Paul Jorion’s blog

A blog gives you visibility, allowing people from all over with views akin to yours getting in touch. That’s what happened a couple of months ago with conceptual artist, Little Shiva asking: “What about a common project?” I told her of a possible allegory for the crisis, a symbol that you could copy here and there, whose name would be Santa Crisis.

After some going back and forth, here he is: a jolly old elf!

Make him known: that’s the idea. Just inform where he was born: here and there.

Click to enhance.

Here is the communication I made on March 3rd to the Socialist members of the European Parliament in Brussels as my contribution to the one-day conference entitled “Closing the casino: building a fairer and stronger real economy”

Modern societies of European origin were historically built according to a tripartite structure composed of warriors-raiders, priests and commoners. By the time the new concept of democracy emerged, the land and the wealth buried in it had already been distributed by the warriors-raiders between themselves. Inheritance of property had contributed at strengthening this pattern. Bourgeois revolutions of the eighteen century condoned the addition of the power of money to that of strength only. From then on cash buttressed the power balance that the sword had first put into place. In the twentieth century, colonialism and paradoxically communism, ensured the full globalization of that order of European origin. Current appeals for “leveling the playing field” ignore the lack of evidence that the field was ever level.

Stock options: the holy alliance between investors and company executives

In an infamous quote that Ben Stein had him concede for the New York Times, investor extraordinaire Warren Buffet stated: “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.” This statement marked the return in common parlance of an outmoded way of speaking. Indeed, with the rise of the Chicago School, the phrase “class warfare” got tabooed and the words “capitalists” (aka “investors”), “bosses” (aka “company executives”) and “workers” (“employees”, “associates”, “team members”, etc.) removed from the economic literature and replaced by the catch-all notion of “monetary mass” as part of a more general process where “physical forces” replaced “people” in explanations of the economy. That didn’t mean though that class warfare was over or had never taken place. The decisive and final move came in the late 1970s when McKinsey devised “stock options” by which the “interests of investors and company executives would henceforth be aligned.” The plan succeeded beyond both parties’ wildest dreams.

The distribution of wealth: what happened to it

Prior to stock options, wage-earners were part of a triangular power game where investors and executives kept each other at bay. With the introduction of stock options, those days were over: a holy alliance was born to which wage-earners were no match. Predictably, their piece of the pie dwindled down. Any attempt they would make to increase their share would be brutally countered by central banks concerned with monetary masses and raising interest rates – that is: raising unemployment – forcing wage-earners to pipe down.

With lower revenues, wage-earners were led to ever borrow more. Commercial banks graciously obliged. Meanwhile, companies had got in the habit of borrowing rather than reinvesting so that by now any money that anyone needed was borrowed. Interest payments were mushrooming, becoming a burdensome component of every price. “Capital” – being money you don’t have but still need – kept concentrating in fewer and deepening pockets. The more capital is concentrated the less likely it is though that it happens to be where it is actually needed.

Speculation: the ascent of the Speculative Society

What do you do then when you don’t have the money you need and you know that working harder won’t make much of a difference ? You buy a lottery ticket. By the end of the twentieth century everyone had come to that same conclusion and “bubbles” and growth had become synonymous notions.

You buy stock but not for dividends which are boringly your share in the surplus the company has made through the stock you purchased, no: you buy stock for capital gains. To insure that this happens the stock exchange needs to be turned into a casino. The price of Total or BP stock needs to change every five seconds. Not that there is anything in the business of Total or BP justifying that the price of its stock changes every five seconds or for that matter even every five days. But it is needed for the stock market to be run as a casino where huge capital gains may materialize. When the scheme stops working, it crashes, which happens indeed every eighty years or so.

Hunger riots stirred by museums and hospitals

If only people who have wheat to deliver or to take delivery of were trading wheat the price of that cereal would be determined by how much of it gets produced and how much is needed: what is commonly called supply and demand. But this is not how things work nowadays: the price of wheat gets determined by bets made by big institutional investors such as pension funds, university endowments, hospitals and museums. A reasonable social expectation is that they would focus on offering pensioners annuities, teaching pupils, curing patients or displaying art, but they are not: they are heavily busy pushing the price of wheat up or down with the goal of protecting their assets and no concern whether anybody would live or die as a consequence of their speculation.

Spot and futures markets allow those exposed to an actual risk (due to the weather, the economic environment, etc.) to cover their positions, hence reducing overall risk. Speculative “naked” positions on the contrary artificially create risk where there was none. Coverage provides an insurance while “naked” positions are risk-generating bets. Insurance protects the economy while bets kill it and measures should be taken accordingly. The means for banning betting on the fluctuation of prices are simple: they are spelled out in FASB 133, a rule issued by the American Financial Association Standards Board that establishes a fiscal differential treatment for coverage and naked positions. FASB 133 should be upgraded to a badly needed and clear-cut prohibition.

Recommendations

1. Break the unholy alliance between investors and company executives: the social fabric is being damaged as we speak. Ban stock options.

2. Free central bankers from monetarism: societies are not made of monetary masses but of people. Central banks have a more crucial role to play than systematically siding with investors and company executives against wage-earners.

3. Apply urgently appropriate fiscal policy so that the chances increase that capital happens to be where it is actually needed.

4. Close down the casino: stop continuous pricing on the spot and future markets.

5. Bar speculators from commodities’ markets: bar “non-commercials.” Let them focus on what they do best: teach pupils, cure patients and display art for the enjoyment and education of the public.

6. Encourage insurance but ban bets on the fluctuation of prices.

Published in Le Monde - Economie, March 2nd 2009 (transl. Danielle Goodman)

Let’s assume that governments are actively concerned with the interests of the populace at this very moment – an ardent hope of mine. To succeed, their actions have to benefit from a certain surprise effect so as not to be thwarted in advance by those who know how to use the new measures for personal gain.

Authorities therefore explain themselves as little as possible as far as their planned initiatives go, and when they do so, to calm people’s worries, their explanations are formulated in such oracular terms that it is difficult even for experts to know what they are talking about. But in the absence of content, they work on the form: their communiqués exude confidence and repeat with affability that the files are in the right hands.

The task is not easy, since those who explain that everything will soon be back on track are the same ones who repeated at the beginning of the crisis, with a sincerity that it would be hard to doubt today, that it was only of limited scope and would definitely, definitely be over soon.

The capital of confidence held by the authorities is thus eroded day by day. The listening public is pulled between two possible interpretations of their too-long silences and their half-truths: is it incompetence, or evil? Both opinions are being reinforced today, in Europe and perhaps even in Asia.

Incompetence for not having seen it coming, then for having underestimated the crisis as it first manifested itself, and now for holding back from taking the radical measures that no one doubts need to be made. Or else malice: so much incompetence is beyond belief, some would say. Our leaders and those who brought them to power know quite well exactly where they want to end up – that is, increasing their grip on power.

Therefore, the authorities’ stand is untenable: those who give them the benefit of the doubt are obliged to read into the deepening of the crisis the growing signs of incompetence; while those who are programmatically suspicious see mushrooming evidence of deliberate dark designs.

The American economist Nouriel Roubini explained on February 21st in an interview with the Wall Street Journal that it would take six more months for the American authorities to finalize the nationalization of the banking sector. If the measure is indispensable, then why not apply it straight away, asked his interlocutor? Because it will take six months, replied Mr. Roubini, until nobody will dare pretend to be solvent anymore –alluding to recent remarks by Kenneth Lewis, the head of Bank of America, which were meant to be reassuring.

That is only one example, but, given the gravity of the current crisis, six more months of the waiting game amount to an eternity. If those who lead us think that drastic measures have to be applied anyway, be it sooner or later, it becomes more urgent every day that they stop procrastinating. The mitigating circumstances conceded by those who judge them to be simply incompetent will no longer protect them from the anger of those who believe them to be evil.

Did you know that on February 17, 2007, Sen. Carl Levin, D-Mich., Sen. Norm Coleman, R-Minn., and Sen. Barack Obama, D-Ill., introduced comprehensive legislation to stop offshore tax haven and tax shelter abuses, the Stop Tax Haven Abuse Act, targeting $100 billion in lost tax revenue each year from offshore tax dodges ?

One of the provisions of the Act states the following :

STOP TAX SHELTER PATENTS by prohibiting the U.S. Patent and Trademark Office from issuing patents for “inventions designed to minimize, avoid, defer, or otherwise affect liability for Federal, State, local, or foreign tax”

This preposterous attempt at stifling innovation was fortunately nipped in the bud.

The SEC (Securities & Exchange Commission) along with the OCC (Office of the Comptroller of the Currency) have just released their report on the valuation of financial products (Fair Value).

The subject is what I discussed in « Juste prix » et « juste valeur » and in L’implosion. La finance contre l’économie: ce que révèle et annonce la “crise des subprimes” (Fayard 2008: 188-202). The issue is the following: firms have requested that Marked-To-Market accounting is suspended for the time being as they regard current circumstances as exceptional and prices “unrealistically” depressed, too far removed in any case from their “true value”.

The report is bulky (255 pages) but its subject being pricing - my special expertise as a financial engineer - I will analyze it in depth and post a brief summary of my observations as a forthcoming blog. Should the full analysis be of interest to you as a financial establishment or a consultancy, please let me know (pauljorion@ucla.edu).

Original French version at rue89.com.

Does the name “Donald Crowhurst” ring a bell? He was one of the contenders in the Golden Globe Race a non-stop, single-handed, round-the-world yacht race held in 1968–1969. While he was ahead and therefore a potential victor, his radio signals stopped abruptly. His craft was later located but it was empty. His log-book was found, revealing that at no point had Crowhurst attempted to leave Southern Atlantic waters : he had all along communicated the fictitious positions of his alleged progress while actually waiting for the other contenders to complete their circumnavigation. He apparently would have contented himself with ending last in the race. But circumstances prevented this from happening : the hardship of the race made it such that he found himself as sole potential winner. He then drifted erratically in the mid-Atlantic for a while, his log-book betraying the way his mind was failing, developing pathetically a theory of the human fate that was sparing him his abominable dilemma : a winner through deceit or a cheater unmasked. His theorizing must have failed at convincing him as he took away his own life.

What reminded me of Crowhurst is of course the current Bernard Madoff-Affair. My first impression had been that of a modern-day Machiavelli : a man convinced that a Ponzi scheme amounts to the ideal business plan and developing a strategy based on that concept. However the information that has recently become available about the detailed statements he was sending his clients makes me think now of something of an entirely different nature : a human tragedy à la Crowhurst. These statements - some mentioning dozens of operations over a single month period - display indeed the very “split-strike conversion strategy” that he claimed he was implementing for the benefit of the participants in his fund. In that strategy, “collars” - being a particular montage of options, are associated with a dynamic stock portfolio, allowing indeed to make regular gains as long as stocks rise constantly and in a quiet manner. A strategy impossible to implement however at the billions of dollars’ scale where Madoff was actually managing his fund.

That he had to turn to deceit derives no doubt from the fact that a plan that may have worked to perfection for his early clients rapidly reached a scale where the stock volume required was too high for the market to absorb without considerable slippage. Then, instead of turning down new applicants he must have begun to pretend, until that is he switched to a pure Ponzi scheme, claiming that his method was still the one he had used at inception but remunerating in fact his early clients with the fresh money brought in by newcomers.

Should my surmise be correct, Madoff’s story would be that of a man who initially sees himself as a giant as his complex plan, worth of a genius - and that the statements sent to his clients persisted at displaying, appears to succeed but who - when he finds out that his scheme is bound by size, can’t reconcile himself with this fact, due to oversized pride, due to hubris. To maintain the fiction he must have at first allowed himself some minor infringements to his principles - of the sort that Michael Ocrant seems to have astutely guessed when he interviewed Madoff back in 2001 [1], to finally succumb. At that point he started cheating and ceased to be a giant in his own eye to become a dwarf instead. Then, many years later, faced with financial headwinds, and in the likeness of Crime et Punishment’s hero Raskolnikov, he cannot take it any longer and confesses his evil.

Let’s not forget indeed that Madoff was not found out: he confessed to his sons, and they in turn alerted the law. Just as with Crowhurst, justice didn’t catch up with him but his own conscience. The human drama here is not so much then that of those who once believed in Madoff but the grotesque manner in which he was led to believe in himself.

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[1] Michael Ocrant, Madoff tops charts ; skeptics ask how, MAR/Hedge (RIP), No. 89 May 2001

Here an account of my column in Le Monde on the concept of a new Bretton Woods.

Bretton Woods 2.0 - Paul Jorion on The Financial Crisis

Paul Jorion wrote a column in Le Monde a few days ago concerning the prospects of a new Bretton Woods (never mind that the original died at Richard Nixon’s hand in 1973). Starting from the fact that the crisis is extremely serious and half-measures won’t do anything, Jorion offers some suggestions:
A radical reconsideration of the role of Central Banks is in order. Within a capitalist framework, Jorion states, the capitalist provides capital to an entrepreneur whose activity will generate a surplus which will be shared by both. However, since the mid-1970s, investors (the capitalists) and business managers have pushed for the substitution of consumer credit for the declining share of the surplus that used to go to wager earners. We are experiencing now the price to pay for such greed.

Central banks played a special part in this scheme by becoming one of the favorite weapons (in the class war) beholden to investors only, through the manipulation of interest rates to force entrepreneurs into compliance through the threat of bankruptcy, and wage earners through the threat of unemployment.
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More on the Global Sociology Blog

The original piece in French can be found here.

I was Walter Traversy’s guest on CFRA a news only radio station in Toronto, between 2 and 2:30 PM.

The podcast is here. I’m talking in the second part of the program … just after the weather report. But hear Walter introduce me in the nicest way at the very beginning.

I’m a bit blasé about talking on French-speaking radios by now but this is a first: the first time ever I was part of an English-speaking broadcast and I’m very pleased!

Finance is in shambles. It has remained until now under the close supervision of economic and financial theory. In recent years, due to the overbearing dominance of views developed under the umbrella of the “Chicago School” of economics, finance has been regarded as explainable through the combination of a very simplified version of psychology: that of the “homo oeconomicus“, and of physics. The physics in question is supposed to have risen all-armoured Minerva-like out of the embarrassingly simplified psychology hitherto mentioned. This is the tenet of methodological individualism presiding nowadays over mainstream economics and financial theory.

Human nature, in the guise of the homo oeconomicus displays a number of qualities such as utilitarianism, ultimate rationality and - somewhat paradoxically combined to the two aforementioned - a pervasive herd instinct. Why this particular version of psychology? For no better reason than having been dominant at the end of the nineteenth century when a supposedly “scientific” economics emerged. This is why homo oeconomicus is so conveniently transparent to himself or herself, working out with clockwork precision in all circumstances the most rational approach that the precise quantity of information available allows - that is, unless the herd instinct prevails. Not for him the murky hesitations and self-delusion that unconscious motives convey.

Back in the nineteenth century, physics were stressing how important it was to remove subjectivity from scientific methodology, meaning the uncontrolled interaction of human beings with the subject of their inquiry. The difficulty here for economics is that when you remove from the economy the uncontrolled interaction of human beings, what is left to study is of not much interest. Here an example: price formation which economists explain as the meeting of a curve representing demand with another representing supply. Now tell me: has any anthropologist ever encountered circumstances where the status of buyer and seller is indifferent to the settling of price? Aristotle knew that reciprocal status determines price and this makes him on the contrary the anthropologist’s friend (1).

So, let us say this bluntly: human nature as envisioned by economics holds but a frightfully tenuous relationship with the type of human nature which anthropologists are familiar with.

What are then the traits of human nature which the current crisis has most prominently emphasized?

Read the rest of this entry »

On September 5th, I wrote on my French blog : “D’ici à la fin du mois il semble donc bien que les conditions d’un krach soient réunies”, meaning in proper English:

It seems therefore that from now until the end of the month the conditions for a crash are being met.

The risk of my being right diminishes of course by the day. What is intriguing however within the current setup is that - should it happen - a culprit would be close at hand. We’ve learned indeed from the press that the discussions yesterday in Washington were about to succeed when John McCain’s interference led a number of Republican congressmen to withdraw from a potential agreement.

So I’d like to reiterate - just in case : the conditions for a crash were met since September 5th.

Of course should anybody be wiling to volunteer as a catalyst…