“Politics is alchemy. It’s not an engineering project. You can’t build it step by step through benchmarks to a solution. It takes people to feel comfortable and to be ready to work together and to feel confidence. We all know this from domestic politics.” David Kilcullen speaking to Charlie Rose, October 8, 2007 [inteview, 18:05].
The quote above struck me if only because the way Kilcullen describes politics as being the opposite of engineering. Yet listening to him describe how counterinsurgencies should be dealt with reminded me – not of the opposite of an engineering project – but of precisely the kind of description of engineering that science studies seeks to capture in which technical projects are profoundly bound up in the delicacies of partisan politics…
(Note: Kilcullen is a counterinsurgency expert who has advised General Petraeus on the troop surge in late 2007. He’s is, perhaps, the prototype of the kind of on the ground terrorism anthropologist the DOD’s Project Minerva sought to promote. A controversy over this initiative erupted since the support was to be channeled through Department of Defense rather than the regular channels of social scientific funding – i.e. NIH, NSF – much to the consternation of the American Anthropological Association [see the AAA’s letter of response])
Quote of the day: Slavery and Finance
June 27, 2009
A research project at University College London is seeking to explore the specific links between slavery and the city of London. Rather than dismissing the slavery as either pervasive or insignificant the purpose of the project it to document in detail the role of enslavement in the history of colonialism. Here is an interesting quote that implicates slaves in financial dealings:
“In the case of Mr Rothschild, the documents reveal for the first time that he made personal gains by using slaves as collateral in banking dealings with a slave owner. / This will surprise those familiar with his role in organising the loan that funded the UK government’s bail-out of British slave owners when colonial slavery was abolished in the 1830s. It was the biggest bail-out of an industry as a percentage of annual government expenditure – dwarfing last year’s rescue of the banking sector.”
The complete article in the FT is here.
If anything, the credit crisis has shown that men and women on the street do not conform to the model of economic rationality. Retail investors, home buyers and credit card users often act against their own interest. In the US, this concern is a pillar of the financial regulation proposed by the Obama administration. Hence the proposed Consumer Financial Protection Agency.
But, as with so many other things, regulation is based on a theory of how the financial consumer behaves. Yet what do we know about that? It is to this controversy that Brooke Harrington’s latest book, Pop Finance, makes a contribution. (You can download the first chapter from her website.) James Baron has just published an interesting — and very positive — review of the book at Administrative Science Quarterly. Here’s an excerpt from the review.
Pop Finance offers a lucid, lively, and literate portrait of an
important and intriguing institution: the investment club. The
book is an ethnographic tour de force, deftly combining
detailed observation of seven Bay Area clubs before and after
the dot.com craze, results from a 1998 survey that Harrington
sent to several thousand investment clubs across the U.S.,
and secondary analysis of archival materials on investment
clubs and their members. The payoff is considerable. Harrington
has acquired an unparalleled understanding of these
organizations, their members, and the contexts in which they
operate. She is able to draw linkages between her fi ndings
and a broad array of important scholarly and policy concerns,
such as how the gender composition of clubs affects clubs’
performance and persistence, how concerns about identity
(particularly relating to gender) shape decision making in
these groups, and how the rise of this form of “investor populism”
is likely to affect corporations. The variety of lenses
through which Harrington views and analyzes investment
clubs is impressive; just the breadth and depth of the reference
list alone may justify owning Pop Finance .Harrington begins by charting the rise of the “ownership
society” and how investment clubs relate to that trend.
She turns next to how the clubs function and how their
members make decisions. Given the bewildering range
of choices available to would-be stock market investors,
Harrington not surprisingly observes considerable evidence
during club meetings of bounded rationality and reliance on
many of the cognitive shorthands emphasized by behavioral
economists. But, she argues, there is much more going on.
She documents that club members seek through their
purchases to forge and reinforce social identities and to
affi rm their collective understanding of the world:In this light, the stock market can be viewed as a collective attempt
by millions of people to establish an intersubjective reality called
“value.”. . . investment in stocks requires the construction of imaginative
links between signifi ers (the stocks) and the signifi ed (value).
This is why narrative is so important in shaping understanding of the
stock market: it is literally the lingua franca of investing. (pp. 47–48)The arrows between stock market decisions and social
identity appear to go in both directions. Clubs rely on shared
aspects of their members’ identities in choosing stocks,
imposing “identity screens” alongside the fi nancial screening
tools they routinely employ. Such behavior is conspicuously
on display when it comes to “socially responsible” and
“faith-based” investing, but Harrington fi nds that it is far more
general than that. In purchasing stocks, clubs are not merely
investing; they are simultaneously consuming, using their
purchases to establish or maintain a shared view of the social
landscape. A compelling example is one all-female club
Harrington observed discussing whether to purchase Harley
Davidson—a very hot stock at the time—but deciding in the
end not to do so because the members would not want to
see their kids riding choppers. Once members agreed that
the stock did not jive with their shared value system, they
shifted immediately to an alternative prospect, Callaway Golf,
which they regarded as much “safer” (in a social rather than
fi nancial sense). Gender identities seem to be especially
salient in shaping stock purchases, with women relying
principally on their role as consumers in identifying targets
and men seeking to leverage their work and professional
identities to spot attractive opportunities.
Fareed Zakaria: What are Capitalism’s Morals?
June 23, 2009
“We will never know when the next bubble will form, what the next innovations will look like and where excesses will build up. But we can ask that the people steer themselves and their institutions with a greater reliance on a moral compass.” Fareed Zakaria, A Capitalist Manifesto, Newsweek, June 22 2009 (p 44 print edition)
Like adding the social back into the economic, adding the moral dimension to financial action will be a big argument to contend with in debates about how to reform the financial system. The position Zakaria takes in his manifesto is at odds with studies of financial markets in two key respects: Firstly, it presumes that financial activity can take place in the absence of any kind of morality; secondly, it presumes that the location of morality is innate to people and institutions, who can be asked to use it – like digging an old bowling ball out of the closet – it in the future.
It seems to me that a key task of studies of finance is to show how moralities are inherent in all financial systems; financial action has a moral component, if by moral we mean it appeals to some kind of justification or good that is claimed to be transcendent. Secondly, moral compasses do not exist in the singular and are not natural components of agents but are conferred on them through infrastructures and systems; if people and institutions act according to a particular morality it is because they have been equipped to do so.
The implication is that instead of politely invoking ‘the’ moral compass, the real question of reform involves building technical devices: What morality has the financial system had, and where has this morality been hardwired so that multiple agents found it suitable to act in a similar manner? What moralitites might be preferable, and what are the nature of the tools that will provide this necessary moral transformation? The keystone article discussing how objects participate in creating common moral expression is Latour’s delightful article, Where are the Missing Masses?
Post script: This article from the FT reports on oath taking by Harvard MBAs. Given the rising divorce rate, however, it seems to me that the oath is somewhat ‘out’ as a mechanism of long term commitment.
This American Life: The Watchmen
June 18, 2009
Who was regulating AIG? Last week’s episode of This American Life in cooperation with Planet Money [here] tries to track down the regulator responsible for AIG’s ship sinking activities. (The second section, about ratings agencies is interesting, but considerably less amusing and informative than the first.)
Anush Kapadia just posted a fascinating reaction to Donald MacKenzie’s review of Gillian Tett’s book on the credit crisis. I thought that the elaborate comment, buried under eleven previous comments, deserved a lot more prominence. Here it is:
Tett’s is the best account I have seen of the crisis, but she leaves us asking the question: why did super-senior tranches of CDOs and synthetics prove to be the achilles heel of the system? She gives us a few clues, and MacKenzie picks up on one of them, correlation, in his review. While adequately measuring correlation was of course critical, hiking the level of correlation would still fail to account for the magnitude of the disaster. Leaving dollars on the sidewalk, both MacKenzie and Tett provide the materials for a more satisfying answer without putting these ingredients together. Perry Mehrling, ironically cited as an historian of economics by MacKenzie rather than the historically-informed monetary economist he is, has.
The key ingredient for a fuller story is an account of liquidity; it is here that MacKenzie always seems to fall short, (Mehrling has a liquidity-driven account of LTCM as well). The term is of course notoriously difficult to define uniquely, but its frequent pairing with the word “deep” ought to tell us something. Liquidity suggests robustness: a market is liquid if one can buy and sell in significant amounts without affecting the price. But who does one deal with? Typically, a market maker offering a spread. It is thus the ecology of market makers that ultimately determines the depth and resilience of a given market, offering to deal in any amount at their stated prices. The robustness of a market thereby reduces to the robustness of the balance sheets of the key market makers therein. The facticity of the “public fact” of market price thus rests on the ability of market markers to fund themselves. Once these balance sheets start to look anaemic, the prices built on them start to look less reliable.
So it was with the key “public fact” that both Tett and MacKenzie point to: the CDS indices. Oddly, MacKenzie does not think it fit to bring up the key role of the indices that he himself eloquently pointed to in his “End-of-the-World Trade” in his review of Tett. This is unfortunate as Tett is quite categorical about their centrality, and indeed her interpretation differs significantly from MacKenzie’s. For Tett, as for Mehrling, the important thing about the indices was that, being more standardised, their market was more liquid and therefore their prices more reliable. Robust pricing in the liquid derivative ABX index would then enable traders to price the illiquid underlying CDO tranches. Tett:
“Trading in mortgage bonds, let alone mortgage derivatives, was sparse. The only obvious guide was the ABX index, which had been launched in 2006. It provided a gauge of the value of the range of bonds in the CDOs—from BBB to AAA. So what many funds—including Bear Stearns—did was to look at the prices as given by ABS and then use that to deduce the prices of the bonds in their own CDOs,” (pg. 171).
MacKenzie notes this relationship in EOTWT, but for him it is not a matter of trading providing liquidity to a price point but trading providing solidity to the facticity of correlation:
“…trading of index tranches made correlation into something apparently observable and even tradeable. The Gaussian copula or similar model can be applied ‘backwards’ to work out the level of correlation implied by the cost of protection on a tranche, which again is publicly known.”
Correlation is critical to MacKenzie’s story because it goes into the manufacturing of that archetypical public fact, ratings. This is true in both EOTWT and the Tett review. In the latter, he notes that “Essential to the [CDO] assembly line was that the higher tranches of its final products…be able to gain Aaa ratings. A critical issue was the likely correlation of mortgage-backed securities.” This focus on correlation over and above the trading architecture leads MacKenzie to interpret Tett too narrowly, in my view, and thereby to miss a critical functional feature of a public fact that he has himself sniffed out as vital. Of course, Tett leaves herself open to this interpretation because she does not fully spell out the criticality of the CDS indices and their consequent impact on the super-senior tranche prices.
MacKenzie suggests that Tett is praising the Morgan credit derivative inventors for noting an empirical fact, that mortgage default correlations were simply unobservable and therefore the risk in betting on them could not be prudently measured. In the absence of further explication, Tett does indeed give this impression, and MacKenzie’s own commitment to correlation pushes him further in this direction, (although it is indeed strange that, in light of his own observation that CDS indices gave these correlations public facitcity, he does not think the indices warrant a mention in his Tett review). But Tett’s observation that is it trading and therefore liquidity in the CDS indices that enabled the pricing of the underlying CDOs leads us in another direction: not to facticity from modelling and ratings but facticity from trading.
To be fair, MacKenzie does note the importance of trading, but it appears to him merely as a “fact-generating mechanism” by way of marking-to-market. Thus he notes towards the end of EOTWT that:
“It has become common to use a set of credit indices, the ABX-HE (Asset Backed, Home Equity), as a proxy for the underlying mortgage market, which is now too illiquid for prices in it to be credible. However, the ABX-HE is itself affected by the processes that have undermined the robustness of the apparent facts produced by other sectors of the index market; in particular, the large demand for protection and reduced supply of it may mean the indices have often painted too uniformly dire a picture of the prospects for mortgage-backed As Carruthers and Stinchcombe note, market liquidity depends on facts. However, today’s financial facts depend on liquidity. The credit markets remain stuck in a vicious circle.”
But if liquidity is so critical why, despite Tett’s corroborating suggestion, does MacKenzie provide no account of it as generative of facticity in addition to the other way round? Tett herself elides the matter.
Liquidity is the missing piece of the puzzle that enables us to understand Tett’s main point regarding the impairment of the super-senior tranches of CDOs. Simply put, these “safer than safe” tranches were so badly hit not merely because all of Wall St. neglected the extent of the correlation of the underlying mortgages but because the markets that priced these tranches had no market maker of last resort. No emergency market-maker, no liquidity, no rational pricing.
When the banks need liquidity, they go to the interbank market and borrow/lend at LIBOR. When they all run out, they go to the central bank’s discount window. As Tett points out, shadow banks had only one liquidity backstop: the absolutely vital “liquidity puts” with the banks themselves, (MacKenzie makes no mention of them at all. See Tett pg. 205-6). Insurance sellers on the ABX were also providing a kind of backstop, and those backing up AAA risks were in effect backing up systemic risk, really the only kind of risk that is expressed in that coveted rating. By making AAA insurance contracts liquid, insurance market makers were implicitly acting as systemic risk providers. Cheap liquidity led them to underprice systemic risk and help create an unsustainable credit boom. When this became clear and everyone ran for the doors, there was no market maker of last resort who the system as a whole could turn to. The system itself melted because the systemic watchdogs were private, profit-driven entities (AIG and the monolines) who, when it comes to systemic risk, are by definition under-capitalized. With the backstops blown out, even the safer-than-safe risks looked unsafe.
This answers the question MacKenzie poses at the end of EOTWT: “Why…have people not been selling end-of-the world insurance when the returns from doing so have jumped ten-fold while the risk of having to pay out remains small?” As noted above, he cites mark-to-market as the paradoxical answer: that fact-generator now blocks the reestablishment of the pubic fact because of…lack of liquidity! This is not paradoxical but circular: what is the difference between mark-to-market as fact generator and fact inhibitor? More generally, when do positive feedback loops turn into negative ones, and why?
A more coherent answer, unavailable in MacKenzie’s vocabulary, is that, in the absence of a liquidity backstop to the insurance market, traders did (do?) not have a sense that the outcomes are bounded in any way. When we are talking about system risk insurance, the only entity capable of providing this backstop is the state (given its super-sized balance sheet) as it does through its central bank in the interbank market, and even it might prove insufficient. We were missing such an entity in the key CDS index markets, markets that form a structural analogy in the erstwhile shadow banking system to the boring credit markets of its “regulated” parent. Given that such devices are only ever the creation of crises, we ought not to be surprised at their absence. But if we want to get these markets starting again, we ought to be agitating for their construction. This is precisely what Mehrling has been doing.
That MacKenzie came so close to this answer but failed to connect the dots might indicate that SSF has a serious epistemological blind spot. So I would like to end this over-long post by briefly reflecting on what this absence of attention to market structure and credit means for the sociology of finance. MacKenzie has made his name by seeking to break open the black boxes of finance and eschew the Parsonian division of labour between sociology and economics. While he has gone further than anyone else in doing this, he has not gone far enough. This is perhaps understandable given his role as a pioneer, but those who have followed in his wake tend to replicate the error, academic markets being acutely prone to herding. While consistently being drawn to the most interesting and critical aspects of modern finance, MacKenzie’s tight focus on particular models and markets has left us without a more general theory of market activity and the pivotal role of the credit markets generally, even when discussing the crisis.
This is ironic, for market making, liquidity, and ultimately credit-money itself are perhaps the most performative aspects of our modern economy. Yet because their performativity has macro-structural predicates—ultimately undergirded by a market theory of money—these objects fall outside the purview of SSF. Yet this is precisely where economic sociology might really take on a faltering mainstream economic paradigm. It is not simply that economics is performative. The critical question is, if the economy is a social entity that does not submit to the scientism of modelling, how is macroeconomic control achieved at all, and how does it break down?
In the conclusion to EOTWT, MacKenzie points out that the power of central banking comes ultimately from the state’s power to tax. True, but this power remains platonic as a control device unless there is a social mechanism for its transmission. Since the inception of central banking, this mechanism has been the credit markets. What does it say about SSF that it was silent on these “boring” markets till after this crisis?
(For Perry Mehrling’s account of the crisis, from which this post is drawn, refer to his interventions here:
http://cedar.barnard.columbia.edu/faculty/mehrling/mehrling_credit_crisis.html)
Market devices for social change? XBRL, GRI and more…
June 12, 2009
I have just received from COST US, a Google group dedicated to corporate sustainability, links to articles about technologies that may reshape how investors and consumers politically engage with companies.
The first one, from the corporate blog of Hitachi, discusses the happy marriage between the Global Reporting Initiative and XBRL language. The GRI is a non-profit that advocates a system for environmental and social reporting, and XBRL is a new format for electronic reporting. This natural union could be one of those happy combinations of content and platform, like mp3s and the ipod.
It’s clear that by providing preparers and users of data with the means to integrate financial and so-called nonfinancial data (i.e., that which discloses a company’s environmental and social performance), XBRL offers exciting possibilities. The potential for XBRL to provide the users of corporate sustainability performance data with the leverage to push and pull information that meets their requirements is certainly there. That was the thinking behind the first version of an XBRL taxonomy for GRI’s sustainability reporting guidelines, released in 2006.
The second one, a Wired magazine article, introduces the efforts of tech-savy programmers to appropriate XBRL for their own activism. See Freerisk.org.
The partners’ solution: a volunteer army of finance geeks. Their project, Freerisk.org, provides a platform for investors, academics, and armchair analysts to rate companies by crowdsourcing. The site amasses data from SEC filings (in XBRL format) to which anyone may add unstructured info (like footnotes) often buried in financial documents. Users can then run those numbers through standard algorithms, such as the Altman Z-Score analysis and the Piotroski method, and publish the results on the site. But here’s the really geeky part: The project’s open API lets users design their own risk-crunching models. The founders hope that these new tools will not only assess the health of a company but also identify the market conditions that could mean trouble for it (like the housing crisis that doomed AIG).
These are exciting developments for sociologists of finance. As Callon has argued, it is the tools that market actors use to calculate that end up shaping prices. There are politics in markets, but they are buried under the device. Following the controversy as it develops during the construction of the tools is the key way to unearth, understand and participate in it. This is of course, a favorite topic of this blog, of several books and of an upcoming workshop, “Politics of Markets.”
One open question, as Gilbert admits, is whether the “open source” approach and tool building will take up.
So, how many companies are tagging their sustainability disclosures in this way? The answer is: surprisingly few. Why is this? Perhaps companies are unaware of the ease with which it can be done. As previous contributors to this blog have noted, XBRL is not that hard an idea to get your head round, and implementing the technology involves very little in terms of investments in time or cash.
An alternative model is Bloomberg’s efforts at introducing environmental, governance and social metrics on their terminals (a worthy topic for another post).
Get it from here.
Today, the Wall Street Journal opens the week with a special section on personal finance. The topic has been attracting my attention and blogging for the past months. Why? The foolish decisions on the part of consumers and savers have been a key contribution to the crisis. The question, then, is clear: how is it that people decide how much to save, buy, invest, etc?
This not just important but theoretically relevant. It goes at the heart of the “market materiality” literature: economic calculation can only take place with the requisite tools… be it calculating implied volatility with Black-Scholes or, as the case now suggests, budgeting the weekly veggies shopping. But the issue, at a personal finance level, has been largely unexplored by academics… as much as by over-indebted consumers themselves.
In an editorial piece, the Journal comments on this neglect, and on the existence of a host of new websites that facilitate this sort of planning:
Your personal finances used to be on automatic pilot. You can’t afford that anymore. You have to monitor your investments, think about how much you’re saving, keep tabs on your spending. Fortunately, it’s easier than ever to do all that.
In an excellent main article, the Journal discusses the different websites that have cropped up to assist in personal finance.
The first and perhaps most effective step to managing your money online is signing up for basic budgeting sites such as Mint.com, from Mint Software Inc. of Mountain View, Calif., Wesabe.com, from San Francisco-based Wesabe Inc., or Geezeo.com, from Geezeo of Hartford, Conn.
To help you avoid bank or credit-card fees, these sites can alert you via email or text message when a bank account is low or when a credit card is approaching its limit. And the sites can slice and dice the information to help you budget better. For instance, they will automatically show you how much you spend in any given category, such as restaurants or gas stations, and can compare your spending habits with those of other users, so you can identify areas where you might need to cut back.
Personally, I am particularly interested in mint.com (not available, I think, outside the US), and found it absolutely fascinating. For those non-Americans interested in understanding the site, I would recommend a visit to the competitors, or even a visit to the online forums of mint, where fanatical users rave about its capabilities.
I am one of them.
In an op-ed on today’s New York Times, Sandy Lewis and William Cohan give voice to an argument that has been roaming through in specialized financial websites and blogs. Organized financial exchanges such as the New York Stock Exchange, the authors argue, are a fundamental part of any economic recovery.
Why isn’t the Obama administration working night and day to give the public a vastly increased amount of detailed information about what happens in financial markets? Ever since traders started disappearing from the floor of the New York Stock Exchange in the last decade of the 20th century, there has been less and less transparency about the price and volume of trades. The New York Stock Exchange really exists in name only, as computers execute a very large percentage of all trades, far away from any exchange.
As a result, there is little flow of information, and small investors are paying the price. The beneficiaries, no surprise, are the remains of the old Wall Street broker-dealers — now bank-holding companies like Goldman Sachs and Morgan Stanley — that can see in advance what their clients are interested in buying, and might trade the same stocks for their own accounts. Incredibly, despite the events of last fall, nearly every one of Wall Street’s proprietary trading desks can still take huge risks and then, if they get into trouble, head to the Federal Reserve for short-term rescue financing.
As it turns out, the Securities and Exchange Commission has been thinking long and hard about these issues. The paradox, however, is that we got to this situation thanks to a regulatory reform, “Reg-NMS,” promoted from the SEC itself. By requiring NYSE specialists to respond within a second to the orders of brokers, live trading on the floor of the NYSE was fundamentally challenged. Ironically, the objective at the time was to promote transparency.
