Bubble machine

Occasionally I will take requests on the blog (actually, I'd love to get more), suggestions on something to write about, and I'm happy to put something together if I can think of something to say. A reader/friend asked me to write something about Matt Taibbi's Rolling Stone article titled The Great American Bubble Machine. In it, Taibbi lays the blame for our financial meltdown on investment bank Goldman Sachs:

The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

Any attempt to construct a narrative around all the former Goldmanites in influential positions quickly becomes an absurd and pointless exercise, like trying to make a list of everything. What you need to know is the big picture: If America is circling the drain, Goldman Sachs has found a way to be that drain — an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.

Reaction has been severe. Of course, Goldman Sachs has responded with outrage, but many other commentators have leapt to the barricades, accusing Taibbi of overreach and sloppiness. One who has attracted a lot of attention with her "takedown" is The Atlantic's Megan McArdle, and I'll swing back to her in a moment.

But, you ask, what of my take on the original article? Ah, yes, but there's a problem: Rolling Stone has, in their infinite old-media wisdom, not published the whole thing online; the link I provided above is a series of excerpts interspersed with videos of Taibbi. So it's hard for me to provide any cogent analysis of the article without running out to the store and picking up a copy of the mag, and I'm not going to do that. (Kevin Drum fell into the trap, reviewing the article without realizing he was looking at bits and pieces. Once he got on track, he read the whole thing, concluding that, "It's a very good takedown of the modern financial industry and well worth reading." Drum also provides a link to a site that purportedly offers the whole article, but that's not working for me.)

I am left, then, trying to review an article based on excerpts, and that's not fair to the piece. I will not try to claim total objectivity anyway, as I am a fan of Taibbi's writing. His reviews of the Tom Friedman oeuvre are canonical, but I already praised those enough. He is a passionate writer, one who, perhaps, sometimes allows his passions to get in the way of precision.

But that's who he is, and to take the other side, to argue that his vehement eloquence is disqualifying is to refuse to engage with his points. And that is a far greater sin. Witness the quote in a TIME piece from a former journalist, "For the record, I don't think any article that contains the line 'vampire squid sucking the face of humanity' [Taibbi's opening description of Goldman] is real journalism." That quote is vacuous and completely unenlightening. (Taibbi himself responds to TIME's piece here.)

Here's Taibbi's position in an somewhat unfair nutshell: Goldman Sachs has been at the center of every negative investing trend over the last several decades, and their involvement in questionable financial instruments and oil speculation directly led to the current world financial crisis. Furthermore, their connections to people in high places ensures that they will be allowed to profit mightily no matter what happens in the global economy.

And that doesn't really seem too wrong. I sense maybe a little too much conspiracy in Taibbi's article, a bit too much willingness to credit Goldman with prescient malevolence. In my experience, there is rarely a decision arc in even the most powerful companies; rather, there is a culture which approaches problems in consistent ways, thus leading to similar results. Once that culture is seen as successful, it becomes widely adopted and the influence is magnified.

One thinks of, in the business consulting realm, the influence of McKinsey. McKinsey is not responsible for some of the worst management trends of the past 30 years, but they do tell their well-paying clients what they want to hear. Once the concepts (things like dehumanization and offshoring, anything in which customers can reap gains without paying the full costs) get the official McKinsey imprimatur, they become consecrated as holy writ, and McKinsey appears to be at the cutting edge of modern management techniques. I believe something similar happens with Goldman Sachs, that whatever they do quickly pervades the industry, giving the appearance of a conspiracy where none exists.

Which brings me to Megan McArdle. I find this self-styled libertarian to be maddeningly inconsistent, capable of penning some clear-eyed pieces that cut through cant (as in this post about retraining, where she couples her own experience with conventional wisdom and finds reasons to question the "wisdom"), but too often falling into a mush of disorganization. One could pin that on the blog format, but she is a major force in the blogging world and I expect more from her.

At any rate, her criticism of Taibbi has received quite a bit of attention, probably because she begins:

What I think, sadly, is that Matt Taibbi is becoming the Sarah Palin of journalism. He seems to deliberately eschew understanding his subjects, because only corrupt, pointy-headed financial journalists who have been co-opted by the system do that. And Matt Taibbi is here to save you from those pointy headed elites.

(Sarah Palin analogies are always attention grabbers.) Her argument is that Taibbi misemphasizes the importance of the things that Goldman did, that they did do those bad things but they're old news and other people did stuff that was worse, so why pick on Goldman?

She then takes her U of Chicago MBA (a degree she shares with this writer) and rolls right off the tracks:

But in fact, everyone was aware that CDO's were repackaging crap mortgages--that was the point. The idea was pure portfolio theory, broadly agreed upon by everyone involved. Everyone knew a lot of the mortgages might go bad, either by defaulting or prepaying. (This is a risk for bankers, who don't like the idea that if interest rates drop, their 7% mortgage might suddenly turn into a pile of non-interest-bearing cash which can only be invested at 5%.) But if you pool the risk, only some of the bonds will go bad, while others pay off. The result is a less risky, less volatile investment than any individual junk mortgage bond. And it would have worked, too, if it hadn't been for those crazy kids a collapse in the housing market of a scale not seen since the Great Depression.

This betrays a misunderstanding of portfolio theory, in that the risk of the pooled security is less only if there is minimal correlation among the component securities. Diversification works only when the underlying elements are different in nature; when they all stem from the same source, for example, residential mortgages, any downturn in the overall housing market will destroy the value of the pooled security, which is, of course, exactly what happened. There is no magic that allows anyone to take D-level garbage that is all of the same type and turn it into AAA by clever dividing and recombining. That's absolutely basic.

McArdle then hedges her own bets by agreeing with Taibbi's basic point:

Wall Street is an arrogant beast that more than held up its half of the devil's bargain which drove us into our current ugly straits. Bankers who thought they were geniuses were deceived by models that assumed away the possibility of a second great depression. They made a terrifying amount of money doing it. And now that the taxpayers have bailed them out at considerable expense, we don't even get a goddamn fruit basket. Instead they merrily go along paying themselves gigantic bonuses for the singular feat of not driving our economy entirely back to the stone age. I think some populist rage is more than warranted.

She simply disagrees with the way Taibbi chose to illustrate these problems, claiming that he didn't ask the right questions and, therefore, profoundly misunderstands the true nature of the problem. So we should be mad at Goldman, but we should also be mad at others too, and we can't know exactly who we should be mad at for what, and so forth into its own brand of incoherence.

McArdle got some pushback for her piece, especially for her assertion that, "financial meltdowns don't offer villains, for the simple reason that no one person or even one group is powerful enough to take down a whole system." So she wrote another long blog post about that, defending herself with this analogy:

A woman gets into her car, and waves at her husband, who is crossing in front of the car. Pressing the pedal to the ground, she puts it into gear . . . and steams forward at full speed, crushing him against the wall of the garage.

Is she a villain? It rather depends, doesn't it?

Scenario #1: she's angry because she found out he had an affair, and decided to kill him "by accident" for the insurance. Scenario #2: she thought she was stepping on the brake, and stepped on the gas instead. The former is a crime, the latter a tragedy. But you can't divine which simply by knowing that something terrible happened....Villainy involves people who know, or should have known, that what they were doing was likely to lead to the awful results.

I mean, you can quibble and say "You should have known that that was the gas pedal", and indeed you should have, but if, for whatever reason, your senses deluded you, you're not a villain. No, even if you were thinking about the presentation you had due at work--or how angry you were at your husband for having a fling with his secreatary--rather than concentrating on your driving.

When something is common enough, I think it definitionally isn't villanous. It may be a practice that should be fixed--we should all be more careful when starting our cars, I'm sure.

This is a bad analogy, so let's try to fix it. Let's say the woman may or may not know how to drive. Her husband asks her if she knows which is the brake pedal. She confidently answers yes, then steps on the gas and kills him.

Alternatively, she chooses to flip a coin as to which pedal to step on.

Is she a "villain" in either of those scenarios? I don't know, but she is certainly criminally negligent, and we do have societal punishments for that kind of recklessness.

And this is closer to what we've seen from our financial corporations. They took unconscionable risks, actions that could bring down a world financial system, then pled, "No one could have known," when it all went south. Their perverse incentive policies made gambling with OPM (other people's money) acceptable, even necessary. This is not their senses deluding them, this is arrogant heedlessness and, whatever the merits of Taibbi's contention that a great deal of it was due to deliberate manipulation on the part of Goldman Sachs, can't be wished away by McArdle's limp argument.

Then, unsurprisingly, McArdle yet again hedges her bets, telling us that she actually doesn't like Goldman Sachs at all:

I have no reason to love Goldman Sachs, and I don't. I didn't like them when I was interviewing for investment banking internships in business school (worst interviews by far were sponsored by Goldman Sachs and Bear Stearns). I dislike the way their alums, and indeed, their current employees, have permeated our politics and our financial regulatory system like some sort of insidious fungus. I have been repelled by Jon Corzine ever since he spoke at my business school graduation ceremony, where he jovially described how he had cheated his way into a diploma by getting his girlfriend to do his final project for him. He seemed to think this was funny.

She goes on in this vein for a while, but ultimately defends the bankers by claiming that they were stupid, but so was everybody else, and that doesn't equate to villainy, and that no change to history would have allowed us to avert the financial crisis (?!?):

But I think the case needs to be a leetle bit tighter than the fact that bankers make stupid decisions, bankers get paid a lot, and we just had a financial crisis. I'd like to see someone make the case that they did things that were actively, knowingly, illegal and morally turpitudinous, rather than simply totally moronic. Because with the total moron thing, they had an awful lot of company.

Of course, that's actually just the case that Taibbi is making (perhaps it is not as airtight as we would like, but it's a start). When money is entrusted to people who are reckless with it, that's wrong - I suppose we can debate the word "villainy" at some length. But the hands-off, "no one is more wrong than anyone else" attitude is profoundly unhelpful, no matter how much the principal actors in this piece would like it to become the prevailing approach.

[Update: I have come across a site on which the whole Taibbi piece has been posted. I don't believe a complete reading changes anything I've already written, but I'll ponder it some more and come back if I have any additional comments to make.]