Mittwoch, Oktober 21, 2009

Markets, Markets, Markets...

This time a troika from the FT.

First of all, Martin Wolf.

He makes, along with Mervyn King (more later), the best argument why moral hazard is a serious problem, since it permits risky behavior with no downside. This has, once again (and I do apologize to those who are tired of reading about markets), everything to do with markets and the results of market resolution of supply and demand.

If someone selling on an open market makes a mistake and doesn't price their product appropriately, they bear the damage: price it too low and you lose income; price it too high and you will have unsold inventory (i.e. your returns will not be where they need to be). Remember - and I fear that this is something that all too few really understand - that business is inherently risky, starting from misunderstanding what market demands are to making the wrong personnel and manufacturing (taken in the broadest sense of the word: service industries "manufacture" in this sense when they produce their admittedly incorporeal products) process decisions, to using the wrong marketing approach or even the wrong word ("Nova" in a Spanish-language market for a car is one of the more spectacular examples, as it means "doesn't move") or the wrong color.

But consider this:

This recovery has been no accident. When central bank money is almost free, prices of risky assets are recovering and competitors have disappeared or are weakened, making money is a relatively simple matter for the strong survivors.

Indeed: this is the market result. If money is free, then there is no risk to do anything. This is, however, the cornerstone of the moral hazard: risks don't simply disappear. By making money free - and removing the risks that were hence plaguing the system - you set up the problem that Mr. Wolf addresses:

We must not get diverted by the financial sector's opposition or by populist rage. We must focus, instead, on the core issue. Trying to make financial systems safer has made them more perilous. Today, as a result, neither market discipline nor regulation is effective. There is a danger, therefore, that this rescue will lead to still greater risk-taking and an even worse crisis at some point in the not too distant future.

Either we impose a credible threat of bankruptcy, or institutions we have to support are made safer, or, better, we have both of these. Open-ended insurance of weakly regulated institutions that take complex gambles is intolerable. We dare not return to business as usual. It is as simple – and brutal – as that.

Bingo: the inherent risks of the market must be allowed to operate with no bail-out mentality: further, and this is more critical, failure has to have meaning, most emphatic meaning, to banking careers. The idea of the bonus system truly means a system that rewards the good: it has become a system that pays simply because those people work in the banking system at all. That is a perverse development if there has ever been one.

Now, let's move to Mervyn King.

He's right: "too big to fail" doesn't mean "too big to fail" but really means "too big to be tolerated".

The key quote, nicely Churchillian:

Never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.

Nicely put.

The Bank governor wants to see the utility aspects of banking – payment systems and deposit taking – hived off from more speculative ventures such as proprietary trading. "There are those who claim that such proposals are impractical. It is hard to see why," he said.

Finally someone who understands that it is the mixture of the two which is deadly: that the same bank that handles the day-to-day business of finance is the same one who can torpedo the entire system by allowing extremely high leveraging into extremely risky instruments.

Next, Daniel Yergin.

Yergin wonders what will happen to capitalism in the wake of the Great Recession: he says that there is less talk about the "magic of markets".

The magic of markets? The only thing magic about markets is how ruthless they are, how little markets care. The only thing that went wrong with markets is the expectations people had about them, that they "understood" how markets work: that is the cause of the bitterness, suspicion and outright hostility to them as Yergin puts it. Government control over the businesses that ruined themselves in the markets is indeed ad-hoc: there was no sinister master plan to take over the automotive, energy and finance industries in the US, but the government intervened to avoid even worse errors, errors made in panic. The government will make its own errors - and given the qualities of the current Administration, they will prove to be errors made in order to enrich the politically connected in true Chicago fashion - but they won't be the errors of those panicking in order to cover up how they made their errors.

Yergin's major points of the emerging narrative are illuminating: too much leverage, risk undetected, failed regulation, political policies, too much greed, psychology, hubris, undetected vulnerabilities, destruction of purchasing power, "can't happen",

Bravo: these are good. Very good, as the underlying core appears. Banks were leveraged too much because the markets were distorted and their own operating conditions deliberately made lewd; risks were undetected because the markets were poorly understood for new products; regulators failed for the same reasons; political policies distorted markets absurdly; given these distortions, too much money could be made too easily; people wanted things so; they thought they had gamed the markets permanently; because market mechanisms were ignored, market vulnerabilities were ignored as well; purchasing power of those losing everything has been destroyed; and most fundamentally, tied in with market psychology and hubris, the idea that it can't happen" led to the Great Recession.

Yergin points out that one result may well be the reversal of willingness to carry risk, which will, of course, slow the economies of the world down. If you are afraid of risk, the road most taken is the safest, but brings the least rewards.

What Yergin comes close to - but alas does not hit - is that if you are going to take risks in this new, scared economy, you need to understand your markets better than ever: not merely demand and supply, but more fundamentally what drives demand and how supply is structured, as well as a detailed understanding of market mechanisms. This won't guarantee success: it will, however, help in avoiding the very risk that no one wants to take anymore.

Finally, someone whose political and professional instincts blind him to the market failure that is destroying his profession: Leonard Downie.

The key quote:

American society must now take responsibility for supporting news reporting, especially local news – as it has, at much greater cost, for services such as education and healthcare.

Must? There is a moral imperative at work here?

All this because the newspapers have had their reason for being yanked out from under them: their business plans no longer function.

Because they ignored the reality of the markets. Hence Mr. Downie's solution: get rid of the market and let journalists produce without regard to economics.


This is, unfortunately, exactly the understanding that leads to collapse, that what someone does is so important that society must support it, regardless of why it cannot support itself.

Societies support education because the economy needs skilled workers to maintain a high standard of living (of course, you can't tell that from any schooling teachers have); they support health care because of moral imperatives to help the helpless and save the sick; journalism as it exists today, that pale shadow of actual reporting of the Murrow age that charades as objective whilst reporting as if there were no objective facts, deserves no death-bed reprive because it has failed in the market.

To do otherwise would be a huge moral hazard: of giving money to those who have failed and continue to fail in the market for their products and to thereby remove the risk, socialize the risk, virtually deny that there even should be a risk.

The fundamental reason why newspapers are failing is that they are not meeting market demand. People stop reading the bread and butter of newspaper journalism, the local daily paper, when it stops reporting on local interests and simply repeats what others say. People stop reading the newspaper when it is a waste of time for them to do so. People stop reading the newspaper when it replaces plain and simple reporting for preachy subjective worldviews masquerading as facts, in effect lying to their public in the name of a greater good. People stop reading the newspaper when it no longer meets their needs.

There are successful local newspapers, thriving ones. The Taos New Mexican for instance, is one. Award winning, it earns money.

Just not a lot.

Here are a few hard, cold facts: newspaper journalists are generally overpaid. It's a job that doesn't require much in the way of skills beyond grade-school grammar and the ability to take notes. Really good journalism, the kind that takes down corrupt politicians and exposes waste and fraud, the kind that Mr, Downie thinks he loves (really, he loves the idea, rather than the reality, as can be seen by the virtually complete compliance of the newspaper journalism profession to missives from the current Administration in Washington; there is enough wrong there to win at least a dozen Pulitzers, but their own political belief have led them to self-censor and not report the barking dog) is, on the other hand, not so easy. But it's also rare: however, journalists are being paid as if they were those folks, rather than the barely skilled labor that most really are.

News reporting, especially the sort that holds accountable those with power and influence throughout the nation, has been a vital part of American democratic life. It may not be essential to save any particular news medium, including printed newspapers. What is paramount is preserving independent, credible news reporting.

What Mr. Downie doesn't seem to realize is that this has already happened. But no one calls them journalists. They're bloggers instead. It's been bloggers that have held those in power and with influence accountable and who have pointed out that the emperor has no clothes.

Not journalists.

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