Tag Archives: Financial crisis

The dirty secret of capitalism

By Nick Hanauer – I am a capitalist, and after a 30-year career in capitalism spanning three dozen companies, generating tens of billions of dollars in market value, I’m not just in the top one percent, I’m in the top .01 percent of all earners. Today, I have come to share the secrets of our success, because rich capitalists like me have never been richer. So the question is, how do we do it? How do we manage to grab an ever-increasing share of the economic pie every year? Is it that rich people are smarter than we were 30 years ago? Is it that we’re working harder than we once did? Are we taller, better looking?

Sadly, no. It all comes down to just one thing: economics. Because, here’s the dirty secret. There was a time in which the economics profession worked in the public interest, but in the neoliberal era, today, they work only for big corporations and billionaires, and that is creating a little bit of a problem.

So, what is a society to do? Well, it’s super clear to me what we need to do. We need a new economics. So, economics has been described as the dismal science, and for good reason, because as much as it is taught today, it isn’t a science at all, in spite of all of the dazzling mathematics. In fact, a growing number of academics and practitioners have concluded that neoliberal economic theory is dangerously wrong and that today’s growing crises of rising inequality and growing political instability are the direct result of decades of bad economic theory. What we now know is that the economics that made me so rich isn’t just wrong, it’s backwards, because it turns out it isn’t capital that creates economic growth, it’s people; and it isn’t self-interest that promotes the public good, it’s reciprocity; and it isn’t competition that produces our prosperity, it’s cooperation. What we can now see is that an economics that is neither just nor inclusive can never sustain the high levels of social cooperation necessary to enable a modern society to thrive.

So where did we go wrong? Well, it turns out that it’s become painfully obvious that the fundamental assumptions that undergird neoliberal economic theory are just objectively false, and so today first I want to take you through some of those mistaken assumptions and then after describe where the science suggests prosperity actually comes from. more>

What’s Elizabeth Warren’s wealth tax worth?

By Isabel V. Sawhill and Christopher Pulliam – On both sides of the Atlantic, economic inequality has rocketed up the political agenda and inspired a new wave of populism. Wealth inequality is high and rising in the UK and staggeringly so in the US. The top 1% of American households now have more wealth than the bottom 90%. In the UK, the top 10% holds over half the wealth. The richest 400 individuals in the US average a net worth of $7.2 billion.

How did we get to this point? As Thomas Piketty, in his book Capital, famously argued, a capitalist economy left to its own devices will tend to produce not just inequality but ever-rising inequality of wealth – and the income derived from wealth. The main reason is because the returns earned on assets such as stocks and bonds normally exceed the growth of wages.

Imagine an economy with one capitalist and one wage earner. If the annual rate of return to financial assets is, say, 3%, but wages are only growing by 2%, more and more income ends up in the hands of the capitalist. Wealth then begets more wealth as the capitalist, not needing to spend all of his added income, adds to his existing wealth and reaps ever-growing income from that wealth. Unless a war or other shock destroys his wealth (think depression or the devastation in Europe after the Second World War), or government decides to tax it away, we end up with the rise in wealth inequality that we are now seeing in many rich countries – the US in particular.

There is something deeply disturbing about Piketty’s work. If one takes his thesis seriously, it means that the inequality of wealth and its corollary, income inequality, along with their continued growth, is the new normal. They are baked into a capitalist economy.

Of course, some financial capital gets invested in productive assets that help the economy grow. But productive investment and growth have slowed in recent decades, making it hard to argue that the rise in wealth at the top has benefited everyone. In the meantime, the accumulation of wealth in high-income households is one reason that income inequality is rising so sharply at the very top. While the richest 20% of US households, which benefit from a lot of human capital but not a lot of wealth, saw their market incomes rise by 96% between 1979 and 2016, the top 1% – which receives far more of their income from wealth – saw their incomes rise by a staggering 219%.

In short, growing wealth inequality spawns growing income inequality, so if we care about the latter, we cannot focus only on redistributing income. We need to tackle the accumulation of wealth as well.

What to do? Senator Elizabeth Warren, a serious contender for the US presidency, has proposed a wealth tax. more>

Updates from Chicago Booth

Why the big banks aren’t safe yet
By Haresh Sapra – The next financial crisis will not come from the traditional banking sector. So goes conventional thinking among financial policy makers. The world’s biggest banks are now safer, according to the narrative, thanks to stricter capital requirements and frequent stress tests that have curbed the appetite for extreme risk and tightened up lax regulatory standards.

I wish I were completely reassured. But as an accountant, I know that the headline capital numbers result from a subjective calculation. Banking regulators typically spend too little time digging into how those figures are calculated. I also know that when the US financial system is healthy, as it is now, we should strive to do better at accounting for potential losses, because that might cushion the blow when the inevitable downturn arrives.

To be sure, the big banks have all passed the Federal Reserve’s stress tests with flying colors. And this reflects substantial increases in capital buffers: the 35 banks that underwent 2018’s stress test have added about $800 billion in the highest quality type of capital over the past decade, according to the Fed. The central bank has deemed that the banks would therefore be strong enough to continue lending if the economy were to plunge into another severe downturn.

But I am not the only observer who remains concerned. In a speech to Americans for Financial Reform in May, Georgetown’s Daniel Tarullo, who was a Fed governor from 2009 to 2017, questioned the robustness of the stress tests. Banks know what regulators are looking for, Tarullo observed, enabling them to “find clever ways to reshape their assets,” thereby reducing their capital levels without reducing their risk exposures. And he also cast doubt on a Fed proposal to create a “stress capital buffer” to stop banks from running down their capital cushions by using dividend payments. Such a buffer, Tarullo argued, could actually prompt banks to take on even more risk. more>

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Updates from Chicago Booth

How machine learning can improve money management<
By Michael Maiello – Two disciplines familiar to econometricians, factor analysis of equities returns and machine learning, have grown up alongside each other. Used in tandem, these fields of study can build effective investment-management tools, according to City University of Hong Kong’s Guanho Feng (a graduate of Chicago Booth’s PhD Program), Booth’s Nicholas Polson, and Booth PhD candidate Jianeng Xu.

The researchers set out to determine whether they could create a deep-learning model to automate the management of a portfolio built on buying stocks that are expected to rise and short selling those that are expected to fall, known as a long-short strategy. They created a machine-learning algorithm that built a long-short equity portfolio from the top and bottom 20 percent of a 3,000-stock universe.

They ranked the equities using the five-factor model of Chicago Booth’s Eugene F. Fama and Dartmouth’s Kenneth R. French. Fama and French break down the components of stock returns over time into five factors: market risk, in which stocks with less risk relative to their benchmark outperform those with more risk; size, in which companies with small market capitalizations outperform larger companies; value, where a low price-to-book ratio outperforms high; profitability, where higher operating profits outperform; and reinvestment, in which companies that reinvest outperform those that don’t. more>

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Optimizing for Human Well-Being


By Douglas Rushkoff – The economy needn’t be a war; it can be a commons. To get there, we must retrieve our innate good will.

The commons is a conscious implementation of reciprocal altruism. Reciprocal altruists, whether human or ape, reward those who cooperate with others and punish those who defect. A commons works the same way. A resource such as a lake or a field, or a monetary system, is understood as a shared asset. The pastures of medieval England were treated as a commons. It wasn’t a free-for-all, but a carefully negotiated and enforced system. People brought their flocks to graze in mutually agreed- upon schedules. Violation of the rules was punished, either with penalties or exclusion.

The commons is not a winner-takes-all economy, but an all-take-the-winnings economy. Shared ownership encourages shared responsibility, which in turn engenders a longer-term perspective on business practices. Nothing can be externalized to some “other” player, because everyone is part of the same trust, drinking from the same well.

If one’s business activities hurt any other market participant, they undermine the integrity of the marketplace itself.

For those entranced by the myth of capitalism, this can be hard to grasp. They’re still stuck thinking of the economy as a two-column ledger, where every credit is someone’s else’s debit. This zero-sum mentality is an artifact of monopoly central currency.

If money has to be borrowed into existence from a single, private treasury and paid back with interest, then this sad, competitive, scarcity model makes sense. I need to pay back more than I borrowed, so I need to get that extra money from someone else. That’s the very premise of zero-sum.

But that’s not how an economy has to work. more>

Consumerism isn’t a sellout – if capitalism works for all

By Richard V. Reeves – The essential thinginess of capitalism has been one of its most-criticized features. Materialism, and specifically consumerism, are almost always used as pejorative terms. Nostalgic conservatives, egalitarian progressives and environmentalists loudly agree on at least one thing: we are just buying too much stuff.

They’re not wrong. The U.S. self-storage market is already worth $38 billion, and growing fast. Almost one in ten households are now renting extra space. One feature of late capitalism is that many of us have more things than we have space for things.

At its best, however, consumerism is a powerful, positive force. It allows for the expression of identity, it can hold sellers to public account, and it drives new thinking and development. But this is only the case when consumers are being served fairly in the market. Today, there is a pressing concern about whether the forces of “bigness” – a trend toward fewer larger companies – combined with a reluctance on the part of governments to intervene in consumer markets, is dampening innovation and narrowing choice.

Before worrying about whether the market is serving consumers, we need to agree that it should. Critiques of consumerism have to be taken seriously before examining whether contemporary capitalism is friendly to consumers. These critiques usually come in four types: moral, aesthetic, financial, or environmental.

The moral critique of consumerism is that the acquisition of things displaces more worthwhile activities or priorities. Instead of shopping, we should be spending time with friends and family, in places of worship, or in nature. more>

Updates from Chicago Booth

Free markets for free men
By Milton Friedman – Do free markets make free men, or do free men make the free markets?

That might seem like a play on words or a purely semantic question, but it is not. It is a very real and very important question, and I think it contributes a great deal to understanding the kind of world we live in, and might live in.

One’s offhand impression is to say, “Well it must be free men who make free markets.” There’s an element of truth in that, but I think to a far greater extent, free markets make free men and not the other way around.

It’s true that there have been free men who have made free markets. The founders of the United States were free men who believed in individual and personal freedom, and they set up a constitution that was designed to preserve free markets.

But many people who regarded themselves as free men have produced totalitarian societies. The intellectual creators of the Soviet Union would have called themselves free men and would have said that they believed in individual and personal freedom. Yet they created not free markets but controlled markets. more>

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Nobel Economist Says Inequality is Destroying Democratic Capitalism

By Angus Deaton – As at no other time in my lifetime, people are troubled by inequality.

Across the rich world, not only in America, large groups of people are currently questioning whether their economies are working for them. The same can be said of politics. Two-thirds of Americans without a college degree believe that there is no point in voting, because elections are rigged in favor of big business and the rich. Britain is divided as never before and, once again, many believe that their voice doesn’t count either in Brussels or in Westminster. And one of the greatest miracles of the 20th century, the miracle of falling mortality and rising lifespans, is no longer delivering for everyone, and is now faltering or reversing.

At the risk of grandiosity, I think that today’s inequalities are signs that democratic capitalism is under threat, not only in the US, where the storm clouds are darkest, but in much of the rich world, where one or more of politics, economics, and health are changing in worrisome ways. I do not believe that democratic capitalism is beyond repair nor that it should be replaced; I am a great believer in what capitalism has done, not only to the oft-cited billions who have been pulled out of poverty in the last half-century, but to all the rest of us who have also escaped poverty and deprivation over the last two and a half centuries.

But we need to think about repairs for democratic capitalism, either by fixing what is broken, or by making changes to head off the threats; indeed, I believe that those of us who believe in social democratic capitalism should be leading the charge to make repairs. As it is, capitalism is not delivering to large fractions of the population; in the US, where the inequalities are clearest, real wages for men without a four-year college degree have fallen for half a century, even at a time when per capita GDP has robustly risen. more>

The Ideology of Self-interest Caused the Financial Crash. We Need a New Economic Paradigm

By Mark van Vugt and Michael E. Price – We are still feeling the effects of the global financial crisis, which started in the US in 2008, and that has now spread to every corner of the world.

The financial crisis should teach us some important lessons about the way economies work and the way we design our organizations. In essence, we have simply made the wrong assumptions about human nature. The leading model in economic theory is that of Homo economicus, a person who makes decisions based on their rational self-interest. Led by an invisible hand, that of the market, the pursuit of self-interest automatically produces the best outcomes for everyone. Looking at the financial crisis today this idea is no longer tenable. When individual greed dominates, everyone suffers. We could have known this all along had we looked more closely at human evolution.

Economic scientists often portray competition between firms as a Darwinian struggle where firms compete and only the fittest ones survive. The British financial historian Niall Ferguson wrote “Left to itself, natural selection should work fast to eliminate the weakest institutions in the market, which typically are gobbled up by the successful.”

This may be true but it is not the outcome of individual greed and competition.

Competition between firms presupposes that individuals cooperate well with each other, and the most cooperative organizations survive, and the least cooperative organizations go extinct. This is group selection, selection operating at the level of groups, where the best groups survive.

This is a far more accurate model of how economies and business operate, and it offers a totally new way of thinking about the design of organizations and ways to avert global financial crises.

A team of evolutionary minded psychologists, biologists and economists led by biologist David Sloan Wilson have come together over the past few years to come up with a more accurate model for how businesses and economies operate. It is based on Homo sapiens rather than Homo economicus. Their efforts are put together in an Evolution Institute report on socially responsible businesses “Doing Well By Doing Good.” more>

Takers and Makers: Who are the Real Value Creators?

By Mariana Mazzucato – We often hear businesses, entrepreneurs or sectors talking about themselves as ‘wealth-creating’. The contexts may differ – finance, big pharma or small start-ups – but the self-descriptions are similar: I am a particularly productive member of the economy, my activities create wealth, I take big ‘risks’, and so I deserve a higher income than people who simply benefit from the spillovers of this activity. But what if, in the end, these descriptions are simply just stories? Narratives created in order to justify inequalities of wealth and income, massively rewarding the few who are able to convince governments and society that they deserve high rewards, while the rest of us make do with the leftovers.

If value is defined by price – set by the supposed forces of supply and demand – then as long as an activity fetches a price (legally), it is seen as creating value. So if you earn a lot you must be a value creator.

I will argue that the way the word ‘value’ is used in modern economics has made it easier for value-extracting activities to masquerade as value-creating activities. And in the process rents (unearned income) get confused with profits (earned income); inequality rises, and investment in the real economy falls.

What’s more, if we cannot differentiate value creation from value extraction, it becomes nearly impossible to reward the former over the latter. If the goal is to produce growth that is more innovation-led (smart growth), more inclusive and more sustainable, we need a better understanding of value to steer us.

This is not an abstract debate.

It has far-reaching consequences – social and political as well as economic – for everyone. How we discuss value affects the way all of us, from giant corporations to the most modest shopper, behave as actors in the economy and in turn feeds back into the economy, and how we measure its performance. This is what philosophers call ‘performativity’: how we talk about things affects behavior, and in turn how we theorize things. In other words, it is a self-fulfilling prophecy.

If we cannot define what we mean by value, we cannot be sure to produce it, nor to share it fairly, nor to sustain economic growth. The understanding of value, then, is critical to all the other conversations we need to have about where our economy is going and how to change its course. more>