THE FUTURE OF FINANCE BLOG

Un-blissful Ignorance of “This Wild Balloon”

November 28, 2010

After my Thanksgiving turkey, I digested two recent commentaries on the financial industry, “Inside Job,” the mostly fair but incomplete documentary narrated by Matt Damon, and the balanced and accurate New Yorker essay, “What Good is Wall Street,” by John Cassidy.

“Inside Job” is not an exciting film – my wife fell asleep halfway through it. But on balance, it offers a reasonable indictment of the modern Wall Street greed-driven culture, unchecked by either asleep or captured regulators. As one would expect in such a film, it plays the entrapment game on several willing, not as smart as they think they are, “thought leaders.”

Newsworthy is the exposure of numerous conflicts of interest within the economics profession at several of the leading universities in the United States. Wall Street has been strategically using well-placed academic economists to dress up their self-interested ideology for years. This tactic was used with great effect as I recall while I was at JPMorgan in the successful battle to rescind Glass-Steagall. It’s about time we shine a light on the practice.

Where the film is unfair is that it paints all of the finance industry with the same brush. I believe most people that work on Wall Street are ethical, certainly as society defines ethics. I know many who rightly become defensive when the entire industry is portrayed as dishonest and greedy. Unfortunately, when a film like “Inside Job” pays no attention to this fact, it forces the good guys to effectively defend the bad guys out of their own self-interest. But this is what one might expect from a Hollywood view down Wall Street.

Where the film misses is in not shining a light on the more fundamental problems with our financial system. With no glimpse of solutions, the viewer is left to conclude that the whole system is not only driven by greed, but that it is corrupt, through and through. I left Wall Street in a formal sense in 2001, and am as shocked as anyone about the increased scale of risk-taking since then, and the unconscionable behavior of many leading firms and individuals. I am no Wall Street apologist. But the transformation of finance so desperately needed must begin with an assessment of the system architecture itself. It cannot rest only on reactionary railing against the bad actors.

In this sense John Cassidy’s essay, “What Good is Wall Street” is much more balanced and accurate. It raises many of the right questions regarding the purpose of finance itself. The image of finance as a “utility” is certainly at odds with the self-regarding of the masters of the universe who populate both investment banking and the trading desks, and it is a useful point of departure. The article highlights Paul Woolley’s excellent work at the Centre for the Study of Capital Market Dysfunctionality – the name says it all – and the hypocrisy of Wall Street CEOs defending the legitimate roll of financing emerging businesses when in truth they make the vast majority of their money financing speculators of all stripes and colors, and trading securities in a secondary market that has at best a second-order (and over-rated), liquidity-enhancing social benefit.

What Cassidy’s piece misses is the underlying sickness in our economy that is driving Wall Street’s insanity: the competitive drive for ever shorter term speculation in the face of increasingly volatile markets that I’ve written about in the past. This is as true of the mangers of 401ks and private endowments who allocate their capital significantly to speculative investment strategies as it is of Wall Street trading desks – well nearly as true.

Policy reform must tackle our seduction into excessive speculation, a vice we’ve been warned about beginning with Aristotle himself and probably before. We have lost the distinction between real investment and speculation, and our policies can’t differentiate effectively. Many policy frameworks, such as the BIS capital requirements, actually encourage (unintentionally) speculation over investment. The pressure for such speculation has been steadily building as liquidity builds up far in excess of the opportunity to put it to productive use given the structural shifts in the economy. We need to stop and think carefully about this.

With the economy deeply sick and fragile, government debt loads exploding as a result of the Wall Street induced meltdown, and with material resource and waste sink limits to growth closing in on us, this pressure will only accelerate in the years ahead. This is why real reform of finance’s fundamental architecture is so critical. This battle will soon shift to the Bank for International Settlements (BIS) Capital and Liquidity Amendments currently under negotiation (and on far too slow of a timeline). Watch the fight erupt over the Liquidity Coverage Ratio in particular, a critical issue we will address in the near future.

The real lesson we need to draw from our recent financial tsunami can be summarized in a word: ignorance.

Until we acknowledge our ignorance about the complexity of the system that rules us, we are guaranteed to fail again. It’s a system that begins with the complexity of the biosphere upon which all life and economics is grounded even though our economic models largely ignore this most important fact of the 21st century. It’s a human economic system in which the decisions and actions of humans do not follow neat predictable “utility maximizing” patterns similar to physics. And it’s a system built on a fundamentally unstable financial and monetary foundation.

We had better shift to the precautionary principle, and begin to live in the chaos, and wonder, of ignorance.

The sturdy capitalist, no matter how deep and square on blocks of Quincy granite he lays the foundations of his banking-house or Exchange, must set it, at last, not on a cube corresponding to the angles of his structure, but on a mass of unknown materials and solidity, red-hot or white-hot perhaps at the core, which rounds off to an almost perfect sphericity, and lies floating in soft air, and goes spinning away, dragging bank and banker with it at a rate of thousands of miles an hour, he knows not whither – bit of bullet, now glimmering, now darkling through a small cubic space on the edge of an unimaginable pit of emptiness. And this wild balloon, in which his whole venture is embarked, is just a symbol of his whole state and faculty.

                                                                                     – Ralph Waldo Emerson, “The Transcendentalist”

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