World?s dominant economy, there were sharp increases in economic activity and the prices of stocks, commodities and other assets. Global trade collapsed. The recession progressively got worse turning into the Great Depression from which the world would not emerge until after the Second World War. Existing economic thought dictated that the fall in values and elimination of bad loans or unsound investments would lead to recovery. It was tough love - the disease simply had to run its course. Keynes argued for government spending to stimulate demand by supporting income and spending power. He broadened the remit of governments to manage the economy to avoid the social consequences of the Depression. Hayek was one critic. A prominent member of the Austrian School, originally founded by Carl Menger in the nineteenth century and extended by Ludwig von Mises, Hayek opposed any interference in markets. Downturns were essential to allow capitalism and markets to purge and renew themselves. The debate was less about economics than differing political ideologies. Keynes? views were shaped by the magnitude of the problem threatened to overwhelm societies and political systems. Hayek?s views were influenced by the epic collapse of the Austro-Hungarian in World War 1. Successive generations have re-interpreted the writings of both men extensively. Milton Friedman, for example, admired Keynes?s economics, which his own work draws on. In contrast, Friedman found Hayek?s economics to be largely incomprehensible. But Friedman was attracted to Hayek?s quest was idealistic renewal. Keynes?s complex bohemian life, including his bi-sexuality and acceptance of short-term political expediency, were not to everyone?s taste. Los Cee-Ca-Go Boys certainly preferred Hayek?s Central European sensibility, captured by John Kenneth Galbraith: ?pessimism is a mark of superior intellect.? Mr. Wapshott does not offer much new, which is understandable because the material has been covered before in greater detail in Robert Skidelsky?s 3 volume biography of Keynes and several biographies of Hayek. Other books on the history of economics have also covered some of the same territory. The attempt to relate the clash to modern developments is strained. In practice, political economy is politics conducted with the language but without the substance of economics. The effort to fit modern policy into the corsets of Keynesian and Hayek-ian thinking is tricky. Profound differences in the structure of economies and financial markets also make any comparison difficult. Commenting on State Socialism, Keynes provided a guide to the relevance of past theories: ?little better than a dusty survival of a plan to meet the problems of fifty years ago, based on misunderstanding of what someone said a hundred years ago?. John Mauldin is described as ?a renowned financial expert and a multiple New York Times best selling author?. He writes an investor newsletter and is an economics commentator and investment adviser. Co-author Jonathan Tepper is founder of a macro-economic research group advising high net worth investors. They are ?market economists?. Keynes and Hayek were pre-occupied with public policy concerns. They would have agreed with Paul Samuelson: ?I don?t care who writes a nation?s laws if I can write its economics textbooks.? In contrast, good market economists concentrate on assessing short-term effects of economic developments on market prices. They have no grand economic scheme. They are like David St. Hubbins in the satiric film This is Spinal Tap: ?Before I met Jeanine?my life was cosmologically a shambles. I would use bit and pieces of whatever Eastern philosophy would drift through my transom.? Less concerned with economic theory, ?Endgame? tries to provide an accessible introduction to the world?s current economic plight. The central theme is that the world has too much debt and will need to reduce this debt with important effects for the global economy. The book is split into two parts ? the first looks at the problems of debt and the second looks at different countries and their unique problems. The central thesis is undeniable. Recent economic growth and the wealth created relied substantially on borrowed money. Since 2001, borrowing against the rising value of houses contributed to around half the recorded economic growth in the US. By 2008, $4 to $5 of debt was required to create $1 of growth. China now needs $6 to $8 of credit to generate $1 of growth; an increase from around $1 to $2 of credit for every $1 of growth. Global trade is built on a financing model where sellers of goods and services, such as China, Japan and Germany, indirectly finance the purchase by lending foreign exchange reserves to countries like the US. The ability to maintain high rates of economic growth through additional debt is now questionable. Mr. Mauldin and Mr. Tepper outline how the system will adjust ? they are ?inflationists? (maybe) but they are also deflationists (first). Irrespective of their position on price levels, the authors are incorrigible ?optimists? ? there will be fabulous innovations, new markets, the population of the earth will continue to grow and the ?human spirit? will triumph. ?Endgame? reads like a series of loosely linked newsletters or excerpts from speeches. The book cites extensively from the author?s collection of famous and brilliant experts (the obvious comparison is with the children of Lake Woebegone who are all above average). One Chapter, for example, restates the analysis of Carmen Reinhart and Kenneth Rogoff?s ?This Time is Different?. The book features many graphs often tangentially connected with the text and argument. Mr. Mauldin and Mr. Tepper?s work poses a fascinating question, perhaps unintentionally. What would Keynes and Hayek be doing and saying if they were alive today? Hayek would probably be at a conservative think tank, railing about government involvement in the economy. Keynes? He would be writing newsletters and policy tracts while quietly making money through his astute investment skills. But on the big issues both would be cautious aware that ?for every complex problem there is a simple solution that is wrong?. © 2011 Satyajit Das All Rights reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives Book Reviews Wed, 14 Dec 2011 02:36:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/12/14/School-for-Economists http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/9/18/The-Financial-Compass Roddy Boyd (2011) Fatal Risk: A Cautionary Tale of AIG?s Corporate Suicide; John Wiley & Sons Inc, New Jersey Justin Cartwright (2010) Other People?s Money; Bloomsbury, London Nicholas Dunbar (2011) The Devil?s Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street?And Are Ready To Do It Again; Harvard Business Press, Boston, Massachusetts Barry Eichengreen (2011) Exorbitant Privilege: The Rise and Fall of the Dollar; Oxford University Press, Oxford Diana B. Henriques (2011) The Wizard of Lies: Bernie Madoff and the Death of Trust; Times Books/ Henry Holt & Company & Scribe Publications, Melbourne Graeme Maxton (2011) The End of Progress: How Modern Economics Has Failed Us; John Wiley, Singapore In his novel, Justin Cartwright writes that: ?There are beginning and there are ends, and there are also many ways of telling the same story.? The problem is that the great 2007 financial crisis shows no signs of ending. Far from ending, the crisis has shown a virus? capacity to reconstitute itself. Given the literary difficulty of an uncertain end, publishers and editors have improvised in telling the story - a multiple points of the compass approach to ?credit lit?. South is the narrative focused on a supposedly pivotal or at least newsworthy event ? Too Big To Fail and In Fed We Trust are examples of this approach, taking as their point of departure the collapse of Lehman Brothers. The relative calm of the last 18-24 months has meant there has been few additions to this list. As the crisis re-intensifies, there will be other Lehman weekends and books about it. East is titles trying to draw more general points from an individual aspect of the crisis, such as the history of an individual organisation or type of instrument, derivatives and securitisation feature prominently. Fatal Risk, Devil?s Derivatives and The Wizard of Lies are examples of this genre. West is the professional economist?s analysis of the crisis or aspects thereof. Exorbitant Privilege belongs to this class of book. North is the solution manual ? the 10-point plan to solve the problems, delivered with polemic gusto. End of Progress comes closest to that type of book. Then there is the centre ? fiction. Untroubled by facts, the author proceeds to use the power of literary rendition to describe the issues. The publicity of Other People?s Money claims that it is a novel about the financial crisis. In Fatal Risk, Roddy Boyd, an investigative reporter (an endangered creature soon to be listed on the CITES list), provides a solid history of AIG and its problems. Based largely on his own reporting for the NY Post and interviews, Mr. Boyd provides an accurate chronology of events leading up to the implosion, requiring a government bailout in September 2008. Fatal Risk struggles to explain the insurance deals that were used to hide losses and the financial instruments within AIG?s Financial Products operations that were responsible for the problems. The omitted technical details are critical. It was a failure to understand the structure and risk of these contracts, at least at senior levels of AIG, which brought about their downfall. There is also a lack of explanation of the rationale for AIG?s expansion into non-insurance business ? the desire to monetise its ?AAA? rating, balance the volatility of its re-insurance operations and also over confidence about it capabilities in risk assessment. Mr. Boyd largely accepts that Hank Greenburg, the driving force behind AIG growth and expansion into financial derivatives, was a superb risk manager, who personally oversaw the exposures of the company. Implicit in this argument is the suggestion that had Greenburg not been ousted as a result of Elliott Spitzer?s investigations, the problems may not have occurred. Writing about the Battle of Borodino, Tolstoy observed that: ?It was not Napoleon who directed the course of the battle, for none of his orders was carried out and during the battle he did not know what was going on.? The same might be true of AIG. An alternative view might be that AIG was too large, ruled by fear of an autocratic CEO and lacked rudimentary controls that its non-insurance businesses required. Given that Greenburg presided over this state of affairs, the cautionary tale of the book?s sub-title might just be an older and more familiar one - avoid powerful and dominant chief executives and entry into businesses which existing management is not experienced in. A career as a trained physicist who turned to financial journalism at Risk Magazine provided Nicholas Dunbar with a unique vantage point to the comings and goings in the market. Mr. Dunbar turned this insight into his first book Investing Money, which examined the demise of Long Term Capital Management. The Devil?s Derivative focuses on the role played by derivatives in the current crisis with an emphasis on the Collaterallised Debt Obligations (?CDOs?) and other manifestations of structured finance. Well-researched and knowledgeable, The Devil?s Derivative has some problems. The experienced practitioner will find little knew here but the inexperienced will struggle to come to terms with the material as it assumes some basic knowledge. Mr. Dunbar?s desire to titillate, perhaps to appeal to a wider readership, frequently distracts. Tales of men in expensive Italian suits in Knightsbridge night clubs drinking £400 bottles of Belvedere Vodka and cavorting with eastern European blondes might confirm the reader?s suspicions but are not integral to the story. The subject matter of The Devil?s Derivative has also been covered before and better by the Financial Times? Gillian Tett in Fool?s Gold. Oddly, The Devil?s Derivative?s very long sub-title (24 words and 100 characters) ? ?The Untold Story of the Slick Traders and Hapless regulators Who Almost Blew Up Wall Street? ?. And Are Ready to Do it Again? - unconsciously competes with that of Fool?s Gold (13 words and 82 characters) ? ?How Unrestrained Greed Corrupted A Dream, Shattered Global Markets and Unleashed A Catastrophe?. Marshall McLuhan?s famous aphorism ? ?the medium is the message? ? has now been replaced by the lengthy sub-title which obviates the need to read the book. Diana B. Henriques, a senior writer for the NY Times (are there ?junior? writers?), covered the Madoff Affair. The Wizard of Lies is her book of the newspaper articles, collating the history of the life and times of Bernard Madoff, grandee of finance, feted investment manager and finally convicted master Ponzi scammer. The thorough and (perhaps excessively) detailed biography is ?long? on personal details (houses, clothing, charities, holidays, parties, friendships and personal behaviour) but ?short? on real insight (the motivations and most importantly the why?s). Madoff emerges as a curiously dull figure, especially relative to the scale of the fraud he was able to perpetrate. A central figure as insipid as Madoff rather robs the narrative of drama. In the absence of the charismatic villain, Ms Henriques unfortunately miss the opportunity to delve into two interesting issues to the extent warranted. The first is the efforts of the eccentric Harry Markopolos to draw the attention of regulators to the fraud. The SEC?s damning post-mortem contrasts with Ms. Henriques excuses for their failure and criticism of Mr. Markopolos for alienating regulators over their ignorance of derivatives. Curiously, Ms. Henriques assertions that Markopolos? questions were irrelevant because no derivatives are required for a Ponzi scheme conflicts with Madoff?s claims that his investment strategy depended critically upon derivatives. The second issue is the complicity of feeders fund, which channelled investors into the Madoff Fund, and wealthy investors in their own destruction. There is a little analysis or coverage of how much they knew and why they continued their involvement. Answers to both these questions would have shed greater light on Madoff but also perhaps the prevailing culture. Madoff was possible because everyone believed in his or her constitutional right to get rich. Investors ignored what they suspected was a Ponzi Scheme or even investigate the source of the returns, in the belief that they would always be able to get out before it collapsed. Everyone, including regulators, believed in this, ultimately to their own detriment. Exorbitant Privilege is a readable short history of the US dollar and how it came to dominate global trade and financial transaction. The title pays homage to the description of the benefits to America of the dollar?s reserve status, attributed to Valéry Giscard d?Estaing, France?s finance minister in the 1960s. Barry Eichengreen, an international monetary historian, who in his 1992 book, Golden Fetters argued that the inflexibility of the gold standard exacerbated the Great Depression, tells the story of the dollar?s ascent. The history is solid and factually reliable demonstrating how the international monetary system based on the dollar evolved, allowing America the capacity to borrow more cheaply and more aggressively than might otherwise have been feasible. Professor Eichengreen glosses over the geo-political basis of this power. America?s military and industrial strength at the time of the Bretton Woods meetings as well as the economic and military weakness of Britain and France battered by two world wars underpinned the rise of the dollar. Exorbitant Privilege sees the dollar?s continued dominance as mainly the effects of incumbency and the absence of a viable alternative. Professor Eichengreen seems to not fully recognise the role that the dollar?s dominance together with trade imbalances played in the current global crisis. He also underplays the backlash against the dollar, primarily from major holders of US government bonds such as China. The chapter on the financial crisis is highly derivative and unsatisfying. In the end, the author cannot find any alternative to a continuation of the existing system because there is really no alternative to the dollar. Economist, author and presenter Graeme Maxton?s End of Progress is a damning attack on the underlying drivers of economic growth ? financialisation, pollution and poor allocation of scarce resources, like oil and water. The book is a powerful polemic highlighting some of the key challenges facing mankind, although they only infrequently trouble policymakers or citizens, busy acquiring the latest must-haves. Mr. Maxton hits the mark in identifying the problems. His attempt to blame all this on modern economic thinking is less convincing, attributing perhaps too much power and importance to the ?dismal science? and its practitioners. Economics is the outcome of a tacit societal accord where economic growth at all costs is the consensus. The sociology of crowds, greed and DNA of homo sapiens were arguably more important than economists in setting the stage for the present crisis. In the final chapter, perhaps at his publisher?s urging, Mr. Maxton sets out a check list of ?solutions?. The prescriptions are predictable ? lower population; better distribution of resources; and reformation of economics ? fair profits; better pricing of the world?s resources. Unfortunately, as Scottish philosopher David Hume observed: ?All plans of government, which suppose great reformation in the manners of mankind, are plainly imaginary.? Mr. Maxton?s short book (probably no more than 50,000 words) ranges widely if thinly over its key pre-occupations. The evidence is not always complete, but there is no doubting the message. Mr. Maxton raises critical issues that should be on the top of the policy agenda. Asked about the difference between non-fiction and fiction, a writer who migrated from the second to the first responded: ?There is no need to do any research; nor do facts matter.? He could just as easily be talking about modern fiction, which has no end and no beginning. This does not prevent the story being told in many ways. Justin Cartwright?s Other People?s Money is acclaimed as a ?brilliant? and ?beautiful? novel about the crisis. The critics and reviewers quoted extensively on the cover were clearly reading a different book. Mr. Cartwright?s well written and cleverly crafted work is at heart an old fashioned tale of the rise and fall (well almost) of the monied classes of England that readers of Dickens and Thackeray would recognise. Borrowing its title from Nomi Prin?s book about corporate America and the eponymous film featuring Danni De Vito and Gregory Peck, Other People?s Money has little to do with finance. Mr. Cartwright?s grasp of banking is rudimentary and painfully second hand. Fortunately, it is irrelevant to an old tale of the scions of families destroying the family business. The characters are cliched and often border on caricature - the English merchant banker resembling Colonel Blimp, his second wife with acting ambition, a slavishly devoted assistant who is secretly in love with her boss, a self indulgent son who travels the world on his trust money seeking experiences, a conscientious son who becomes an unhappy banker with a Californication wife devoted to urban organic farming, a sundry affair with a hirsute South African rugby player, a despotic American banker etc. The characters that dot the book are shallow and unconvincing. The real people who populate Michael Lewis? The Big Short are far more interesting and better drawn than Mr. Cartwright?s cast. The one exception is the auteur Artair MacCleod with his wild dreams of bringing the works of Flann O?Brien to the stage with Daniel Day-Lewis. Bumbling MacCleod with his dependence on the rich to realise his flaky artistic dreams points to the uneasy compact between those who have money and those who have dreams in modern society. Other People?s Money?s ending is also too contrived and too trite to be credible. But Mr. Cartwright does understand something of the role that ordinary people play in the world of money. One character expresses it accurately: ?The rest of us are just the extras, without speaking parts, just fill in the blank spaces in the frame.? It is sad that there wasn?t more of such sharp observations in Other People?s Money. © 2011 Satyajit Das All Rights Reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (August 2011) Book Reviews Sun, 18 Sep 2011 04:46:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/9/18/The-Financial-Compass http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/4/20/Dead-Hand-of-Economics John Quiggin (2010) Zombie Economics: How Dead Ideas Still Walk Among Us; Princeton University Press, Princeton and Oxford R. Christopher Whalen (2011) Inflated: How Money and Debt Built the American Dream, John Wiley, New Jersey Michael E. Lewitt (2010) The Death of Capital: How Creative Policy Can Restore Policy, John Wiley, New Jersey ?Mortmain?, derived from medieval French meaning ?dead hand?, refers to legal ownership of property in perpetuity. Jurisprudence, to varying degrees, has sought to prohibit the control of property by the ?dead hand?. Unfortunately, economic thinking seems to be controlled by dead economists or as John Quiggin, himself an economist, argues - ?living dead? economists. In ?Zombie Economics?, Professor Quiggin takes aim at a number of ?dead? ideas ? the Great Moderation; Efficient Markets Hypotheses; Dynamic Stochastic General Equilibrium; Trickle Down Economics; Privatisation. The central thesis underlying ?Zombie Economics? is that the global financial crisis (?GFC?) exposed the weaknesses of these ideas, which underpin free market or neo-liberal economics. But as William Faulkner argued: ?The past is never dead. It's not even past.? Worried that these ideas continue to live on in the minds of economist and politicians influenced by them, Professor Quiggin wants to kill them off. Clever titled, with a wonderful and very un-academic cartoon cover and written without excessive use of technical jargon, ?Zombie Economics? provides an elegant critical introduction and analysis of some of the key ideas of modern economic thought. The arguments are generally thorough, though lack depth reflecting the brevity of the work (around 200 pages). Professor Quiggin?s personal sympathies, which are politically left of center, are never hidden. Two recent books ? John Cassidy?s (2009) ?How Markets Fail: The Logic of Economic Calamities? and Justin Fox?s (2009) ?The Myth of the Rational Market: A History of Risk, Reward and Delusion on Wall Street? ? cover similar territory. Professor Quiggin?s economics training makes ?Zombie Economics? far less character or narrative driven and far more interesting in its understanding and criticism of the theory. The most interesting thing about ?Zombie Economics? is actually its lack of interest in why the weaknesses in the theory, much of which has been recognised for years, does not preclude its acceptance. The answer most likely lies in politicians and ultimately the electorate need for simple painless remedies and nostrums. For example, Professor Quiggin?s criticism of privatisation of infrastructure does not seem to recognise the obvious driver of this policy - political expediency of circumventing public finance constraints. The interesting thing, of course, is that any ?new? idea that takes the place of the ?zombie? ideas is not likely to be an improvement. Perhaps homo economicus and homo politicus is like David St. Hubbins in the satiric film This is Spinal Tap: ?Before I met Jeanine?my life was cosmologically a shambles. I would use bit and pieces of whatever Eastern philosophy would drift through my transom.? Christopher Whalen?s ?Inflated? deals with one aspect of zombie economics ? inflation. Changes in price level are ambiguous at best. Even measuring it can present considerable challenges ? some years ago, Argentina consciously decided to exclude items where the price rise was particularly high on the basis that no one could afford to buy such products, justifying their irrelevance to the measured inflation rate. Government everywhere, similarly, manipulate inflation measures. The real issue about inflation, however measured, is its use as a policy tool. The popular economic narrative assumes that inflation is an outcome of economic activity. In reality, it is a key weapon in policy maker?s armoury. Throughout history, governments have used inflation to wipe out excessive debt, a practice that is now central to the policy of the Bernanke Fed to reduce systemic leverage. Mr. Whalen, a former banker and co-founder of Institutional Risk Analytics, provides an interesting history of inflation in the US. His objective is to use the past to seek insights into the 2008 financial crisis. Highly opinionated, ?Inflated? uses a series of episodes of American economic history to outline the work?s central thesis ? the US has traditionally financed its economic objectives through debt, governmental, corporate and personal, using periodic bouts of inflation to manage its leverage. A phenomenon that Mr. Whalen argues is driven by ?a national agenda and standard of living that is beyond our current income? and one which is at odds with American?s self image as ?reasonably prudent and sober people.? The book is strongest in some of the earlier chapters when it covers debate about a national bank in the late 18th and early 19th centuries, the issuance of paper money to finance the Union effort during the Civil War and the panic of 1893 and 1907. The book is less successful in its coverage of modern times ? from the stagflation of the 1970s and the period of banking and financial deregulation, leading up to the GFC. The coverage of recent events seems to be driven by the author?s personal repugnance of excessive government indebtedness and sloppy monetary management. ?Inflated? contributes to the important current debate on public finances. Mr. Whalen?s call to arms ?the distinction between ?real economic growth and the illusions of growth created by inflation and credit-driven speculation? - is central to any logical reappraisal of economic policy. Unfortunately, this reviewer and perhaps Mr. Whalen doubts whether it will take place. As William Faulkner remarked: ?Facts and truth really don't have much to do with each other.? In ?The Death of Capital?, Michael Lewitt, an investment professional and editor of the HCM Market Letter, explores the ultimate effect of ?zombie economics?. Mr. Lewitt?s thesis focuses on the outcome of these economics, in particular, the rise of financialisation, debt and speculation and its effect on the real economy. ?The Death of Capital? is robust in its arguments, especially in it denunciation of Wall Street practices which he views as unproductive and morally reprehensible. The book makes the case that financialisation ultimately has the effect of undermining the fundamental role of capital in societies and financial markets as a mechanism for saving and channelling funds into real businesses. Drawing heavily on the work of Adam Smith, Karl Marx, Keynes and Hyman Minsky, Mr. Lewitt outlines his thesis clearly. His solution seems curious, in the light of the trajectory of his critical argument - greater regulation, imposition of a tax on speculative transactions (in effect, a Tobin tax) and ?principle based? reform. It is unclear why the proposed reforms can or will work, given that the very forces that propelled the financialisation that Mr. Lewitt criticises would be charged with implementing them. As Scottish philosopher David Hume knew: ?All plans of government, which suppose great reformation in the manners of mankind, are plainly imaginary.? The reality is that economics and economic relations are an adjunct to a larger process ? the process of broad social control. Marx wrote about the fetishism of money, arguing that ?the money-form of the world of commodities ? actually conceals, instead of disclosing the social character of private labour, and the social relations between individual producers?. Human beings and societies are unable to see their own products and social relationships for what they are and become slaves to powerful forces. French philosopher Michel Foucault identified a carceral continuum, the system of cruelty, power, supervision, surveillance and enforcement of acceptable behaviour affecting working and domestic lives. Economics and economic systems are part of this system of power. In Lewis Caroll?s Alice in Wonderland, Humpty Dumpty understood the issue: ?The question is which is to be master ? that?s all.? Economics and economist have been always been part of the mechanism of social control and power. The rest is just noise. © 2011 Satyajit Das All Rights reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming September 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2006 and 2010) Book Reviews Wed, 20 Apr 2011 07:43:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/4/20/Dead-Hand-of-Economics http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/3/2/Potemkin-Villages--The-Truth-about-Emerging-Markets Martin Gilman (2010) No Precedent, No Plan: Inside Russia? 1998 Default; MIT Press, Cambridge, Massachusetts Victor C. Shih (2008) Factions and Finance in China; Cambridge University Press, Cambridge, Massachusetts Carl E Walter and Fraser J. T. Howie (2010) Red Capitalism: The Fragile Financial Foundation of China?s Extraordinary Rise; John Wiley, Singapore According to myth, Russian minister Grigory Potyomkin ordered the erection of fake settlements, consisting of hollow facades of villages along the Dnieper River, to impress Empress Catherine II, about the value of her new conquests during her visit to Crimea in 1787. More than two centuries later, emerging market nations have borrowed the strategy. These three books provide insights into the Potemkin village like structure of emerging economies. In ?No Precedent?, Professor Gilman, a former International Monetary Fund (?IMF?) staffer and experienced Russian hand, focuses on the 1998 default of Russia on its debt. ?No Precedent? is covers the chronology of the Russian default. Professor Gilman provides a highly readable description of the Russian financial crash with default on domestic treasury bills, sharp devaluation of the Ruble, and a three-month freeze of foreign bank payments. The greatest insight, though not necessarily a surprising one, is the lack of institutional structure in post Communist Russia as well as the lack of infrastructure and expertise to deal with the opening up of the economy after 1989. The lack of political structure and leadership is evident: ?The problem on the government side was that no one was clearly in charge.? Professor Gilman identifies the lack of information and absence of policy coordination. The finance minister and the head of the Russian Central Bank do not talk to each other. People without official government positions frequently make crucial decisions, often by default. ?No Precedent? also provides insight into Russia?s recovery and the rise of the siloviki (shadowy military and security forces) and Putin. For practitioners who have experience in emerging markets or under in extremis situations , the insights will ring very true. As they say, all battle plans dissolve during the first exchanges with the enemy. Russia?s default provides useful insights into the current problems of many European sovereigns. Problems of tax collection to maintain a functioning state able to meet its financial obligations are not dissimilar to those of some peripheral European countries. Russia?s recovery from default and it financial rehabilitation were driven by devaluation of the Ruble and luck (higher oil prices). With the first option probably unavailable in the near term, it seem troubled European economies will need more of the latter. Greece, I am told, makes very good chess sets. Professor Gilman?s favourable views of the IMF?s role, while understandable (IMF head Michel Camdessus provides a foreword), appears a little self-serving. Despite this minor criticism, ?No Precedent? is well worth reading, complementing Chrystia Freeland?s ?Sale of the Century? as a record of this stage of Russia?s modern evolution. Political economist Dr. Victor Shih and bankers Messrs. Carl Walter and Fraser Howie focus on China and its banking system. Dr. Shih?s ?Factions and Finance in China? focuses on the underlying political drivers that shape China?s domestic banking system. Dr. Walter and Mr. Howie?s ?Red Capitalism? focuses on the financial structure of China?s banking system and its evolution over the last 20 years. Both analyses bear out the subtitle of Dr. Walter and Mr. Howie?s subtitle - Fragile Financial Foundation of China?s Extraordinary Rise. The analysis in these two books reaffirms the non-market nature of China?s domestic economy and the over riding, paranoid controlling role of the Chinese Communist Party over any activity. The central purpose of the regime?s constant presence in the banking sector is to further two objectives: firstly, assuring depositors of the safety of their money, and secondly access to money to manipulate economic outcomes. Policymakers, frequently inexperienced in functioning market economies, seize and maintain control over financial policies to control credit. This allows the use of financial resources to provide short term apparent fixes to the economy. At a personal level it allows individuals to gain promotion and power. Camouflaged in superb state of the art infrastructure, markets are ?primitive?, lacking basic mechanisms for allocating capital and pricing risk. As Dr. Shih sums up: ??Although particular financial outcomes or control over the banking sector were not the ultimate objectives of factional politics, the banking sector became an important means of political survival in China. With its vast store of money from increasingly prosperous depositors, the banking sector became a victim of its own success as the party leadership? increasingly saw banks as a bountiful source of political resource? the political elite?s need for a highly fungible policy and political resource ? money ? led to a persistence reluctance to liberalise the banking sector beyond state control. Banking policies were made to bolster the short-term strength of both generalist and technocratic factions with little regard to long-term consequences.? Despite the commentariat?s speculation about ?capitalism with Chinese characteristics?, the Chinese financial system, at least, emerges as a relic of Soviet era bureaucracy, where Borgia court intrigues substitute for decision making. Perhaps, there is little difference between the Chinese banking system and Wall Street after all. The historical background provides insight into China?s recovery from the 2008 crisis. Predictably, the State instructed the banks to lend vast sums to restore growth to target levels. Based on previous experience, the lending, much of it secured over land, will result in large NPLs (non-performing loans). In 1999, NPLs were 39% of total loans of Chinese Banks. Between 2001 and 2007, the major banks spun off $480 billion in bad loans into government sponsored Asset Management Companies (?AMCs?) to prepare them for initial public offering to raise capital. Most of these NPLS remain unresolved, being rolled over with Government guarantees indefinitely. The central importance of bank depositors from ordinary Chinese to the entire system of financial games also raises questions about the willingness of China to increase domestic consumption. The absence of these deposits would destroy a central pillar of the system of patronage and control dominated by the Chinese Communist Party. The structure also focuses attention on the productivity of investments, fuelled by bank lending. Both books also highlight the myth of low debt levels in China. Dr. Walter and Mr. Howie argue that actual government debt levels, properly measured, are not 20% of GDP but closer to 76%. The puzzling thing is investor?s willingness to ignore these deep fault lines in the popular narrative about the China growth story. The reason is provided by Stanley Fischer, now Governor of the Central Bank of Israel but at the time at the IMF: ?One has to wonder how people can both have been investing at triple digit interest rates and expecting that in the end the West would find the money to enable Russia to continue to pay. Surely, they should have understood that the markets were trying to tell them something. Actually, there may be an explanation. The people who did not expect Russia to be able to pay were already out of the market. Those who remained in the market were the optimists, who thought that somehow the market had got it wrong. Those were the people who appeared genuinely shocked when Russia could no longer pay.? The relevant question was not whether Grigory Potyomkin?s villages were fake. The real question was always whether Empress Catherine believed them to be real. © 2011 Satyajit Das All Rights reserved. Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming in Q3 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2006 and 2010) Book Reviews Wed, 02 Mar 2011 01:26:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2011/3/2/Potemkin-Villages--The-Truth-about-Emerging-Markets http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/12/12/The-Past-The-Present-and-an-Unusually-Uncertain-Future Nicholas Phillipson (2010) Adam Smith: An Enlightened Life; Allen Lane Matt Taibbi (2010) Griftopia: Bubble Machines, Vampire and the Long Con That Is Breaking America; Random House Joe Nocera and Bethany McLean (2010) All the Devil?s Are Here: The Hidden History of the Financial Crisis; Portfolio Hamish MacDonald (2010) Mahabharata in Polyester: The Making of the World?s Richest Brothers and Their Feud: New South Jeff Kingston (2011) Contemporary Japan: History, Politics and Social Change Since the 1980s; John Wiley The present is where the future crumbles into the past. The ?past? in this case is Adam Smith, the doyen of economic liberals. Nicholas Phillipson?s ?An Enlightened Life? is an ?intellectual biography?, forced by the paucity of factual details about Smith?s life. In a pre-FacebookTM and TwitterTM age, Smith jealously guarded his privacy and instructed his unpublished papers be destroyed upon his death. Little information of his private life survives. The absence of the personal is, in part, the book?s strength, allowing exploration of the influences and cultural milieu, especially the commercial and academic life of Scotland, which shaped Adam Smith?s work. A key element of the book is the discussion of the interplay between Smith and David Hume as well as that between Smith and Quesnay and the French school of economistes. The man that emerges from the book is somewhat different from the traditional portrait of the founder of modern economics. Smith saw himself as a moral philosopher. He saw his famed ?Wealth of Nations? and his earlier ?Theory of Moral Sentiments? as attempts to integrate history, jurisprudence, ethics, aesthetics and (incidentally) economics in a GUT (grand unifying theory) of ?scientific man?. In some respects, Smith was unmistakably modern. Mr. Phillipson?s description of Smith?s lecturing style reveals a streak of cunning vanity and recognition of the power of rhetoric in getting across his ideas. After unsuccessfully experimenting with extemporized unscripted lectures, Smith used written speeches with tangential flourishes and asides. The iconic reference to the ?invisible hand? and the idea of ?regard to their own interest? may have developed as a rhetorical flourish, that today would have been instantly transmitted around the world in a ?tweet?. While Adam Smith?s ideas about economic issues ? the dynamics of economic activity, the role of government, taxation and regulation ? are interesting, they are firmly embedded in the culture of Glasgow and Edinburgh at the time of the Scottish Enlightenment. Smith?s influence over time may be because the ideas he articulated are so general that subsequent intellectuals have been able to read into them layers of unintended meaning and significance. For example, the invisible hand guided by self interest is capable of being turned into a variety of rhetorical ideas, including the efficient market hypothesis. Smith, hesitant about precision and the application of mathematics to human behavior, would have found that curious. This opacity and ambiguity allows Smith to remain relevant for each subsequent generation, which can shape Smith to fit the times and their particular agendas. As the Argentinean writer Jorge Luis Borges insisted every writer creates his own precursor. Each economic movement has shaped Smith in their image. Restrained in tone, ?An Enlightened Life? is a sound and fine introduction to Adam Smith. It will hopefully inspire readers to delve into Smith?s frequently unread but oft quoted writings. The ?present? is Rolling Stone journalist Matt Taibbi?s ?Griftopia?. If ?restraint? is a word that Mr. Taibbi is familiar with, it is not evident in this book. ?Griftopia? extends the author?s Rolling Stone article justly famed for the notable description of Goldman Sachs ? ?the vampire squid wrapped around the face of humanity?. In modern celebrity culture, 45 characters can explain just about everything, at least, to the satisfaction of the majority. The writing is the ?gonzo style? journalism, made famous by the former Rolling Stone contributor Hunter S. Thompson. Alan Greenspan is ?The Biggest Asshole in the Universe?. Insult and high dudgeon is the preferred form of dialectic. Interest in one orifice in the alimentary canal is prominent throughout the text. Mr. Taibbi marries Thomas More?s ?Utopia? and the idea of the ?Grift? (deception) into a phrase that is meant to describe all that is wrong with America. Mt. Taibbi sees a vast conspiracy by bankers, especially by Goldman Sachs, to take over the running of the state, enslaving and robbing its citizens. Mr. Taibbi clearly does not share philosopher Alasdair MacIntyre?s view: ?One key reason why the presidents of large corporations do not, as some radical critics believe, control the US is that they do not even succeed controlling their own corporations.? The argument has some validity, but the truth is far subtler than ?Griftopia? would like to make out. The argument has also been made far more subtly with better supporting documentation in Simon Johnson and James Kwak?s ?13 Bankers?. Mr. Taibbi confesses to not knowing much about economics. The admission on a reading of the book seems largely correct. The use of numbers owes much to Mark Twain?s advice: ?Get your facts first, and then you can distort them as much as you please.? It is difficult to know whether the first part of the injunction was complied with, as there is little detail or evidence of the basis of the numbers cited. The book asserts that the American government?s total commitment to rescue the economy, estimated at US$ [insert a number a number of your choice] trillion, sufficient to pay off all US mortgages. The author misunderstands, at least, the support offered and its rationale. If the government had not guaranteed financial institutions then bank collapses would have destroyed the savings of the millions of Americans for whom Mr. Taibbi is the self appointed champion. The guarantees and capital injections were backed by assets, some even had some value. Many of the loans or capital commitment have to and have been repaid. Many programs, like extended unemployment benefits, staved off penury for the people affected. All these facts are inconvenient to the narrative and therefore ignored. In his analysis of infrastructure, Mr. Taibbi argues that American states sold their infrastructure to private investors too cheaply. They did. But American ideological reluctance to raise taxes to finance essential public services and assets forced governments to resort to these forms of financing. Investors were frequently pension funds who reaped the benefit of the reduced prices and high resulting returns on behalf of their investors ? often teachers and other citizens. ?Griftopia? begins with the story of the rise of the Republican Tea Party movement. Mr. Taibbi sees the rise as a diversionary tactic, focusing the attention of the populace away from the real issues ? the grifters, bankers and people that the author dislikes ? towards tangential issues - immigration, foreigners and the role of government. But the book itself is diversionary. In resorting to crude ?blaming? and ?flaming? even the correct targets without a thorough and accurate understanding of the true issues, ?Griftopia? cheapens its case and ultimately allows the hated ?system? to continue unhindered. ?Griftopia? may fall into its own trap. Its rage and blame perpetuates a lack of understanding of the real causes of the problem. The Roman Caesars understood that the crowd needed bread and games. They also knew that when things went wrong, an occasional sacrifice and crucifixion was the key to maintaining power. The clever vampire squid may have suborned Mr. Taibbi into its service. The present is also ?All the Devil?s Are Here?, written by acclaimed journalists Joe Nocera and Bethany McLean (co-author of the definitive history of Enron ?The Smartest Guys in the Room?). ?All the Devil?s Are Here? is a well written, solid history of the crisis. Its strength is that it tries to cover several aspects of the crisis, which in part makes the history and theory superficial. As its central focus is the crisis, the book does not examine deeper social aspects of the events and essential drivers of the age of capital. The text is character driven making for a narrative, focusing firmly on the ?devils?, which turns out to be the ?usual suspects?. The subtitle ?The Hidden History of the Financial Crisis? is misleading as there is little new here. The root causes identified are unsurprising ? political pressure to increase homeownership, the GSE?s, political and business failures, the process of securitisation, mathematical models and the familiar evil of ?greed?. ?Griftopia? and ?All the Devil?s Are Here? do not acknowledge the complicity of everyone in the body politic in the essential financialisation of modern life and the reliance on economic growth. They do not acknowledge the fact that while the grift worked and everyone got richer, everyone remained sanguine about the ?system?. No one cared as long as his or her stock portfolios and houses rose in value. No one cared as his or her living standards improved or there was the possibility of improvement ?Griftopia? and ?All the Devil?s Are Here? also never recognise that normal people abnegated all responsibility, both political and economic, to the financial superclass. The low voter turnout in American elections is ample testament to that problem. The book does not recognise the lack of financial literacy and the naïve belief in the ability of policymaker?s to control and engineer the economy. In this regard, neither title matches Joe Baegeant?s poignant portrait of American life and its problems in ?Deer Hunting for Jesus?. Both books are also silent on the role of the media which has fervently embraces a message that financialisation of economic life is an unqualified good. It is also silent on how the media itself fosters ignorance, through its treatment of issues in narrow and simplistic political terms. Laudatory biographies of business leaders helped create the all-knowing financial elite. The message of ?stocks for the long run? and ?increasing wealth? bears some responsibility for the global financial crisis. Mr. Nocera and Ms. McLean draw the title of their book from the line in Shakespeare?s ?The Tempest?: ?Hell is empty, and all the devils are here.? The implication is that all would be well if the devils were rounded up and consigned back to the nether regions. Unfortunately, reality is more complex. Other observations from the Bard might be apposite. In ?Julius Caesar?, Cassius tells Brutus: ?The fault, dear Brutus, is not in our stars, But in ourselves, that we are underlings.? In ?Othello?, the real ?devil? Iago tells Roderigo: ?Tis in ourselves that we are this and thus.? If we live presently in ?Griftopia? and amongst ?All the Devils?, then the future, we are told, belongs to the emerging markets. Australian journalist Hamish MacDonald?s wonderfully titled ?Mahabarata in Polyester? provides a tantalising insight into this future through the recent history of the Ambani business family and its rise in India. The book details the progress of entrepreneur Dhirubhai Ambani, as he rises to dominate the market in polyester in India, eventually evolved into the Reliance empire, which has more facets than many Indian Gods have limbs. Rather than a hagiographic Bollywood narrative of a gifted and determined individual battling the odds and emerging triumphant, Mr. MacDonald undertakes a forensic and critical analysis of the growth of the Ambani business interests. In the process, he provides clinical and compelling insights into the nature of Indian economic and business life. ?Mahabarata in Polyester? documents rampant corruption, stock market manipulation, trading of political influence as well as the exploitation of the media to further business ends. It provides perhaps the most compelling documentation of the evolution of India?s business environment from the era of the ?license raj? where favoured Marwari and the Parsi businessmen dominated to the current regime of entrepreneurial oligarchs. Recent revelations of ?anomalies? in the auction of mobile phone spectrum and construction projects associated with the New Delhi Commonwealth Games highlights the deeply embedded corruption of the system. As Mr. McDonald concludes: ?One legacy of Dhirubhai Ambani is a dangerously suborned state.? However, in a world with ?a shrinking moral universe? where business is concerned, India is the future. If Mr. Taibbi?s thesis is correct, then American business, especially Goldman Sachs, should be well placed to succeed in India. An earlier edition of the ?Mahabarata in Polyester? was not released in India after the Ambanis stopped its publication. Indian businessmen and leaders are generally delusional as to their methods and standing, with anything less than veneration, adulation and comparison to Mahatma Ghandi being unacceptable. This new edition, which was released uneventfully in India, continues the story describing the split between the two scions, Mukesh and Anil, after the death of their father. It documents their continued accumulation of wealth, which embraces most aspects of the Indian economy. It also documents the continuation of their father?s business practices. ?Mahabarata in Polyester? provides readers with a glimpse of the ?real? India and Indian business, in the unlikely event that they want to know the truth. Japanese scholar Jeff Kingston?s ?Contemporary Japan? provides an alternative view of the future, at least for the beleaguered developed economies of the world. Documenting the history of Japan from 1989 when the ?bubble? economy collapsed, Mr. Kingston provides an insightful portrait of the evolution of society during the lost decades. Along the way, it challenges many conceptions about Japan, especially its industrial acumen, labor relations and social cohesion. ?Contemporary Japan? does not focus on the economic history, although it is the essential backdrop against which the changes that are explored take place. During the last decade, Japan lost approximately 3 times its annual GDP, equivalent to around $16 trillion. The economic collapse affected Japan?s middle class profoundly, destroying its egalitarian society ushering in the ?kakusa shakai? (society of disparities). Its once copied labour system of lifetime employment became unsustainable. Today, temporary and part-time workers total up to one-third of the labour force. Lacking training, career prospects and with low, uncertain income, the ?preca-tariat? (a combination of ?precarious? and ?proletariat?) are disaffected and also disengaged from the political and economic system. Mr. Kingston argues convincingly that the crisis exposed and exacerbated hidden social problem, such as high rates of suicides and domestic violence. It also exposed bureaucratic incompetence and dishonesty that the years of strong growth and prosperity had disguised. The resulting loss of faith in authority has created near paralysis. Mr. Kingston argues that Japan?s problems cannot be addressed by resorting to the past and existing systems. Puzzlingly, in the light of his own analysis and the facts he musters in support of his thesis, the author remains optimistic that Japan will overcome its problems, eventually. Throughout the global financial crisis, politicians, business and economic leaders have steadfastly refused to contemplate a Japanese future for the global economy, at least for the developed economies. As the problems remain unresolved and policy options dwindle, the prospect of ?turning Japanese? is now openly debated. ?Contemporary Japan? provides a detailed and important perspective on what the future may look like and prospects that await the underclass that ?Griftopia? portrays. Human history is the stuff of myth. Adam Smith, Goldman Sachs, Alan Greenspan, the Ambanis and Japan are icons that mask elusive truths. As with any myth, the real importance is in what it reveals about those who hold them important and self evident. © 2010 Satyajit Das All Rights reserved. Satyajit Das is author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sun, 12 Dec 2010 00:11:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/12/12/The-Past-The-Present-and-an-Unusually-Uncertain-Future http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/10/11/Pleasant--Unpleasant-Truths Michael Hirsh (2010) Capital Offense: How Washington's Wise Men Turned America's Future Over to Wall Street; John Wiley Mark T. Williams (2010) Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System; McGraw-Hill David Harvey (2010) The Enigma of Capital and the Crisis of Capitalism; Oxford University Press Gary B. Gorton (2010) Slapped by the Invisible Hand: The Panic of 2007; Oxford University Press Kevin Dowd and Martin Hutchinson (2010) Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System; John Wiley William Isaac (2010) Senseless Panic: How Washington Failed America; John Wiley Maria Bartiromo with Catherine Whitney (2010) The Weekend that Changed Wall Street: An Eyewitness Account; Portfolio/ Penguin Randall Lane (2010) The Zeroes: My Misadventures in the Decade Wall Street went Insane; Scribe Publications In Japanese Director Akira Kurosawa?s film Rashomon, the rape of a woman and the murder of her Samurai husband is seen through the accounts of four witnesses. The bandit/rapist, the wife, the dead man (speaking through a medium) and narrator outline different accounts of events. Unfolding in a series of flashbacks, the descriptions are shared by the characters with a commoner waiting out a fierce thunderstorm in a decrepit gatehouse only identified by a sign as Rash?mon. Only the final account from the only witness (although he did not admit this at the trial) appears objective, unbiased and unmotivated by other factors. In so far as the viewer accepts the ?truth? of the final version, it allows each different version to be examined in terms of its motivations. The bandit/ rapist accepts responsibility but claims it was a duel, imbuing the event with honour and heroism. The wife casts herself as a victim, although she may have incited the duel, allowing her to appear modest and innocent. Given that all parties were present at the incident and know the factual sequence of events, it is the motivations behind the various versions that remain intriguing. A Rashomon like character now imbues books on the global financial crisis. Multiple versions of the events are emerging. As the old saying goes there is ?my truth, your truth and the truth.? One approach is the ?chronology?. In ?Capital Offense?, veteran journalist (formerly at Newsweek and now at the National Journal) Michael Hirsh provides a history of ?the Age of Capital?. Mr. Hirsh?s thesis is that the foundations for the global financial crisis can be traced to an extended period of history where political ideology rather than sound economics and policy dominated. A supercilious belief that ?free markets? would lead to prosperity did not quite tally with a succession of economic crises: the Asian crisis, LTCM, the collapse of the Internet bubble and finally the sub-prime mortgage debacle that morphed into a global credit crunch. The author?s critique is not really of ?free markets? but of the ?financial-government complex? and ?crony capitalism?- ? the later term being coined ironically by Larry Summers to chastise the business-government links in Asia that he argued needed reformation! ?Capital Offense? provides an insightful history of the failure of successive US Administrations and regulatory regimes to understand the Frankenstein monster they were creating. The portraits of the ?wise men? is particularly unflattering. Well written, Mr. Hirsh?s status as a Washington insider enables him to give a vivid portrait of the history of the deregulation of the financial system and the implementation of rules to assist financiers with ultimately disastrous consequences. Just as Andrew Ross Sorkin?s book ?Too Big Too Fail? provided a portrait about the process and players attempting to salvage a failing financial system in September 2008, ?Capital Offense? provides a equally interesting view of how over 30+ years a sequence of decisions created the conditions for the crisis. ?Uncontrolled Risk? attempts a similar but more focused chronology of the failure of Lehman Brothers. Mark William, an academic and former risk management professional, provides a solid history of the rise and collapse of the firm. Factually correct, the text draws heavily on a plethora of works covering Lehman?s history (Greed and Glory and Wall Street? and ?Last of the Imperious Rich?) and the events leading up to the Chapter 11 filing (?Colossal Failure of Common Sense? and ?Too Big to Fail? and ?In Fed We Trust?). In this sense, ?Uncontrolled Risk? is a ?meta? book (a book about other books), providing a summary for the reader unwilling to read the primary sources. One reviewer on amazon.com found this feature of the book particularly compelling. Short on time and needing to prepare a final term paper, the reviewer found Mr. William?s book ideal as the title of the review states: ?Great book, especially when under a deadline.? The narrative suffers from the fact that it appears to have been written prior to the release of the exquisitely detailed Valukas Report, which provides a fuller picture of the rise and fall of Lehmans especially of some of the firm?s practices. The evidence from the Report, at times, is at odd with the more conventional narrative of ?Uncontrolled Risk?. The Epilogue offers ten suggestions for avoiding future problems, including a call to adopt policies in place in Canada, where banks avoided the worst of problems. The author appears to have confused good fortune and path dependency with competence. The suggestions are similar to that already being debated including ?motherhood? and ?apple pie? proposals for higher capital, reduction of moral hazard and greater accountability. The faith in politicians, regulators and policymakers is touching but at odds with their repeated failures over the last 30 years. As Scottish philosopher David Hume observed: ?All plans of government, which suppose great reformation in the manners of mankind, are plainly imaginary.? An alternative to the ?chronology? is the ?analytical study?. This generally means the author?s prejudices can be given full scope. David Harvey, an academic, provides a Marxist perspective on the crisis. ?The Enigma of Capital? views the current problems as merely the latest manifestation of capitalism?s recurrent crises. The author also sees this crisis as different, signalling limits to growth have been reached. In Professor Harvey?s view, the credibility of the financial growth model has been undermined. At the same time, the continuance of US global dominance has been weakened because of the rise of India and China. Professor Harvey accepts that its resilience and inventiveness means that capitalism is capable of reinventing itself. But the author believes the cost that must be paid by the weak and poor is simply too great to allow a return to the status quo. ?The Enigma of Capital? is at its most lucid in the early chapters where Professor Harvey describes how capital moves and shapes the world, always creating the conditions for the next crisis. In later Chapters, the author?s attempts to fit the present crisis into neat frameworks consistent with the work of Marx and Engels seem formulaic and forced. The argument at the core of ?The Enigma of Capital? is unconvincing at several levels. The labour movements throughout the world have not moved beyond a desire to improve the existing ?system? for most of a century. Declining union membership and diminished bargaining power means any response is fragmented. In fairness, Professor Harvey recognises these problems in his thesis. He also accepts that, at least in the US, being labelled a ?communist" is hardly the recipe for success. Marx, himself, wrote that capitalism would not perish before all its options and strategies for renewal were exhausted. There is still some way to go before that occurs, if ever. There is also little sign, at least as yet, that the population is willing to abandon capitalism. After all as John Kenneth Galbraith observed: ?Under capitalism, man exploits man. Under communism, it?s just the opposite.? ?Slapped by the Invisible Hand? is an extended version of Yale Professor Gary Gorton?s academic papers, including those presented at the Fed?s Jackson Hole Conference in August 2008 and at a further conference in May 2009. Professor Gorton writes for his admiring academic clan, known to include Fed Chairman Ben Bernanke. This is reflected in a certain loquacious if circumlocutory exposition style: ?This agent cares about the intertemporal marginal rate of substitution, so the pricing kernel weights the expected returns on the demand deposits in determining the currency-deposit ratio.? As Steely Dan?s Donald Fagen once sang: ?What passes for knowledge, I can?t understand.? Professor Gorton?s analysis of the causes and development of the crisis is entirely conventional. The inclusion of curious cartoons, illustrations and a photo of e. coli bacterium (undoubtedly a form of academic ?daring? treated in academic seminars with gasps!) is not. The book focuses on the Panic of 2007, finding that it wasn?t significantly different in general terms from the Panics of 1893 or 1907. In fact, ?Slapped by the Invisible Hand? portrays much of what went wrong as obvious, although the author appears to be surprised by events as they played out. For example, on the topic of the shadow banking system, Professor Gorton reaches the ?startling? conclusion that the network of hedge funds, structured investment vehicles and securitisation operated like an alternative banking system. This resulted in a ?wholesale bank run? when funding for these vehicles dried up. There is limited discussion of the factors, including bank capital rules and accounting standards, which encouraged the development of these factors. Professor Gorton displays considerable naivete in describing valuation models and the collateralisation of derivative transactions. As an adviser and consultant to AIG, Professor Gorton could reasonably be expected to have a deeper understanding of the issues. In August 2008, AIG estimated CDS losses at $8.5 billion but the firm remained confident that no actual loss would eventuate as its risk models showed that there was a 99.85% chance that there would be no actual losses. But as required under derivative contracts, collateral calls began to flow in. Counterparty?s models showed larger losses than AIG?s internal models. There was suspicion that AIG?s trading partners were manipulating prices to increase losses and the collateral demanded. Commenting on the battles over collateral, Gary Gorton observes only that: ?It is difficult to convey, the ferocity of the fights over collateral.? AIG proprietary risk models used historical data on defaults to estimate the likelihood of losses on the insured portfolios of corporate debt and mortgages. The chance of losses on the super senior tranches that FP insured, based on the modelling, was assessed as remote. It wasn?t a one-in-ten-thousand year event, it was a one-in-a-million year event. The risk was priced on the assumption that no losses would ever occur. The models do not appear to have taken into account the risk of mark-to-market losses and also the need to potentially post collateral. Both failures proved fatal. AIG seems to have ignored German historian Ernst Junger?s warning: ?a half witted mathematician could cause more damage in a second than Frederick the Great in three Silesian campaigns.? In ?Alchemists of Loss?, Kevin Dowd, a former academic and author of financial risk management books, and Martin Hutchinson, a former banker and now a journalist, take aim at the financial and economic theories which lie at the heart of the global financial crisis. The alchemists of the title are several Nobel Prize winners, investment bankers, the political class, economists, and regulators. ?Alchemists of Loss? argues that the financial economy has become one massive rent extraction machine where gains are privatised and the losses are socialised. The authors conclude that bails outs funded by deficit spending will not ?solve? the problem leading instead to problems of government debt, which in turn will require monetisation by inflation or default. Entertainingly written and well argued, ?Alchemists of Loss? is sharpest in its criticism of poorly conceived and even more poorly enforced financial regulation and flawed risk models. The book is less successful in some of its prescriptions. Puzzlingly, the book embraces ?extreme value theory? as a superior although imperfect risk management methodology. The reader may not be convinced that hydrologists, practised at predicting the likelihood of catastrophic floods, will prove superior to physicists in modelling financial risk. As Richard Feynman observed about the Challenger disaster: ?If some guy tells me that the probability of failure is 1 in 105, I know he?s full of crap.? In the absence of everything else, there is always the ?personal? perspective. This allows pervasive ?name dropping?, extensive use of gossip and avoids, sometime entirely, the need for detailed research or the horrors of accurate referencing. In ?Senseless Panic? William Isaac, a former Chairman of the Federal Deposit Insurance Corporation (?FDIC?), outlines a selective history of the author?s tenure during the banking and S&L crises of the 1980s. The connection to the present is somewhat tenuous, seeking undoubtedly to cash in on the current interest in the current global financial crisis. Short and concise, ?Senseless Panic? is at its most interesting when it explores the savings and loans problem when the FDIC closed 534 banks in 1989. Mr. Isaac provides insights into the problems of the ?too big too fail?, pointing to his refusal to allow the failure of Continental Illinios, then the country?s seventh-largest bank. The author argues that maintaining public confidence is more important than reducing market discipline or creating moral hazard. Mr. Isaac, naturally, believes that Lehman Brothers should have been rescued and argues for a more interventionist regulator who forces banks to increase capital and reserves in good times to cover losses through bad times. Mr. Isaac seems to be unaware of the observation of English Philosopher Herbert Spencer that: ??the ultimate result of shielding men from the effects of folly is to fill the world with fools.? In ?The Weekend that Changed Wall Street? CNBC ?star? Maria Bartiromo aka ?Money Honey? provides a ?celebrity? take on the crisis. Some readers may be reminded of Groucho Marx?s famous comment: ?From the moment I picked your book up until I laid it down, I convulsed with laughter. Someday I intend on reading it.? There was a time, long past, when reporters merely reported on the facts and only occasionally passed opinions. Ms Bartiromo seems to have cast herself as a central and sometime the sole character in the drama. ?Weekend? self consciously on each page focuses on the ?I?. The author seeks to share what happened ?in a way that ordinary people can understand?. In order to do this, ?Weekend? takes us into the author?s boudoir ? ?my world ? behind the curtain of capitalism? (a hitherto unknown financial metaphor) to provide ? an intimate look at the personal stories of those involved?from the richest and most powerful to the average workers.? From the airbrushed ?come hither? look on the dusk jacket to highly derivative and, at times, corny text, ?Weekend? exceeds the sum of your worst fears. Certainly, as Faulkner noted about Hemingway, there will be no need for the reader to rush for a dictionary in perusing this offering. There are problems of ?time space? as the weekend seems to stretch out for a number of years, emerging through a wormhole into the European debt crisis (imaginatively entitled ?A Greek Tragedy?) and the Goldman Sachs indictment over a CDO transaction. There are problems of judgement ? Ken Lewis is ?a quiet man who masked his masterful business sense?? (page 85) and Goldman Sachs? ?reputation was solid?. (page 183) There are problems of classification ? Nassim Taleb?s ?Black Swan? is apparently ?a critical view of the deception inherent in financial instruments? (Page 177). There is ?in depth? analysis ? ?Greece was in over its head and didn?t show it.? (Page 179). There is poetry ? ?Each afternoon, when I alight from my car on Broad Street in front of the New York Stock Exchange, I pause for a moment to look up. I have been doing this for sixteen years; it's an automatic response. There is majesty to the edifice, and its architectural grace is breathtaking.? (page 208) There is hope, although some readers by this stage may be in despair ? ??we must restore fundamental principles. We must, once again, allow integrity to guide and protect us.? (Page 208) The real insight provided by ?Weekend? is unintended. The surreal power of the vapid medium of financial TV and its frequently shallow coverage of events is striking. The ?names? that curry favour with the networks for coverage and airtime is astonishing. What they say is perhaps even more astonishing, as is the author?s readiness to share ?off air? and presumably private remarks. The book also reveals some interesting things about modern publishing, especially its focus on celebrity rather than content, argument or writing skill. If the future of democracy and capitalism requires a free, knowledgeable and fearless press then this book does not augur well. In December 1998, the Economist, reviewed Soros? The Crisis of Global Capitalism (a fellow ?celebrity?, albeit with considerably more market savvy and a habit of making money) as follows: ?Because of who he is there will always be buyers for his books, publishers for his books and cash-strapped academics to say flattering things about his books. None of this alters the fact that his books are no good? A remarkable thing happens to money when it passes through Mr. Soros; it emerges multiplied, but otherwise unchanged. With other inputs the results are more disappointing ? to be blunt, more in line with biology. Mr. Soros gorged on chopped philosophy, mashed economics and fact and figures swimming in grease. It was too much. Before he knew what was happening out rushed this book.? It is not known whether The Economist plans to review ?Weekend?. In the ?Zeroes?, Randall Lane, a journalist and founder of a number of ill-fated publications like including Trader Monthly, Dealmaker, and Private Air, provides undoubtedly one of the most entertaining and ultimately the most insightful views of the crisis. Mr. Lane sought to capitalise on the ?conspicuous consumption? of the trading and banking classes. His magazines were targeted at this demographic with features like the Trader?s Monthly roll call of salaries/ bonuses. The game was to attract advertising dollars from luxury goods manufacturers who wanted to sell their over-priced and over-hyped products to people with a lot of money and not a lot of taste. As the title suggests, the book traces the author?s adventures in this world. Descriptions of previously well-documented excesses of traders and bankers are enlivened by the author?s own dealings with traders and private equity investors who bankroll his empire. The book paints a realistic picture of the culture and milieus of the trading classes that were at the heart of the crisis. It accurately renders the attitudes, especially the ignorance and avaricious self-interest of bankers. Entirely autobiographical, beautifully written with a lively, self deprecating humour, Lane observes from the peripheries, setting down a highly readable record of the times. The account is deeply personal as Mr. Lane has ?skin in the game? losing his own, his family and friend?s money in the ultimate failure of the business. In the same way as ?Liar?s Poker? and ?Wall Street? came to represent the financial world of the 1980s, ?Zeroes? tales of trading fortunes made and lost and excessive life styles provides an entertaining record of the period. In Rashomon, Akira Kurosawa presents a meditation on the subjectivity of truth and the uncertainty of factual accuracy. Like the film, the growing literature on the financial crisis is increasingly a meditation on the nature of financial reality. The truth remains unknowable and illusive but the purveyors of the different versions of the facts reveal a lot about their own motivations and agendas. © 2010 Satyajit Das All Rights reserved. Satyajit Das is author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Mon, 11 Oct 2010 01:09:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/10/11/Pleasant--Unpleasant-Truths http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/9/26/Chinese-Contradictions Peter Hessler (2010) ?Country Driving: Three Journeys Across A Changing China?; Text Publishing Richard McGregor (2010) ?The Party: The Secret World of China?s Communist Rulers?; Allen Lane Richard Baum (2010) ?China Watcher: Confessions of a Peking Tom?; University of Washington Press Winston Churchill once described Russia as ?a riddle wrapped in a mystery inside an enigma?. Churchill?s epigram captures the difficulty of understanding Russia or placing it into an accepted framework of reference and experience. It also betrays a particular foreign view of Russia, relying on traditional Western models of economics, politics and culture which the rest of the world is expected to conform with. In a similar vien, China may be an ?internally consistent contradiction? for foreigners. The rising economic importance of China has led to an increase in ?sino-phila? or ?sino-phobia?, depending on political persuasion and the issue. The rise in books and ?experts? seeking the ?explain? China attest to this interest. In ?Country Driving?, Peter Hessler, a staff writer for the New Yorker, applies a distinctly American form ? ?the road movie? ? to China. The book contains three episodes ? a journey along the Great Wall, life in a ?weekender? in a semi-rural setting outside Beijing and time spent around the industrial zones of Wenzhou. Curiously, the ?driving? of the title features heavily only in the first story but makes ?guest? appearances in the remainder of the book. Well written as befits a professional journalist, Mr. Hessler tries hard to capture the ambiguities of the emerging China. For the most part, the book focuses on the strains and pressures of a people transiting from an older centrally controlled feudal society into a newer centrally controlled feudal society. The fact that this change is taking place at breakneck pace adds to the strain and stress. ?Country Driving? is an interesting foreigner?s view of China. Gracious and sympathetic towards his hosts, the author creates a series of carefully constructed portraits of the people he meets and the workings of Chinese society. The record of his life in Sancha and his friendship with the child Wei Jia are especially good and sometimes touching. His description of the business culture in Lishui, a small city developing into a manufacturing centre, and a newly established company specialising in manufacturing a small ring used in making bras, provide useful insights into Chinese industry. ?Country Driving? is, however, pitched as entertainment and tries hard at being amusing. It also caters to its readers? biases. Lengthy descriptions of the wacky world of Chinese driving (appalling and dangerous) and driving schools (bizarre training practices) reinforce favoured foreign stereotypes. In an effort at self-conscious neutrality and being non-judgemental, Mr. Hessler casts himself as mostly a passive and sometimes incurious spectator to events. Impressionistic in style, there is little detail and analysis of the forces and concerns that shape the events the author describes. ?Country Driving? is a pleasant, readable foreign perspective on China. The contrast with dissident Ma Jian?s 2001 ?Red Dust: A Path Through China? is striking. The 30-year old Jian?s journey escaping a clampdown against ?spiritual pollution? provided a far more powerful view of life in and the internal contradictions of China. Jian, as an insider who was also an outsider, provided insights into his country which Hessler, an outsider, can not. Richard Macgregor?s ?The Party? is a fascinating portrait of the internal workings of the Chinese Communist Party. Head of the Beijing bureau of the Financial Times, Mr. McGregor illustrates how the Party controls every aspect of Chinese life in considerable detail. ?The Party? examines the relationships between the Party, the state, business and military. It examines how the Party runs the country through its control of personnel (through the Orwellian titled ?Central Organisation Department?) and Party Cells implanted in every business and government department. Mr. McGregor deals with issues of corruption - permitted within unwritten bounds as long as it contributes to the Party?s objectives and does not become too visible. He outline difficulties of controlling regional administrations - in the words of a vice-minister ?the central government?s control does not extend beyond the walls of Zhongnanhai [the Government?s central office in Beijing]?. Written with admirable restraint and clarity, the author?s treatment is journalistic relying on his personal knowledge gained through sources and interviews. It does not offer explicit analysis, although considerable insights are evident. Perhaps the most important insight is just how non-ideological the Chinese Communist Party is. The Chinese rulers have adapted the Soviet apparatus of Lenin and Stalin as a highly effective form of social and economic control. Party membership is largely driven by potential access to power and status, often to gain immunity and protection that allows engaging in activity including business transactions, unavailable to non-Party members. The inherent conflicts of interest in the parallel mechanism of Party and Business are captured by the ill-fated Zhang Ruimin, the CEO of China?s largest whitegoods maker Haier: ?I appointed myself party secretary of Haier. So I can?t have any conflicts with myself, can I?? He could and did with predictable consequences. ?The Party? exposes a system focused on only one objective, its own survival and power, which is taken to be automatically synonymous with the success and destiny of China. The Party itself emerges as an infinitely adaptable and highly complex organism that dominates life in China. In the wonderfully titled ?China Watcher: Confessions of a Peking Tom?, Richard Baum, a respected and long-time China scholar, provides an at times irreverent and always personal perspective on forty years of dealing with China. A scholar who admits he stumbled into Sino-study, Baum?s book is chronological and autobiographical. He traces the emergence of China from its post War centrally controlled, socialist isolationism into a more market oriented world power. The journey takes in key events: the 1970?s Xidan Democracy Wall, the move to a more oriented market economy under Deng after the death of Mao and the removal of the Gang of Four, the set back of the Tiananmen Square massacre and the return to market reforms following Deng?s famous 1992 Southern Tour. Baum?s deep connections with China and key players as well as his own insights are evident throughout. He does not try to hide the bitter academic rivalries that his work and renown created. A fascinating aspect of ?China Watcher? is the length of time covered, allowing the reader to gain an appreciation of the changes in the country. It also provides acute insights into the various policy debates and disputes that have shaped this progress. Baum?s book will appeal to the Zhongguotong (old China Hand) and layman alike. The rise of China fascinates politicians, policymakers, businessmen and interested foreigners. Each is looking to ?understand? China from its own perspective and for its own benefit, usually monetary, political or economic. Some of the fascinating anecdotes in ?China Watcher? are where Baum is called upon together with other prominent Sinologists to brief politicians, such as the first President Bush. The different points of view of advisers and the lack of knowledge of political and business leaders are revealing. In the main, the West views China as its ?salvation? - a source of vast savings to finance the West and a large domestic market for its goods and services. The alternative view, which frequently co-exists with the first, is a ?threat?, at an economic, political and military level. The picture of China that emerges from these three books, representative of the growing non-technical literature on the subject, is of a complex, unexpected and alien place. For a foreigner, China is, on the whole, impenetrable. The Party?s internal machinations make Machiavelli?s The Prince appear facile. The complexity of business dealings is equally confusing. Concepts of intellectual property, rule of law and accepted business practice are entirely absent. The chances of finding yourself in competition with your partner or a firm owned by the Party or the People?s Liberation Army are high. The only thing that probably is certain is that you are going to be fleeced. Recent mutterings by Western business leaders testifies to some of these problems. A common theme is the fierce and defensive internal focus of China at both government and individual levels. The primary concern is the internal stability of the Middle Kingdom, at all cost. This will create problems in a world where a cooperative approach to some issues, such as global capital imbalances and the environment, are unavoidable. Whatever the future holds, it will not be dull where China is concerned. Baum captures the essential contradictions of China in the closing paragraphs of ?China Watcher?: ??China has been my passion, my calling, my own personal Shangri-la and Chimera rolled into one. Although three decades of economic reform and global engagement have made China?s political and social reality far more accessible ? and far less bizarre ? then they were in Mao?s time, the People?s Republic remains for me a profound puzzle. Ever changing, ever fascinating, and ever frustrating, it compels my attention even as it stubbornly defies comprehension. I cannot look away.? © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sun, 26 Sep 2010 21:26:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/9/26/Chinese-Contradictions http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/9/5/Financial-Babel Eli Ayache (2010) The Blank Swan: The End of Probability; John Wiley, Chichester The mythical Tower of Babel was an enormous building designed to reach heaven. The story?s theme is competition between divine and human beings, the construction of the tower being a hubristic act of defiance against God. In recent history, humans have constructed many financial towers of Babel, seeking to defy risk and the uncertainties that underlie markets. Unlike physical sciences bounded by actual phenomenon, social pseudo sciences, including economics and finance, entail a peculiar dialectic. Someone somewhere writes a paper. Someone somewhere else, either in the next room or half a world away, writes a paper citing the original, either agreeing or disagreeing with its arguments. If enough participants engage in the debate, then it becomes in varying stages a discussion group, a minor cult, an offshoot of an existing discipline or, in a few cases, an entirely new discipline. This idea was the subject of a disarmingly short (6 page), simple yet intellectually puzzling short story by Jorge Luis Borges, the Argentinian writer, ?Pierre Menard, the Author of Don Quixote". The story takes the form of literary criticism about the fictitious Pierre Menard, a 20th century French writer. The story describes Menard?s translation of Don Quixote, which in reality is a line for line recreation of the original. Ironic and humorous, the story raises profound questions about writing and interpretation. Borges, writing as the reviewer, considers Menard?s Quixote to be much richer in allusion than the original text, to which it is identical. This reflects the context of the world and the author, which shapes the work. In ?Pierre Menard?, Borges anticipated post-modern literary theory and philosophy. Nassim Nicholas Taleb?s ?Black Swan? is undergoing a similar developmental arc. If the Black Swan is Donald Rumsfeld?s Unknown Unknown, then the White Swan, a term now frequently used for anticipated crises, is the Known Unknown. There is also the Gray Swan, which presumably has elements of both. In ?The Blank Swan?, Dr. Eli Ayache, a former derivative trader and principal of a software firm, extends the idea, perhaps creating the new discipline of ?Cygnus Finance?. ?Pierre Menard? has its own history. In Italo Calvino?s ?If on a Winter's Night a Traveleri?, a character, Silas Flannery, tries to copy a famous novel, ?Crime and Punishment?, to assist his own writing. Gonzo journalist Hunter S. Thompson reportedly re-typed ?The Great Gatsby? when studying at Columbia University. Intriguingly, Dr. Ayache?s critical analysis of ?The Black Swan? was specifically structured around Borges? ?Pierre Menard?. Dr. Ayache?s central thesis is that the existing approach to derivative pricing and, ultimately, probability at least as it applies to financial instruments, is incomplete and inherently inadequate. He sees the excesses of modern finance, such as CDOs and CDO2, as a manifestation of an underlying philosophy grounded in probability. Traditional financial theory assumes that risk equates to standard deviation or variance of price changes in a Gaussian (standard distribution) probability framework. Option prices ?derive? from the underlying. Options premiums are either an expression of expected volatility or the ability to dynamically recreate the instrument through trading in the underlying asset. Dr. Ayache argues that the price of stock or an option cannot be based purely on probabilities but must take into account the context. So probabilities are meaningless since contexts keep changing. If a stock is priced at $10 based all the available information, then the price is a function of a unique context and assigned probabilities are only valid for that context. As economic, political and social variables change, new contexts are created. In the new context, the original probabilities may become meaningless, requiring the creation a new set of probabilities to model the new scenarios. In addition, the premise of acting in the market to hedge options of itself changes the context, creating an inherent circularity. The title ?Blank Swan? reflects the fact that as these contexts change unexpectedly and unpredictably, the original probability and its very idea become increasingly meaningless. Dr. Ayache?s solution is to bypass the probability conundrum. He would prefer to think of all options as a special case of a deeper generalised problem of contingent claims. Pricing then becomes a function of what people today value different payoffs, using any tractable logical framework available. At an extreme, this implies that there is a market price for a contingent claim that exists independently of probability or options. This recognises a truth that anyone who trades option understands ? option pricing models don?t price options, instead traders use models to recovery the equivalent volatility (the probability parameter) for a given option premium, frequently to derive the delta and other Greeks for hedging. ?The Blank Swan? thesis is reminiscent of the advice of Jacobi, the Prussian Mathematician, to always invert to solve the problem. The thesis is developed through discursive discussions of philosophy, literature, film and practical issues, arising from a trip to a client in Sydney Australia. The book?s approach owes a considerable debt to Roland Barthes? textual analysis and the French Deconstructivist philosophers, like Derrida. The writing style is dense, matching the challenging content. Dr. Ayache told one interviewer that he tends ?to write only the things that will be as difficult to read as they were to write.? Paul Wilmott, the respected derivative researcher, advises on the cover that the book is not recommended beach reading. He counsels reading its in front of a log fire with a large Scotch or several. Economics developed out of political thought and philosophy, eventually branching into macro and microeconomics. Microeconomics spawned financial economics and quantitative finance. In turn, there is now financial sociology and financial philosophy. ?The Blank Swan?, like its namesake ?Black Swan?, may be part of that evolution. Borges in another short story ?The Library of Babel?, similar to his essay ?The Total Library?, wrote about the impoverishment of text through the means of its reproduction. All texts are reproduced in a vast library only because complete randomness eventually produces all possible combinations of letters. Like ?Pierre Menard?, ?The Library of Babel? explores the complex nature of meaning. In ?Pierre Menard? meaning depends on context of the work while in ?The Library of Babel? meaning is a function of randomness, as the library contains all possible works. ?The Blank Swan? can be interpreted as ?Pierre Menard?, ?The Library of Babel? or both. In post modern thought, there is anxiety about the nature of reality. As in all modernism, the problem in finance is the meta level. Modern meta finance creates instruments, like options, abstracted from real things, making traditional concepts of money otiose. In post modernity, the meta level eventually dominates the primary level that it emanates from. Candy floss money of derivatives and securitisation dominates ordinary money creating circularity and self reference. Value becomes driven by itself. New instruments emerge, being traded in huge volumes amongst institutions essentially trading with themselves. They undertake transactions, price them and book fictitious earnings, neglecting to establish whether any of it is real or makes economic sense. The function of money markets to raise and invest money is undermined. The true function of money as a mechanism for exchange, a store of buying power and a measure of value is corrupted. The significance of ?The Blank Swan? is difficult to know, at least now. In another Borges short story ?Death and the Compass?, detective Erik Lönnrot attempts to solve a mysterious series of murders which seem to follow a kabbalistic pattern. The detective finds that his enemy Scharlach has set a trap counting on Lönnrot?s overly developed intelligence to read into the events a pattern. The detective?s over-intellectualising leads to his death. Could it be that ?The Blank Swan? over-intellectualises and creates it own labyrinth from which it cannot escape? After all, financial markets exist simply to facilitate investing and borrowing or make items tradeable to facilitate speculation. The rest, as they say, is ?noise?. Another alternative is Borges? story ?The Garden of the Forking Paths?. Based on the concept of parallel worlds, Borges outlines a series of infinite paths or sequences of events, in which every alternative can co-exist. As we can only take a singular path, our history seems concrete and definitive when it is merely one of a number of possibilities. Has the world of economics and finance already taken a path in which probability, ill considered and flawed as it may be, shapes our framework of activities? Or is there still time in this journey to re-shape our world in the way that ?The Blank Swan? argues? Robert Frost describes this choice in his poem ?The Road Not Taken?. Dr. Ayache has taken the path ?less travelled by? and that is an extraordinary act of courage and self belief. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sun, 05 Sep 2010 11:25:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/9/5/Financial-Babel http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/8/26/Cross-Dressing-in-Political-Economy Anatole Kaletsky (2010) Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis; Public Affairs, New York In their song Lola, Ray Davies and the Kinks sang: ?Girls will be boys and boys will be girls/It's a mixed up muddled up, shook up world/ Except for Lola, L-L-Lola?. A similar cross dressing phase is evident in modern political economy. While the Chinese have adopted Capitalism Chinese style, the West now flirts with Socialism Western style. Political positions are increasingly fluid, as evident from the fact that many public intellectuals, darling Libertarians and Conservatives, seem enthusiastic about the rise of China and its systems. The flux has been marked by the return of old fashioned political pamphlets, calls to arms for particular ideologies. Most are delivered via Internet blogs, T.V. chat shows and the occasional tome, the soapbox and Hyde Park?s Speaker?s Corner now being otiose. In Capitalism 4.0, Anatole Kaletsky, an editor at the Times, former journalist at The Economist, and an economic consultant, argues that the global financial crisis is transforming capitalism. Capitalism 1.0 (the classical era of laissez-faire), Capitalism 2.0 (the Depression and the rise of government intervention) and Capitalism 3.0 (the stagflation of the 1970s and the rise of free-markets) will evolve into Capitalism 4.0. There are a few ?X.1? and ?X.2? interspersed in between. The new release entails a redefined relationship between markets and governments. Mr. Kaletsky argues, perhaps blandly, that this is due to capitalism?s innate ability to adapt and evolve. According to the Kaletsky code, Capitalism 4.0 will require competent and active governments to create the framework for a viable market. It will require governments to manage demand and recognise the imperfections and errors of markets. There is a lengthy list of things that will need to be changed at the political and economic levels to bring the new Xanadu into being. The new order will be characterised by ?experimentation?, where government intervention increases in some parts of the economy, financial markets, but decreases in others, such as education and health. Mr. Kaletsky preaches that if governments use their tools properly a rapid and robust recovery will occur. The arguments and proposals are not novel or original. Many are in active discussion, having been put forward earlier by other authors. The most surprising thing about Capitalism 4.0 is the optimism about policy makers having the ability to make decisions that will improve the system. The policy makers are the same ones that the author vivisects as having failed in the lead up to the current crisis. Capitalism 4.0 is founded on the bedrock of Joseph Schumpeter?s idea of ?creative destruction?. It also sounds ominously like the mixed economy nostrums that all political persuasions have embraced with slight and minor variations in the post World War 2 era. Unfortunately, most people like the creative part of Schumpeter?s formulation, rather than the second less joyful part of the aphorism. Everyone also agrees on a mixed economy, provided that in the mix they are left to make money without interference in good times and bailed out in others. The written form chosen or the size of the work (just over 300 pages) seems insufficient for the breadth of Mr. Kaletsky?s ambitions and unbounded enthusiasms. Capitalism 4.0 lurches uneasily at times from superficiality to excessive detail. The readers will find potions and remedies for everything from correcting deficits, trade imbalances to running the Chinese economy. The author embraces futurism, unafraid to make predictions where others dare not predict. There are forecasts on currencies (the dollar), finance, energy (oil), healthcare, housing, tax and the environment. There is even career advice ? business and financial institutions will stop employing economists, trained in traditional rational and efficient markets. The potted history is standard. The author?s interpretation of it will undoubtedly have supporters and detractors depending on the political colour of the critic. The tone lurches from earnest econo-speak to polemic, branching off occasionally into vituperative attack. Mr. Kaletsky believes that the magnitude of the crisis is largely attributable to George Bush?s Treasury Secretary - Henry ?Hank? Paulson. An entire chapter ?The Economic Consequences of Mr Paulson? (around 8% of the book) consists of an ad hominem attack of Paulson, in particular his decision to allow Lehman Brothers to file for bankruptcy. Despite hyperbole, Mr. Kaletsky claims that Paulson came ?closer to destroying capitalism than Marx, Lenin, Stalin and Mao Zedong combined?, the chapter does not match Keynes? 1925 ?The Economic Consequences of Mr Churchill?, a critique of Sir Winston?s defence of the gold standard. The chapter is self consciously titled after Keynes? piece, a note drawing this to reader?s attention. Mr. Kaletsky sees no inherent contradiction in espousing capitalism?s self renewal process and avoiding periodically violent and destructive failures to impose necessary market discipline. Puzzlingly, he chooses to believe that voters realise that banks are always government supported and will merely now demand that all banks should pay in advance for government insurance. Crises are generally useful in forcing decisions. Crises can be also extremely useful in creating a market, whether needed or superfluous, for big ideas about resolving the ?crisis?, whether real or manufactured. Capitalism 4.0 is one of a glut of these crisis solution works, searching for the next ?big idea?, that will make it onto the best seller list even if it doesn?t change the world or make a difference. The truth of political economy may be simpler. Capitalism simply survives not on its merits but because it avoids the failure of command economies such as Russia, described once as ?Upper Volta with rockets and nuclear weapons?. It also plays to the base instincts of the biological drivers of competition between human animals. It might also be as George Soros observed that at a certain point in cycle ?people continue to play the game although they no longer believe in it.? Politicians are rarely ideological. The process dictates pragmatism and spin in equal measures. The aim is to attain and retain power for as long as possible. In Rome, this meant ensuring the people had food, drink, employment and games. Surprisingly, little has changed in those political dynamics. The chattering classes and commentators may believe that political economy matters. Unfortunately, the only use that politicians have for theory is to either elucidate decisions already made or discredit opponents. Other than North Korea, no country has adopted a pure form of political economy in recent history and that fact is unlikely to change soon. Keynes wanted economics to become a better respected profession on a par with dentistry. We remain some way short of that objective. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Thu, 26 Aug 2010 08:08:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/8/26/Cross-Dressing-in-Political-Economy http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/6/7/Even-More-CrunchPorn--CrashLit Carmen M. Reinhart & Kenneth Rogoff (2009) This Time is Different: Eight Centuries of Financial Folly; Princeton University Press, London Raghuram G. Rajan (2010) Fault Lines: How Hidden Fractures Still Threaten the World Economy Princeton University Press, London Simon Johnson and James Kwak (2010) 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown; Pantheon Books, New York Nouriel Roubini and Stephen Mihm (2010) Crisis Economics: A Crash Course in the Future of Finance; Penguin Joseph Stiglitz (2010) Freefall: Free Markets and the Sinking of the Global Economy; Allen Lane, London Robert Pozen (2010) Too Big To Save: How to Fix the U.S. Financial System; John Wiley, New Jersey Yves Smith (2010) ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism; MacMillan Thomas Carlyle, the Victorian historian, christened economics the "dismal science". In Eat The Rich, P.J.O?Rourke described economics as "an entire scientific discipline of not knowing what you?re talking about." One can only quibble with the word "scientific". The publisher led recovery ? "crunch porn" or, more kindly, "crash lit" - in the global economy has entered a new and more dangerous stage. Economists have begun to hold forth on the problems. Keynesians, Monetarists, Cavaliers, Roundheads and Vegetarians are stirring to give their own views of reality and putative solutions. Worryingly, at least two of the books are now in the Best Seller lists for Business Books. A key characteristic of the emerging tidal wave of books is the fact that almost everyone saw the writing on the wall, predicted the crisis and now moreover have solutions that can ensure that this was the crisis to end all crises. Unfortunately in the prediction stakes no economist can claim the prescience of Pope Benedict XVI. According to Italian Finance Minister Giulio Tremonti (as reported on Bloomberg News (20 November 2008)), the Pope, then merely Cardinal Joseph Ratzinger, in an article written in 1985 predicted that "an undisciplined economy would collapse by its own rules". It is unclear which crisis the Holy Father was predicting, but given papal infallibility, probably all of them. In the wonderfully titled "This Time is Different", Carmen Reinhart and Kenneth Rogoff expand on their recent academic papers and empirical work on "eight hundred years" of financial crises. Marshalling a mind numbing array of statistics and data, the authors find similarities between financial crises. Their conclusion is that the cause is excessive debt accumulation by government, banks, corporations or consumers. The combination of excessive leverage and short-term debt lies at the heart of the problem. If you are unsurprised at the predictable conclusions, "This Time is Different" provides solid empirical support for the intuitions. The book misses an essential point "This Time is Different" depends on identifying the correct base precedent that is being used for the economic state being studied. The interesting part of the book is the evidence of what happens after a financial crisis. The authors show that severe financial crises share the following characteristics: Declines in real housing prices averaging 35% over six years. Equity prices fall an average 56% over 3.5 years. Unemployment rises an average of 7% during the down phase with average length of four years. Output falls more than 9% over a two-year period. Government debt increases an average 86% in real terms, as a result of the collapse in tax revenues, counter-cyclical fiscal policy efforts and spiking interest rates. So much for a ?V? shaped recovery! But "this time is different". To prevent future crisis, Mrs Reinhart and Mr Rogoff propose a new global financial regulator and improving the IMF (Mr Rogoff?s former alma mater where he was once chief economist). Puzzlingly, they are not optimistic about their reforms: "The persistent and recurrent nature of the ?this-time-is-different? syndrome is itself suggestive that we are not dealing with a challenge that can be overcome in a straightforward way." Raghuram Rajan, Professor of Finance at the University of Chicago Booth School of Business and former chief economist at the IMF (there seem to be a lot of those going around!), did warn about the risk of the global financial crisis. His early warnings led to the economist?s version of a duel at dawn (only with irony and sarcastic epigrams) at a conference held at Jackson Hole. In "Fault Lines" Professor Rajan?s focus is on deep-seated problems in the global economy, including the absence of income growth, employment, health care and the problems of global capital and trade imbalances. Bravely, he argues that the over borrowing that caused the problems was an entirely ?rational? response to a deeply flawed economic and financial system. He also identifies growing inequality as a theme in the problems. He argues that these "fault lines" are the real problems rather than a group of greedy bankers taking irrational risks. The "Fault Lines" position on bankers is at odds with "13 Bankers", co-written by Professor Simon Johnson and James Kwak, a former McKinsey consultant. Expanding on their earlier Atlantic Monthly piece "The Quiet Coup", the authors outline the thesis that big banks, especially in America, have used their economic power to gain political power. The economic power of the banks derives from their growing importance in the broader economy as measured by share of corporate earnings and stock market capitalisation. This economic strength is then leveraged using lobbying, campaign contributions and the transition of staff between Washington and Wall Street. "13 Bankers" sees a conspiracy in this arrangement and also considerable danger. Like all good conspiracy theories there is some validity in the argument. Suggestions of political influence and a palpable lack of transparency in recent government actions to bail out banks have emerged. There are allegations that the Henry Paulson, the previous U.S. Treasury Secretary, may have "pushed" Bank of America to consummate its controversial acquisition of Merrill Lynch when it sought to withdraw after additional losses came to light. The "closeness" between banks and government officials and regulators that has been exposed is increasingly part of the problem in dealing with the real issues. The thesis in "13 Bankers" is similar to the work of Mancur Olson, the American economist. In his books ("The Logic of Collective Action" and "The Rise and Decline of Nations"), Olson speculated that small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The policies result in benefits for the coalitions and its members but large costs borne by the rest of population. Over time, the incentive structure means that more distributional coalitions accumulate burdening and ultimately paralysing the economic system causing inevitable and irretrievable economic decline. Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, may illustrate Olson?s thesis. Active well funded lobbying efforts and "regulatory capture" is impeding necessary actions to make needed changes in the financial system. "13 Bankers" is grounded in a traditional American fear of a financial oligarchy, dating back to the fights between Thomas Jefferson and Alexander Hamilton over the "Bank of the United States" and Franklin Roosevelt?s Depression-era regulation of finance. While American banks may certainly be powerful and highly influential, the case for a conspiracy is not entirely convincing. Bankers are keen to pick the pockets of anybody including each other. The highly nuanced differences in the positions of individual banks are unlikely to be consistent. Bankers agree and disagree with each other on about the same number of issues. One online commentator noted the intersection between Wall Street, Constitution Avenue and Main Street was best named: "Confusion Corner". In addition, the potential risks of such a powerful clique are not fully explained. Large banking and other industrial complex dominate many nations and economies with not always negative consequences. The authors? remedy is to cap the size of banks as a percentage of the economy. This may not be effective without reform of campaign finance rules, restrictions on political appointees to many positions, reform of the central banking system and other measures. Nouriel Roubini (who had inherited the mantle of "Dr Doom" from Henry Kaufman) also predicted the global financial crisis. In case you didn?t know this, statements like the following ensure you are left in no doubt: "Roubini?s prescience was as singular as it was remarkable: no other economist in the world foresaw the recent crisis with nearly the same level of clarity and specificity." The problems of joint authorship and reference to only one of them presents challenges within the English language. In "Crisis Economics", Professor Roubini with co-author Stephen Mihm take a distinctly Minsky line in analysing the global financial crisis. They argue that financial crises are the result of a confluence of historical and economic factors. Building on Hyman Minsky?s "stability is itself destabilising" hypotheses, "Crisis Economics" blends economy theory, behavioural economics and agency theory to try to explain the present crisis. The authors conclude that financial systems are inherently fragile and prone to collapse. Interestingly, while it is wary about the value of theories, statistics and mathematical economics and finance, "Crisis Economics" argues that crises are not only predictable, preventable and, with the Roubini/ Mihm brand medicine, curable. Professor Joseph Stiglitz?s "Freefall: Free Markets and the Sinking of the Global Economy" and Robert Pozen?s "Too Big To Save: How to Fix the U.S. Financial System" focus less on the cause of the crisis than on solutions. Professor Stiglitz believes that the origins of the present crisis lie in neo-liberalism and its fascination with free markets and de-regulation. Correcting these problems, Professor Stiglitz produces an extensive list of policy reforms. On the way, the author launches into often abrasive attacks of the government actions to date. The analysis of the causes of the crisis is not original. His criticisms of policy actions range from insightful to assertions that need supporting facts. "Freefall?s" call to action disappointingly ends rather tamely in a serious of well-worn prescriptions for stronger regulation (by the same apparatus that caused the problems) to correct market failures. Somewhere, Professor Stiglitz finds the time to argue for a less materialistic society and adoption of something akin to Bhutan?s measure of Gross Domestic Happiness ("GDH"). "Too Big To Save" is light on causes (thankfully) and long on lengthy lists of proposals. The proposals themselves focus on analysing alternative models for government stakes in banks, new board structure for large financial institutions, jurisdictional issues over systemic risks and the securitisation of loans. None of the proposals are startling or differ much from that offered by others. Some are in the process of being implemented. Both "Freefall" and "Too Big To Save" tend to telesis ascribing events to innate, inexorable facts. Reality is far more nuanced than such a simple view of history. Perhaps this why economists generally tell you tomorrow why what they forecast yesterday didn?t happen today. Both books also embrace regulation and regulators freely whilst being critical of regulators as lacking in skills and beholden to special interests. The faith in government activism is perverse. It fails to consider why a new set of rules will necessarily be more effective and existing regulators will be able to deal with complex issues well above their pay grades. This is particularly the case when the same regulators failed in the very same tasks in the lead up to this crisis. This dissonance is striking. In "ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism" Yves Smith, the creator of the Naked Capitalism website, provides an edgy and interesting antidote to the other books on offer. It is an anti-economics economics book that explores the failures of the discipline itself as revealed by the global financial crisis. Ms Smith argues, consistent with Professor Rajan, that the proximate causes (excessive leverage, global imbalances and model failures) are symptomatic of deeper financial problems. "ECONned" focuses on a central issue - the role of economists as policy-makers and the weaknesses of economic thought. The thesis is that economists, some in key policy making roles, relied on dogma ignoring the dangers that eventually led to the financial crisis. The book?s coverage of the sequence of errors, misrepresentations and rationalisations of poor outcomes and instability is revealing. "ECONned" is strongest in its coverage of the role played by economists in the crisis and the flaws in the widely used financial models and concepts that created the conditions for the crisis. The books, with the exception of "This Time is Different" which lurches around a space time continuum that would have made Dr. Who giddy, are primarily American in focus. For the main part, the world ends appears to end at the Atlantic and Pacific Oceans (Mexico and Canada are American off-shoots in any case). American exceptionalism extends to financial crises or it must seem to the reader. The style of these books varies. The tone is mostly the desiccated drone (reminiscent of John Cage?s experimental work from the 1960s). Some are deliberately academic in tone to achieve the correct type of unreadability. One assumes that they are weapons deployed in the dawn duels between economic scholars. "This Time is Different" is not wholly successful in condensing its stupefying density of data and facts into an accessible tract. The book favours the repetition of minimalist music. Aaron Brown (who authored a less than complimentary review in the Wilmott Magazine) noted that the book uses the word "inflation" 154 times, "default" 220 times and "crisis" 253 times. It also repeats the title phrase "This Time is Different" from time to time in a form of economic incantation. "Freefall" reads like a 19th century pamphlet with equal measures of vitriol, self-righteousness and broad prescriptions. "13 Bankers" and "ECONned" are written intelligently with the non-technical layman, rather than the "econo-wonk", in mind. It seems that the global financial crisis is the economist?s moment in the sun. They are busily "solving" the problem, sometime with pet theories or, more often, rehashing old ones. Unsurprisingly, there have been spats between economists with allegiances to different camps. Most notable fights include Paul Krugman versus Stephen Roach, Martin Wolf versus Niall Ferguson etc. If Friedman had been alive, then it would have been Milton versus all comers. If Keynes had been alive, then the jousts would have at least been witty and cultured. No modern economist can touch Keynes and John Kenneth Galbraith for pungent wit. Most economists, it seems, believe strongly in their own superior intelligence and take themselves far too seriously. In his open letter of 22 July 2001 to Joseph Stiglitz, Kenneth Rogoff identified this problem: "One of my favourite stories from that era is a lunch with you and our former colleague, Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, "Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?" I responded something to the effect of "Well, he was arguably the greatest Federal Reserve Chairman of the twentieth century" To which you replied, "But is he smart like us?" Economists have delusions of adequacy and a related assured self-confidence that they bring to any problem. Rogoff went on note that in one of Stiglitz?s books ? "Globalisation and its Discontents": "? I failed to detect a single instance where you, Joe Stiglitz, admit to having been even slightly wrong about a major real world problem. When the U.S. economy booms in the 1990s, you take some credit. But when anything goes wrong, it is because lesser mortals like Federal Reserve Chairman Greenspan or then-Treasury Secretary Rubin did not listen to your advice." Rogoff concluded that Stiglitz was "? a towering genius. Like your fellow Nobel Prize winner, John Nash, you have a "beautiful mind." As a policymaker, however, you were just a bit less impressive." Writing in his preface to Benjamin Graham?s "Intelligent Investor", Warren Buffet observed that: "?not only does a sky-high IQ not guarantee success but it could also pose a danger?I therefore urge the relevant regulatory bodies of the United Studies and Canada to incorporate an IQ test into their securities licensing exams. ? nobody would be allowed to work in the financial markets in any capacity with a score of 115 or higher. Finance is too important to be left to smart people." One could add economics should definitely never be left to economists. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Mon, 07 Jun 2010 09:56:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/6/7/Even-More-CrunchPorn--CrashLit http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/5/22/The-Human-Touch Michael Lewis (2010) The Big Short: Inside the Doomsday Machine; Allen Lane John Lanchester (2010) Whoops! Why Everyone Owes Everyone and No One Can Pay; Allen Lane Roger Lowenstein (2010) The End of Wall Street; Allen Lane Vicky Ward (2010) The Devil?s Casino: Friendship, Betrayal, and the High-Stakes Games Played Inside Lehman Brothers; Wiley Harry Markopoulos (2010) No One Would Listen: A True Financial Thriller; John Wiley Modern finance is generally incomprehensible to ordinary men and women. The level of comprehension of many bankers and regulators is not significantly higher. It was probably designed that way. Like the wolf in the fairy tale: ?All the better to fleece you with.? In a thoroughly post-modern contradiction, this incomprehensibility creates a market for a literature that pretends to explain the inner workings of arcane finance. The average reader is not only happy to be stripped of his or her saving in every which way but is also willing to fork out further money to read how it was all done. The latest books on the global financial crisis inhabit this strange no man?s land between fiction and non-fiction writing. Like all things, the writing is formulaic. Central to these works is the idea of the ?human touch?, entailing the humanisation of money. It involves characters that the readers can identify with or hate and an overly Manichean perspective of the world where preferably good triumphs over evil. In ?The Big Short?, Michael Lewis returns to the world of finance. In fact, Lewis self-consciously uses a lunch with John Guttenfreud, the head of Salomon Brothers during his time in banking in the 1980s featured in his earlier work, as a framing device in his story. The inevitable question is how does it compare to ?Liar?s Poker? (the gold standard for the genre). The answer is complicated. Unlike ?Liar?s Poker? which was based on his direct experiences, ?The Big Short? is a highly contrived narrative focused on a group of individuals who prospered from the collapse of the sub-prime mortgage market. Lewis uses their experiences to explore and explain the world of mortgage lending and the excesses of banks. Lewis? highly polished writing style makes ?The Big Short? an easy and compelling read. As in ?Liar?s Poker?, the book succeeds in providing a feeling for the times and some of its dynamics. His choice of characters to portray varies. Perhaps the most interesting is Dr. Michael Burry, a neurologist who becomes a fund manager. Burry is also a self diagnosed Asperger Syndrome sufferer. It seems that all the fashionable people suffer from this condition ? witness Lisbeth Salander, the heroine of Steigg Larsson?s Millennium trilogy. The coverage of Burry?s personal travails and especially his relationship with his own investors as well as banks is interesting. ?The Big Short? lacks the raw vibrancy of ?Liar?s Poker?. It also lacks the immediacy of the first person narrative and the first-hand knowledge that made the earlier book interesting. The technical details of the instruments and markets described are superficial. Lewis uses the book to espouse his theory that the woes of Wall Street derive largely from the shift from partnerships to publicly owned investment banks. This view of the issues is simplistic. Parts of the book derive from a series of pieces that Lewis wrote for various magazines giving it, at times, the feel of a magazine article that has been extended or a series of shorter pieces that have been amalgamated. In the final analysis, ?The Big Short? is a wonderful piece of ?Faction? ? neither history nor fiction, neither accurate nor seeking the real truth. Lewis constructs a conventional tale of fear, greed and stupidity and the triumph of good over evil without ever attempting to get to the heart of the problem. In doing this, Lewis caters, one suspects, to the audience that he now serves. As Guttenfreud correctly states that ?Liar?s Poker? made Lewis? career while destroying his. Lewis is now referred to routinely as a ?master story teller? ? therein may lie a problem. A journalist and novelist, John Lanchester started studying financial markets as research for a potential novel. ?I.O.U.: Why Everyone Owes Everyone and No One Can Pay? (the American title) or ?Whoops: Why Everyone Owes Everyone and No One Can Pay? (the non-American title) is his take on the unfolding global financial crisis, which was in the author?s view ?the most interesting story I?ve ever found.? Perhaps Mr. Lanchester should get out more often. In what also sometimes reads like an extended magazine article (Mr. Lanchester contributes to The New Yorker and The New York Review of Books), ?Whoops? presents a personalised perspective on the author?s journey of discovery. There is little new here but an understated, humorous, jokey writing style and a gift for the telling phrase enlivens the book. For example, Mr. Lanchester describes the fall of the Berlin Wall and the integration of socialist economies as: ?The jet engine of capitalism was harnessed to the oxcart of social justice, to much bleating from the advocates of pure capitalism?.? The rise of credit default swaps attracts the following comment: ?It's as if people had used the invention of seat belts as an opportunity to take up drunk driving.? In ignoring the tell tale signs of the risk of Madoff?s promises, officials failed to recognise ?a critically important category of funny smells.? The book is at its best when it is personal. Mr. Lanchester?s father was a banker with the then Hong Kong and Shanghai Banking Corporation. The recollection of his father and his childhood fear of ATM sometimes creates vivid imagery for the abstract world of money. Mr. Lanchester?s writing about the obligatory fieldwork visiting Baltimore, where thousands of borrowers have had their homes repossessed, is, at times, moving. Like Lewis, the book is skimpy on details and is superficial in its understanding of the financial horror stories that underlie the current problems. Mr. Lanchester finds the mystical belief in Alan Greenspan, the former Federal Reserve chairman, and the self-regulating power of the markets fascinating. Unfortunately, the Greenspan legacy and Rand-ian belief system is more nuanced than ?Whoops? describes and has been more effectively covered elsewhere. ?Whoops? reaches the conclusion that the current problems are ?climatic? where a confluence of weather systems (free market capitalism, regulatory failures, belief in mathematical finance and global imbalances) are the primary culprits. Mr. Lanchester finds the world of finance and financiers odd: ?One of the peculiar things about the world of finance is that it freely offers the sensation of being proved right to its participants ... One of our culture's deepest beliefs is expressed in the question 'If you're so smart, why ain't you rich?' But people in finance are rich ? so it logically follows that everything they choose to do must be smart.? In ?End of Wall Street?, Roger Lowenstein, author of ?When Genius Failed?, the history of the collapse of uber hedge fund LTCM, undertakes a more conventional narrative about the financial crisis. The ?human touch? in ?End of Wall Street? comes from behind the scenes episodes - Jim Cramer, Ben Bernanke?s meanderings and, predictably, Alan Greenspan. Lowenstein draws a chronological arc focusing on the excesses of the mortgage market (built around discussion of the rapid growth of Fannie Mae and banks), the Bear Stearns problems, the Lehman collapse and the government?s rescue actions. In its historical analysis, ?End of Wall Street? follows and is similar to other preceding books that record the same history. Lowenstein writes well and his access to the luminaries who play key parts illuminates the tale. As in ?When Genuis Fails?, Lowenstein attempts to draw significant deep conclusions from the immediate events. In his book about LTCM, it was about the failure of models and quantitative models and, to a lesser degree, of hedge funds. But hedge funds and quantitative finance grew and prospered post LTCM. Even John Meriwether went on to form JWM Partners that duly had problems in 2008. In ?End of Wall Street?, Lowenstein tries to extrapolate from current events to predict the changes in investment banking and financial business models. Events over the last twelve months perhaps detract somewhat from that thesis as the ?Street? has rediscovered old ways. As Andy Serwer, Managing Editor of Fortune put it: ?The party is over until it comes back again?I?ve been around long enough to see that we have these cycles. These guys get their cigars and champagne. They have a great time. The whole thing blows up. But then they re-emerge years later. This one is a really bad one. But I don?t think Wall Street is dead.? [Abbie Bordeau, David Fitzpatrick and Scott Zamost ?Wall Street: Fall of the Fat Cats? (17 October 2008) cnn.com] Perhaps, the only truism about bankers and traders is that along with cockroaches and rates they would be the survivors of a nuclear explosion. In ?The Devil?s Casino?, Vicky Ward, a contributor to Vanity Fair magazine (a noted publication with ordinary people as its target), explores the human side of Lehman Brothers and its culture over the last quarter of a century. The conclusions are unsurprising and the picture of a macho, self delusional culture is consistent with that at any investment bank. Ward does not uncover any secrets, details of illegality or new information about the principal players in her book. Ward paints a picture a tight cabal of ?lifers? whose views shape and determine the business and strategy of Lehman brothers. Ms. Ward?s sometimes entertaining account is at its best in the chapter titled appropriately ?Lehman?s Desperate Housewives?. The portrait of a rigid, highly controlled and manipulative culture of ?Stepford Wives? is engaging. But the portrait would be the same for any spouses of any large corporate organisation. As a first person narrative based on the author?s own experiences, ?No Open Would Listen? is different from the other books. It also benefits from its focus on a single subject ? Bernard Madoff?s Ponzi inspired ?hedge fund? and Harry Markopoulos? quest to expose the fraud. Shown the exemplary returns of a fund run by Bernard Madoff, Mr, Markapoulos, an analyst at a small Boston firm, detected what John Lanchester would term a telltale ?funny smell?. Attempting to unravel the secrets of Madoff?s money machine, Mr. Markopooulos found the world?s largest Ponzi scheme. The most interesting part of ?No Open Would Listen? is his attempt to bring the fraud to the attention of the Securities and Exchange Commission (?SEC?). Despite no less than five separate efforts, the SEC failed to follow up and take any enforcement action. Mr. Markapoulos sees the failure as driven by ignorance, incompetence, arrogance and lack of willingness to take on a former chairman of NASDAQ and an industry grandee. Given Madoff?s scheme took in more than $40 billion between Mr. Markapoulos? first letters to the SEC and Madoff?s eventual arrest in December 2008, this would have to be one of the greatest regulatory failure in history by a considerable margin. Despite a writing style that owes more to Gestalt sessions or accounting (his profession) than Shakespeare, Mr. Markopoulos? tale provides considerable insights to the factors that created the conditions for the global financial crisis. The burgeoning literature about the global financial crisis targeted at the mass-market audiences is increasingly focused on tales of excess, greed, brilliance and stupidity. They are based on narratives about good and evil and success against the odds. They are also simplistic, frequently factually incorrect and can be misleading. Readability combined with a celebrity, ?brand name? author (and the critical media access it provides) is now the accepted formula for fitting a narrative to important events. The vast majority of people of limited financial literacy, it seems, prefer to be entertained by well-told familiar stories from well-known authors rather than strain their synapses for the truth. As growing public apathy to the financial and environmental problems of the world shows, the public is content with an anodyne and airbrushed version of reality. The literature of the age accepts rather than challenges this view. As Frederick Neitzche wrote: ?To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown -- the first instinct is to eliminate these distressing states. First principle: any explanation is better than none?? It is perhaps not the end of Wall Street but it surely getting close to the end of the road for books about the financial crisis. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sat, 22 May 2010 23:58:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/5/22/The-Human-Touch http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/4/25/Rand-World Jennifer Burns (2010) ?Goddess of the Market: Ayn Rand and the American Right? Oxford University Press One of the strange by-products of the publishing boom around the global financial crisis is the revival of the Ayn Rand?s reputation. The sales of her books, such as ?The Fountainhead? and especially ?Atlas Shrugged?, the 1957 novel that for libertarians is the marker for the rise and failure of collectivism, has risen sharply outperforming most living writers and most recent contributions. The spike is neither unexpected nor surprising. The rise in fortune coincides directly with massive state intervention in the economy following market failures in the fallout from the financial crisis. As one recently formed group on the social networking site, Facebook, expressed it: ?Read the news today? It?s like ?Atlas Shrugged? is happening in real life?. The writer just forgot to add the ?Oh boy!? at the end of ?Read the news today?? to complete the nostalgia. For some, the future predicted and feared by Rand is coming true. Alan Greenspan?s downcast admission in Congress about the failure in his view of the world echoed similar admissions by the character, Robert Stadler, the gifted physicist in ?Atlas Shrugged?, who had betrayed his faith cravenly in exchange for political favour. The fact that Alan Greenspan was once a member Rand?s circle merely added to the parallels. Ayn Rand was a trenchant critic of the popular collectivism movements of the twentieth century. Her view was always resolutely pro-individual and anti-government. Rand helped shape the libertarian self image ? the gifted individual restricted, brought down and in permanent conflict with power hungry bureaucrats, officials and the untalented ?second handers? who populate life. Born Alisa Rosenbaum, Rand, a Russian Jew, had first hand experience of the Communist revolution and it effects on her native land. It shaped a philosophy that was fervently anti-communist and devoted to the rights and liberty of the individual. An experienced scriptwriter, Rand shaped her two major novels less as literary works and more as vehicles for her polemic. In her time, the academic establishment found her views to be shallow and limited. Perhaps one reason was her strident criticism of everybody including people whose views were not dissimilar to her own, such as Hayek. She, it seemed, found it impossible to agree with anybody even if they agreed with her. Her writing never rose to high standards. The stereotyped characters in her novels were poor caricatures. These weaknesses did not detract from a unique popular appeal. In ?Goddess of the Market?, Jennifer Burns identifies the source of her appeal. The very shallowness of her thinking that intellectuals dismissed was inherently attractive to a certain sensibility, especially adolescents. Her absolute values and intolerance are attractive to those who prefer a Manichean worldview. Rand?s popularity also derives from her correct insight that thriving societies are not possible without freedom, entrepreneurial abilities and innovation. This fact is most evident in China?s embrace of market economics to some degree. Rand?s popularity is also in no small part driven by her greatest talent - creating mystique and self-promotion. Rand anticipated the cult of ?celebrity thought leadership? (practised by Richard Gere, Madonna, Bono, Bob Geldorf and others) even before the terms existed. Her power came from her greatest creation ? Ayn Rand herself. Highly deliberate, Rand cultivated a distinctive image. She had a glare according to a magazine profile that ?could wilt a cactus?. She wore a broach in the shape of a dollar sign. As Ms Burns writes, her personal life completed the imagery. Her long-suffering husband had to wear a bell on his shoe to ensure that Rand could hear him approach. She informed both her husband and Mrs Branden of the arrangement whereby she met and had sex with her leading acolyte, Nathaniel Branden, twice a week. Ms Burns identifies the internal contradictions of Rand. Within her inner circle (known ironically as ?the collective?), the promoter of individual liberty could not tolerate dissent of any kind. Her stifling worldview encompassed everything from politics to interior design and dancing. Despite her following, Rand never succeeded in creating a lasting legacy or political movement. The collective fell apart when she fell out with Branden. In ?Goddess of the Market?, Jennifer Burns, Assistant Professor of History at the University of Virginia, provides an insightful and, at times, entertaining perspective of Ayn Rand and her thinking. Ms. Burns has fashioned an interesting portrait of one of the twentieth century?s most fascinating and yet Quixotic figures. Rand?s influence lives on in her book and also in the watered down elements of her libertarian philosophy that has penetrated liberal political thinking. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sun, 25 Apr 2010 05:45:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/4/25/Rand-World http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/4/11/Liquid-in-Every-Sense Zygmunt Bauman (2007) Liquid Times: Living in an Age of Uncertainty; Polity Press, Cambridge Zygmunt Bauman (2010) Living on Borrowed Times; Polity Press, Cambridge Alex Preda (2009) Framing Finance: The Boundaries of Markets and Modern Capitalism; University of Chicago Press, Illinois Karen Ho (2009) Liquidated: An Ethnography of Wall Street; Duke University Press, Durham and London Money is deeply embedded in and inseparable from the cultural and psychological environment within which it is used. The debate about ?efficient markets? and ?rational actors? is really about the deeper belief systems that underlie modern economies. In recent years, an increasing literature in the sociology of finance has developed. While sometimes not easily accessible, this body of work is often far more insightful about the global financial crisis than the work of economist and financiers. Resident in England after being driven out of Poland by an anti-Semitic campaign, Zygmunt Bauman is Professor of sociology at the University of Leeds. In his later works, such as ?Liquid Times? and ?Living on Borrowed Times?, Professor Bauman examines two different but interrelated issues ? ?post modernity? and ?consumerism?. Professor Bauman?s central thesis is that in the latter half of the 20th century the world shifted from a society of producers to a society of consumers. Security was given up to enjoy increased freedom to purchase, to consume and to enjoy life. Professor Bauman uses the metaphors of 'liquid' and 'solid' modernity to capture this shift. Financial market?s obsession with liquidity and the word?s specific significance within finance is noteworthy. In contrast with its ?solid? shape, ?liquid? modernity created new and unprecedented challenges. Social forms and institutions no longer had enough time to solidify into accepted frames of reference for human actions and long-term plans. Individuals now had to be flexible and adaptable, pursuing available opportunities. Liquid modernity required calculation of the likely gains and losses of acting (or failing to act) under conditions of endemic uncertainty. The rise of financial markets and financialisation of everyday life is the irresistible result of liquid modernity. The rise of debt fuelled consumption and speculation derives directly from an uncertain world where risk taking is an essential survival strategy. The shift from the solidity of welfare statism to the liquid neo-liberalism is seen as a direct extension of this process. Professor Bauman?s concerns are primarily social and cultural . He writes compellingly about the effect of declines in social safety nets and the increase in economic insecurity. Bauman describes a process in which individuals must desperately reinvent themselves through consumption. ?What the denizens of the liquid-modern world quickly find out is that nothing in the world is bound to last, let alone last forever. Everything is born with a brand of imminent death and emerges from the production line with a use-by date printed or presumed.? The readiness to discard extends to people who we do not recognise as fellow human beings - migrant workers, immigrants or terrorist suspects. ?It seems all things, born or made, human or not, are until-further-notice and dispensable.? He concludes that consumerism and debt offers individuals a self-perpetuating illusion of utopia. ?Liquid Times? and ?Living on Borrowed Times? offer deep insights into post-modern life. Specifically, it exposes the essential social and philosophical changes that lie at the heart of the conditions that led to the global financial crisis. ?Framing Finance? focuses on the history of markets. It tries to understand how the idea of the market that underpins modern economics developed from a social and cultural perspective. The author, a sociologist, provides rich insights into how speculation moved from a declasse activity into a central pillar of modern life. The book is particularly interesting in showing how various devices or strategies were crucial in legitimising finance and trading. Professor Preda?s discussion of the employment of mathematics and market data to create a pseudo-scientific aura around money is enlightening. It also provides valuable insight into the origins and traps of quantitative finance. ?Framing Finance? provides an interesting focus on how culture and imagination shaped and in turn were shaped by markets and their model. ?Liquidated: An Ethnography of Wall Street? uses the techniques of modern anthropological study to observe and comment on financiers, especially investment bankers and traders. Professor Karen Ho created this interesting study based on her personal experience of working on Wall Street and classical field study techniques. Observing the behaviours of bankers in Manhattan was perhaps no less enlightening but less glamorous and less exotic than studying rituals of remote Kazakh tribes (a field once favoured by Gillian Tett, now Assistant Editor of the Financial Times). Professor Ho describes the banker?s worlds in a non-judgmental way and tries to provide a holistic view of how the culture works. As her fieldwork was undertaken before the global financial crisis, she does not have a chance to comment of the Chairman of Goldman Sach?s recent observation that bankers were ?doing God?s work?. It would have surely added a religious dimension to banking, worthy of exploration. Professor Ho?s central focus is to try to expose the system of beliefs, reinforced by education and experience that underpins finance. While bankers may not be aware of these, they are present and powerfully shape the world in which they operate. ?Liquidated? highlights certain factors that lie at the core of the global financial crisis. The best and brightest are hired by banks and then brutalised in a form of slave labour for 100 to 140 hours a week. Job security is non-existent and fear of failure is constant. The only part of the equation that makes sense is the pay grades that are obsequious. This amalgamation of forces creates a culture where narrow, short-term self-interest dominates. Creating and selling products of no intrinsic value to people who do not understand them is a direct result of this culture. The title and the underlying concepts evoke Bauman?s idea of ?liquid? modernity. Bankers seek to make assets liquid or tradeable. The inherent contradiction is that they too are highly ?liquid? assets and can be ?liquidated?, living in fear of this eventuality constantly. This brutal world is masked in the narrative of free-markets and capitalism. Bankers cannot reject these ?truths? that are held up as core values even if they are riddled with contradictions. This is because it would essential lead to ostracism from the society and culture and, most important, its monetary and material rewards. While the ideas in these books are fascinating, the writing style is not easy. For example, Professor Ho?s book is derived from her dissertation and it shows, unfortunately. The writing styles can be described, politely, as ?academic?. The conjunction of prolix text and jargon would not be out-of-place on a structured product desk. But it does not increase the readability of these otherwise insightful and interesting works. The culture and societal background of finance are key factors in the financial crisis. To understand and prevent future crisis and human tragedy, these factors need to be understood and managed. The issue of executive compensation and the environment in which they work needs to be changed to avoid perpetuating and reinforcing current problems. As Adair Turner, chairman of the U.K. Financial Services Authority, stated at a meeting of the Future of Banking Commission: ?We simply don?t know whether we really have tools which can change culture.? Unfortunately, bankers or economists generally see George Orwell?s ?Animal Farm? as a tale about farm animals. They are unlikely to challenge themselves and venture into these uncharted worlds. © 2010 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives ? Revised Edition (2010, FT-Prentice Hall). Book Reviews Sun, 11 Apr 2010 00:23:00 --0100 http://www.wilmott.com/blogs/satyajitdas/index.cfm/2010/4/11/Liquid-in-Every-Sense