Home > #OWS, finance, modeling, rant > Alan Greenspan still doesn’t get it. #OWS

Alan Greenspan still doesn’t get it. #OWS

November 8, 2013

Yesterday I read Alan Greenspan’s recent article in Foreign Affairs magazine (hat tip Rhoda Schermer). It is entitled “Never Saw It Coming: Why the Financial Crisis Took Economists By Surprise,” and for those of you who want to save some time, it basically goes like this:

I’ll admit it, the macroeconomic models that we used before the crisis failed, because we assumed people financial firms behaved rationally. But now there are new models that assume predictable irrational behavior, and once we add those bells and whistles onto our existing models, we’ll be all good. Y’all can start trusting economists again.

Here’s the thing that drives me nuts about Greenspan. He is still talking about financial firms as if they are single people. He just didn’t really read Adam Smith’s Wealth of Nations, or at least didn’t understand it, because if he had, he’d have seen that Adam Smith argued against large firms in which the agendas of the individuals ran counter to the agenda of the company they worked for.

If you think about individuals inside the banks, in other words, then their individual incentives explain their behavior pretty damn well. But Greenspan ignores that and still insists on looking at the bank as a whole. Here’s a quote from the piece:

Financial firms accepted the risk that they would be unable to anticipate the onset of a crisis in time to retrench. However, they thought the risk was limited, believing that even if a crisis developed, the seemingly insatiable demand for exotic financial products would dissipate only slowly, allowing them to sell almost all their portfolios without loss. They were mistaken.

Let’s be clear. Financial firms were not “mistaken”, because legal contracts can’t think. As for the individuals working inside those firms, there was no such assumption about a slow exhale. Everyone was furiously getting their bonuses pumped up while the getting was good. People on the inside knew the market for exotic financial products would blow at some point, and that their personal risks were limited, so why not make systemic risk worse until then.

As a mathematical modeler myself, it bugs me to try to put a mathematical band-aid on an inherently failed model. We should instead build a totally new model, or even better remove the individual perverted incentives of the market using new rules (I’m using the word “rules” instead of “regulations” because people don’t hate rules as much as they hate regulations).

Wouldn’t it be nice if the agendas of the individuals inside a financial firm were more closely aligned with the financial firm? And if it was over a long period of time instead of just until the bonus day? Not impossible.

And, since I’m an occupier, I get to ask even more. Namely, wouldn’t it be even nicer if that agenda was also shared by the general public? Doable!

Mr. Greenspan, there are ways to address the mistake you economists made and continue to make, but they don’t involve fancier math models from behavioral economics. They involve really simple rule changes and, generally speaking, making finance much more boring and much less profitable.

Categories: #OWS, finance, modeling, rant
  1. November 8, 2013 at 8:51 am

    Great points that make sense to people just about anywhere on the political spectrum…except for the people inside the Beltway. Beltway types (including those on Capital Hill) are just as responsive to personal incentives as bankers, and their personal incentives with respect to the financial system are largely perverse.

  2. November 8, 2013 at 9:00 am

    As Ellen Brown once wrote, rule (regulations) are just laws and when you remove laws you get criminals.

    As to Greenspan.

    “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” –

    Upton Sinclair

    http://mindcontagion.org/people/alangreenspan.html

  3. November 8, 2013 at 9:42 am

    I actually SAW Greenspan say the first quote, I believe in front of a Senate Committee, as part of a documentary and wanted to throw something at the screen.

    Just wave the wand over it and let’s get back to it (literally)…makes me sick.

  4. Guest2
    November 8, 2013 at 10:31 am

    Not impossible?????

    “Wouldn’t it be nice if the agendas of the individuals inside a financial firm were more closely aligned with the financial firm? And if it was over a long period of time instead of just until the bonus day? Not impossible.”

    Wrong!

    Don’t let your utopian-ideological bent get in the way of brilliant analysis:

    “Adam Smith argued against large firms in which the agendas of the individuals ran counter to the agenda of the company they worked for.” (i.e., Those at the top think and act differently from those at the bottom of the organizational pyramid, sometimes very differently.)

    This is encapsulates the division of labor that Marx so despised.

    Karl Marx dreamed of a society where a man could be “A farmer in the morning, a laborer in the afternoon, and a philosopher in the evening”– an open attack on Adam Smith’s worship of the division of labor in the opening chapter of The Wealth of Nations.

  5. Sally
    November 8, 2013 at 10:37 am

    Thankyou for your clear thoughts, Cathy. I’m no brilliant economist or mathematician or whatever, but I adore your blogs and think your generation is just wonderful and will go far to right the wrongs.

  6. November 8, 2013 at 4:37 pm

    Bob Rubin had to have really done a job on both Greenspan and Summers back then as right now Greenspan is the biggest Algo Dupee in US history. From what I have read on the web and your comments it sounds like Larry Summers was along drinking the same Rubin Kool-Aid he brought from Goldman Sachs. PBS did a really good documentary called “The Warning” and I have it on the Algo Duping page too for content so the layman can see what a “big dupe” is all about:) Bob Rubin has to really know how to work it, all I can say.

    PBS Frontline back in 2009 did a great documentary called “The Warning” good one to watch and it probably has more meaning today than it did then. I think Bob Rubin doesn’t have any political ties, just ties to money and where it can be gamed.

    http://dailybail.com/home/pbs-frontline-the-warning-how-greenspan-summers-rubin-conspi.html

  7. Mark
    November 8, 2013 at 6:59 pm

    Milton Friedman made a very similar mistake in his writings. He brilliantly described how special interests grow up within government, ready to make decisions with other people’s money, but not fundamental committed to the suceess of the government itself – only their pet or crony cause. He cited the responsibility disconnect. But Friedman never once mentioned or even qualitifed his remarks with the same observation of people in the private sector. My experience in the private sector is that everyone is a special interest, and sometimes groups of them caucus within companies to achieve pet causes, promotions, power, money, all of it. It’s naive to think otherwise. They also can be fairly disconnected from the money they spend if the enterprise is large enough. And they can be breathtakingly disconnected from responiibility for the wider economy that makes their private sectror livelihood possible.

    I think, ironically enough, that some of the most supposedly market oriented economists are actually the closest to being isolated in academia and government. As they have been policy wonks their entire lives, they don’t realize how BUSINESS ACTUALLY WORKS. It’s easier to worship the business interest and teh rationality of markets and the power of numerical analysis while cocooned somewhere else at a safe distance.

  8. Mark
    November 8, 2013 at 7:12 pm

    By the way, Greenspan is the Fed Chairman who actually thought it’d be a cool idea to have two separate reglatory agencies writing regs in competition with each other for ‘clients,’ where clients are the entities to be regulated. That is singularly the dumbest thing I have ever heard a financial expert utter, let alone actually do.

  9. alg0rhythm
    November 10, 2013 at 3:01 am

    Eloquently put. It always . Greenspan did note the rise of the corporate and the drift from the private partnerships of the seventies on the Daily Show. Your point about individuals incentives being aligned with a companies seems so laughably obvious, but is a sign of the times’ confusion that it has to be explained.
    Everyone was furiously getting their bonuses pumped up while the getting was good. People on the inside knew the market for exotic financial products would blow at some point, and that their personal risks were limited. I’d venture to say that any sales office, anywhere, any people, end up the same way with that legal setup. People who make decisions in companies should have financial and criminal liabilities. THat today is a radical idea.

  10. jameselgringo
    December 4, 2013 at 9:17 am

    classic book from 1933, free read online, is it in the occupy finance book club? i’d love to hear what greenspan thinks of it. https://archive.org/details/roleofmoney032861mbp

  1. November 9, 2013 at 6:01 am
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