Yves Smith is the author of the successful and highly respected financial blog naked capitalism. She took some time out from her writing to answer some questions about her new book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism for www.tradingdiary.co.uk.
1. What is your book ECONned about?
ECONNED shows how the financial crisis is ultimately rooted in dubious economic theory. Its wide-ranging historical treatment starts with changes in methodology in the economics profession in the decade after World War II, leading to the rise of neoclassical economics and financial economics, which over time came to dominate policy thinking. These ideas were seized upon by conservative and corporate interests to promote deregulation starting in the 1970s, which included deregulation of financial services. But as ECONNED explains, financial markets operate differently than goods markets. Most importantly, they lack a propensity to self-correct. The result of deregulation of financial services was a rise in predatory behavior and looting, which unwittingly aided by overly accommodative Federal Reserve interest rate policies, produced the financial crisis. ECONNED also broke the story of how Magnetar, a Chicago-based hedge fund, played a critical role in turning the subprime crisis into the detonator of a global banking crisis.
2. You write a blog called naked capitalism. What made you decide to write a book?
It seemed like a good idea at the time
3. How did writing your book compare to writing your blog?
With a book, you get to dig into various issues and do serous research, which is pretty much impossible given the short time frames and effective space constraints of a blog. The frustrating thing about book writing, however, is the long lead times involved. The book was a crash project (which in retrospect was nuts given how ambitious the book is) and it still took a full year from the signing of the contract to its publication. And of that time, a full five months were activities post the copy edit phase (further proofreading, layout, galleys, printing and distribution). While some of those steps could have been eliminated, they would have hurt sales.
4. When did you start to become sceptical about economics? What was it that made you think something was wrong with the ideas that economics presents?
I don’t recall ever having been a true believer. My father (an engineer and later corporate executive) contrary to his unusually non-interventionist parenting style, forbade me to major in economics or sociology. “They won’t teach you how to think and they won’t teach you how to write.” I went to business school and Wall Street just when the precepts of financial economics were being widely embraced. While anyone in finance winds up relying on some of the techniques, I was always struck by how they were adopted wholesale, with no concern about their limitations. And when I did the research for the book, I was stunned to find out both how rotten the edifice was, and (from academics and practising economists) how aggressive and wide-ranging the efforts are to reinforce the orthodoxy.
5. Do you have any predictions for what the cause of the next big financial crisis will be?
I’m loath to make predictions. Conventional wisdom is that it will be sovereign debt. Another possible trigger is the Chinese bubble. Many investors accept that valuations in China are dependent on unsustainable stimulus and increasingly unproductive capital investment, but nevertheless believe the trend has longer to go and are riding it. That sort of thinking (fairly widespread acknowledgement of and participation in an overvalued market) usually ends in tears.
6. What advice could you give the average investor to help them avoid getting stung by the next crash?
Be very mindful of risk. The old saying is “Rule number one in investing is not to lose money. Rule number two is never forget rule number one.” Conventional theories and rules of thumb greatly understate the risk of markets. (like ones that argue that one’s equity allocation should be roughly 100% minus ones age, so 40 year olds should allocate 60% to equities) push average people and money managers into taking more risk than they realize. The good news for average investors now is they have a lot more options for diversification than before, such as foreign currency stocks and bonds (or straight currency plays) and commodities.
The other important precept is “know your limits”. An excellent short book by Benjamin Graham, The Intelligent Investor, argues that investors need either to do some very simple things and stick to them (his version was find eight excellent companies, know then well enough to be able to recognize when their stocks were cheap and buy them only then, and to similarly buy bonds only when the bond market as a whole was cheap) or make investing a second job. Any approach in the middle (spending a fair bit of time on investing but not at the amateur pro level) leads to overtrading and worse performance than finding some simple decision rules and sticking to them.
7. What do you think of Nassim Nicholas Taleb’s ideas? You refer to his writing quite a number of times. And from your book it sounds like neither of you are willing to get fooled by conventional thinking.
He’s done a great job of popularizing the ideas of Benoit Mandelbrot, the mathematician who first demonstrated that the risk distributions in markets differ from those used in financial/economic theories, and he also has the market/analytical expertise to be a credible critic.
8. What is your favourite financial 1) blog, 2) book and 3) website? (you aren’t allowed to pick your own!)
Ooh, it’s hard to pick only one in each category.
With the blogs, the tradeoff is often frequency of output versus overall quality. There are some blogs I like very much, like Steve Waldman’s and Mike Konczal’s, where their work is consistently top quality but they don’t write regularly enough to qualify as a favorite. I really enjoyed Willem Buiter, but he is no longer posting. I also respect Matt Taibbi tremendously, he has such a daring writing style. Dean Baker specializes in drive-by shootings of misguided economic reporting in the MSM. Rolfe Winkler is very good but he has been pressed into service by Reuters as more of a journo and is doing less blogging than before. Robert Peston is a must read.
Picking a book is easier. I particularly like Roger Lowenstein’s When Genius Failed, the account of the rise and fall of Long Term Capital Management (ed: read our mini review of the LTCM book here). It’s the rare engrossing journalistic account that gets the financial details right (and this isn’t just my opinion, some of my clients had a seat at the table and say Lowenstein was just about perfect in his reporting).
The best go-to financial website is FT Alphaville. Wide ranging and well informed.
9. Will there be a second book? If so what will it be about?
I’m puzzling this now. ECONNED was a Bataan death march, even with the input and support of quite a few collaborators, in particular three (Andrew Dittmer, Tom Adams, and Richard Smith) who were hugely generous in their contributions, particularly in the two weeks before the text was finalized. The conundrum for me is the topic that seems to be the most germane and interesting to me now, debunk “financial innovation” may not be a wise personal or commercial choice, even though it is an important topic and has not gotten a serious long-form treatment. It would help sharpen the debate to define the standards by which innovation ought to be judged, look at a host of products and techniques and see how they stack up, and also look at the politics and propaganda of “financial innovation”. But that is probably time sensitive (as in another crunch project) and might appeal only to a narrow audience.
10. And finally – all the cute animal photos on your blog – what’s that all about?
It’s called “Antidote du jour” for a reason! Looking hard at the state of the world is a gloomy exercise, readers need some relief. When I started posting animal pictures, it became so popular that readers would be VERY unhappy if I were to drop that feature.