Posts Tagged ‘ECONned’

Yves Smith Interview about ECONned and naked capitalism

Monday, April 26th, 2010

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

1. What is your book ECONned about?

ECONned book by Yves SmithECONNED 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.

ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism by Yves Smith is out now at Amazon and all good book shops.

ECONned by Yves Smith book review

Monday, April 19th, 2010

Yves Smith runs the popular financial blog naked capitalism. This is a review of her first book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

It puts forward the case that flawed economic theory, and the influential followers of those theories, have played a large part in the economic crisis which started in 2007, and which is still not over as of 2010.

ECONned book by Yves SmithChapters 1-5 which form the first half of the book, focus on standard economic theories and what is wrong with them. She goes through topics such as supply and demand, neoclassical economics, free markets, and normal distribution. She gives the background and history to these theories, and then picks them apart, with plenty of examples as to why the standard thinking is wrong. I’ve never studied economics but had no problem following the arguments in these chapters.

One example is that the normal distribution (or bell curve), calculated the odds of a 10% move in the Dow Jones as only being possible one in every 73 to 603 billion years. And yet this move happened twice in the same month. Yes – it would be possible in these odds – but much more likely is that the odds were devastatingly wrong due to relying on flawed bell curve assumptions.

If you have read the Fooled by Randomness and Black Swan books by Nassim Nicholas Taleb, you may notice some overlap in the people, stories and opinions in the first 5 chapters. That’s not a bad thing though, as Nassim and Yves both make very good arguments.

Chapters 6 and 7 are different, and tell of financial people and companies making very stupid decisions, and losing a lot of money. I always like reading about people who make massive financial mistakes. It you like these chapters then see Traders, Guns and Money by Satyajit Das for more. Chapter 7 also details the problems with Value at Risk (VaR), and compares the differences in power structures between the banks and the military.

Chapters 8 and 9 get into details as to how the crisis happened. She gives a great explanation as to how risky loans were turned into complex financial instruments with AAA ratings – meaning they should be as secure as government bonds.

Chapter 10 is one of the scariest as it details what happened after the major crashes, when government money was pumped into the worlds banking systems as lightning speed. Rather than going toward propping up the stability of the critical banking elements, much of the money was going straight (or nearly straight) into the pockets of those highly paid bankers who got us into this mess in the first place.

Yves then gives her suggestions for how to make the financial system more stable, and how it can better serve the needs of the general population, rather than only serving the needs of the rich.

This is definitely a recommended book, well written, and with good arguments put forward from someone who clearly knows their subject. I hope that whoever is our next Chancellor of the Exchequer after the May 2010 elections will read a copy.