Ponzi and Usury (2 pieces)
Riaz K Tayob
These could be the names for twin poster boys of this era of Wall Street
expansion and collapse. Usury is that ancient sin of making money from
money. Prohibited by religious mandates (and thus legal ones) in one
form or another for millennia, receiving or paying interest on money is
taken for granted in our modern economic system. But, one could argue
that it reached the heights of insanity in the recent housing and
derivatives-fueled credit bubble, creating its own ponzi structure.
As London Business School founder Charles Handy said recently in an
interview on Kai Ryssdal's Marketplace radio show from American Public
Media...
"And that's what the banks started doing. They forgot what their proper
job was, in my view, which was to take money from some people who had
some to spare and to pass it on to people who could use it usefully and
profitably. And they started inventing nice little products that they
came up with, which basically were a way of making money out of money."
That's a soft way of putting it. Appropriate, since Mr. Handy is a
soft-spoken British gentleman. But he was just warming up, and it is
likely his wisdom more than his kindness that commands the respect of
business leaders and economists everywhere who seek his opinions and
consultations on organizational behavior. He elaborated after Ryssdal
asked for clarification about the purpose of lending and whether anyone
would do it if they couldn't make money...
"That's right, but you must make sure that you don't exceed the money
that you've been given by the people who are saving it. These people
went wild, actually. They went way in excess of the ratios that normally
were deemed respectable -- ratios of how much money they were giving out
to the assets that they were looking after. They were very keen about
selling things. They weren't too keen about managing the risk, because
they thought that prices would forever go up. They got carried away.
It's understandable. They were young, they were sitting in front of
computers, they weren't out in the real world. They were selling, you
know, interesting derivative products, which were ultimately based on
house prices. But none of those people selling those things had ever
visited the houses, which were the basis of their assets price, you know."
This is similar to what I've been saying for over a year ever since I
read Nassim Nicholas Taleb's The Black Swan and learned about the severe
limitations of risk models built on standard deviation. Those models,
used by Wall Street quants (and those paid to believe them) to evaluate
complex, long-term portfolios of bonds and asset-backed securities, have
been fantastic fictions in many cases because they presumed two things:
(1) to know the volatility of the given instruments, and (2) that the
standard volatility curve was itself a reliable measure of the
likelihood of a ten-plus deviation in financial markets.
As Taleb taught us, standard deviation and the normal distribution of
the bell curve were invented to measure the variance in the data of
physical realms like human height and weight, and errors in astronomy.
The social universe, of which markets are a part, are a whole new ball
game for such precise statistics. Human behavior and it's extremes,
along with human systems and their complexities, are far too "wild" to
be measured by standard deviation and it's obsession with the mild,
boring, and comforting "average." Markets, indeed all social dynamics,
are rarely mild, boring, or comforting.
In Handy's interview from last week, which can be found on the
Marketplace website here, he also predicts today's news...
"I think we'll see Citigroup splitting itself up into much smaller kinds
of entities."
Not a left-field, top-rope prediction, but I thought it worth mentioning
since I am writing this today and Citigroup unloading SmithBarney to
Morgan Stanley is the morning's top news. Check out the interview
(available in print and audio) to also get his perspective on how
investment and retail banking under the same umbrella "contaminate each
other."
Not that my analysis is anywhere near the plane of Charles Handy, I
offer a recent article of mine that touches on the topic of usury. In
January's issue of SFO magazine, I wrote about "The Balancing Act of
Put-Call Parity" and included some historical background about how the
use of simple financial instruments to avoid the usury prohibition have
existed for millennia -- sort of the story of put and call logic before
Black-Scholes. Here's a link to the article:
The Balancing Act of Put-Call Parity
----------------
http://optionsnewsnetwork.blogspot.com/2009/01/ponzi-and-usury.html
Thursday, January 8, 2009
Listen to the show
Taking Stock
Taking Stock: Get banks smaller
Charles Handy
There are a lot of reasons why our economy is in a sorry state. Among
them, the way we've done business and how banks have been structured.
Kai Ryssdal speaks with management expert Charles Handy about how we got
in this current economic mess.
London Business School founder and Claremont Graduate University's
Drucker School of Business Professor, Charles Handy. (Liz Handy)
TEXT OF INTERVIEW
Kai Ryssdal: A lot of things got this economy to where it is. Greed or,
more politely, the desire to make more money and have more things. Also,
a lack of transparency, a lack of understanding about how all those
newfangled financial instruments were going to work. Or not going to
work. But on top of that there was the way we did business and how some
of the players, like the banks, were and still are structured. We're
going to continue today with Taking Stock, our series of occasional
conversations with people who can give us the longer view of our
economic situation. Management consultant Charles Handy makes a
specialty of organizational behavior. And when we spoke, I asked him why
he thinks we wound up in this mess.
Charles Handy: I think we got carried away, you know, at least the
bankers did mainly. After all, for many, many centuries, making money
out of money has been regarded as rather a bad thing. In fact, it used
to be called "usury" -- it still is in the Muslim world. And that's what
the banks started doing. They forgot what their proper job was, in my
view, which was to take money from some people who had some to spare and
to pass it on to people who could use it usefully and profitably. And
they started inventing nice little products that they came up with,
which basically were a way of making money out of money.
Ryssdal: But from purely a business proposition, if you can't make money
giving a loan, why do it at all?
Handy: That's right, but you must make sure that you don't exceed the
money that you've been given by the people who are saving it. These
people went wild, actually. They went way in excess of the ratios that
normally were deemed respectable -- ratios of how much money they were
giving out to the assets that they were looking after. They were very
keen about selling things. They weren't too keen about managing the
risk, because they thought that prices would forever go up. They got
carried away. It's understandable. They were young, they were sitting in
front of computers, they weren't out in the real world. They were
selling, you know, interesting derivative products, which were
ultimately based on house prices. But none of those people selling those
things had ever visited the houses, which were the basis of their assets
price, you know.
Ryssdal: It seems to me the solution, when we have one of these crises,
is always a variation on what I suppose you could call the "big three,"
right. One is increased transparency, the other is increased
accountability, and then some kind of regulation. But we've tried all of
those things in crises past, so what's the answer this time?
Handy: Get them smaller.
Ryssdal: Get the banks smaller?
Handy: Yeah. Get the banks smaller. I'm actually sure. Markets work well
when there are a lot of players, and if one falls out, the whole system
doesn't crash. When we create organizations that, in the words of some
people, are too big to fail, what we really mean is we can't allow them
to fail. So, I really think that we've allowed the banks to get too big.
So I think the answer is basically to de-structure them. I think we'll
see that happening. I think we'll see Citigroup splitting itself up into
much smaller kinds of entities. I also think we really should stop
everybody putting everything in one basket. I think investment banking
should be separated out from retail banking. They contaminate each other.
Ryssdal: Does the government come in and regulate them smaller? Or do we
wait for the market, as is happening it seems in Citigroup's case, to
make them small?
Handy: Well, it'd be awful nice if the market happens, and did it,
because I really don't want government poking its nose in as much as it
seems to want to. But I think in the end the government has to act if
the banks don't do it.
Ryssdal: What about the issue, though, of shared blame? Because, while
certainly Wall Street and Canary Wharf had their share of
responsibility, it's not just them. It's the mortgage brokers. It's
appraisers who appraised houses at values too high. But also it's us,
right? I mean, we all spent too much money, because we could.
Handy: Well, absolutely. We got carried away. I -- can I read you a
quote that Adam Smith made 250 years ago, which will always please me?
He said, "A profitably speculation is presented as a public good because
growth will stimulate demand and everywhere diffuse comfort and
improvement. No patriot or man of feeling could therefore oppose it. But
the nature of this growth, in opposition, for example, to older ideas
such as cultivation, is that it is at once undirected and infinitely
self-generating in the endless demand for all the useless things in the
world."
Ryssdal: So now what then? I mean, if Adam Smith -- who wrote "The
Wealth of Nations" that we all know about -- if he's right, and we got
it wrong 250 years later, now what do we do?
Handy: Well, I think governments are faced with a difficult problem.
They are trying to get people to spend. But it does seem a rather
un-Adam Smith idea to get people to go out shopping in order to get the
economy going again. More "useless things," in other words. But in order
to get that happening, they have reduced the base rate from the Federal
Reserve or the Bank of England, in order to get people finding it easier
to borrow. But actually there are more savers than borrowers in society.
And so, of course, now the savers are not going to save because there's
no incentive to it. So, I'm not sure that the solution is going to be
easy to get by, and I think it'll take about three years for things to
bottom out. But there may be some good news in all of that. I mean we
may get back to a saner kind of world -- what Adam Smith called
"cultivation" or "civilization" -- where we don't all sort of spend our
life trying to make money, to buy things we don't really need to impress
the neighbors, and so on. Where we actually do work -- not 60 hours a
week, but 40 hours a week. Where we actually do take holidays. Where we
actually get to know our kids again. Where it actually becomes smart to
have a tiny car, to walk and bicycle and these sorts of things. And we
may find we enjoy it actually just as much as the hectic pace that we've
seen in recent years. I've often said that capitalism, particularly in
America, is a very exhausting business. It tires people out.
Ryssdal: Charles Handy, thank you very much for your time.
Handy: Thank you very much. It was wonderful to talk to you.
http://marketplace.publicradio.org/display/web/2009/01/08/pm_taking_stock/
------------------------