"The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing."
This strikes a chord with me. Stop chasing money. Chase changing the world.
He's mistaken. There is a real structural difference between a Ponzi scheme and an investment fund.
And as for the high incomes of money managers, it seems reasonable to pay someone a lot to manage a huge fund. So much is at stake that it would be a false economy to hire someone cheap.
But what Krugman is highlighting here -- and Nicholas Taleb has done in more detail previously -- is that fortunes have been made pursuing strategies that are net losers for investors and society.
All you have to do is make sure the giant losses occur just 1 year out of N. It doesn't matter that the one year's losses wipe out the other N-1 year gains; you've already collected your fees and quite possibly retired, and there's no claw-back of your cut.
A reasonable aim of financial technology is to ameliorate the risks that could obscure or destroy truly productive activities. But the same tools can easily be used to do the opposite, construct net-wealth-destroying strategies which enrich only money managers.
To cook up such a strategy purposefully is a crime, and the classic ponzi scheme is the blatant extreme case. But many other strategies based on collecting fees during the upswing of an unsustainable bubble, while being insulated from the downswing, are close cousins of the full ponzi. That the loot is laundered through ostensibly legitimate investments (like mortgage securities this time around) is a convenient consensus cover story; it helps even the perpetrators believe they are providing valuable investment services rather than just a scam.
This view doesn't indict all investment activity/funds as being similar to ponzi schemes. But an awful lot of this most recent financial-services boom appears to have been like a ponzi skim.
(Despite the truth I see in this column, I would not trust Krugman's suggested solutions, which are likely to be heavy on new regulation. Ultimately capital has to learn to protect itself, with novel compensation schemes that disincentivize the 'year N explosion' pseudo-ponzi strategies.)
fortunes have been made pursuing strategies that are net losers for investors and society
That seems unavoidable. It's the same in most industries. You have to pay top baseball players high salaries, even though there's no guarantee they'll do well after you hire them.
To cook up such a strategy purposefully is a crime
There are no guarantees, of course. Sometimes chance breaks the relationship between results and rewards. And, sometimes crime pays.
But the degree matters. If looting and destruction is occasionally rewarded, it can be a manageable expense. If it dominates the industry, even if not via conscious malice, we've got problems. What if every high-paid 'top baseball player' for 10 seasons running was a bust? Then something in scouting or compensation would have to change, a lot.
Is it [a crime], actually?
Yes. A manager who promises investors the possibility of positive return, but knows he has purposefully designed things so that the investors are guaranteed to ultimately lose, while the manager gains, has at the very least engaged in criminal fraud.
So to pull off net-losing strategies within the law, a manager should deceive himself as well as his investors. Fortunately for this class of managers, a whole industry of external rationalizations was spawned by the potential profits.
Take something like day trading, where a company is out of all positions at/after the close each day. Every transaction they engage in is zero-sum. No wealth is being created, but tons of people are wasting time on it (destroying potential wealth).
I don't think the case of day trading is covered by the baseball player analogy.
> So much is at stake that it would be a false economy to hire someone cheap.
This is probably net true, but maybe there is a also a flip side: do these products exhibit some negative price elasticity? (i.e. a fund that charges high fees and pays it's managers highly may actually be more attractive than one that is cheaper but otherwise identical). Given the intangibility and the expectationary-nature of the product, it is possible.
Ten years ago, if you invested with a balanced portfolio ( 40% CD's, 40% index funds, and 20% real estate trusts) you not only would have failed to make money, you would have actually lost money in real terms. Meanwhile, the financial sector comprised 50% of all corporate profits. The bonuses were not rewarding managers for investing prudently, the entire sector was making money off of legalized theft.
Would have? It's did in my case. But you're picking the ten year period that supports your argument. What matters is whether you're right for most ten year stretches, and I'm pretty sure you're not.
It's not that uncommon for a particular asset class to lose money for a decade. But a basket comprising the safest investments from the major asset classes should never lose money over a 10 year period. Nor should CD's lose money over a 10 year period. If they do, it's a sign the financial system has serious problems. And if the average investor is losing money, while those running the show ( Wall St., the Ivy League endowments, Robert Rubin, Rahm Emmanuel ) are making more than ever, it's a sign the financial system is not only fubarred, but down right corrupt.
The underlying issue is the dilution rate of the dollar. From 1998 to 2008 the money supply was diluting at ~10% a year. With the money supply growing that fast, and CD's are paying only ~3% a year, holding anything other than dollars seems like a good idea. So people speculate in stocks, gold, oil, real estate - anything that dilutes at a lower rate than dollars. But most people aren't good at speculating, so they lose money.
No government running a sound money system should be diluting at 10% a year. It's simply inexcusable.
We're discussing the conduct of money managers over the last few years, not the stock market in general. What matters for that purpose is not whether he's right for most ten-year stretches; it's whether he would be right for most stretches in which money managers played martingale games as widely as they have in the last few. (If you limit it to ten-year stretches, you can game the metric by adjusting the frequency of the negative outcome to once per century.)
Since the expectation (integral of probability density times outcome) of such games can be net-negative, he might be. It depends on how prevalent those games are.
There's another angle, too. What matters for the economy as a whole is not one player's expected outcome, but the sum of the expected outcomes over all the players.
It would be hard to find a 10-year stretch post Great Depression with less regulation on banks. Here's a video that was on CSPAN of the former CEO of Wells Fargo, with a detailed breakdown of every regulation that was lifted since he started (with Citigroup, if I remember from when I saw this on TV) in the 70's:
Kurgman makes the point (briefly) that the incentives for hedge fund managers are only given for short term performance. That incentive means that they can look for strategies that won't blow up for a few years and make bank the whole time.
It's not Ponzi, but it's not in the interest of investors (unless their money's in short-term enough to miss the implosion).
There is a similarity between a ponzi scheme and the bubble created by the financial system: it works only as long as you find fools to trust it, and the last one to get out loses.
Even though the cheap one will do substantially better, over the long run, than most of the expensive ones?(Index funds vs. managed funds: the record is clear).
Why is anyone who doubts the overall integrity of then investment industry is getting downmodded here? The HN crowd is usually smarter than this. First of all, downmods are for spam so stop treating this board like diggiotic censorbots. Second of all, educate yourselves about the truth of the investment industry. Or better yet try trusting your own money with it and learn the hard way. Big brokerages buy large blocks of a stock which sends the price up, then they call affiliated brokerages to advise all of their clients to buy the same stock because the price is going up which sends the price up more, then the big brokerage dumps their shares and keeps the profit. Pump and dump. It's one of the many price manipulation games the finance services industry plays against its own clients, it's illegal, and it happens every trading day in full view of the SEC. Madoff proved the SEC are the Keystone Cops. Suckers believe that brokers are paid according to the success of the client's profile because that's what their brokers tell them. Dead wrong. Brokers are paid according to the number of sales, transactions, and new clients (suckers) they can reel in. So go ahead and downmod me. There's one born every minute. Always more sheep to be shorn.
Krugman is missing the elephant in the room. The most obvious comparison to Madoff's scheme is Social Security. New funds fuel current payouts, and the entire system rests on the addition of new members (population growth) which is why its insolvent as our population levels off in the next 30 years.
Luckily the government isnt crazy enough to promise extraordinary returns on your social security contributions, however once the funds run out for the current recipients, watch our forced contribution be raised sky high to keep paying it out.
Bad times ahead. But thats the predetermined path for a Ponzi scheme, no matter what the size.
Are you talking about medicare or social security? If we took a little under half of the increase in defense spending in the ~2002-2006 period, social security could be made solvent for the next 75 years:
http://video.google.com/videoplay?docid=-6514572148606053094...
It isn't exactly out of our capacity to do. We just have to stop blowing things up and destroying wealth.
It's interesting that Krugman, a Keynesian, is so down on Madoff. During a recession, I would think that Krugman would want some form of economic stimulus that causes people, in the aggregate, to spend more money compared to how much they save. What better way to do so than a ponzi scheme, wherein Bernie spends the money he knows he's stolen, and his investors spend the money they think they've earned?
is Mr. Madoff’s tale from the story of the investment industry as a whole?
This is a statement one might expect from a pure juvenile. No, Mr. Krugman, the investment industry serves a viable purpose, in deep contrast with a Ponzi scheme. There are good and bad methods in the investment industry, but Ponzi schemes, in every instance, are indelibly insolvent, unproductive, and unprofitable.
I normally disagree with Krugman, but he's closer to the truth than you think.
A Ponzi scheme is defined as an operation "that involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business. "
In 2007, the dividend yield of the S&P 500 was 1.5% People were not buying stocks to obtain the cash flow of a real business. People bought stocks under the assumption that eventually they could sell to someone else for a higher price.
The "S&P 500" is not the same as the "investment industry" which is the subject. Buying an asset with the expectation that it will increase in value is not the same thing as a direct system of payments between clients with no underlying assets. You're not really addressing my comment or Krugman's article.
But that's not the point. The point is that Krugman's objects of comparison share almost no correspondence. Even Lehman Brothers was substantially profitable when brought down by one class of securities, the creation of which was largely a government affair. It is important for everyone to understand that Krugman is the worst kind of shill.
The "S&P 500" is not the same as the "investment industry"
It's a big part of it, and the rest of the industry was operating in much the same way.
Buying an asset with the expectation that it will increase in value...
People expected the asset to increase in price. The only way an asset can increase in price is if new buyers are willing to pay more money for it. If this increase in price corresponded to an increase in the underlying cashflow, that would be healthy. But the price of stocks were increasing at a far greater rate than dividends were increasing. Therefore it was not healthy at all.
Another way of putting it: if you bought a share a S&P 500 ETF, and knew you could never, ever sell it, what kind of dividend yield would you demand? I would demand at least a 5% dividend, maybe more. By that metric, the S&P in 2007 was overpriced by about 70%. That premium is based on the idea that someone else would be willing to pay that price or more.
The S&P is not really a ponzi scheme. When a ponzi scheme is big enough, and it is legal, we have a new name for it: money. S&P stocks were essentially trading as private currencies. See my longer comment on this here: http://www.newmogul.com/item?id=2587
It is important for everyone to understand that Krugman is the worst kind of shill.
He is a shill, but it's important to criticize him for the right reasons. The elephant that Krugman misses is that from 1995-2008 the dollar was diluting at ~10% a year. When that happens, holding any asset other than the dollar - stocks, real estate, gold, oil - starts looking like a great idea.
I hardly see that as a counter. Both Kling and Krugman are right! The government is a ponzi scheme, and lots of the financial sector has been ponzi-like, too!
(And a point that Kling might make but Krugman tends not to: much of the financial-sector ponzi-ism was propelled by government policy, which inflated the housing bubble with tax benefits, Fed-lowered interest rates, government-sponsored mortgage-underwriting, and regulatory favoritism for dubious mortgage-lending. And policy which then further insulated finance institutions from existential risk with the implied promise -- now delivered -- of giant bailouts.)
It's one thing to conclude one specific article is offtopic (in which case please just flag it instead of commenting), but are you really saying that nothing Krugman could ever write would be interesting to hackers?
I think a great deal of what Krugman says is interesting (perhaps minus the Bush bashing, that just gets old), and occasionally something on reason.com, too, for that matter. I also like to read Kling, Thoma, Cowen and Mankiw, as well as The Economist's Free Exchange, and a few others from time to time. I suspect that I'm not alone in those interests.
However, I very rarely submit the articles I find that I like. My fear is that the ensuing discussions tend to be very much about ideologies and create lots of heat, but little light - they're about 'firm beliefs' rather than something that can ever really be proven in an internet discussion forum. These sorts of discussions, in my opinion, attract people that want to talk about politics and economics, which are sort of low-hanging fruit - everyone, not just hackers, has opinions on them. Also, there is so much written about those topics that it would be extremely easy to crowd out hacker/startup topics with economic ones, even restricting economics/politics postings to relatively good ones. My gut feeling is that if these articles prosper, this site will, with time, decline. Your site, your call though - if you say economics and or politics go, I will no longer comment or flag them. Maybe I'll even submit a few of my own.
BTW, one of my favorite articles of Krugman's is this one:
You're very protective of this community, David, and I appreciate it. But this economic crisis is not only a once-in-a-lifetime event, but it has tremendous consequences for start-ups.
It's better just to flag what you don't like. Personally, I find this article to be both insightful and important.
Heh, I suppose I get a bit wrapped up in it. Living in the middle of the Tirolean Alps, and not speaking much of the local language (German), I don't really interact much with hackers outside of this site, or pretty much at all in real life, which is less than ideal - I'm a fairly social person. Hopefully we'll be back in Italy in a few months and things will improve.
> But this economic crisis is not only a once-in-a-lifetime event, but it has tremendous consequences for start-ups.
Sure, but plenty of real, serious economists are still discussing the great depression too, so I am quite sure that there will be enough discussion about current events to last at least a generation. This article wasn't really all that directly related to startups, either. I thought it was pretty evident he wasn't talking about plain old stocks and bonds, but a lot of the wackier things going on (CDO's, CDS's, hedge funds, etc...). Even there, though, he was doing it in sort of a facile way that probably doesn't add much to the debate.
Easy counter-question: would it be okay to publish economists with different political opinions as long as some hacker was interested in it?
At some point, a public person decides to make politics part of his brand. That's a business decision. The results of that decision is that whenever they write, whatever the topic, politics gets inserted into the stream.
Personally I thought it was a poorly-worded and easily constructed essay based on class warfare and ignorance of the value of managing risk. (Which is odd given Krugman's occupation) All securities are risky. People make lots of money managing that risk for their clients. Every now and then Wall Street blows up and investors get screwed.
Nothing much to see here, except Krugman's dancing on the grave of hundreds of billions lost to the tune of "I'm with the little guy"
Can't you just look up any of 2343243432 other internet discussions about libertarians, austrian economists, centrists and more leftist types arguing until they are blue in the face? Do you honestly think there's going to be anything new said here?
This strikes a chord with me. Stop chasing money. Chase changing the world.