George Will: The Markets Aint Misbehavin’

March 28, 2009

George Will is chief political columnist at Newsweek, ABC TV’s This Week commentator, and a deeply convinced and convicted conservative. It was at George Will’s place in Washington, that newly inagurated President Barack Obama came for dinner and a frank conversation among the elite conservative thinkers in the US. I share George Will’s love of capitalism, baseball, and democracy; however not in that order.The disagreement arose in George’s commentary on This Week this past Sunday when he argued that government should “let the markets work” and let the bankrupt banks and other distraught financial institutions just fail. “Let the markets do their efficient thing”. And it struck me, and fellow This Week panelist Robert Reich, that this is precisely where George Will is wrong. Robert said that the events of the past two years were proof that markets were just not working. Unfortunately, time was nearly up – and all George was able to do was to shoot a glance that clearly said “I beg to differ”.

George Will’s “I beg to differ” would likely be echoed emphatically by many of the survivors in the financial community. Their denial arguments would be the following:

1)we are not responsible for this worldwide financial breakdown either individually or collectively;
2)rather these problems are due to many exogenous factors beyond our control;
3)they are chiefly caused by the shortsighted decisions of gullible consumers who took on loans and spending they simply could not manage;
4)plus the 1 in 100 years perfect storm of bad events which, like Hurricane Katrina, brought financial markets down;
5)In fact, if government had not acted imprudently, rescuing some and not other institutions while relaxing financial regulations too much, the capital markets would have acted efficiently and cleared the problems of their own accord.
6)The proof of the latter point is that when Bear Sterns and Lehman Brothers failed, their shareholders and most of their employees were “disciplined” by the markets.

In sum, surviving financial executives and apparently Geoge Will too are saying that capitalism and their linch pin, efficient capital markets, are working just fine. One can find stories that coraborate this world view of financial executives here and here.In contrast, I would argue that financial markets are badly out of control and far from being Darwinian efficient. The problems are with both financial people and processes. The number of signs pointing to financial markets misbehaving for a long time are not just dismaying but proof that the warning signals were there and in abundance for the market to take note and “fix itself” with its vaunted Darwinian efficiency. Here is a list of 10 major signs that Financial Markets were and are still misbehaving: 

1)Returns in the financial markets for the past 20-30 years were growing disproportionately large relative to other markets. Market theory itself predicts that a) efficient markets should see ups and downs and should fluctuate around a reasonably steady (not always rising) risk-return level. Thus by its own standards and methods, the financial markets were providing warning signs that they were not working efficiently. And the fact that huge billion dollar Ponzi schemes by Madoff and Stanford were ignored by regulators and the market makers just underlines this conspiracy of silence on financial bubbles;
2)Financial compensation mimiced the market’s growth – total compensation has been growing at huge multiples of national wages rates, almost never tracking the underlying performance of the financial companies, and reaching stratospheric reward levels – total annual financial compensation achieving multipliers ranging from 4,500 to 35,000 times the average US wage level. Six Sigma and statistical analysis say such wage earners should be truly godlike in their infallibility making only one wrong decision in a million, incapable of falling into the mortgae meltdown, which many of them did;
3)Financial bubbles like the S&L disaster, Long Term Capital and the Dot.COM bust were occuring with greater frequency and larger impact;
4)Financial markets were using increasingly complex and sophisticated instruments and processing methods the full implications of which were being “beta” tested on live markets. Think of complex computerized trading and the derivative instruments (CDS, etc)that have failed so toxically in the current financial crisis;
5)Many of these instruments were being deployed and used on hidden markets where even government regulators had no access to the transaction details despite the fact that these new markets had quickly ballooned into trillions of dollars in size;
6)Failure has been rewarded with golden parachutes sometimes multiple times bigger than a financial excutives annual total compensation package;
7)Failure has been rewarded with merry-go-round fire-rehire or fund managers abandoning their underperforming portfolios and then restarting with related financial firms often at an increase in total compensation;
8)Fiduciary trust and the client’s best interests have been replaced by own account trading, front running and deep-throat insider information laundering;
9)Zero sum strategy and trading widely prevail where my win means all others have to completely lose. This is at the crux of the distrust that permeates the current financial markets;
10)Information hiding which is in direct contradiction to transparent, open and therefore efficient markets has become the key to securing outsized returns in the marketplace. Thus more and more markets are becoming shadow, large and not subject to any but the most minimal regulatory control. But even worse these shadow markets mimic the major public stock, bond and commodity markets – they lack any but the most menial self-policing or self-insurance mechanisms to guarantee that the markets are able to cope with the 1 in 100 year financial storms.  

Factors 8 through 10 alone would indicate a malfunctioning market. But all 10 factors indicate a nearly dysfunctional market especially prone to misbehaving catastrophically – which it has done with probaility 1.0, uh … George, that is certainty. Now my question to you George is given these cirumstances what is to prevent financial markets from reproducing a complete collapse the next time out. If one looks at the current cycle of bubbles that should be in 3-5 years time.

Summary:It appears that George Will fears democratic government even more than free capitalistic markets despite the financial wringer the latter has taken the World through. It is almost as if George agrees explicitly with Walt Kelly’s cartoon character Pogo who famously said “we have met the enemy and they is us  and Congers”. George Will’s distrust of government’s ability to function well is even greater than his mistrust of capital markets. I beg to differ and this is how. Under President George W. Bush and the Republican Congress, I agree with George Will, government was more incompetent and/or mean spirited than the financial capital markets although it is close. Under President Barack Obama I have more confidence in government than in the still greatly misbehaving capital markets despite the huge largess that has been rained down upon financiers in efforts to get worldwide financial markets working again. So I fear George has a case of myopia – he cannot see that capital markets and their players are not functioning close to their declared Darwinian efficiency. George also has a bad case of fixation – he cannot adjust his priorities and evaluations contingent on the quality of the players. The French have an expression for this – “C’est dommage.”   

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