June 20, 2008
Bankers and Patriots
I am pleased to be able to bring you another wonderful piece of writing by Uwe Reinhardt. In some ways it is a a sequel to his earlier piece on this blog “I hate mom (and the government too)”, but it also stands very well on its own. This article was first published in The Daily Princetonian, on Tuesday, April 29th, 2008. The marine referred to in the column is Uwe’s youngest son, Mark (aka Hsiao Hoo or Little Tiger). I knew him as a tiny tot, when he used to hang around the pool and fountain next to the Woodrow Wilson School at Princeton University.
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As the Fed and the Treasury once again staff the shovel brigade behind one of Wall
Street’s periodic asset-bubble parades - lest the foul economic odor in its wake seep too
deeply into the rest of the economy - my mind wanders back to spring 2002, when the
previous asset bubble had burst. At the end of the financial accounting course I then
taught, I projected onto the screen the picture of a Princeton graduate who had just
joined the Marines. “Take a good look at your classmate,” I told the 300 or so students
in the class. “He is likely to be ordered abroad soon, there to lead a platoon of enlisted
Marines into possibly lethal combat, for the sake of you and me, he is told. When he and
his men come home - if they do come home - what will you have made of their country?
Will you have used the accounting tools I taught you to make the country better and
stronger, or will you have used them to engage in the shenanigans that drove our recent
asset bubble and begot the current recession - just to make money, country be
damned?”
America is a nation at war. Our sailors, soldiers and Marines fight with great honor at
high risk to life and limb, and at very low pay, for what they believe to be our nation’s
best interest. They often take added personal risks to avoid visiting collateral damage on
innocent bystanders of a foreign land. Against that backdrop and the financial crisis and
consequent recession now besetting our country, it is pertinent to ask: Do the leaders of
our financial markets ever stop to think what their reckless recent conduct has done to
the country these brave warriors fight to protect?
At their best, our financial markets play a pivotal role in enhancing human welfare.
They then channel the savings of households, business firms and governments
anywhere in the world efficiently to their most productive uses anywhere else in the
world and allocate financial risk from those unable or unwilling to bear it to those who
can tolerate it. Many of the recent innovations in these markets such as structured
securities, currency- and interest-rate swaps, credit default swaps, and so on, have
made these important functions ever more efficient.
But when investment banks seek profits by recklessly concocting hundreds of billions
of mortgage-backed securities that are anchored in shaky mortgages whose quality no
one has bothered to check, sell these dodgy derivatives to others, and even risk their
own institution’s equity cushions by borrowing billions of dollars to invest in junk
securities themselves, they are not making their country stronger. Instead, they act like
reckless laboratory scientists who concoct toxic substances that can infect not only
them, but also millions of innocent bystanders.
When investment banks sell multiple credit default swaps to buyers who do not own
the underlying bond, but merely want to bet on its default, the banks stray into pure Las
Vegas-style gambling. Productive risk taking is the central driver of efficient capitalism,
but how does helping person A gamble on the default of a bond held by person B
strengthen the American economy? Why not sell bets on the weather as well? No one
seems to have a clear idea of the net financial exposure our banks have to the $45
trillion or so of notional credit-default swaps currently reported to be outstanding. In an
era of widespread credit defaults, such multiple credit-insurance contracts on given
bonds could confront some banks with huge claims that their equity cushions might not
be able to absorb, forcing the Fed and the Treasury yet again to mobilize their shovel
brigade, at taxpayers’ expense.
Finally, when, for handsome fees, smooth-talking investment bankers persuade
unsophisticated treasurers of local school districts or small endowments to enter into
highly risky and opaque interest-rate swaps, or into investing their limited funds in the
so-called “toxic waste” tranches of complex structured securities, they are not making
America stronger. They risk driving important local institutions to the brink of bankruptcy.
An innate professional ethic deters the overwhelming fraction of our physicians from
exploiting their patients’ clinical ignorance as no set of explicit regulations ever could.
Does an analogous ethical anchor - a financial Primum Non Nocere - constrain Wall
Street as well?
This is not an idle question. American leaders of finance now promise to practice
self-discipline guided merely by regulatory principles rather than by explicit rules. That
would be a sensible approach, but only in markets whose agents are ethically principled
and, yes, patriotic - like, say, 18-year old sailors, soldiers and Marines.
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Uwe E. Reinhardt is the James Madison Professor of Political Economy and a
professor in the Woodrow Wilson School of Princeton University. He can be reached at reinhard@princeton.edu.
First, one of the more useful things the financial world has been doing is selling more bets on the weather. It is called insurance. As the weather is getting less easily predictable (a predictable consequence of carbon dioxide retaining more energy in the atmosphere), the benefit of being able to insure against it rises.
Second, when their country needs them, the leaders of Wall Street will sign dollar a year (and no vacations) contracts at Uncle Sam’s behest the way their predecessors did. And some of them will have risked their lives for their country when they were younger.
Third, the aspirations of the financial world to regulate itself remind one of the posters saying that your dog would use the poop bag if he could. Whatever credit one gives to good intentions, neither is in the nature of the beast. What is in the nature of the financial world is to give itself the benfit of the doubt in any deal. There is doubt in most deals. That is why the finacial world needs outside regulation; especially when dealing with parties who do not know enough to have proper doubts.
Posted by: David Heigham | June 21st, 2008 at 9:10 pm | Report this commentI agree with David Heigham that weather insurance useful, but it should be sold by insurance companies who know what they are doing and not by investment banks the Federal Reserve has to bail out when they do not know what they are doing.
Next, I am afraid I do not understand this sentence: “Second, when their country needs them, the leaders of Wall Street will sign dollar a year (and no vacations) contracts at Uncle Sam’s behest the way their predecessors did.”
Even if a handful of bankers (how many could it be?) did risk their lives for their country when they were young, that does not give them the right to wreck their country as others risk their lives for their country.
As to the need for regulation, I agree.
UER
Posted by: Uwe Reinhardt | June 22nd, 2008 at 1:24 am | Report this commentDear Mr Buiter,
with all due respect, I don’t believe this is a “wonderful piece”.
Firstly, Pr Reinhardt makes a mistake in comparing the foot soldiers of the army (or the marines in that case) with the top brass of the banking world.
At the foot soldier level, personnel working for investment banks have nothing to envy to the marines in terms of individual qualities : Most of them have been recruited as the top students of major universities, an endeavor that requires a strong work ethic and character. In both cases, their ability to derail an ill-devised strategy is limited. Corporations, like the armies, are hierarchical organizations : In the same way that it is not up to the soldier to judge the strategy of its officer (both from a practical standpoint - (s)he doesn’t have all the relevant information at hand - and an institutional standpoint - her(is) opinion is neither requested nor welcome), junior personnel in banks just do as they are told.
That leaves us in both organizations with the top 1 or 2% that have real decision power. I would argue that the scorecard is not better on the military than on banking. For any banker that didn’t disclose to his boss/investor/regulator the potential risk of a business (or “dance to the music” as Charles Prince said), I am sure one can find an officer at the pentagon that caved in for fear that speaking up would cost his(er) career.
I don’t see what a Colin Powell - who privately ranted about the “bullsh…t” intelligence he was fed with, but nevertheless conveyed to the UN - has to teach in terms of integrity to a Charles Prince. At least, when you lie on the record to US investors, you go to jail. I wish politicians and army brass had the same dilemma !
Secondly, there is a good reason why the need for ethical behavior is actually higher for soldiers than for bankers : the harming potential of the military is larger by an order of magnitude.
You show it yourself in your piece http://blogs.ft.com/maverecon/2008/03/double-counting-101-inside-versus-outside-assets/ money lost in banking is mostly reshuffling the wealth : the “real” assets that are built during a bubble are still there to be used for our benefits, the employee that are fired from Enron can still be productive elsewhere… I admit that there is genuine wealth destruction from the misallocation of capital to investments but it is still a second order phenomenon.
But in war, wealth destruction is not a second order phenomenon : wealth spent on a dropped bomb is a net loss, a soldier that is killed is one less young educated productive citizen, and this is dwarfed by the huge liabilities stemming from the indemnification of wounded veterans !
If the US banking system has a responsibility in the current war, it is not what Pr Reinhardt thinks. It is to have devised such an efficient overseas funding system for the US government that it temporarily shielded the US population from the huge cost of the war, thus delaying the realization of the folly of such enterprise.
Posted by: charles monneron | June 22nd, 2008 at 12:45 pm | Report this commentFirst an apology to Uwe Reinhardt. I got interrupted before I finished the post above, and the final paragraph got left out. It reads:
“Fourth, Prof. Reinhardt deserves every praise for hammering home to accountancy students that what they have been studying is deeply important to the world and to their country. Accountancy, like shooting, is never perfectly accurate. But like bad shooting, bad accountancy always wastes resources, often frustrates and all too often wastes lives. Bad accountancy includes stupid accounting, mistaken accounting and bent accounting to produce the answer the boss thinks he wants. The “valuations” that lead to the current crisis are extraordinary combinations of all three. Accountants collectively have a veto on bad accounting. They must be willing to use it.”
As to weather bets, I had particularly in mind some reinsurance contracts which seem to have some of the characteristics of weather derivatives. Prof. Reinhardt is right, and it is an important point, that these are contracts between insurers who are fully informed.
As to dollar a year contracts, I was casting back to the Second World War.
As to risking their lives for their country, more of Wall Street’s current bosses will have been willing to risk their lives than actually did. They have some foundation for feeling patriotic. However they have no justification for dealing blindly, as so many of them did.
Posted by: David Heigham | June 22nd, 2008 at 2:31 pm | Report this commentBankers tend to be international, with allegiance to shareholders; whereas soldiers are employees of the nation and paid to be patriots. However central bankers are expected to be patriots - this questions why the multi -billion losses to the UK public purse on Black Wednesday were allowed to happen, let alone never thoroughly reported. The FT had to use the freedom of information legislation to get an idea of the exact losses.
In this context it’s worth raising the question of audit and its allegiance.
Posted by: Slightly Optimistic | June 22nd, 2008 at 5:29 pm | Report this comment“Slightly optimistic” makes an interesting point that had also been made by former US Labor Secretary Robert Reich in one of his books.
The point is that modern societies are splitting into two groups: (1) a financial or professional elite whose members basically are internationalists and do not have firm roots in any country (they live as comfortably in London or Singapore as in New York) and (2)those whose feet and souls are firmly rooted in their own country’s soil.
Thus, when you see a US gas station showing a US flag, it probably means that the owner and his or her employees most likely would sacrifice and lay down their lives for their country. In fact, the bulk of the US armed forces come from the rural and urban lower middle class.
A few members of the financial or professional elite also are genuine patriots in this regard, but very few indeed. If as many as 10 graduates in the graduating class of 1,200 to 2,000 of an Ivy league university opt to serve in the armed forces to lead enlisted men and women as officers, I would be surprised. It is so even as the country cries out desperately for more recruits, and as the existing forces are cycled and recycled time and again into the war theater. In fact, none other than John McCain voted against the recent GI bill designed to make college attendance easier for veterans on the specific ground that this benefit might erode the retention rate of officers and enlisted members of the armed forces.
To be sure, many of the non-serving elite sport US flags in their lapels (and blast Obama for not waering one)to advertise their patriotism. It is the thing to do these days. One may even see it in London. But to me that lapel-flag just shows these flag wearers are very fond of America. Even an Englishman could wear it in that spirit. The lapel-flag does not typically signifiy that its wearer would bear personal sacrifice for it.
Alexis de Tocqueville had it right when he wrote in ch. 15 of DEMOCRACY IN AMERICA: “I have heard of patriotism in America and I have met many patriotic Americans, but never among their leaders.” His description does grave injustice to the WWII generation, but it describes current America to a T.
UER
Posted by: Uwe Reinhardt | June 22nd, 2008 at 5:50 pm | Report this commentIf patriotism means signing up to die for your country (which essentially means to kill people you have nothing against in the name of your country), I say “no thank you”.
I believe people who question what the government is doing going into these wars when the majority of the people are asking for blood are the real patriots.
We don’t need suggestions of wasting young lives covered under this glorified word that is patriotism. We need intelligent people working to bring the world together (a lofty goal for sure). International financial markets also helps make the world a smaller place.
I was a foreigner working on Wall Street. Even though Wall Street is in the US, I don’t think it’s for the US only. It is international. To expect its leaders to think of US interest only would put Wall Street at a disadvantage to other international financial markets. Is that what the patriotic professor wants?
Posted by: this is patriotism? | June 24th, 2008 at 1:20 am | Report this commentthis is patriotism?
If you read what the patriotic professor is advocating, it is economic action in the public interest of the whole wide world. I am a European, not an American. I am a patriot, like most of the British, only when necessary. But I have noticed that the best of American patriotism, and that includes the greater part of it, has this qualty of being in line with the interests of all of us. That is the American patriotism which the Chinese students were paying tribute to when they tried to put up a Statue of Liberty in Tien-An Min Square.
Posted by: David Heigham | June 24th, 2008 at 2:57 pm | Report this commentYes, there is a big questionmark over the allegiance of financial audit. The events surrounding the launch of Europe’s common currency are also fascinating.
Posted by: Slightly Optimistic | June 24th, 2008 at 5:00 pm | Report this comment