Random Articles – 11/02/08
November 2, 2008
I’ve realized that my posts are unable to keep up with my brain and the random connections it draws, so I’m going to experiment with a new format here, inspired by the “Philanthropy Daily Digest” at TacticalPhilanthropy.com (though to be honest, it’s something many blogs do). Most of my previous posts try to expand on one insightful point that I really wanted to emphasize, but in these “Random Articles” series, I’m going to highlight some of the articles I have read that I have found particularly interesting, insightful, and/or inspirational (and by inspirational, I don’t mean that warm and fuzzy feeling, but inspirational in terms of inspiring creative thoughts).
So for today, I’ll start with a bunch of articles I saw on the NYTimes:
“Wisconsin schools and New York subways are among the players in a financial fiasco that has ricocheted globally.” This is why people are pissed off at investment bankers and other executives who got rich during the boom but don’t have to deal with the fallout from the crisis. And somehow I don’t think the law is going to be able to help school boards and other municipalities recover their investments.
Conclusion: Most investment bankers can’t be trusted since they have a perverse incentive to sell you something that may not be in your best interest.
Solution: More ethical investment bankers? Hahaha. But as hilarious as I find the idea, I think that’s part of the solution. We need to create stronger governance structures that align the interests of those who sell investment products and those who buy them – if the seller is also forced to evaluate the risk of the investment product, then he might do more due diligence. But in order to do that, we have to separate the lemons (bad investment bankers) and non-lemons (good investment bankers) in the market. (Random aside: I have a good friend from White Fish Bay and went on tour there with Testimony.)
“Explaining the psychology of how panels of economic experts can make colossal mistakes.” Robert J. Shiller, a professor of economics and finance at Yale, wanted to challenge the crowd. But who would listen? If not the Federal Reserve (the Groupthink analysis is particularly salient here – and at some point I’d like to visualize an incentive analysis of the actors in the Federal Reserve), then perhaps institutional investors should have done more due diligence and reduced or hedged their investments.
I like the following passage in particular:
Why do professional economists always seem to find that concerns with bubbles are overblown or unsubstantiated? I have wondered about this for years, and still do not quite have an answer. It must have something to do with the tool kit given to economists (as opposed to psychologists) and perhaps even with the self-selection of those attracted to the technical, mathematical field of economics. Economists aren’t generally trained in psychology, and so want to divert the subject of discussion to things they understand well. They pride themselves on being rational. The notion that people are making huge errors in judgment is not appealing.
As someone who does research in philosophy and economics, I still don’t understand why econ classes teach students that profit maximizing behavior leads to welfare maximization. It is the Absolute Rule that is handed down to students without question (most of my econ peers repeat the idea of profit maximization like mantra), but it is so obviously wrong! Here, feminist epistemology might shed some light – that those in power (professional economists) have no incentive to acknowledge that their views are wrong.
Conclusion: Professional economists may not have very many incentives to forecast bubbles.
Solution: Mitigate the factors of groupthink in Federal Reserve decision making. Allow more independent actors besides the Fed (institutional investors) to act on relevant information and make their own risk valuations (if more institutions did this, the financial crisis would not be as severe since losses wouldn’t have been as great). Punish those economists who were overconfident or brushed aside concerns.
“In ‘Outliers: The Story of Success,’ Malcolm Gladwell refutes the simplistic old saw of the self-made man — and reminds us that success is social.” The book lends more weight to determinism – that it’s not our free will that shapes our destiny, but rather, it might be the social forces. Interestingly, the idea that success might be social may be critical to understanding how we encourage others to be successful. If we stop blaming people’s lack of success on their own shortcomings, but instead realize that there may be environmental barriers, perhaps from this deeper understanding we can enable more people to become successful.
“Extraordinarily callous and inept management, combined with huge rewards for success and incentives for hiding failure, are some of the typical attitudes exhibited by financial institutions, many of which have been collapsing. HR leaders should understand the dynamics of such meltdowns in order to avoid such a fate in their own organizations.”
Peter Cappelli is the George W. Taylor Professor of Management and director of the Center for Human Resources at the Wharton School of Business. And he thinks – and I agree – that the investment banking culture is silly. I’ve long thought this and many of my colleagues, even in the investment banking world, agree. Newly hired investment bankers are expected to work ridiculous amount of hours, even though effective management or efficient hiring practices could reduce the amount of time individuals work (why not just hire more people and have people work fewer hours?). And the salaries of investment bankers is quite price inelastic (what if someone were willing to work at half of an investment banker’s salary but is able to do 2/3 of the work? why doesn’t it happen?).
Conclusion: Investment banks are terribly managed organizations.
Solution: There need to be more mainstream investment banks that change the practices of investment banking management. Professor Cappelli mentions that Goldman Sachs has done well because of its HR practices. But there’s a limited supply of Goldman Sachs positions that can’t meet demand – there are more people who are qualified to be investment bankers that want an organization that emphasizes teamwork, values, and good management. Let’s hope more investment banks become a little more humble and change their culture a little bit from all that’s happened in recent events.
