Baseline Scenario -- Goldman Sachs Kernal

(c) 2009 F. Bruce Abel

Read "Where Else Are You Going to Go" below. There is a huge kernal regarding why Goldman trader Andrew Hall got a $100 million bonus. He captured the benefit of Goldman Sachs being a large entity, pure and simple. Like the radiologist getting paid a lot because of a better machine.


The Baseline Scenario
Fox, Henhouse?
Hey, Where’s My Free Advance Copy of Superfreakonomics?
Where Else Are You Going to Go?
Cognitive Dissonance and Global Macroeconomics
Fox, Henhouse?
Posted: 19 Oct 2009 11:00 AM PDT
One of our readers emailed in a link to this Bloomberg story about the new “chief operating officer” of the enforcement division of the SEC: Adam Storch, “a 29-year-old from Goldman Sachs Group Inc.’s business intelligence unit” who “had worked since 2004 in a unit at that reviewed contracts and transactions for signs of fraud.”
I went back and forth about posting this because, as far as I can tell, it’s not that important a job; according to the WSJ, “Mr. Storch will oversee division operations that include budget, information technology and administrative services. He will also supervise the workflow associated with the collection and distribution of fair funds to harmed investors.” It’s back-office administration, not deciding whom the SEC is going to pursue. I don’t think this is in the same league as, say, Goldman’s chief lobbyist becoming the Treasury secretary’s chief of staff. (Note, however, that Zero Hedge says it is “arguably the most critical post at the SEC.”)
But still, even if it is a routine back-office job, why someone from Goldman who makes Neel Kashkari look like an elder statesman? As our reader pointed out, there are at least two relevant themes here. One is the revolving door: someone who is 29 on Wall Street is likely to see his future there, not as a civil servant in Washington. The other is cognitive capture; why does the SEC think it needs a Goldmanite to handle its budget, IT, and administrative services? There are other good companies out there, really, somewhere, or we have a much bigger problem on its hands.
Maybe he’s independently wealthy and immune to job offers from Wall Street. Maybe he’s a genius and aced his job interview. You’d think there must be something special about him that convinced the SEC to give him the job despite all the additional “Government Sachs” fodder it creates. I hope he does a wonderful job.
By James Kwak

Hey, Where’s My Free Advance Copy of Superfreakonomics?
Posted: 19 Oct 2009 06:45 AM PDT
Just kidding. I don’t have time to read it anyway (nor am I all that interested).
In case you’ve missed it, there has been an enormous controversy (by blogosphere standards) over a chapter in Superfreakonomics (to be released tomorrow, I think) on climate change, carbon reduction, and geo-engineering. Brad DeLong has the most coverage (I believe this was his first post; read backwards from there), including links to some people who are supportive of the book. The summary is that a number of people have accused Levitt and Dubner of saying silly things about climate change (bad), accepting an “expert’s” opinion without doing due diligence (more bad), and possibly distorting the opinion of another expert (very bad), with the assumed goal of being contrarian and controversial. Levitt and Dubner disagree. Paul Krugman has some interesting thoughts on the dynamics involved.
This did, however, make me think a little about the difference between blogs and books. [Note: After finishing this post -- which is over 1,300 words -- I realized it is not as interesting as I thought it would be. So feel free to go do something else fun.]
On the Internet, it is fairly common for people to cite sources without investigating them thoroughly. How do I know this? Well, several times I have clicked through people’s footnotes and found that the sources they cited did not in fact say what they were purported to say. For example, I was writing a post about health care and the curious fact that Republicans have converted themselves into defenders of Medicare. I found an article claiming that John Boehner had, while George W. Bush was president, endorsed exactly the types of Medicare spending reductions that are in the bills in Congress. Aha! I thought. But when I clicked through to the source, it was an anodyne press release praising Bush’s entire proposed budget, of which the Medicare spending reductions were one of no doubt thousands of line items. I actually thought for half a second about just citing the article, because that would be convenient, but then I realized that of course I can’t do that. It’s sloppy not to check the source; it’s dishonest to check the source and then pretend you didn’t.
And so I’ve been bothered by a four-part takedown of Megan McArdle that Thomas Levenson wrote. (Here’s part four, via DeLong.) Here’s the part that bothers me:
“Here’s the deal: in science journalism — in any attempt to write about technical material for the public — it’s not enough simply to read an abstract or even the whole piece and call it done.
“You can’t just read the paper and assume –unless you are genuinely expert in that subdiscipline of the field you wish to cover, and often not even then — that you know what its authors’ actually have done and what it means. [...]
“So what you do if you are a properly trained and ethical science journalist/popular writer is read first, of course, with care and attention to all the places you either or both don’t understand and/or get the sense of an important subtlety…and then you call.
“You talk to someone, lots of someones if necessary.
“You get people in the field to explain what they are doing; you allow yourself to appear dumb to yourself; [...] you ask simple questions, and then more complicated ones, until you and your interlocutor agree you’ve got what you need.
“You have to persist — and if someone says check out this or that, you do, looking up the papers if necessary and then calling back…and so on. You do what a good reporter does: you cover the story.”
Why does it bother me? Because I do what Levenson accuses McArdle of — I cite papers having read through them (and sometimes I even skim certain bits), without talking to the author, and certainly without talking to other people in the field (although I may read their papers). (Levenson, by the way, is a professor of science writing at MIT.) I think I’m more careful than the average blogger, although two of my habitual critics are sure to disagree. If I don’t know what a word means, I look it up; if someone’s explanation doesn’t make logical sense to me, I go over it until it does (or I don’t use it). I check people’s sources (if I can do it online — I don’t put off blog posts so I can go to the library) before I repeat their facts. But I do write about things I’m not an expert in, and I click Publish before becoming an expert.
For the most part, I think this just comes with the territory. I tend to have a utilitarian moral sensibility, and I believe I am doing more good than harm here, even if I make a mistake here or there. The Internet does have the nice property of exposing people’s mistakes pretty quickly, often in the comment stream. But there is the problem that Megan McArdle has a much bigger audience than Thomas Levenson, and, like an urban myth in a mass email, error can spread much faster than truth can catch up with it. And I have the nagging sense that I have set my standards where they are convenient for me, not where they are best for the world. (But as I said, I’m no Kantian.)
Anyway, to get back to our subject, it seems to me that Levitt and Dubner’s critics are accusing them of bad blogging — but doing it in a book. When someone writes a blog post (or a newspaper op-ed) that is obviously a piece of advocacy where the author has mined the facts to find whatever supports his or her argument, a few people blast it in what has come to be known as a “takedown,” and then everyone moves on. If it’s in a book, though, then things get more serious.
I can think of four reasons for this.
First, a book is disproportionate to its reviews. All Internet posts are formally equal, even if some people have bigger audiences than others; but no one is going to write a book debating Superfreakonomics, and if someone did, it wouldn’t sell as many copies.
Second, a book is meant to be read by many people who do not follow debates on the Internet. With a book, the authors are reaching beyond the presumably skeptical and sophisticated audience of the blogs, out to the “general audience” where it can potentially do more damage.
Third, books last in ways that Internet posts don’t. (At least they are assumed to.) There is an assumption that they are serious, well-researched, and fact-checked, while there is an opposite assumption that blog posts are none of those. Books are more likely to be cited in Congressional testimony than their meticulous takedowns on the Internet.
Fourth, authors might stir up controversy in a book in order to generate sales.
In other words, it’s because The Book has a special place in our cultural environment. What’s ironic, however, is that few people read books anymore. Although Superfreakonomics will no doubt do well, people in publishing have told me that 50,000 copies sold will pretty much guarantee you a spot on the nonfiction bestseller list. By contrast, our Financial Crisis for Beginners page has gotten almost 200,000 pageviews, and a quick post on health insurance rescission that I banged out in a few minutes got over 80,000 pageviews on one day, thanks to the Huffington Post. (And our Atlantic article got over a million pageviews by mid-summer.)
So … I don’t really have a conclusion here. I think it’s good that people care about whether Levitt and Dubner cited their sources accurately. But I also think that this applies equally (or almost equally) to writing of the online type. And I worry that there really is no good mechanism to enforce accuracy on the Internet. Even among print newspapers, I’ve noticed that op-ed articles are not fact-checked, and some print magazines don’t fact-check either. Blogs, of course, have never been fact-checked. Counting on writers’ internal sense of duty isn’t going to work. And the marketplace of ideas is better at valuing heat than light. Ultimately the Superfreakonomics controversy is a sign of a much, much bigger problem, and one for which I have no solution.
Update: Mark Thoma wonders along the same lines. Also, I highly recommend StatsGuy’s comment below (it’s the first one).
By James Kwak

Where Else Are You Going to Go?
Posted: 19 Oct 2009 04:00 AM PDT
Yves Smith returned from book-writing land to catch up on the Andrew Hall story, which is one that I pretty much decided to ignore from the beginning. Hall is the Citigroup trader who, according to his compensation agreement, was due a $100 million bonus. The bonus was so big because Hall and his team were due 30% of the profits from their trades, which is even more than typical hedge fund fees. (This tradition of particular trading groups negotiating a share of their profits dates back at least to Salomon in its heyday; AIG Financial Products also had this type of deal.)
But Smith focused on one element that got me thinking. Hall’s division, Phibro, was bought by Occidental Petroleum. “Oxy paid $250 million, the current value of Phibro’s trading positions. There was NO premium, zero, zip, nada, for the earning potential of the business. Zero. Oxy bought the business for its liquidation value.” Smith infers that no one was willing to pay more because the success of Phibro depended on its being part of Citigroup and benefiting from Citi’s low cost of funding; in other words, the massive profitability of Phibro was in part due to an accounting error — not charging it an appropriate cost of capital given the risk it was taking.
This made me think of something else, though. The typical excuse for paying traders enormous amounts of money is that if you don’t, they will leave for somewhere else. During the boom, it was certainly true that they would have left. (Whether anyone would have missed them is another question — it seems to me that some of the reasons to be skeptical of mutual fund managers apply equally to proprietary traders.) But after the crisis, the options for someone hoping to leave a major investment bank must have declined.
I’ve written so many times that reduced competition has helped the survivors increase market share and margins, but I never realized the other consequence: it gives them more bargaining power relative to their employees. There are fewer banks to go to; some of them (Citi, Bank of America) are in no shape to be paying top dollar; and while some hedge funds are doing just fine, their cost of funds must have gone up relative to the big banks in the current environment. With less competition for talent, compensation should go down, at least a little.
So why is Goldman reportedly on track to pay record or near-record bonuses this year? I imagine they would say something about how, in order to maximize long-run firm value, they shouldn’t take this opportunity to screw their employees. But if I were a shareholder, I would think a small amount of employee-screwing would be in order. This is a company that claims to live and die by the free market, after all.
By James Kwak

Cognitive Dissonance and Global Macroeconomics
Posted: 18 Oct 2009 07:00 PM PDT
One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.
There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:
“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.
“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”
People agree what the biggest imbalance is: it’s over-consumption in the United States and over-saving in China, thanks to an artificially low renminbi/yuan, which creates an artificially high dollar.
Yet in the same statement, “Trichet said U.S. policy makers’ commitment to a strong dollar was important in keeping currency markets and the global economy stable, repeating a long-held position.” Separately, French finance minister Christine Lagarde said, “Everyone needs a strong dollar.” Tim Geithner, like every senior government official for decades, has been repeating that we have a “strong dollar policy,” whatever that means.
But if no one wants the dollar to depreciate — which is the standard solution to a trade imbalance — what does it mean to be against global imbalances? No one will come out in favor of tariffs. Using fiscal policy to encourage domestic sourcing of goods and services did not go over well with the Europeans. I guess that leaves exhorting Americans to buy less and save more, which is a little like asking Goldman to pay smaller bonuses.
So the EU complains about our huge trade deficits and overconsumption, yet at the same time (along with China) seems to desperately want us to continue to play that role. This is a convenient position, since it allows them to blame us for the financial crisis, while continuing to export to us. (Germany, the largest economy in Europe, is surprisingly export-dependent, compared to the U.S. and the U.K.) Unfortunately, it’s also logically inconsistent.
By James Kwak (with a major assist)