In August we’re going to have a week’s holiday, and I’ll also be declining all but the most absolutely urgent online meetings, so am looking forward to some reading. The pile of books to read is very satisfying.

Meanwhile, this week I’ve enjoyed the newly-published Boom and Bust: A Global History of Financial Bubbles by William Quinn and John Turner. The book recounts the history of 10 bubbles in history, some well known – the South Sea Bubble, Wall Street in the 20s – others less so – I for one had never heard of the British Bicycle Mania of the late 1890s. It also ranges from 19th century Australia to modern China.

Each episode is set in the context of a framework described in the first chapter, the Bubble Triangle. These are the three necessary conditions for a bubble to take off: good marketability of the assets involved; abundant money & credit; and large numbers of speculators. With these in place, they argue there are two potential sparks: technology (radio in the 1920s, bicycle innovations in the 1890s) or politics (often, governments seeking to engineer higher asset prices to meet a policy goal, such as encourgang home ownership (the early to mid 2000s) or reducing government debt (John Law in France in the 1760s).

This is a very nice framework, and the book is an enjoyable read, its large array of references kept unobtrusive while testimony to the amount of research that has gone into it. There are some interesting points along the way. For example, the authors argue that the form of railway network shaped by the railway mania of 1848 locked in inefficiencies “which have plagued British railways down to the present day.” Other, less laissez faire, countries invested in a better planned and less duplicative network at lower cost. In Britain, they argue, politicians were too accomodating to constituency interests rather than able to plan a national network.

However, they also highlight the distinction between bubbles sparked by technology and those sparked by politics: “Technology bubbles often involve large sums of money flowing into extremely innovative sectors of the economy, which might otherwise have trouble getting off the ground.” During political bubbles, the money flows into sectors where there are few positive externalities.

The book ends by returning to the Bubble Triangle as a means of predicting when a bubble might occur and some discussion of policy choices – to avert the bubble (hard, with the political ones), or clean up afer it? The final chapter includes a discussion of the role of the media, whose role during bubbles has not always been blameless.

All in all, a great read and a great addition to the literature on financial bubbles.




Finance, the state and innovation

Yesterday brought the launch of a new and revised edition of Doing Capitalism in the Innovation Economy by William Janeway. Anybody who read the first (2012) edition will recall the theme of the ‘three player game’ – market innovators, speculators and the state – informed by Keynes and Minsky as well as Janeway’s own experience combining an economics PhD with his experience shaping the world of venture capital investment.

The term refers to how the complicated interactions between government, providers of finance and capitalists drive technological innovation and economic growth. The overlapping institutions create an inherently fragile system, the book argues – and also a contingent one. Things can easily turn out differently.

The book starts with a more descriptive first half, including Janeway’s “Cash and Control” approach to investing in new technologies, and also an account of how the three players in the US shaped the computer revolution. This is an admirably clear but nuanced history emphasising the important role of the state – through defense spending in particular – but also the equally vital private sector involvement. I find this sense of the complicated and path dependent interplay far more persuasive than simplistic accounts emphasising either the government or the market.

The second half of the book takes an analytical turn, covering financial instability, and the role of state action. It’s fair to say Janeway is not a fan of much of mainstream economic theory (at least macro and financial economics). He includes a good deal of economic history, and Carlota Perez features alongside Minsky in this account.

The years between the two editions of the book, characterised by sluggish growth, flatlining productivity, and also extraordinary changes in the economy and society brought about by technology perhaps underline the reasons for this lack of esteem. After all, there do seem to be some intractable ‘puzzles’, and meanwhile, just in time for publication, Italy looks like it might be kciking off the Euro/banking crisis again. The experience of the past few years also helps explain the rationale for a second edition. That’s quite a lot of economic history and structural change packed into half a decade.

Although I read the first edition, I’m enjoying the second as well. And for those who didn’t read the book first time around, there’s a treat in store.


The culture of finance

Shelia Kolhatkar’s Black Edge is a cracking good read about how the growth of hedge funds was rocket-fuelled by their extensive reliance on insider trading. The focus of the story is Steve Cohen’s SAC capital. The abuse was enabled by the fact that the regulators were slow to cotton on to the scale and interconnections of the sector, and by the presence at the head of the SEC at the time a Bush-appointed free marketeer who thought the government should keep out of the way of the markets. The book reads like a thriller (leaving just the usual slight uneasiness about how the author knows what people were feeling, and wondering who spilled the beans out of two people in a reported conversation).

It left me reflecting about the culture of financial markets and how quickly and extensively unethical and illegal behaviour spread, like a rampant infection, after the deregulatory turn in the US and UK. Perhaps the obvious conclusion is that a culture of eternal vigilance is necessary in finance, and there was something sensible about the extremely strong cultural prohibitions applying to finance in times past. It is interesting, and sobering, to note how much the main characters in this sorry saga act just like homo economicus.

The authorities did eventually charge Cohen with failing to prevent insider trading; SAC was fined Capital and the fund was closed. Cohen is active again in the markets and a super-wealthy man.


Wise and foolish finance

I’ve thoroughly enjoyed reading The Wisdom of Finance by Mihir Desai. It aims to humanise finance in two ways. One is by pointing out to non-finance folk that finance is dealing with inescapable aspects of the human condition: risk and uncertainty, asymmetric information, values, stewardship for the future. The other is by pointing out to finance folk how finance can and should serve society.

The approach is to draw examples from literature and history – and films and TV shows – demonstrating the way financial techniques absolutely permeate life. The cultural references range from The Simpsons to Jane Austen, Euripides to Bob Dylan, linked to recent events in business and the financial markets. The book starts with the fundamentals: insurance against risk, opening with The Maltese Falcon. It goes on to discuss options, valuation, leverage, and M&A.These chapters have lots of examples that could prove useful in the classroom, as well as being an enjoyable read.

The latter part of the book takes a more philosophical turn, and rather than explaining finance to the uninitiated reflects more on the character of the financial sector and the motivations of those who work in it. What drives people to lead highly leveraged personal existences rather than opting for simplicity (taking leverage broadly to mean building interdependence with other people in order to benefit from their skills or resources – and correspondingly owe them commitments in return)? Is it always possible to identify the ‘right’ course of action in a context such as financial failure or takeovers? Here the book quotes Martha Nussbaum:

“To be a good human being is to have a kind of openness to the world, an ability to trust uncertain things beyond your own control that can lead you to be shattered in extreme circumstances, in circumstances for which you are not yourself to blame. And I think that says something very important about the condition of the ethical life. That it is based on a trust in the uncertain, a willingness to be exposed.”

Needless to say, this almost existential openness is not what comes to mind when we think of finance, of Enron, Madoff, the sub-prime frauds. So Desai ends by pondering – without reaching a firm conclusion  –  what makes so many people in the financial markets so unethical, or at least driven by selfishness and greed. He also gives us a wonderful model of an ethical financier. It is Alexandra Bergson in Willa Cather’s O Pioneers!, the homesteader who borrows to invest and brings the land to life. What a great example. I devoured Willa Cather’s books some 30 years ago and had forgotten about them. It sin’t finance that’s good or bad, it’s people.

The Wisdom of Finance ends with a nice afterword pleading for inter-disciplinary alertness, citing C.P.Snow’s famous The Two Cultures and E.O.Wilson’s Conscilience, both excellent books.

All in all, highly recommended, for those who already know a lot about finance, and those who don’t.


Agents and theorists

There are three books in one in Richard Bookstaber’s The End of Theory, it seemed to me. This compôte is even flagged up in the subtitle: ‘Financial Crises, the Failure of Economics, and the Sweep of Human Interaction’.

One sub-book is a tedious critique of economics, tedious because like all (the many) similar critiques it (a) says ‘economics’ but means ‘macro/financial economics’; (b) assumes economics is a monolithic subject stuck some time around 1980-85, which was indeed the height of the rational expectations, real business cycle approach. Some of the points Bookstaber makes are perfectly valid. Macroeconomists have responded to the implications of the financial crisis for their approach, but not yet enough – this is why the ESRC has funded the new ‘Rebuilding Macroeconomics‘ network. I also agree in particular with his point about economics needing to get to grips better with self-fulfilling phenomena and performativity. But, really, a lot of economists – at least in academia but I think out in the non-ivory tower world too – are now doing exactly the kind of work Bookstaber enthuses about. I’d argue that even when economists are using rational choice equilibrium modelling, or ignoring the radical uncertainty of the real world, it is often done in a knowing way – that is, understanding the assumptions fail, but using the conclusions they lead to as a way of evaluating what is happening and why. Anyway, his complaints about economics are both wearily familiar territory and decreasingly true; economics is and has been changing a lot. In finance specifically, think of Andrew Lo’s new book, Adaptive Markets.

The second element of The End of Theory is a useful mini-survey of some alternative approaches (alternative to rational choice, maximising, equilibrium) models for financial markets in particular: this includes complexity and emergent phenomena, non-ergodic processes, heuristics in decision making, and so on. None of these is novel either – for example, Paul Ormerod’s Butterfly Economics and Why Most Things Fail tackle many of the same areas, Kahneman’s Thinking Fast and Slow was a best seller and Gigerenzer’s heuristics approach is widely discussed among behavioral economists, while Taleb’s books have brought the ideas about radical uncertainty to millions. Still, having these ideas set out again in a concise and accessible way is useful.

The third book-in-a-book is a very interesting approach to an agent-based modeling approach to the financial system, looking back at the 2008 crisis. Here, the author’s expertise shines through. But this section is very condensed – I wished the whole book had been about this and had used the extra room to say more about the complexities of the financial structure and how the agent based approach can illuminate them. For example, the section on the 2007-8 liquidity crisis in US markets is fascinating but condensed. Again, agent based modeling is hardly new, and is even growing more popular in economics, but I found the detail from someone who is an experienced market participant very interesting, although the idea that agent based modelling really spells the end of theory is not really addressed explicitly.

In the end, I wondered what audience Bookstaber had in mind. The final chapter ends, “I’m a frustrated novelist.” He is a indeed a good writer but needs to work on the narrative arc. I’d have thought the three components of this book appeal to at least two different sets of readers; and it distracted at least this economist reader to have the argument keep heading off on a tangent to criticise economics: ‘And another thing,….’. I hope he goes on to write the book starting to emerge from this one diagnosing the past about an agent based future for finance. If this is the right way to model financial markets, what do we do with it?

PS I see The End of Theory is doing well on Amazon, with some 5* reviews, so my perspective may be jaundiced!