Peter Levin’s Rethinking Markets

July 17, 2008

Rethinking markets - market metaphors

Filed under: Art, Markets, Pollution, Ramble — Peter @ 2:43 pm

I think it’s time to regroup, and actually do some of the ‘re’ thinking of markets I’m always planning to get around to. I want to do so in the context of three recent observations:

The Examples

The first observation comes from Fabio Rojas, over at the orgtheory blog - though it is slowly becoming the orgborg (almost 20 current or past posters!). In talking about the possibility (likelihood, I’d say) of a downturn in the contemporary art market, and sifting through the comments of restive art producers, Rojas is puzzled by four things:

Interestingly, for me at least, the comment thread turned into a discussion about how the readers (mostly practicing artists) felt about Chelsea (the fancy pants NY art district). A few things came up in this thread, which are obvious to anyone hanging around artists:

* Some folks seem to have bitter feelings towards the booming art market. Winkleman himself seemed perplexed that some readers should wish for the disappearance of the galleries which are responsible for selling the art. It’s like car engineers hating local dealerships.
* Some folks resent the fact that there are types of art which are popular in hip art districts like Chelsea.
* There is often a severe mistrust of dealers, not just specific dealers.
* People believe that markets are irresistable forces that undermine art.

Fabio wants to inject “a little bit of Cowenism,” which as I understand it means economics+incentives+assumption of efficiency-via-markets. Or something. Somebody has to pay for art. So rather than whine about dealers getting their share of the financial compensation for art, or the power of galleries/dealers in setting aesthetic and market standards for the art world, artists ought to be more appreciative of the expansion of the art world via art markets. And we ought to simply recognize art as another market, organized in similar fashion (if a little quirky), and play by those rules. Or, you can get a real job.

The second example comes from the EPA’s recent decision to lower the value of human life. Or rather, to lower the determination of the value of a statistical human life, the hypothetical monetary value of the loss of human life. As a result, decisions are being altered for how the EPA would regulate the environment. The EPA, since the 1970s, has used cost-benefit analysis in its decisions to regulate or not (read Wendy Espeland’s Struggle for Water, and Ted Porter’s Trust in Numbers!). Thus, reducing the value of human life has the practical effect of making regulation less likely - the ‘costs’ of regulation have to be lower than the ‘benefits’ of saving X number of human lives. The more the costs and the lower the benefits, the less likely environmental regulation would be.

Analysis of the costs of human life vary, but the main way to measure it is via the economic principle of ‘revealed preference.’ That is, people make decisions everyday that put them at risk of death, and by measuring these decisions, we could assumedly make inferences about peoples’ own value on life. The probability of a firefighter dying in a fire over the course of their career, combined with the salaries of firefighters in the labor market, yields a kind of indirect decision that ‘reveals’ one’s own value on human life. You may not be willing to be paid $3 million to die, but you might be willing to be paid $65,000 to take a job with a possibility that you could die during the course of your duties.

In practice, the EPA has dropped the value of human life from $7.8 million in 2003 to $6.9 million in 2008. Interestingly, a number of different federal agencies apparently have different valuations of human life, despite attempts to come to a single price. The EPA, in its Solomonic wisdom, decided to split the difference between a couple different studies giving a high and low estimate for the value of human life.

The final example comes from the ongoing housing meltdown, this time the Freddie Mac/Fannie Mae edition ¹. These two agencies are quasi-governmental, meaning that they have had a governmental imprimatur to buy and package mortgages, not backed by the federal government per se, but really backed by the federal government. In the coming bailout that you, me, and your grandchildren will be paying for, a number of folks in the business press are suggesting that we’re treating these agencies, and bad homeowners, to a version of ‘capitalism lite’:

Why should responsible homeowners have to foot the bill for the irresponsible behavior of others in a capitalist system? (No, the folks buying homes they couldn’t afford weren’t all hoodwinked by mortgage lenders.)

The answer: A higher power has decided that the anticipated future cost — the risky behavior it encourages tomorrow by rewarding it today — is less than the more easily measured current cost.

The housing market is a mess. Sales and prices are still falling, competition from distressed sales (of foreclosed properties or short sales by the bank) is mounting, lenders are tightening credit standards and employment is falling. Policy makers have decided that short-term pain is intolerable, especially in an election year, with constituents badgering their representatives to “do something” about high gas prices and a lousy economy.

Assumedly, this means that we should be treating them as just capitalism (or ‘capitalism classic,’ maybe). That is, let the banks fail, let markets separate the wheat from the chaff, let the capitalist system to its work. This is the financial crisis writ small, I think. The argument goes something like, let Bear Stearns fail, banks should close, people making stupid decisions should be punished. Capitalist markets are about market signals, punish with poverty, reward with prosperity. Let the government get out of the way of these signals.

This reminds me of my recent trip to Canada (rocks and trees and water!), where our tour guide kept saying that since the government no longer lets the forests catch fire, they overgrow, get diseased, and now no wildlife really live in them. Fire is natural. Analogously, downturns in capitalist economies are natural. Get in the way of them (with government!), and we get disease, rot, and no more wildlife. Er, innovation.

The problem

Here is the problem. In each of these cases, MARKETS ARE A METAPHOR. In the real world, markets are a metaphor. Say it with me, now. Markets are a metaphor. We’ve arrived at a socio-cultural place where so many people believe that markets are things found in nature that it’s just out of control. Even in the best of cases, say, a core financial capital trading environment, it is a metaphor.

Of course, that it is a metaphor does not make it inconsequential. On the contrary, what this insight should tell you is that if someone tries to convince you with an authoritative, ‘well, you know, markets!’, you should call BS. The extraction and distribution of resources is a political question², subject to formal and informal rules of authority, cultural, and social practices.

There are resources, yes. Raw materials, found in nature, as well as in human ingenuity. Lots of coordination among lots of people is necessary to get at some of these resources, to be sure. And these resources do have to be distributed, with enough subjectively-understood fairness that people continue to want to participate. These things are all true. But there is a big big difference between saying markets=what economics tells us markets are, and markets=how these resources are extracted from the social and natural environment in the world-that-is. I’m not just saying that markets are different where the rubber hits the road, compared to the textbooks of neo-classical economics. I am saying that economic markets do not describe some found reality. They describe an existing set of institutional arrangements. People who believe markets are natural are like people who believe that mathematics taps the mind of God because a nautilus’ shell grows like the Golden Spiral. It has the benefit of being completely arrogant. And the added benefit of being not, you know, true.

Markets are one means of creating incentives for extracting resources and distributing their rewards. Doing so in other ways may require such a shift in what we are currently about that it seems crazy. This is a fancy way of saying that markets are hegemonic; they have achieved ‘theoretical closure’; they have an aura of ‘naturalness’; they are taken-for granted. In Michael Pollan’s Omnivore’s Dilemma, he comes across a pastoral, slow-food organic farmer whom he asked about how a place like New York City would fit into his vision of local food economies: “…he startled me with his answer: ‘Why do we have to have a New York City? What good is it?’” (245). Unthinkable! Our society would change a lot, lot lot, if we were to really consider extracting, using, and distributing resources in more radically new and different ways. (Another aside, don’t you just want to kick the asses of those who get the vapors over manufacturing that isn’t carbon-neutral, but don’t give a shit about manufacturing, or farming, or service work for that matter, that doesn’t pay a living wage?)

What has happened here? My own guess is a relative collapse of imagination, combined with a hearty stake in the existing state of things, particularly for the first world (and those aspiring to get there). And that the only alternative to markets is state-determined extraction and distribution of resources (ie communism/socialism) is a testament to the enduring power of Marx to inspire along with a long-term successful stoking of anti-communism as a political maneuver. Are there really no other ways to coordinate and extract resources, and then to distribute those resources, than markets or via the state?

In the meantime, why shouldn’t artists be ticked off at dealers who make money from their labors? To me, a little bit of Cowenism is kind of a version of hectoring laid-off factory workers about the aggregate benefits of comparative advantage, or being ticked at college students who don’t love globalization.

And the EPA doesn’t place a monetary value on life, don’t be moronic (or rather, try to pay the EPA to snuff out a colleague and see what happens). It makes decisions about how and how much to regulate polluters. Cost-benefit analysis is kabuki theater to give well-meaning, and sometimes not so well-meaning, to a decidedly political process of balancing the interests of industrial polluters and the rest of us. ‘Valuation of a statistical life’ is a metaphor, being used to allow polluters to continue to pollute irrespective of the rest of us. Is this that difficult to understand? And Wall Street has never had the interests of the rest of us at heart. Never in its two hundred year history. That it has made some rich, spread some wealth, allocated financial capital to where and when it was needed, provided a powerful ‘information mechanism’ is all true. But we should start comparing these things to the degradations Wall Street has also fostered. Every time someone hides behind ‘markets,’ I feel like getting all Dolores Umbridge ³ on ‘em. So enough BS with assuming markets real things discovered in nature and not social practices bolstered by rules, culture, and practices, already; let’s start working on other ways to tackle the problem.

¹ back
As an aside, I’d like give a shoutout to that subset of jerks who knew you could not afford the homes you bought and bought them anyway, feigning shock over the future costs of those giant fake mortgages. Thanks, guys! Way to give a crap about the rest of us!)

² back
You know, you don’t have-a a patron saint for the United States, but there are some American saints. Just the last couple of years they made-a some. The first was-a about-a two years ago. Her name was-a Saint Elizabeth Ann Seton. Mother Seton-is-a what they call her. And she’s got-a these nuns of her own order who lobby-they’re real heavy-they came to Rome and everything. And it’s amazing, you see. To be made a saint in-a the catholic church, you have to have-a four miracles. That’s-a the rules, you know. It’s-a always been that-a. Four miracles, and-a to prove it. Well, this-a Mother Seton-now they could only prove-a three miracles. But the Pope-he just waved the fourth one. He just waved it! And do you know why? It’s-a because she was American. It’s all-a politics. We got-a some Italian-a people, they got-a forty, fifty, sixty miracles to their name. They can’t-a get in just cause they say there’s already too many Italian saints, and this woman comes along with-a three lousy miracles. I understand that-a two of them was-a card tricks. Next thing you know, they’re gonna be making Kreskin a saint. Saint Kreskin-they’ll probably call him. It’s a good one.

³ back
Dolores Umbridge: [walks in front of Harry with a straight face] Yes?
Harry Potter: [hesitates and looks at his scarred hand] Nothing.
Dolores Umbridge: [bends down] That’s right. Because deep down you know that you deserve to be punished. Don’t you Mr. Potter?

May 23, 2008

Museums as value-chargers

Filed under: Art, Culture, Markets, Uncategorized — Peter @ 8:01 am

I have not worked out the distinctions between value and values, or the separate spheres arguments of Zelizer as it fits more generally into economic sociology - efforts to bend her work to my frameworks don’t generally work, and it’s a failure of my frameworking. Still, this excerpt from Kopytoff seems incredibly insightful to me:

When things participate simultaneously in cognitively distinct yet effectively intermeshed exchange spheres, one is constantly confronted with seeming paradoxes of value. A Picasso, though possessing a monetary vale, is priceless in another, higher scheme. Hence, we feel uneasy, even offended, when a newspaper declares the Picasso to be worth $690,000, for one should not be pricing the priceless. But in a pluralistic society, the “objective” pricelessness of the Picasso can only be unambiguously confirmed to us by its immense market price. Yet, the pricelessness still makes the Picasso in some sense more valuable than the pile of dollars it can fetch - as will be duly pointed out by the newspapers if the Picasso is stolen. Singularity, in brief, is confirmed not by the object’s structural position in an exchange system, but by intermittent forays into the commodity sphere, quickly followed by reentries into the closed sphere of singular “art.”
- Igor Kopytoff. 1986. “The cultural biography of things”, pp. 82-83 in Appadurai, ed. The Social Life of Things

The idea here is radical in its insight that objects float into and out of commodity states. We have an old paperback copy of Anna Karenina that is clearly a mass market paperback. But it was given to my partner by her dad, who passed away a couple years back. The book, with its missing cover and folded pages, is no longer a commodity but is now an object imbued with memory. It’s specific to her though, and it would revert back to commodity if she were to give it away to Goodwill. Currently though, it has no price as we think about it.

But some things lose their value for being brought in and out of this commodity state. It can only be commoditized for the first time once. This is why social ties, once monetized, are difficult (but not impossible) to revert back. And if art is to remain valuable by virtue of its cultural value, art world participants have to be careful about how and when they manage the culture/market spheres.

This reference to Charles Saatchi’s joining the efforts of the Art Trading Fund sings to me about how the monetary sphere/cultural sphere dance works.

Damien Hirst is commissioned by Saatchi to produce “The Physical Impossibility of Death in the Mind of Someone Living,” in 1992 for £50,000 (about $100,000). It is displayed in his gallery until 2005, when it is sold to Steve Cohen of SAC Capital for $8M. Then, just as suddenly as it was moved into the sphere of commodity, it is snatched back into the realm of culture, placed on display at the Metropolitan Museum of Art for three years, from 2007-2010.

I like the fact that everyone knows that the Met is recharging the cultural batteries of the shark, depleted by its run-in with the marketplace. And of course, as Roberta Smith’s article points out, the Met does not represent some culture-only venue, but a marketplace in its own right. All sides are both totally cynical and totally authentic - art needs to be displayed, and art is a commodity. After another 10 years off the market (probably less), we’ll hear of another sale, another moment of commodification. And then it will be off for another traveling show at Bilbao or somesuch. Just you wait and see.

May 21, 2008

Education = success

Filed under: Markets — Peter @ 9:33 am

Via Ezra Klein, a discussion of the stagnation of wages for college students. It turns out that the 2000s thus far have been mediocre to lousy for college graduates, with inflation-adjusted average hourly wages for young college graduates barely rising from last year, and having fallen by $.60 for women and $1.60 for men since 2002 (the hourly wages are currently $21.09 for men and $18.17 for women in 2007). The good news is that men still make $3 more per hour than women. Yay men (cue interjections about comparability of jobs, human capital differences, brain research, the bold physiological power of the penis).

I always wonder at what we’ve settled on here in the US, w/r/t education as an answer to inequality - give more people access to college! True, but when your economy looks increasingly like an hourglass (actually this is wrong - it’s more of an hourglass with a tiny bulb at the top and a larger one at bottom, pardon my graphical skills), there’s really not much place to put college graduates into good jobs.

I think there’s a ‘new deal’ type discussion that would benefit out country, and of course I’m not the only one to think so. Give a read to the original, it’s worth it. FDR makes the point that in an era when we needed/wanted to industrially develop the US, we were willing to offer things like giant economic disparities between rich and poor, monopolies over infrastructure, etc. The closing of the American West and overproduction in the early part of the 20th c. made that a lousy deal - we needed a new one.

Fast forward to now, what is the rationale for allowing the economy to develop in the ways it does? It is almost purely a self-interested one from the ‘haves’ combined with a rigorous macro-economic defense of trade and capitalism. It is a defense of the status quo, and it is so much less durable than it appears when it is in front of us.

May 20, 2008

Chagall v Cezanne

Filed under: Art, Markets — Peter @ 7:16 am

I was a panelist yesterday discussing art markets, at the Christie’s education center. Great group of people, and really lovely of Marisa Kayyem to invite me. One of the more interesting moments was in our discussion of the primacy of market prices as a measure of value for a work. I had put up a slide noting that ‘centrality’ was the commensurative measure for fine art: that pieces that were closer to the ‘center’ of categories would be considered more important, and hence would command higher values. Someone rightly asked me about the fact that sometimes ‘centrality’ for experts (i.e., art historians) differed from ‘centrality’ for the public; and shouldn’t I clarify the distinction between market value and cultural value.

This led to a surprisingly common discussion - the distinction between Marc Chagall and Paul Cézanne. Chagall is well-liked by the public, and when his pictures comes to auction, they sell well. All the time. Cézanne is considered ‘challenging’, and his art tends to command less high prices. Of course there are large numbers of variables here: the quality of pieces that come to auction, private sales, number of works produced. And yet, Cézanne is considered much, much more central by experts. Chagall is more highly valued by the market.

I am not very articulate about it yet, but there is a funny way that art world participants both completely believe and completely reject ‘the market’ as a measure of value. Following art sales is like tracking baseball scores for many (most?) people; seeing Mark Rothko’s paintings sell for records after such a lull in sales in the 80s, or the rise of Lucien Freud are tracked carefully by participants in the high-end art world. Still, Chagall v. Cézanne - the market sometimes rewards popularity more than important artists. Those former market markers are to be tracked, the latter to be dismissed.

So I (snarkily) suggested that if you believe the market, then, well, really believe it - if prices for Chagall are higher than Cézanne, maybe art historians are simply wrong. Uproar (well, art historians don’t really uproar - more like polite murmur). But what’s interesting is this selective use of the market as an indicator of value when it confirms expert valuations, a sort-of belief in it when it changes somewhat expert valuations (let’s reconsider Klimt!), and a disbelief in it when it contradicts expert valuations. I don’t yet have a complete grasp on why this is, the circumstances under which it operates, or how it really works.

May 16, 2008

Commensuration across commodities

Filed under: Markets, Organizations, Prices — Peter @ 11:10 am

Commensuration, the making comparable of qualitative differences via a common third metric, is valuable for its theoretical contributions to cultural economic sociology. It is a process that makes some things visible and hides others, resulting in an extremely impressive if underrated shaping of the social world. Qualitative distinctions across individual student applicants to college, for instance, are wiped out, replaced by test scores, GPA’s, and comparable lists of extracurricular activities. These social realities can be re-made visible (ie a system whereby individuals are judged as individuals with a whole portfolio), but then easy comparisons are made more difficult.

It is also central to the making of commodities, as I’ve argued before. But if you are deciding how to make real-world investments, it is worth understanding the criteria by which the commodities you are interested in are judged. This is not a direct ‘buy company x’, ’sell company y’ kind of argument, just a way to help understand where experts are coming from. It is also where experts are most likely to be wrong in their misapplication of measures to the values they are measuring. That’s the Moneyball argument, that the ways that players were being commensurated were at best inaccurate.

In any case, I thought I’d post a table of what I have in mind, and see if it leads anyplace interesting. This is what blogs are for, right?

In these cases, the idea is that a simple quantified measure is not sufficient; you need to know enough content to understand the criteria used to make the transformative assessments of qualities through quantities. And though VaR has beautiful problems, it is in fact the ways that assessments across different kinds of financial instruments are made; likewise centrality, price per square foot, etc.

Incidentally, this conception I think bridges some of the more highfalutin discussions of performativity and social studies of finance to the more mundane world of organizations and work. But that’s not my point right here and now.

May 14, 2008

A sociological analysis of the current market crisis

Filed under: Markets, Technology — Peter @ 2:54 pm

For my talk at the UCSD Culture conference, I spoke about market crises, commensuration, and market linkages. The slides are a .pdf of my keynote presentation, available here (the keynote presentation for those who can manage it, is a zip file available here). And this post goes along generally though not perfectly with the slides: (more…)

April 24, 2008

What would a system collapse look like?

Filed under: Markets — Peter @ 8:55 am

A blurb-y article from Thompson Financial (in Forbes online) cites a common feeling among the financial movers and shakers about the current and most recent credit crunch:

The international financial system was close to the brink in March when joint action by the U.S. Federal Reserve and JP Morgan Chase & Co. avoided the collapse of investment bank Bear Stearns, Credit Suisse Group’s ex-CEO Oswald Gruebel said.

The breakdown of the comparatively small investment bank would have triggered a global run on other financial institutions around the world and the situation would have spiraled out of control, he said in an interview with Swiss Sunday newspaper SonntagsBlick.

Gruebel, chief executive of Switzerland’s second largest bank from 2004 to 2007, said that central banks fortunately realized that they had to de facto take over the interbanking market.

‘We’ve narrowly escaped a system collapse. This has never happened before,’ Gruebel said.

I wonder about this last bit, and what a ’system collapse’ means in the current financial system vernacular. Craig Calhoun has been writing about ‘emergency’ and the ways that emergency has taken a rarified place in international relations, providing a moral justification for action that cuts across traditional notions of nation-state and interests, while also solidifying those very categories. Emergency implies anomaly, and particularly for things like humanitarian emergencies it provides a counterpoint to something like, say, ‘national interest’ as a way to mobilize international resources and attention.

I don’t want to push his point too much. But I think there is something similar going on in financial markets. Here we should substitute ‘crisis’ for ‘emergency’. But there are strikingly similar elements: a market crisis implies an anomaly in an otherwise working institution. That is, a market crisis suggests a global system of allocating risk and resources that works with glitches. An alternative would be a permanently failing system, one where market crises are the rule rather than the exception, and where the fixes to the system - governmental interventions on behalf of a small group of investors, while purporting to be acting in the best interests of the rest of us - don’t actually fix anything.

So let me sketch this out. A system collapse would mean the failure of trillions of dollars worth of notional value. This is not the same thing as saying the loss of trillions of dollars worth of wheat or US dollars or houses, but rather the value of the contractual obligations on which derivatives are built. If the wheat futures markets closed tomorrow, there would still be farmers growing wheat, selling it on the spot market to wholesalers, who would still make it into tasty Hostess Cupcakes. The futures markets for a number of hard commodities disappeared during WWII, replaced by price controls in the spot market, and well, people still ate.

In the currency markets, we would still have trade. In fixed income, banks would still issue loans, the US government would still auction treasury bills. You would still be able to buy AT&T stock.

What would disappear is two things: 1) an absolutely enormous amount of value for a small number of investment banks and related institutions - on the order of hundreds of billions if not trillions of dollars; and 2) a system for distributing risk, and its attendant costs/benefits.

For the former, that would indeed be a crisis. Well, for some people. It would have real effects, and dramatic ones for places like NYC which is built not just on the finance industry but on all the consumption patterns of high-income people.

For the latter, it would mean that risk would be managed more locally, and probably much, much, much, much, much, much more conservatively than it is now. It would be reasonable for a bank to give out a loan, but without the ability to lay off their risks in a global market they would do more due diligence. Ditto housing lenders, grain wholesalers, etc. The effect would be a massive tightening of credit and much more volatile prices for commodities (both physical and financial).

And that’s it. The argument that we need global finance is simply a status quo argument, not necessarily a substantive one. And while there was (and is) economic justification for the global structures of financial markets - making the distribution of resources more efficient - these justifications have not always held sway, even in finance. Their seeming solidity is a mid-20th century invention at best. A collapse would be a massive change. But it would not be Armageddon.

April 3, 2008

Bubble bubble bubble

Filed under: Markets — Peter @ 4:11 pm

Josh Guetzkow, who has outed himself as that person who is reading my blog, is a professor at Arizona and works on income inequality and mass imprisonment (though he masquerades as a sociologist of sociology). He passes along an interesting article on bubbles and the new new real estate downturn. This is appreciated, and I think it’s his trying to make sense of his own decision to buy property at the top of the market my earlier half-assed attempt to explain housing CMOs.

As for the article, I have a sneaky suspicion that the author is full of it. His contention is that bubbles are preceded by legislation (this is similar to Neil Fligstein’s contention that legislative activity precedes merger waves), and:

That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.

The rest is an analysis of the dot-bomb and the new housing troubles.

I think it’s worth disentangling the housing bubble, which may well be what we are facing here, and the new global financialization, which is less well-understood. Greta Kripner is doing some work on this, with an emphasis on the US economy. For those ambitious graduate students out there, I would say that global financialization may be one of the most important master-narratives since modernity and the industrial revolution at the end of the 19th century (I’ve had this conversation with Ryon Lancaster as well, we may well be on the same page I think). And there were, you know, a couple of good books written about that earlier transformation.

April 1, 2008

It must be you…

Filed under: Markets — Peter @ 10:56 pm

An article by Richard Florida notes large disparities between the numbers of single men and single women in urban locations across the US. Let the conforming to already-existing gendered assumptions begin!

As you can see, if you are looking for a single man, he’s on the West Coast - if you are looking for single women, they’re on the East Coast. Of course, this says nothing about who they are, sexual orientation, and the like. Now, sure, I can go into the sociological implications of life course decision-making, job opportunities, gender differences and similarities. But really, I just want to say that if you are a straight woman in New York looking for a straight man, you’re kind of S.O.L. If you’re that same woman looking for a straight man in LA (though many more men in LA are gay than comparables elsewhere) or Dallas or Denver or Seattle, it must be you. If you are a straight man looking for a straight woman in NYC and not succeeding, you aren’t working hard enough.

March 25, 2008

Housing CMO Primer

Filed under: Markets, Prices — Peter @ 4:05 pm

I want to re-tell a story from Frank Partnoy’s F.I.A.S.C.O., but a bit of background on Collatoralized Mortgage Obligations is first in order. CMOs, and their generalized cousin Collatoralized Debt Obligations (CDOs) are the current culprits in the sub-prime meltdown, so this is probably useful to know practically as it is to know theoretically. Also, I’m participating in a conference on Crisis, Emergency, and Global Processes, and I’m thinking about incorporating some of this thinking into that. This is a long post, and kind of technical, but probably not too much. There is a nice visual at Portfolio Magazine, so if this whole primer doesn’t help, perhaps that will. (more…)

March 17, 2008

High finance and you…

Filed under: Markets — Peter @ 1:17 pm

Funny story: about a two and half years back, my mother-in-law’s financial advisor suggested to her that she could edge up a point or two of interest income by investing some of her money in Puerto Rican municipal bonds. This was the late spring of 2006. In May of 2006, Puerto Rico went bankrupt, and its bonds were downgraded to Baa3 - effectively, one step above junk bonds. Interestingly, a look at Moody’s ratings suggests that PR bonds had been consistently downgraded in spring 2006. So it was not a shock that the slightly higher premium paid to PR bonds were due to risk of default. He just didn’t disclose that to my mother-in-law. She took a pass on the opportunity, by the way.

I didn’t say anything at the time, and I still don’t make a big deal out of it, because to do so would throw into question whether my mother-in-law can trust her financial advisor. But this person - who, incidentally, wins prizes for being one of the best financial advisors in the state of Hawaii - is a bad man. And his advice was, and is, morally reprehensible. Or rather, it’s not the man, it’s the structural position of being a financial advisor for a large financial services firm. Because I can guess what really happened back in 2006. His firm - Merril Lynch - owned a bunch of Puerto Rican municipal bonds, and a call went out to salespeople to offload these losers to their customers. PR munis have high tax-exempt status, which gives them a great selling point, especially when you can obfuscate the rest.

Why do I relate this story? Let me be as clear as possible: the interests of Wall Street are not your interests. Let me say it again: the interests of Wall Street are not your interests. The main interest of Wall Street is to use your bank account to enlarge their own. There are, quite simply, no exceptions to this rule, no nice guys who are different and have your interests at heart. Puerto Rican munis. Puerto-Rican-frickin-munis.

So what’s a person to do? Here’s what I think:

1) You can’t beat the market. Theoretical discussions of the Efficient Markets Hypothesis aside, you don’t have the technology, time, and tools to beat the market. Your cognitive biases and lack of experience make you likely to trade too much, to herd, to fail to take gains, and to fail to minimize losses. Believe this in your heart. You can beat the market like you can win at poker. Someone can win at poker, but it ain’t you.

1a) They have access that you don’t. The reason why investment banks and hedge funds can beat the market is less due to their brilliance - though they are sometimes brilliant - and more due to the availability of opportunities they have that you don’t. You’ve heard of private equity. Notice that this is not public equity. Private equity is the purchase, sale, investment in, privately held firms. My brother runs a legal loan sharking business. Investment in his business will yield you 15-20% returns. But you can’t get it. Investment banks have a better shot at getting stuff like this. It’s not the same as saying that they are better stock traders than you are.**

2) Fees kill. Buy a passively managed fund, because active funds = more involvement by a fund manager = more opportunity for you to get hosed by a moron with an MBA (or a PhD!). But even relatively passively managed funds have variation. These are two mutual funds, vanilla investment vehicles, both directed towards mimicking the broadest market:

JP Morgan’s Institutional US Equity Fund (JMUEX) has fees of .64% (1-year expenses of $56.65 on $10,000). And over the course of 10 years, for a minimum of $3M and $225,000 in fees. Their performance over 10 years was 3.42% compared with 3.06% for the S&P as a whole.

The Vanguard Total Stock Index fund (VTSMX) has fees of .19% (1-year expenses of $16.74 on $10,000). Over the course of 10 years, with a $3M investment - though their minimum is $3000 - you pay $70,000 in fees. Their performance over 10 years was 3.92% compared with 3.06% for the S&P as a whole.

And these are both passively managed index funds. A hedge fund can have fees of 2 and 20 - 2% of assets and 20% of gross profits (performance fee). Woot! When someone tells you ‘2 and 20 is standard’, point and laugh at them. Or write them a check. Or better yet, write me a check! When they offer to show you track records, ask that management fees and performance fees be included in a bar graph. Besides, none of their derivatives obligations are on the books, so you likely won’t really know how to interpret their track record anyhow.

2a) Transaction fees are fees. Your financial advisor wants to move money, since they make money when money moves. Repeat this over and over. Your financial advisor is not your friend. S/he is your adversary. S/he wants your money.

3) Stocks, bonds, cash. 40% bonds, 40% total US stock market, 20% international stock market. When stocks go down, bonds go up, and vice versa. By ‘bonds’ I mean ‘total bond market’ or ‘treasuries’ - not crazy-ass multi-tiered mortgage swaps. Think the dollar sucks? Berkshire Hathaway has been betting against the dollar for years, go ahead and buy a share of Class B - it’s like buying a slightly riskier mutual fund with high fees, run by Buffett (though he won’t live forever). Or buy a materials (i.e. gold) fund. Again, higher fees, more volatility. If you are more risk averse, 80% bonds, 15% stock market, 5% international. The point is, invest in lazy funds.

4) Stuff I don’t know but I know. It’s better to forgo 1-2% investment income and reduce spending by 1-2%. Less risky by a lot.

It is often good to own a house - we don’t but we live in NYC. I have no idea if this suggestion holds up under current housing market conditions.

Volatility means that randomness can be ascribed to real market movement, but that movement can also just be randomness. That is, check your portfolio once every month or two or six, not every day. If the volatility is making you crazy, move most of your money to cash or treasury bills. And get some sleep, I hear that it is more important that we think.

5) People versus positions. I know a number of people in financial services, and I’ve studied them as well. Wicked smart, not necessarily nice but certainly not moral reprobates. The problem is, the rules are tilted. It’s not about whether Steve, or Jenny, or Chet is trying to steal from you. But it is a system that benefits you and benefits financial firms more. There was a time in history when I would defend high finance; I might still. But it seems ripe for a New Deal-type re-visioning.

**When my uncle went to college, my grandmother sent him an allowance for food, clothing, books, spending money. She arrived at a figure by asking his roommate’s mother if she sent an allowance, and if so, how much. She matched that figure. Of course, the roommate’s mother sent the allowance, and also paid for food, clothing, books. Even with a job, my uncle went through school relatively poor, and with my grandma’s unshakable belief that since he never had enough cash, he must have been spending it all on drugs. Investment banks are like the roommate - they may look like you, but they have resources behind the scenes that you don’t have.

February 22, 2008

A two-by-two on markets and culture

Filed under: Culture, Markets — Peter @ 9:38 pm

With Brayden upping the ante, Lena suggests a table, but I feel that this may confuse more than illuminate. Welp, only one way to find out:

I also realize it’s tacky to stick neo-classical economics in the low/low box. And the yes/no doesn’t quite work - I originally went with ‘low’ and ‘high’, or ’settled’ and ‘unsettled’. But you get the gist, I hope..

More on Markets, culture, markets

Filed under: Culture, Markets — Peter @ 6:26 pm

I still haven’t addressed the payoff question, but here’s more of my thinking about culture and economic sociology, in pictorial:

The constitutive group, which does in fact tend to study the ’settlement’ (a loaded term, yes, but think of it more like a butterfly alighting temporarily than obdurate institutions) of markets, treats the market itself as the dependent variable: how does a market become something that looks like a market?

The second group, what I think of as complementary (as in, it complements economic studies of markets, doesn’t challenge the idea of markets as such), is more like:

From a paper I’m working on, here’s the problem:
The dichotomy between the constitutive and complementary approaches has resulted in a theoretical limitation for the field. The central problem is not necessarily the lack of conversation between these two groups, as they often do build on one another. It is the either/or conception of culture. Culture acts as either something that affects how markets are built, or else it affects how markets operate. Constitutive activities are necessary to stabilize market actors, objects, and actions, enough so that ‘normal’ market forces – now with cultural variables added as key determinants – can operate. And once these activities occur, markets are seen as acquiring a kind of permanent stability which allows us to then gauge their operation. As a result, we end up with analyses of how creativity and highly contextualized knowledge of fashion is transformed into a commodity for consumer sale (like Patrik Aspers’ work), and studies of how social ties affect performance among garment industry firms (eg, Uzzi’s awesome study of the garment industry in NYC). But very little on the interactions across these processes.

I’m ready to start getting on to these kinds of interactions.

Photo credits, various but all from Flickr, w/Creative Commons licenses:
Apple
Apple pie
Baked apple
Apple preserves
Apple opened

February 14, 2008

Economic Sociology, Culture, Markets

Filed under: Culture, Markets — Peter @ 2:04 pm

I’ve been thinking about this for a while, wrote about it in an in-process manuscript, and I’m just trying to work out the argument out loud for a bit. Bear with me, it’ll probably be a few posts.

Limitations on how we think about markets and culture. This is two parts a limitation of our theoretical tools, and one part a limitation that stems from doing sociology from the kinds of markets we are studying. From a theoretical point of view, we remain in something of a false dichotomous bind, between those kinds of markets that have a culture, and those kinds of markets that are culture. The paradigm of embeddedness - and with over 2500 citations, I’m not going to jump into that argument, but instead I think fairly assume for the moment that embeddedness=structural embeddedness=networks - suggests that economic activities are influenced by the fact that they occur in repeated rather than one-off interactions. More broadly, the embeddedness framework implies a split between the economic activity, something purely economic, and the culture/structures/networks that have effects on that economic activity. In effect embeddedness argues for more sociological independent variables for economic dependent variables.

This is not the radical critique of someone like Harrison White, who wants to shift the whole discussion from actors and ties to analyses of ties and structures of ties themselves. But the movement in that direction has not been taken up by economic sociology but by the network people in the proto-socio-physics camp. Duncan Watts in sociology leading to its apotheosis in the Reality Mining of the MIT Media Lab. A post for another day.

On the other side of this dichotomy are those who argue that markets are culture. That is, markets are themselves cultural phenomena. This is close to, but not identical to Viviana Zelizer’s critique, that markets are subsumed by culture. I think she’s right for many cultural anthropologists, but the contemporary economic sociology research points to something a little different (and I claim myself to be more a part of this camp than the first). Here, the aim is to understand the determinants of markets - so, what is a commodity, agency, exchange, interests. Markets become the dependent variables, and a rather wide range of other kinds of variables become the explanations for markets. These include institutions, law, conventions, formulae, theory. Callon and the performativity crowd potentially fits on this side of the divide.

This divide maps onto a distinction made by Ann Swidler with regard to culture (and thanks to KH for pointing this out to me, though he’s not responsible for my argument here) - that the kind of markets that are analyzed come into play when taking one position or the other. When markets are settled, we are likely to look at culture as it affects them; when markets are unsettled, we are likely to analyze the determinants of them. Many studies of manufacturing jobs are now about cultural effects on labor and performance outcomes, not about the making of labor (this was certainly the main gist of Marx and industrial sociology, but as we have split organizational and industrial sociology from economic sociology it has dropped out as such). In capital markets, there is a wide split between those looking for sociological effects on finance - and I might include behavioral finance on the settled/’markets-have-culture’ side of the argument - and those looking for the creation of calculative agencies. And while I’ve placed various markets along this axis, even the same market can slide along this axis as it moves in time from settled to unsettled. So we look at network effects on volatility for options markets (Baker 1984; markets have culture, settled market), but the role of formulae in the making of the options market (MacKenzie and Millo 2003; markets are culture, unsettled market). The origins of the CBOT in the 19th century are about the making of futures; the contemporary work is about effects of regulation on market exchange.

I want to argue that this limits what we research and how we go about researching it. I’d like to suggest that are culture/have culture, and are settled/are unsettled ought to be an orthogonal rather than a two-dimensional axis.

February 7, 2008

What is XBRL, and Who does XBRL help?

Filed under: Data, Institutional, Markets, Technology — Peter @ 10:02 am

Put it on your radar screens, the next big thing is going to be XBRL. It stands for extensible business reporting language, and it is meant to commensurate business reporting via standardization. So instead of entering text into an annual report, companies, governments, NGOs, anyone who would like to comply with governmental mandate will be using XBRL. You can think of XBRL as a set of metatags for financial and company data, so that instead of bracket-tags for header, title, links, etc. you would have bracket-tags for earnings, time periods, definitions of costs, etc.

From CoreFiling’s insight blog: “It won’t be very long before it is those documents - the bar-coded financial disclosures - that will be the primary materials consumed by financial market systems to help analysts and investors make decisions about the best way to invest. This is vastly more sophisticated than today’s processes that rely on slow and inaccurate re-keying of a subset of the financial information published by companies.”

This is commensuration more than just standardization, since the tags are designed to be specific to a particular business enough so that everyone is not required to give the same information, yet the tags are standardized enough that everyone is required to give information that can be made comparable. The pitch for companies (other than, because otherwise we’ll fine you and take away your business license) is that XBRL will make their financial reporting less costly, less prone to error, and ultimately more efficient.

Personally, I think this is a flat out misrepresentation of what’s going on here. XBRL helps one group of people orders of magnitude more than anyone else: investors. And the trade-off between increased government efficiency and business streamlining of compliance data on the one hand, and increased ability for data-gatherers for banks, hedge funds, and the investor class is totally totally off the charts. What this will end up doing is: 1) creating a standard way for companies to report financials; 2) creating some increased efficiency for government entities to keep tabs on the finances of these organizations; and 3) create a massive additional datastream for financial services and investment firms to work with. If you think it is a challenge for public firms to resist making short-term decisions based on financial analysts’ quarterly reports of earnings now, wait until this information is directly readable by quant trading models.

This would be an amazing dissertation topic. I would track: a) the creation of the standard; b) the adoption of the standard around the world; c) how XBRL is being incorporated into financial modeling; d) the before-and-after effects of XBRL on market prices for firms; and e) qualitatively, what gets excised from XBRL, or rather, what remains incommensurable about firms, governments, etc.

UBMatrix
XBRL’s main site
US SEC’s ‘Interactive Data Viewers’
Microsoft uses XBRL
US GAAP XBRL Taxonomy (GAAP is the accounting standard in the US)
CoreFiling

February 2, 2008

An Opportunity to learn about Performativity

Filed under: Management Schools, Markets — Peter @ 4:26 pm

This would be an interesting opportunity for someone who would like to learn, network, discuss:

From Bodies to Black-Scholes: A Two-day Workshop on Performativity and the Social Studies of Finance
Organized by Daniel Beunza (Columbia U.) and Yuval Millo (LSE)
Columbia Business School, New York, 28-29 April 2008

The Social Studies of Finance (SSF) is one of the fastest-growing and most intriguing new fields in the social sciences today. Born from the intersection of sociology of science, economic sociology, management and critical accounting, SSF offers a new vantage point for the analysis of financial markets and their dynamics.

This intensive two-day workshop is convened by Daniel Beunza from Columbia Business School and Yuval Millo from the London School of Economics. It is aimed at presenting the field to newcomers, and is directed at research students and early-career researchers in accounting, finance, management, political science and sociology.

To allow effective discussion, the group size is limited to 12 participants. The workshop’s fee is US$ 200, which includes meals. To apply for the workshop, please send by February 31 your CV and a one-page description of your research and how it relates to SSF to y.millo@lse.ac.uk

For more details

January 24, 2008

Is qual/quant hybridity possible?

Filed under: Institutional, Markets — Peter @ 1:04 pm

Jeremy Grantham, principal of GMO, makes an interesting point about quants in his 4th quarter letter to investors (free registration required):

The good old days of the domination of the first generation quant models, where you simply show up with three concepts – value, momentum, and discipline – are over. But, even more critically and, perhaps like career and business risk, out at the limits of arbitrage, is this need for judgmental overrides on rare macro events. Quants like to show off their discipline by marching off the cliff in rows (it is said, I hope apocryphally, that Shaka, the great Zulu Chief, marched an impi, or regiment, off a cliff to impress European observers and I hope it did). Well, in real life it would be nice to stop at the edge and say “I don’t like the look of this, perhaps my model missed something.” The extremely difficult objective is to maintain the advantages of quant discipline 95% or so of the time and hand over to a human being when you reach the edge of the cliff. You can imagine the problems in making this kind of phase change. But only by slowly overcoming this problem and integrating this hybrid approach into the DNA of the investment process can one aspire to being very effective investors in the long run.

His point is that the benefits to quantitative investing are mostly in the fatter part of the outlier events curve. Or, in the language of March and Simon, quants are better at exploitation that exploration. Qualitative investors (stock pickers, in Grantham’s language) by contrast are potentially more helpful when the models depart from reality. An ideal world would have a hybrid model of quals and quants.

But that almost never works in practice. In practice, a qual firm uses quants as showcases to show their ‘balance’, while quants use quals to demonstrate their creative flexibilities. The underlying problem is that the two styles at their best represent different (and incompatible) views of the world. If you believe that human behavioral frailty gets in the way of seeing financial facts for what they are, it makes it difficult to envision a world where a stock picker can accurately tell you when you’re running off a cliff. By contrast, quals are simply limited by human cognitive capacity, combined with all sorts of cumulative social contexts, to never be able ‘really’ know why they are right or wrong. Leaving money on the table is also a form of running off a cliff. Just a different cliff.

Or rather, in Grantham’s story, there is simply no way to tell which 5% of the time is going to be the time when quals are going to be invaluable.

There might be an answer is abandoning the (theoretical) notion of maximizing efficiency, in favor of a more Type I versus Type II error view of the world. A Type I error is a false positive, in this context to believe there is risk where there actually is none. This is the ‘leave money on the table’ problem - if you cut back on the amount of risk you take, effectively you are underperforming the ‘economically efficient’ horizon. Type II errors are false negatives, to believe there is no risk where there actually is some. This results in many more ‘Whoa, we should have seen this coming!’ kinds of mistakes, I think.

In short, there is a collective action problem at work, insofar as we are collectively trained to believe that maximization is desirable. I would guess that 95%+ of the problems of the financial system are not due to institutions shooting for returns of 3% over prime. It’s when we build a system based on 20% over prime returns that we always seem to create incentives to blow up.

January 20, 2008

Another name for random. Or luck.

Filed under: Institutional, Markets, Organizations — Peter @ 3:43 pm

An anthropologist attempts to explain variation in how investment banks fared in the current credit crisis. Gilian Tett argues that three elements account for it: 1) successful firms have hands-on management (meddlers); 2) successful firms have management who rose through the ranks via trading desks rather than sales or legal; 3) successful firms have a ‘culture of power’ whereby firm members see themselves as tied to the firm rather than the business line, which creates a culture of accountability.

Alternatively, Michael Lewis noticed the way that Goldman Sachs has profited by the dramatic increase in credit defaults. Effectively, someone higher up in the firm made a series of dramatically-large trades against the CDOs that everyone else (including GS) was creating, marketing, and purchasing. In other words:

Enter two smart guys who trade Goldman’s proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes. End of story.

And it’s a good story. But consider what it implies. Their own traders and salespeople in subprime mortgages and related securities had put Goldman in exactly the same position as every other Wall Street firm: long subprime mortgages.

The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.

This does not imply anything about the management team, where they come from, or the firm’s culture. Instead, it describes a firm where higher-up risk managers have the ear of people in power, and this allowed them to cancel out the stupidity of the rest of their own firm.

Or, perhaps this is all a fancy way of saying that there is a huge amount of luck and randomness happening at the organizational level in perhaps the most important core sector of the contemporary economy.

January 13, 2008

Two forms of institutions

Filed under: Institutional, Markets — Peter @ 8:37 am

I’ve been thinking a lot about institutions lately, in light of my earlier post on check-lists and medical practices. I originally had in mind a post about how the Berger and Luckmann version of institutionalization at the more marco-level is about the crystallization of practices. So what check-lists are theoretically are the same as other kinds of models and technologies: they are congealed expertise. For good and for bad, technologies, models, and checklists act as an alternative to pure expertise and craft knowledge. To the extent that they become taken-for-granted, they become the cognitive institutions envisioned by B&L. This does not imply a break from creativity, or ’structure’ as the opposite of ‘action’ (insert Giddens here if you like). They enable creative action as well. They also preclude new action or mask the world sometimes, if the world changes but the knowledge remains stuck in a model or technology. But the point is that we can look at institutions broadly as congealed knowledge.

But then I ran across the recent news that Second Life is banning banks. The issue is that virtual banks offer interest, which can then be returned to depositors, but they do not offer protections of real-world banks. Because Linden Dollars can be exchanged for real dollars, SL banks can actually be sources of profit and loss in the real world. And now they’re being banned:

as of January 22, Linden Lab will be removing all objects that are related to in-world banking. Until then, the company hopes that the banks will settle their debts with residents as best they can, but if they are caught trying to operate after January 22, they will be punished by possible suspension, termination of accounts, and (*gasp*) loss of land. Legitimate banks that provide a government registration statement or financial institution charter will be allowed to continue doing business, as will entities conducting marketing or education.

No FDIC in real-life means no banking in Second Life. This is institutions in the more Douglas North, economic sense. Here, banking ‘institutions’ act as rules of the game, and the Linden Labs folks act as rules and structures of SL. And we might be witness to a singular event: a set of runs on virtual banks as customers line up to take their Linden Dollars out before 1/22.

What’s interesting is the power of real-world institutions to actually impinge on a made up reality. After all, SL could have been created with any number of rules and ties to real life. Or no ties at all, as there’s no ‘rule’ in SL that people who cannot fly in RL are also not allowed to fly in SL.

There’s good stuff in between these two visions of institutions. For instance, think about which sets of conventions and rules are reproduced in an SL environment and which are not. Physical laws are often ditched, but those pertaining to land and real estate are kept. Gambling was eliminated because it might have been subject to RL laws and regulations, but laws regarding appraisals and insurance of real estate are left out despite the centrality of those kinds of transactions.

In any event, I’m not sure that institutions are anything, but I do think there are some specific phenomena amenable to one or another institutional distinction.

January 7, 2008

Rival Goods

Filed under: Culture, Markets — Peter @ 4:35 pm

Now that’s a rival good.