
What's wrong with finance - akg_67
http://www.economist.com/blogs/buttonwood/2015/05/finance-and-economics
======
crdoconnor
>This is where academic theory comes in. The finance sector damages the
economy because it does not function as well as the models contend.

This is rather an understatement. Most neoclassical models (the dominant
strain of economics, despite its demonstrated failure to predict crises)
basically assume that the financial sector doesn't exist.

This is why most economists' reaction was "nobody could see it coming" and
their policy recommendation response to the crisis was " _even_ more of the
same, please" (deregulation, desupervision and de-facto decriminalization).

Then they wonder why people don't respect them any more.

"Hope", as such, does not come from the school of behavioral economics. That
was getting trendy even before the crisis hit and did not help at all.
Personally, I can think of only one economist who is making models that
accurately model the behavior of financial institutions in the macro-economy -
Steve Keen, who is resurrecting and extending upon Hyman Minsky's instability
hypothesis.

~~~
TheOtherHobbes
A lot of "uneducated" people could see 2008 coming. I had many conversations
with people with no economic training who were all thinking "Uh oh..."

The rational conclusion from this is that mainstream academic theory - i.e.
not people like Keen - is a source of collective stupidity.

See e.g.

[http://www.telegraph.co.uk/finance/economics/8089832/We-
cant...](http://www.telegraph.co.uk/finance/economics/8089832/We-cant-predict-
recession-says-Bank-of-England-deputy-governor-Charles-Bean.html)

When untrained people can predict the future more accurately than trained
experts, the training of those experts has _negative social value._

~~~
Ollinson
To paraphrase Nobel prize winning economist Paul Samuelson, everyone has
predicted 9 of the last 5 recessions.

~~~
prostoalex
+1 to that. A lot of people predicted rapid fall of the US dollar following
various stages of QE, and the number of Silicon Valley headlines with the word
"bubble" in them went up significantly in the past 2 years, and yet...

------
cm2187
I think people like to listen to economists because they see them as some kind
of scientists and because when facing uncertainty, most people like someone
who confidently predicts the future, whether it is an economist or a fortune
teller. The reality is that one can't reduce our complex human societies to an
excel formula, and economists are not scientists: they have no way to
absolutely prove or refute any theory. They can only express an opinion in
which one can believe or or not, and which are most of the time based on a
massive over-simplification.

I don't think bubbles need a complex financial system to form (the famous
example of the tulips). And a society can sustain any bubble. A bubble only
really hurts if it is combined with high leverage, as it was in 1929 and as it
was in 2007.

The mechanism by which this leverage is achieved doesn't really matter, it is
the over-reliance on debt we should focus on. That people leveraged themselves
through mortgages financed by CDO^2, by a shadow banking system (p2p loans)
like in China, or by good old banking loans is a technicality.

One can blame the financial industry but the problem is really the addiction
of society to leverage. Banks are merely the drug dealer.

I live in the UK and I am always perplex when I see how natural it is for
people here to mobilise all their financial resources, bury themselves into
debt through all the means possible in order to bid as much as they physically
can on a house. And this is encouraged by the government who pushes for 100%
LTV loans. And when confronted they always respond "it is fine, the property
market only goes up, we just need to get on the ladder". Sure...

Governments are doing exactly the same. The rise of public debt since the 60s
should be absolutely alarming. We have reached war time levels of
indebtedness. How will this not result in a financial collapse?

One can blame bankers and speculators but I think this is missing the big
picture here.

~~~
crdoconnor
>I don't think bubbles need a complex financial system to form (the famous
example of the tulips). And a society can sustain any bubble.

The tulip bubble was small and did not have knock on effects for the Dutch
economy, and for what it's worth, there _was_ a futures market for tulips in
1637. Complex financial systems are not new.

>I live in the UK and I am always perplex when I see how natural it is for
people here to mobilise all their financial resources, bury themselves into
debt through all the means possible in order to bid as much as they physically
can on a house. And this is encouraged by the government who pushes for 100%
LTV loans.

Guess who gets the government to push loans on people?

People take loans and buy a house because they're told by those above them
that it's "the responsible thing to do". This message is echoed around the
media as well.

>One can blame bankers and speculators but I think this is missing the big
picture here.

No, that _is_ the big picture. _They_ are the ones who benefit from an over-
leveraged economy and they are the ones who are pushing for it.

Ordinary people certainly aren't dying to drown themselves in debt, just as
they weren't the ones pushing for student loans. In five years time they won't
be the ones pushing for the student loan book to be privatized either, but
guess what? _Someone_ out there is salivating over it.

~~~
notahacker
Ordinary people certainly are the ones pushing for home ownership, for the
simple reason that when homes are in a serious shortage, it makes a lot of
economic sense to own them if you can commit to the mortgage payments. It's
the same reason as people with no connection to the UK whatsoever and piles of
their own cash to spend think that London property is a good place to park it.

The government is buying electoral support with Help to Buy schemes and Right
to Buy extensions; the fact the banks also like it is incidental.

~~~
crdoconnor
>Ordinary people certainly are the ones pushing for home ownership, for the
simple reason that when homes are in a serious shortage

A) No, they're not.

B) Home ownership _doesn 't solve_ the shortage problem. Actually, it can
exacerbate it because it gives landlords an opportunity to gouge you. Building
more council housing might help, but is that on the table? No. Banks wouldn't
want that. That's rental income that is not being diverted to their pockets.

>The government is buying electoral support with Help to Buy schemes and Right
to Buy extensions;

This is just the most palatable way of giving help to the banks. If electoral
support were what they were _really_ after, they would build more homes to
offset the shortage.

>the fact the banks also like it is incidental.

You misspelled 'central'.

~~~
notahacker
Home ownership obviously does solve the housing shortage for the homeowner,
since (i) they have a home and (ii) the ensuing rise in the cost of housing is
their capital gain; far in excess of any mortgage interest they pay in most
parts of the UK. Hence home ownership being desirable for renters with stable
employment. Which was my point, rather than the straw man you chose to
truncate my sentence to attack.

Help to Buy is tiny in the scheme of banks' balance sheets, huge in the scheme
of the household finances of those wishing to join the majority of Britons in
owning their own home.

------
PaulHoule
Lotsa issues.

If financing (of some kind or another) is available for housing, education or
health care, prices go up. In the case of housing nobody saw this as a
problem: the house my parents built appreciated 10x before we sold it, and
even people who were stuck buying a postage stamp sized house in California
for $1M believed they were going to sell it for $5M.

At some point you have to starve the beast, that's the one thing that works.

It is astonishing how much capital is kicking around doing nothing. There is
this continuous drumbeat that we can't upgrade rural America to optic fiber
for instance, although Apple has the cash to do it and surely it has to be a
better investment than negative interest rate bonds.

There are lots of reason why it doesn't happen and it is not that "fiber is
too expensive", rather it is that Frontier can make $135 a month already
selling me two phone lines and two 1.2 Mbps DSL connections and that Apple has
cozy relations with wireless carriers who wouldn't want any competition for
their $10 a GB money party.

~~~
seanmcdirmid
Fiber to non-dense rural locations would almost certainly cost more than you
are willing to pay, which is part of the reason you pay that much for the
little you are getting now (the other being a lack of competition since the
market is too small to support much diversity). There are plenty of bridges to
nowhere that we can apply capital too, but they won't be good investments.

~~~
PaulHoule
If we'd had that attitude 80 years ago there would be no electricity or phone
service in rural areas.

So far as the cost, when you consider the effect on property values, income
and stuff, the eye-popping numbers for what it costs to wire a house really
are not that much, particularly when you realize services can be offered over
them for 50+ years.

Often those eye-popping numbers are offered as a bluff by providers who don't
want to serve an area. If you work in the IT field, $20,000 to get cable at
your house pays itself back and you can put it on your HELOC if you don't have
it an cash.

The problem here is not just a lack of competition but it is the competition
for capital against bling-bling LTE phones and harvesting old copper wires and
other things that make money quicker.

It is generally the case that government redistributes money from urban areas
to rural, largely because rural areas subsidize urban areas in other ways. For
instance, Silicon Valley would not have the stream of young labor that it has
if there weren't places where people could afford to raise children.

~~~
digi_owl
One wonder if telecom should be handled like roads. Have one set of
cables/fibers put in place by a government entity and then rent it out to all
comers that want to deliver a service over it.

~~~
PaulHoule
That's the best idea. There would be none of these interconnection problems if
you could switch your middle mile provider if they wren't providing good
service to Netflix.

~~~
seanmcdirmid
Ironically, rural voters tend to be more conservative and increasingly
libertarian, so they will never ask for this.

~~~
PaulHoule
Oddly, they will vote for candidates who will push for fiber at the municipal
level, but once you get involved with the Republican machine at the state
level it is about bending over for Frontier.

------
contingencies
Original @
[http://faculty.chicagobooth.edu/luigi.zingales/papers/resear...](http://faculty.chicagobooth.edu/luigi.zingales/papers/research/Finance.pdf)
includes an interesting list of _Fines paid by financial institutions to US
enforcement agencies 2012-14_.

~~~
goodmachine
Great paper indeed, tackles all players in the problem (financiers, theorists,
regulators) unsparingly. Well worth reading.

------
huac
Some of the biggest problems in academia (especially in marketing) now revolve
around similar phenomena of 'momentum' or 'clustering.' It's incredibly
difficult to predict or model this kind of behavior, and even more difficult
to take advantage of these trends. We see the same kind of "well, if we ignore
this difficult-to-model process, then the equations look good" in physics, so
where's the outcry over the Navier-Stokes theorems?

I don't think you can call this a failure of academics, it seems more like
next on a long bucket list of questions to answer.

As an aside -- some of the explanations of M-M and CAPM are wrong, which is
straight up first semester finance.

~~~
makomk
Physics has one major advantage over economics - in physics, the system you're
modelling is not sentient and actively trying to exploit flaws in your model,
whereas we see this time and time again in economics.

------
rwmj
Genuine question for behavioural economists: Has anyone tried to simulate an
entire population's financial transactions yet? Computers are surely getting
fast enough to simulate millions of people interacting. It would let you do
"what if" scenarios without needing an underlying theory (I often suspect the
"theories" around macroeconomics are nonsense).

~~~
digi_owl
I think the closest you are getting are Steve Keen's work with a new dynamic
modelling program called Minsky.

[http://www.debtdeflation.com/blogs/minsky/](http://www.debtdeflation.com/blogs/minsky/)

But frankly trying to model every damn individual is a fools errand. Keen
limits himself to "classes", like workers, bankers and business owners.

------
spiritplumber
If the economy is a power plant, the financial sector is supposed to be its
control system.

The problem is that the control system is now using a non-negligible amount of
the power generated by the plant.

Most economic models make the basic assumption that this is not the case. This
makes them not very useful.

However, they have a lot of social inertia when it comes to getting listened
to.

~~~
digi_owl
Try this instead:

Economy, circulatory system.

Finance, bone marrow.

------
thret
Spellcheckers should really detect repeated sentence fragments. Also 'theiw'.

25 standard deviations has to be an exaggeration? I fail to see how any model
could ever be that far off the mark.

~~~
formulaT
It's just a blog post. Regular economist articles are better edited, but
mainstream economics doesn't make the HN front page.

 _> 25 standard deviations has to be an exaggeration? I fail to see how any
model could ever be that far off the mark._

It's easy to be that far off the mark. E.g. assume a normal distribution for a
fat-tailed distribution.

------
lotsofmangos
_In his new book “Misbehaving: The Making of Behavioural Economics”, Richard
Thaler uses a different term: econs. He writes that “compared to this
fictional world of econs, humans do a lot of misbehaving, and that means that
economic models make a lot of bad predictions.”_

I wonder if he's been reading "Life among The Econ" by Axel Leijonhufvud.
[http://www.econ.ucla.edu/alleras/teaching/life_among_the_eco...](http://www.econ.ucla.edu/alleras/teaching/life_among_the_econs_leijonhufvud_1973.pdf)

------
Htsthbjig
"BOTH financiers and economists still get the blame for the 2007-2009
financial crisis: the first group for causing it and the second for not
predicting it"

Economist worth their name had predicted the crisis and way more. There are
good serious economist out there, but do not look for them in the media,
including the Economist.

It is economists in the media and power institutions who failed to predict the
crisis, on record, because most of them are not as stupid as the look when
they talk.

That is, if you get to chat with them personally, you realize they know pretty
well what is happening. They have the biggest amount of intelligence resources
in the world, and again they use to be very smart. But they can't say what
they know in public as a word for them could bankrupt entire nations.

In the inner circles in meetings in Switzerland cities they are really worried
about what is happening, but then in public they say everything is ok.

Keynesianism had become the non sense dogma of today economist on media and
Universities. If Keynes were alive he would not approve what is being called
Keynesianism today, as you can see if you read Keynes.

~~~
FeepingCreature
If they predicted the crisis, why aren't they rich?

Economics has the remarkable property that if you can see the future coming
better than your peers, you can profit off it. So conversely, whenever
somebody claims in retrospect that they saw the future coming it should be
asked why they didn't profit.

~~~
slavik81
The market can stay irrational longer than you can stay solvent.

Even if you can easily see the inevitable correction coming, it's difficult to
say when it will happen. A powder keg still needs a spark to take.

~~~
FeepingCreature
I want to say "if you can't see when it'll come, you're not really predicting
it", but that's too easy.

I wonder if there's a way to "far-short" a stock. Like, if you think the stock
in question will "eventually" go up to $1k, you can buy now and sell when it
does. But if you think it'll "eventually" drop to $10, you can't easily trade
on that, right?

Maybe the way to go is to buy everything _but_ that stock (via overlapping
index funds?), then sell once the stock drops to $10 and reevaluate from
there? I don't know.

------
pcurve
I think these are symptoms.

I truly believe the root of all of these problems is over investing in
financial instruments like equities, which in turn give power to financial
industry, economists, and CEOs.

------
bawana
are the comments in that article written by humans or spambots?

------
tezza
It's convenient to blame the finance peeps. But wrong.

It is a face saving measure by the people actually responsible, namely Pension
Funds and Government Policy makers in that order.

Pension Funds were chasing returns... and finance types depend on Pension
funding at many levels. Pension funds own 95+ percent of the stockmarket
shares overall and in some cases closer to 100%. Shareholders elect the board
who appoint the staff. Further Hedge Funds do not hedge their own money
exclusively. They sell to outside people, ultimately again mostly coming from
Pension Funds.

Government agencies like Alan Greenspan had the option to use their blunt
tools to control matters via interest rates and perhaps policy changes. They
chose not to do so.

To me it is like a Railway Tycoon shouting "faster faster.." to the train
drivers and then blaming the driver of the day when a massive accident
happens. Even if the driver is reckless... who hired they guy and gave
guidance to ignore the warning signals ??

~~~
crdoconnor
It's convenient to blame the pension funds. But wrong.

Pension funds only started chasing returns _after_ the crisis.

Why did they do that? Because the government made a policy decision to drop
interest rates like a stone.

Why did they do that? Because the too big to fail banks were sitting on a pile
of mortgages without sufficient collateral because of a popping bubble that
_they_ created and they couldn't withstand the potential onslaught of
defaults.

They were exposed and insolvent and in danger of being destroyed unless quick
political action was taken.

Fortunately, for them, quick political action was taken and they were saved
from facing the consequences of their actions. We had to deal with them
instead.

~~~
tezza
Dude, they've always chased returns... It didn't magically start happening
post 2008

The sub funds that Pensions invest in get rewarded according to Alpha... the
amount the sub fund _exceeded_ the main stock price movement.

How is that not chasing returns??

[http://www.investopedia.com/terms/a/alpha.asp](http://www.investopedia.com/terms/a/alpha.asp)

~~~
crdoconnor
Pension funds used to be highly invested in government bonds, which are risk-
free. The risks they did take were, by and large, reasonable and minimal. They
owned some shares as well, of course.

They _weren 't_ taking outsized risks in order to chase an outsized gain -
"chasing returns" as you put it.

2008 changed all that.

Once government debt yields dropped to zero (done to save the bankers' hides),
in order to still maintain the same returns which they needed, they started
chasing returns.

This was more done out of desperation than greed. They had made promises pre-
crisis that presumed the economy would continue as normal - _exactly_ what
economists and bankers of the time promised us would happen.

~~~
tezza
They're highly invested in literally everything. Again they own the shares in
the companies that own other assets. They do buy government bonds as an asset
class but have a diversified approach where they own FX, property etc.

The only non pension funds who own anything substantial are governments.
Private holdings are vanishingly small.

Who do you think owned the shares in the banks that took all the risks? 99%
Pension Funds. Even if the Pension Funds had 85% as Government Bonds, from the
rest they still owned 99% of the banks and hedge funds and private equity.

~~~
crdoconnor
Yes, pension funds do have investments in a lot of things. Some did own
banking shares, too, though banks were not 99% owned by pensioners.

Holding bank shares is a suckers' game, however. Real money is made in
bonuses:

[http://www.cbsnews.com/news/study-bank-bonuses-far-
exceeded-...](http://www.cbsnews.com/news/study-bank-bonuses-far-exceeded-
profits/)

 _Control_ is more important than holding a share certificate entitling you to
a residual claim on profits.

