Friday, December 19, 2008

Madoff economies

Paul Krugman asks a basic question. While everyone is tutt-tutting about Bernard Madoff's amazing fraud (how come the SEC never saw it even though it had been denounced as a Ponzi scheme in 1999? How come knowledgeable investors fell for it? etc etc etc) isn't Madoff not really just a symptom of what is endemic in the US (and perhaps global) finance industry? Madoff was an explicit crook but large sections of the US finance industry as a whole are crooked.  They have destroyed value, distorted individual incentives (including those of politicians!) and ruined lives while making those who operate the industry incredibly wealthy. 

Spivs invest in worthless mortgage contracts (or ultra-high risk investments) and make millions just before the contracts turn toxic.  Doing this yields the practitioners more wealth in a short period than a skilled scientist or engineer can earn in a lifetime. Indeed, American wages generallly have stagnated over the past few decades while the salaries of the spivs and bankers have exploded. Moreover, it is not the equity issues that are of major concern but the sheer illogic of believing that such outcomes have economic rationality.


jc said...

Gee Harry

And I suppose all the equity offering done to move capital from the savers to industry was just done by spivvy bankers.

I guess you're looking for a rise?

How exactly do you morph "Made off" into a banker , harry.

He wasn't even a money manager in the strict sense of the word.

hc said...


OK I am looking for a rise but I am genuinely puzzled by the antics of millionaire factories.

Again this week the CBA-Merrill Lynch fiasco was widely criticised for non-disclosure. Finally the deal - raising something less than $1.6 billion for CBA - was implemented by UBS for $50 million.

I was most puzzled by the scale of the fee paid to UBS (rather than the non-dislosure scandal) which is a cost of around 3.75%. There was no underwriting of the issue as far as I know and the whole deal was arranged in a day or so - though UBS had some preparation for the deal since they had originally tendered for it.

$50 million would fund a reasonable sized university department for a decade. Thousands of students would be educated and academics would be paid salaries from this for teaching hundreds of courses.

Yet to a finance company this amount is a transaction cost fee for a limited capital raising that is concluded in a few days. I assume those involved pay themselves multi-million dollar bonuses for productively releasing savings for equity investment!

The puzzle to me is that competition does not drive outcomes with much lower transaction costs.

jc said...


the CBA deal appears to be a screw up. We will know soon enough whose fault it is as it will invariably go to court.

UBS did underwrite the deal.

jc said...


International I-banks have not been making the stellar returns you infer in your missive over the past 20 years or so.

If the fees, which are market determined, are so high, where has all the loot been hiding?

You think we ought to go back to the regulatory environment prior to the big bang which is when brokerage and i-bank fees where imposed by regulation?

You need to choose Harry.

hc said...

Yes UBS did underwrite the deal.

Much of the fees have disappeared in bonuses. In the case of Merrill these have amounted to billions.

I favour a much more regulated financial system. Always have.

conrad said...

"I am looking for a rise"

Looking at the current state of La Trobe, I wish you luck. I'll assume that they couldn't even give you one if they wanted too. Perhaps it's time to move to Melbourne or somewhere else you can get to easily. Either that, or move to a bank or somewhere that pays real money -- surely there must be reasonable demand for good economists, even in a recession. I've no idea why someone like you would torture yourself at La Trobe given the current state unless they are giving you a really cushy deal.

hc said...


I mean't 'looking for a rise' in the sense of provoking a response not in the sense of seeking more money.

La Trobe economics has done very well over the past 5 years with staffing increasing from 17 to near 45. I just (yesterday) shared an internal research grant for $23,000 and still hold claim to a large ARC Grant.

I teach two units per year and do not take tutorials.

I am very happy with LTU and have no desire to go anyewhere else at present. I am happy with my current Dean and with the administration of the Department - particularly as I am not Head of Department now! The Library is a bit short of funds but specialised books I want I can buy with research funding.

LTU is making voluntary staff cuts but generally I am very positive on the future of my university.

hc said...


One of the sources of negative impressions about LTU is The Age newspaper. This left-wing rag - Melbourne's Pravda always presents LTU in the worst possible light.

It is an instance of the worst sort of arrogant left-wing snobbery.

The recent financial issues were grossly exaggerated by The Age. The move to provide voluntary redundancies is to generate greater surpluses than can be used to improve the campuses' infrastructure.

jc said...


I-banks risk weight underwritings to dervive risk to capital and the return required to compensate for that risk. It's wrong to suggest the proceeds of an underwriting would mostly go to pay bonuses.

Would you prefer to see th lions share of I-bank revenue retained by the shareholder? This would be a very corporatist view to take.

Harry selling wholesale financial products is not easy. The people that succeed does so by using their wits.

I suggst you should try it if you think it's easy.

Please explain what other regulations you would introduce.

observa said...

A few obvious points on regulators and regulation. We've never had so many of both and yet this whole meltdown is bigger than the 30s now. A major problem with Madoff was the regulator ran their eye over them and virtually gave them a clean bill of health. Typically investors will come to believe the regulator will protect them, rather than the caveat emptor truth, that regulators are just there to mourn with you when they like you read about your sad losses in the newspapers. When did our regulators ever produce anything useful in that regard? From Enrons to Madoffs, Ansetts to HIH and Onetels. In September our banks were safe as houses and a few weeks later needed taxpayer guarantees. And now the ACCC is still trying to prosecute Dick Pratt for reneging on a 'deal' to collude on prices, so he could actually undercut his close competitor. All this while any box maker is free to undercut both of them. The same ACCC that has had umpteen enquiries into fuel pricing, found nothing, yet supported Fuelwatch and look at the pump prices today? What can you say? They don't get the big bucks of finance but they do get permanent tenure to average it all out.

As for Krugman's loaded question-
'They have destroyed value, distorted individual incentives (including those of politicians!) and ruined lives while making those who operate the industry incredibly wealthy.'
Fair bloody dinkum! What does Krugman expect when central banks are complicit in delberately targetting 2-3% reduction in savings each year? Where in hell does he expect the ill-gotten gains to go for chrissakes, if not to the complicit financiers and taxers by stealth? That is assuming they can get that level of theft correct and are not grossly fooled by baby boomer demographics and the propensities of Asian savers in their grevious caclculations. The Gordon Geckos of finance and the Louis Leeches of govt are like symbiotic anemones and clownfish dear Krugman. They have no vested interest in real money supply. That which produces a quiet appreciation of say 2-3% pa in value of monetary savings, which is what you'd expect with productivity growth. That'll be the day when we don't need any regulators and the funny money men will fall on very lean times.

jc said...

A few obvious points on regulators and regulation. We've never had so many of both and yet this whole meltdown is bigger than the 30s now.

No that's not true, Observer. from 1929 to 1932 US GDP was sawed in half and unemployment reached 25%. It shouldn't come as any surprise at the number of banks that failed.

What we have now is a good old fashioned 19 century like panic in the banking system.

Those panics were actually quite frequent in those days, yet a number of left wing economics are trying to suggest this is the end of capitalism when capitalism has always experienced these sorts of events.

derrida derider said...

What we have now is a good old fashioned 19 century like panic in the banking system.

Those panics were actually quite frequent in those days

All true, and those panics led to huge swings in GDP and unemployment too.

Because, of course, markets were effectively unregulated then. Plus they had the gold standard that made sure economic activity varied to preserve the value of the currency rather than vice versa.

Neither phenomenon is much comfort to the libertarian fringe.

jc said...


the 19th century panics were short lived and the growth spurts were incredibly big. It wasn' a bad time at all actually.