Cyberlibris blog

Marchés de dupes d'Henri Bourguinat et Eric Briys: le livre en librairie le 9 septembre!

Le communiqué de presse des Editions Maxima : CP MARCHES DE DUPES

L'Arrogance de la Finance: comment la théorie financière a produit le krach

En janvier 2009, dans toutes les bonnes librairies et dans toutes les bonnes bibliothèques numériques, l'ouvrage écrit par Eric Briys (Co-fondateur de Cyberlibris) et Henri Bourguinat (Professeur Emérite à l'université de Bordeaux-4) et intitulé "L'Arrogance de la Finance" publié aux Editions La Découverte.

Sous-titre: Comment la théorie financière a produit le krach.

La quatrième de couverture en guise d'apéritif:

"La cause semble entendue : le krach financier d’octobre 2008 incombe aux crédits hypothécaires du marché immobilier américain, les fameux subprimes. En réalité, comme l’expliquent dans ce livre lumineux deux éminents spécialistes de la finance internationale, les racines du mal sont beaucoup plus profondes.

Mus par une sorte d’ivresse technique et une avidité pécuniaire démesurée, les professionnels des marchés ont fait de la « finance pour la finance », comme on fait de l’«art pour l’art ».

Encouragés par les économistes théoriciens de la finance, dont plusieurs prix Nobel, ils ont succombé à un véritable péché d’arrogance. En apportant leur caution scientifique aussi bien au travail des « quants » (les experts des modèles mathématiques d’ingénierie financière) qu’à celui des équipes de gestion des risques, les théoriciens ont conforté les praticiens dans le fantasme d’avoir dompté tous les risques. Or, comme le montrent les auteurs, contrairement à ses prétentions, la théorie financière est bien loin d’offrir cette garantie.

Errements des marchés, perversion du « génome théorique » de la finance et carences de la régulation ont produit une véritable dislocation du système financier. Seule une refonte profonde de celui-ci peut le guérir. Elle risque fort de se révéler longue et douloureuse pour l’« économie réelle » et ses agents, salariés et entrepreneurs."

Risk can be securitized, information may not and that means heading for trouble...

Securitization has become a panacea on financial markets.

Indeed, it is predicated on the simple idea that balance sheets are more often than not the best parking for risks. In other (shareholders) words, they are the most costly parking you can find. Hence, commercial banks with the structuring help of Wall Street firms have "shipped" assets and liabilities that were so far stored in their balance sheets to investors.

It sounds like a marvelous and lucrative never ending innovation spiral à la Merton where banks can do more business, investors have access to a wider spectrum of securities and risks are more efficiently shared.

Too good to be true: The subprime mess is a wake up call, one that calls for deep thinking.

There are some things that do not change. In October 1987, the equity market crashed and portfolio insurance was designated as the culprit. Portfolio insurance used to be considered as the solution to downside risk protection. Investors hate downside risk even more than they love upside. University of Berkeley mavericks, Hayne Leland and Mark Rubinstein (co-founders if LOR), came up with a technique that promised to replicate what a long put option does, namely pay off, when the market goes south. The "trick" was simply to use Black-Scholes-Merton option hedging argument to replicate the put option payoff. In other words, they were selling stock index futures (mechanically/dynamically) and going long T-bills (cash) when the equity market was tanking. When the market was rallying up, they did the opposite. That's why when the market crashed in October 87, LOR was accused of provoking/amplifying the downward trend. The argument is a bit odd: Mark Rubinstein rightly pointed out that nobody praised LOR when the market was going up for making the growth even stronger.

The truth is that while portfolio insurance is in effect more of car insurance than earthquake insurance type there is an important market item that it paradoxically "destroys": Information. Indeed, when lots of investors are willing to buy put options bidding the price up they signal their bearishness to the market. What portfolio insurance does is to break down a single (put) transaction into two separate transactions: stock index futures and T-bills. Information about market expectations may get distorted in the process as it is hard for the rest of the market to decipher the initial intent. Worse, as shown by Sanford Grossman and others when portfolio insurers sell mechanically to dynamically replicate the target put, people may mistakenly think that this signals bad news. Asymmetric information problems have increased and we know both from the seminal works of George Akerlof, Michael Spence and Joseph Stiglitz and casual business experience that this is a sure recipe for trouble.

Sadly enough, the same holds true with securitization as witnessed by the subprime mess. Bad loans have been securitized. As a result the shareholders of the originating banks do not bear the consequences, good or bad, of their loan activity anymore. They have no incentive anymore to monitor these loans that get "diluted" in securitization vehicles. Hence while risks seem to have been more efficiently cut into pieces and shared the overall situation has worsened drastically because asymmetric information problems are now more toxic (1). Asymmetric information is a market killer and we end up collectively harvesting what others have planted.

Not convinced. Well, think of what microfinance does. It does exactly the opposite: It reduces information asymmetries by putting monitoring and safety devices in the micro-lending process: Lend only to women, in a village where everybody knows each other, make the borrowers collectively liable when one of them defaults etc... This is why it is successful.

So, next time innovation in the form of sophisticated securitization knocks at your door, ask yourself whether information and incentives have been reduced or not before joining the bandwagon. If portfolio insurance and the subprime can teach us one thing or two, it is precisely this.



(1) Not to mention the fact that it becomes very hard, almost impossible, to restructure the (securitized) loans when disaster strikes.

Who said academic conversation was boring!: Vox Academia is live!

We said we would do it. We've done it. Vox Academia is live! Vox Academia is the place for academic chronicles.

It is the place for starting academic conversations and, indeed, from what I've seen already these conversations are far from boring!

So, join Vox Academia and let's have a buoyant worldwide academic conversation!

Stiglitz's Crusade: Rescuing Hostages from International Capital Markets

Here is an interesting video of Nobel Laureate Joseph Stiglitz. Stiglitz is well-known for his contribution to the microeconomics of information, adverse selection and moral hazard.

After having been a World Bank official and receiving the Nobel distinction he embarked on a crusade against international finance and the big players thereof.

According to him, Argentina (and Brazil for that matter) was cursed. Indeed, financial markets decided that Argentina was risky despite the fact its debt to GDP ratio was no worse than most European countries. No matter what Argentina would do right, its fate was carved in stone from outside: Thumbs down as if international financial markets were a large Roman crowd asking for the wounded gladiator's death.

Frankly, I find it hard to swallow. I fail to get the full picture. As always the devil lies in the details. It was a time when Stiglitz had a passion for details (see his insurance and banking papers). It seems that this time is over and leads him to gross oversimplification which is sad for a man of his stature and responsibility.

I leave you the task of judging:

Stiglitz Explains International Finance
Uploaded by madmundo

Microfinance: The untold truth

Microfinance and fair trade are trendy these days. Rich people somehow feel guilty towards poor (South) people. Poor people do not enjoy the same access to financing opportunities as the North people. Moreover poor people  can't sell their products at what has been called fair price.

Microfinance is about lending small amount of money to poor people who have a project in mind (What_is_Microfinance.pdf ). What is funny is the gullibility of far too many people with respect to microfinance. Microfinance is a good thing, it makes them feel less guilty. They see it as an alternative to allmighty (destructive) capitalism.

All this is pure crap! Microfinance is finance at its best. It is easy to lend to poor people in poor countries because you are almost sure that they will repay. It is difficult to lend to rich people because you're never sure that they will reimburse! How can it be? To answer to this you have to understand what makes lending a difficult task in the first place.

In rich countries, banks lend to people whom they don't know. They try hard figuring out their creditworthiness and more often than not ask for collateral. Economists talk about moral hazard and adverse selection to describe the phenomena at stake.

With microfinance, lenders are in the ideal situation: First, they can discriminate among borrowers, they simply don't lend (in many instances) to men (who run with the money to have a good drink). Women are reliable, hence they get the money. To make sure that the money is well-spent contractual provisions often involve the community in which the lending woman live. For instance, if she fails to pay, the community may be on the hook and have to repay for her or be punished by having a more difficult access to the next loan. The community plays a monitoring and a supportive role to ensure success. This is the dream situation for any banker!

History teaches us that the minute growth kicks in, the minute you deal with strangers (who are not all crooks of course), you start having problems and you end up with economics and finance professors!

So next time you hear somebody telling you how different microfinance is from ugly capitalism, do yourself and your friend a favor: Don't feel unnecessarily guilty, don't be gullible: microfinance is just about Economics and Finance 101!

Californian brain, Chinese muscles

Have a look at your iPod, its base or its plug and read what it says: "Designed in California, Assembled in China or Taïwan."

Interesting. Easy to rephrase: "Inspired in California, Perspired in China."

Or, if you wish, "Californian brain, Chinese muscles."

This reflects a rather binary view of the world.

A recent work at MIT offers a different perspective. Indeed, I am currently reading MIT Professor Suzanne Berger's new book entitled: How We Compete. It's a good read because it offers a balanced view of globalisation and shows, as always, that nothing is either black or white, in other words that the world has not become flat.

By the way, I prefer the French title: "Made in World" (not exactly French but more to the point!): Made is both brain and muscles.

IPADE International Week on Mass Media Social and Economic Impact

Last week I attended one of the best events I ever went to in years. Indeed, I was fortunate to be invited to lecture at IPADE in Mexico City. IPADE is a business school that was founded in 1967 in the city of Mexico. Since its early days IPADE has developed many fine programs including an MBA for young executives and an Executive MBA (MEDEX). IPADE has reached top positions in many rankings (see for instance MB_05_Scoreboard.pdf ). It has now three campuses in Mexico City, in Guadalajara and in Monterrey.

The one thing that struck me most is IPADE's passion for details. Indeed, as the saying goes, God (sometimes the Devil) lies in the details. Any businessman knows, often by (painful) experience, that details are the source of many successes and failures. If by any chance you're in Mexico City, visit IPADE's campus, you'll see what it takes to care for details.

IPADE has run for some years now an interesting program called the MEDEX International Week. This program bring together (roughly 500) lecturers, professors and participants from IPADE and other business schools worldwide where the Executive MBA programs are being taught in order to share in a unique international event at IPADE´s main campus. This year the topic was devoted to the Mass Media and their social and economic impact.

The program included fine speakers such as Christopher Crommett (SVP, CNN en Espanol), Prasanto Kumar Roy (President and Chief Editor, Cybermedia Publications), Professor Doktor Arno Müller (FHNordAkademie) and many others.

I gave several lectures around the same topic entitled "Who's afraid of the Big Bad Wolf?: Internet and the Content Industry in the New (?) Economy" (presentation is here IPADE_Lecture.pdf ).

The main line of the talk is that we have gone from a perspiration economy (The robbing barons, the gilded age) to an inspiration economy (based on ideas and a cost structure where the marginal cost of production lies below the average cost). This has tremendous implications for those I call the media robbing barons (the content industry). In a sense, the robbing barons of the late nineteenth century / early twentieth century controlled capital and assets and you had to perspire for them.

Then came the financial revolution (easy access to capital, venture capital, private equity) and talent was freed from the robbing barons. Talent could go on its own. What happens to the media mogul (the media robbing barons) these days has the same flavor. Users (the We the Media of Dan Gillmor) have been empowered by a formidable technological revolution (backed by the financial revolution) including infrastructure (bandwidth, fiber optic etc...), hardware (iPod, computers, digital cameras, mp3 players...) and software (blogs, RSS, XML, Linux etc...).

This has far-reaching consequences on the way we want to consume content. Media moguls want the business landscape to remain vertical even if its now digital: top-down, they produce what we consume. Moreover they fight big time to retain control for as long as possible ("copyright") of the content they distribute. "We the media" view things differently. We beg to differ as the Napster kids have shown. Our view is more horizontal and predicated on network effects.

Hence our demand for (digital) content has become a lot more elastic to price than the media moguls usually think it is. Why? Because we have the option to go for free: Pay nothing. Yes it is illegal. But think of the Prohibition in the US: When alcohol was prohibited (infinite price), guess what people did, they produced it themselves! When it became legal again at normal prices, nobody bothered to produce alcohol on his own.

Same here. And, that's why the content industry has to be creative and listen to its customers. It has the economic means for it: Indeed, with digital content, it saves on a lot of (distribution, storage...) costs. This money can be reinvested in new offerings that grow the pie instead of spending it on lawyers' fees to defend and control the current pie.

Steve Jobs has paved the way with iTunes. So does Yahoo with its latest Yahoo Unlimited. What is worrying though is that the old demons are not slayed yet. Indeed, the music industry is putting pressure on Jobs to increase iTunes per download price.

Again the content industry seems to ignore the economics of its current demand curve: To put it in Jobs' words:

"We're trying to compete with piracy, we're trying to pull people away from piracy and say you can buy these songs legally for a fair price'.

"But if the price goes up a lot, they'll go back to piracy. Then everybody loses."

The digital economy is not a Terra Incognita. It is for those who focus on their current slice of the pie only. It is not for those whose aim is to grow the pie. No wonder IPADE has picked this topic of Media and Content for this year International week. This is indeed what you would expect from a fine school that teaches its students to grow the pie!

A Question of Perspective: A Propos the Lisbon Strategy, France and the European Constitution

Unemployment strikes back. Horrendous figures have been released from Germany: More than 5 million people are jobless there. The European Constitution is jeopardized by the French Referendum where the No seems to be stronger and stronger. At the same time, the President of the European Commission, José Manuel Barroso,  pushes his newly polished plan for the so-called Lisbon Strategy: "Working Together for Growth and Jobs" .

The Lisbon Strategy for economic, social and environmental renewal agenda is rather ambitious:

The Lisbon Strategy is a commitment to bring about economic, social and environmental renewal in the EU. In March 2000, the European Council in Lisbon set out a ten-year strategy to make the EU the world's most dynamic and competitive economy. Under the strategy, a stronger economy will drive job creation alongside social and environmental policies that ensure sustainable development and social inclusion.

However, the recently released unemployment figures raise doubts about the probability of a successful completion of the agenda. Moreover, it makes a victory of the No at the French Referendum on the European Constitution more likely. To be fair the issues at stake are far from easy especially when you think of the complex social fabric the European Union is made of. A lot of details have to be taken care of.

Talking about details, Anglo-Saxons are used to say that the Devil lies in the details. Interestingly enough, Jews from XVIth century Amsterdam were used to say that God lies in the details. This is obviously quite different. I would assume that you prefer God visiting you and have the Devil stay quiet. Question of perspective you may say. I have nonetheless the feeling that the Anglo-Saxons are closer to the truth. Their legendary pragmatism has taught them that when you miss a detail, even a tiny one, God does not pay you a visit but a rather angry Devil. You don't bother the Devil inadvertently: Any negligence is paid cash!

Talking again about details, I recently read a short note in a magazine (can't remember where it was though). nothing deep or fancy in appearance. The author observed that American people are keen on books like "How to Get Hired", "How to Make your First Million", "How to make it big in the Corporate Arena" etc... while French people are more attracted by titles like "How to Protect Yourself from Being Fired", "How to Successfully Implement the 35 Hours week", not to mention the all too famous "Hello Laziness" (Bonjour Paresse).

So what? After all, "de gustibus non est disputandum", especially when it comes to reading choices!. However, in my opinion, this note is deeper than it seems. It is like the tree that hides the forest, the detail that you should look at twice. Tell me what you read and I'll let you know who you are.

Let me explain. We, the Europeans (mainland) have the bad habit of being quite  condescending toward American people. To almighty Uncle Sam, we object the US of cheap labor, small jobs, the so-called McDonald jobs. American capitalism is viewed as merciless, some kind of monstruous machine yielding massive wealth inequalities.  Interestingly enough, economists have their own shortcut way to describe what differentiates America from Europe: Moneyless America, Jobless Europe. Indeed, talking about France vs. the US, the Centre of Economic Policy Research (CEPR) says:

"The ‘moneyless America, jobless Europe’ description of transatlantic labour market differences is well-known and well documented: while US inequalities rose dramatically during the 1980s, the average unemployment rate remained fairly stable. Over the same period, exactly the opposite happened in France: wage dispersion remained fairly stable while unemployment rates almost quadrupled."

In a not so recent paper by Daniel Cohen, Arnaud Lefranc and Gilles  propose some explanations to the unemployment gap between the US and France.

Let me submit an additional one which, in a sense, is inspired by this news on what people read on both sides of the ocean. It seems to me that in Moneyless America people accept less-paid jobs (on top of the obvious reason that they need to get by) to remain in the flow, to avoid being excluded from it. Being in the flow means staying tune with what's happening and seizing opportunities when they come by. To use a financial jargon, these people hold a call option on future events that may turn out to be favourable to them. Some will argue that this is what America is made of: Land of opportunities built by people who left Old Europe...

In Europe, and especially in France, it seems that we have institutionalized a reverse order. We insist a lot on the social safety net and unemployed people receive unemployment indemnities far more generous than their US counterparts. In other words, to use the same financial analogy, people on this side of the option are long a put option (insurance) that mitigates the financial pain of not having an income anymore. Everything goes as if the emphasis was put more on the insurance aspect of things rather than making sure that people don't stay away for too long from the flow. And, indeed, empirical evidence shows that French unemployed stay 5 times longer from the flow that their US counterpart. Being "kept" away from the flow means losing the opportunity of seizing timely options. This is sad and current French unemployment figures are not encouraging from that standpoint. Note that the European Constitution itself has to insist on the "social market economy" concept, a concept that Deng Xia Ping truly mastered!

Hence it is not so surprising to see French people so skeptical when asked to support the European Constitution. This is simply not their current mood.  That's bad . What is even worse is that some shrewd French politicians (rightists and leftists by the way) have seized the opportunity to spread anxiety, fear to, among other personal objectives, regain audience in the media. Listening to tem, I am sure that Frédéric Bastiat must be turning in his grave.

So, does what you read tell others what you are? Should French people change their reading habits? Do these reading habits convey interesting information that European politicians should take into considerarion?

Well, to be frank I am still investigating the case. More homework is for sure needed. I am currently reading Barbara Ehrenreich's Nickel and Dimed: On (Not) Getting by in America (Owl Books, also available in French as L'Amérique Pauvre). Very reminiscent of Jack's London The People of the Abyss (read it, this is London at his best!) by the way.  Ehrenreich's book is a valuable first-hand  account of Moneyless America. A journalist, Ehrenreich decided to give up her cozy comfort for a while to become a low-wage earner. The book is her diary and analysis of the experiment. As such it should be  an interesting check of my "flow hypothesis".

In any case, I'd be glad to get your comments!

Research at Chicago: Food for thought a mouse click away

Back from some days off in Sicily. Very interesting island which is these days considered as one of EU's priority region. When you think of it this is odd. Walking in the streets of Palermo, Trapani, Agrigento tells you a lot about how rich and prosperous this island once was. Things change and prosperity seems to have left the island. This is the mystery of economic growth. As Robert E. Lucas once said when you start thinking about what drives economic growth, it becomes an obsession. Why are we rich, why are they poor, why were they rich and now poor etc...? are indeed questions that can keep you awake at night. They deal with mankind, its past, present and future.

Well if you are interested in these issues (and more) you should visit Research at Chicago (University of Chicago). In the Business/Economics section you'll find three presentations worth listening to. The first one explores the limits to globalization. The second one involves a review of India's economy by Professor Raghuram Rajan. The last one tells the tale of two giants: China and India. Discussion is led by Professor Gary S. Becker and Professor Raghuram Rajan.

The second one is particularly interesting as it discusses why India's past growth has been so slow and what the future may have in its bag for India. Professor Rajan argues there that it's neither politicians nor bureaucrats who have hindered growth but the business houses (although they kept complaining about being too regulated). He uses the framework of "hacienda economies" (economies dominated by large plantation owners that relied on slave labor) and compares it to what he calls "Costa Rica" type economies.

He provides for instance evidence that Northern India and Eastern India have been growth-hindered because of the "zamindari" system (hacienda type) where landlords (who had the right to raise taxes on behalf of the government) had no interest in an educated workforce. They simply wanted to control a cheap labor force. In the rest of India, cultivators paid directly taxes to the government and were in some sense more "free".

Rajan shows that this legacy of the past explains why Northern/Eastern India exhibit growth patterns very different from the rest of India. I don't know whether this explains the whole thing. What it tells me is that explaining economic growth is indeed a thorny task: The devil lies in the details (miss one detail and you get the wrong picture) which usually are difficult to accomodate by standard theories. Indeed, theories, whatever schools of thought they represent, start with (simplifying) assumptions whose purpose is precisely to avoid capturing too many details.

Talking about details, this is where "standard" economists and behavioral economists seem to disagree:  Again Research at Chicago has a good piece on the topic. One quote drawn from this piece puzzles me though:

"At Becker’s Rational Choice Workshop last spring, Harvard’s Edward Glaeser, PhD’92, took up the question of group psychology in his paper “Psychology and the Market.” “The great achievement of economics is understanding aggregation,” he writes. “Our discipline has always been about the wealth of nations, not individuals.”

I think it says it all. How can one be satisfied with such an ill-defined research agenda? This may be why they call economics the dismal science.