It happens every December – suddenly it’s Christmas, and then it’s not, and the year is ending. That means it’s time for the retrospectives – all that looking back stuff, looking at the year gone by to try to figure out what the heck just happened.
Of course you get lists, the best of and worst of this and that. And Time Magazine names its person of the year – this time Barack Obama, to no one’s surprise. His election was one for the ages – our first black president, the man who rose from the oddest of families and circumstances to blow everyone away at Harvard Law School, work as a community organizer, jump to the Illinois legislature, then to the US Senate, then run a flawless campaign and defeat the Clinton machine for the Democratic nomination, then to go on and trounce McCain in spite of all the efforts of every sputtering outraged white guy on talk radio and Fox News, and in spite of the McCain folks staffing up with all of Karl Rove’s guys and choosing the extraordinary Sarah Plain as McCain’s running mate. She was a pip – boastfully uninformed and a bit ditzy. Of course, as expected, Tina Fey Voted AP Entertainer of the Year.
And Obama will take the oath of office on the Bible that Abraham Lincoln used at his inauguration so long ago. Things come full circle. The Civil War is finally over, and Sarah Palin can see Russia from her porch. That was quite a year.
But then the economy collapsed. That may be putting it mildly.
Many of us have friends who work on Wall Street, or used to. None of them have seen anything like this before. We’ve had recessions before. This is beginning to look like the start of a real collapse, not a downturn, but a system failure.
That’s the big story for the year. For perspective on that see Madlen Read, the AP Business Writer, here:
Decades from now, economic professors may well point to 2008 as the year capitalism went on life support. Home prices sank further than any mortgage lender could have imagined. Banks including Lehman Brothers Holdings Inc. and Washington Mutual Inc. failed, and many others received government funding or were bought up in desperate shotgun deals.
As investors recoiled and cashed out even their safe assets to build up reserves, the Dow Jones industrial average tumbled by as much as 47 percent from its October 2007 record. The stock market’s drop between October 2007 and November 2008 wiped out more than $10 trillion in stockholder wealth.
In 2008, governments around the world have shoved trillions of dollars into the financial system, primarily by offering and guaranteeing various types of loans and investing in troubled companies. Signs are emerging that these rescue plans are beginning to stick.
But getting U.S. stocks moving higher again – let alone back to their 2007 levels – is going to be a long haul.
Something went terribly wrong, perhaps structurally wrong, or conceptually wrong. One Wall Street friend, with many decades of experience, from the trading floor through years in merger and acquisitions and arbitrage, and then to securities law, expects that long haul to recovery may take ten or fifteen years – things will not be the same for a long time, if they are ever the same. But he doesn’t want to be quoted. Actually, no one wants to be quoted – pointing out how bad things actually are, for real, only makes things worse. The whole house of cards depends upon widely-shared obstinate optimism.
That may be the whole problem.
From the AP item:
“So many people have been so badly damaged,” said Alfred E. Goldman, chief market strategist at Wachovia Securities, who has spent nearly 49 years monitoring the market.
Goldman said he’s never seen despair worse than it was in late November. Indeed, that’s a sign the market has hit bottom.
There you have it. Things are so bad this must be the bottom. We civilians don’t see the logic. An expert with a half a century of experience cannot imagine things getting worse, so things must be going to get better. But what if we’re dealing with a failure of imagination? Things that no one imagined happen all the time – we have a black president, young and smart and thoughtful and careful, with a stunning and brilliant wife, and two impossibly cute and smart and nice kids.
No one expected that. What Goldman here expects is interesting. He does know, and the signs are that he’s deep into that obstinate optimism. See No Christmas Cheer as Recession Gathers Steam (Reuters) – “Existing home sales fell by a record amount last month as the recession picked up pace although a collapse in gasoline prices gave consumer sentiment a rare lift, data on Tuesday showed.”
Yeah, the collapse in gasoline prices is cool, but no one is driving anywhere much – they’re too afraid to do much, they’ve hunkered down. It’s best to stay home, and/or drink.
See Recession Cocktails May Take Edge off Dark Year (also Reuters):
Liquor companies and bartenders are finding inspiration in the financial crisis, devising new recipes and reviving old cocktail standards to keep spirits alive during the holidays.
Julian Cohen, head of the consumer insights team at Fortune Brands Inc’s beverage division, said those “heritage cocktails,” traditionally made with heavier-flavored spirits like bourbon and cognac, mirror a wider preference.
“You’re seeing a lot of darker flavors – honeys, blackberries and raspberries, versus things like pomegranate and papaya,” Cohen said. “When times are tough we want to go to things that are comfortable … that are part of our history.”
So, now thick and sweet drinks are the thing. Maybe we’re punishing ourselves.
And there’s this:
Stolichnaya, a Russian vodka brand, has been working with bartenders to concoct drinks with names like Rejected Resume, Battered Bull and Welfare Punch, said a spokeswoman. Absolut vodka owner Pernod Ricard is packaging its unflavored vodka in a mirrored bottle holder reminiscent of a disco ball to liven up home parties.
That is what the rest of the item is about – a change in marketing. People are drinking at home now, alone.
No wonder. Dow Falls For 5th Straight Session on Grim Data (AP – Tuesday, December 23) – “Wall Street pulled back again Tuesday in muted trading ahead of the holiday, as another round of reports showed further deterioration in the housing market and broader economy.”
And of course, this was inevitable:
A fund manager who lost more than $1 billion of his clients’ money to Bernard Madoff was discovered dead Tuesday after committing suicide at his Manhattan office, marking a grim turn in a scandal that has left investors around the world in financial ruin.
Rene-Thierry Magon de la Villehuchet was found sitting at his desk at about 8 a.m. with both wrists slashed, NYPD spokesman Paul Browne said. A box cutter was found on the floor along with a bottle of sleeping pills on his desk. Police did not find a suicide note.
Well, what was there to say, after all?
This is the fellow:
De la Villehuchet, 65, was a distinguished financier who came from a long line of aristocratic Frenchmen, and he tapped his connections in the world of European high society to attract clients to his firm, Access International Advisors.
One senses a world ending. Things will never be the same.
How did this happen? Didn’t anyone see where all this was heading.
At American Prospect, Ezra Klein, here posts an email from the economist Dean Baker, who “offers an explanation why so few economists accurately saw the trembling instability beneath the economy, much less sounded the alarm.
Klein says that “They didn’t know” is “not an operative explanation.’ People like Nouriel Roubini and Paul Krugman knew, as did Baker – the analysis was public. But no one was much of a Cassandra, or even wanted to be one. Baker explains that’s just not how things work:
Just apply economics to economists.
The honchos in the profession (Paul Krugman excepted) said everything was fine. Agreeing with the honchos will never get you in trouble. You will never lose your job or even miss a promotion because you made the same mistake as all the leading lights in the profession.
On the other hand, if you go against the honchos and end up being wrong, well you should be prepared to be sent to oblivion. You are obviously a raving lunatic who has no business being taken seriously as an economist. Even when you end being right against the honchos, you can’t count on any great reward, since the honchos so control the profession and the media, and “nobody could have seen” will be repeated at least frequently as the fact that some people did see.
Anyhow, what would an economist expect to happen in a situation in which option one carries no risks and reasonable expected rewards, and option two carries enormous risks and only moderately higher expected rewards? In short, the incentives in the economics profession, just as in finance, strongly encourage a lack of original thinking.
So it’s a cost-benefit thing – there’s nothing in it for you if you do original thinking, and even less if you say something provocative. You say “no one could have anticipated” whatever. After all, that worked for Condoleezza Rice – sure, the August 2001 presidential briefing was titled “Ben Laden Determined to Strike Within the United States” right there on the cover, but “no one could have anticipated” he’d really do that. She was rewarded for that explanation with the post of Secretary of State. As with her, so with the economists – how we got here is a mystery, no one saw this coming. Those who had been, as they say, running around with their hair on fire were fools, you see – just too excitable.
At his Washington Monthly blog, Kevin Drum has more on this, on how “there’s not much risk in agreeing with the conventional wisdom and being wrong, and there’s not much reward in bucking the conventional wisdom and being right.”
He thinks Baker is being too simplistic:
There are some exceptions, of course, but even the economists who saw the housing bubble for what it was mostly didn’t predict that its bursting was going to cause a massive global credit crunch and the biggest slowdown since the Great Depression.
In fact, to a large extent, we still don’t quite know why the reaction to the housing bust has been so severe. So there’s a genuine question here that’s worth diving into in more detail.
Still, he thinks Baker is basically right, and then turns things around to discuss how the incentives work in the finance industry:
Suppose, for example, that everyone on Wall Street knows there’s an investment strategy that will pay off big 19 years out of 20, but implode in that one remaining year. What’s the right thing to do?
Obviously, the answer is: follow the flawed strategy. If you don’t, and everyone else does, then within a couple of years you’ll either get with the program or you’ll be out of a job. Even in the absence of any kind of fraud or collusion or mass insanity, following a strategy that you know will be disastrous 5% of the time is simply too profitable to pass up.
And if that is so, the question becomes what the role of the government in trying to prevent systemic meltdown should be:
Regulations that target fraud are useful, but remember: even if everyone is purer than Caesar’s wife, they’ll still be forced to follow the flawed strategy. They can’t afford not to, and unless they’re smart enough to predict precisely when the 5% of disasters will take place (and few are), the collective result is some kind of periodic meltdown.
My own guess is that the answer is a set of regulations that slow things down. Something that throws just a little bit of sand in the gears of the global finance machine and prevents bubbles from growing quite as quickly as they otherwise might.
Baker has proposed a small fee on financial transactions, for example, and that seems like the right kind of idea. I’ve long thought that very modest capital controls might also be a good idea, even for advanced economies. In the mortgage market, requiring even a small down payment plays the same role.
And that comes back to the “no one could have anticipated” Condoleezza Rice gambit:
I think one misconception that’s become awfully popular recently is that the current meltdown is a “black swan” event, a perfect storm that happens only once a century or so. But I think Paul Krugman has made a persuasive case (in both the original edition of The Return of Depression Economics and the new one) that the kind of bubble related disaster we’re seeing now is simply a common feature of the modern, global, hyper-fast, hyper-unconstrained financial market.
The only difference is that it’s mostly affected only small countries in the past couple of decades, and now it’s worked its way all the way up the food chain – and if we don’t introduce a little bit of institutional deliberation and constraint into the system, this won’t be the last time we see it. Given the limitations of human wetware, after all, there may be such a thing as a financial system that’s too efficient.
This is efficient?
But maybe this is how we got here. No one was paying attention – there wasn’t any percentage in it. And if they were paying attention, it was best to remain silent.
So the year of momentous events draws to a close. And, save for a cool guy who will be the new president, we’re no wiser.
Maybe next year will be better. But no one can anticipate that.