Tag Archives: financial crisis

Treating the web as an archive – or finding the financial crisis' ground zero online

Most often when people think of the web they think of it as a place to get new information. Companies are told they must constantly update their website while customers and citizens look for the latest updates. But because the web is relatively new, it is strongly biased towards digitally displaying and archiving “new” information.

What happens when the web gets older?

One possibility… it could change how we study history. Again, nothing is different per se – the same old research methods will be used – but what if it is 10 times easier to do, a 100 times faster and contains with a million time the quantity of information? With the archives of newspapers, blogs and other websites readily available to be searched the types of research once reserved for only the most diligent and patient might be more broadly accessible.

Consider this piece in the New York Times published on November 5th 1999. It essentially defines ground zero of the financial crisis:

Congress approved landmark legislation today that opens the door for a new era on Wall Street in which commercial banks, securities houses and insurers will find it easier and cheaper to enter one anothers businesses.

The measure, considered by many the most important banking legislation in 66 years, was approved in the Senate by a vote of 90 to 8 and in the House tonight by 362 to 57. The bill will now be sent to the president, who is expected to sign it, aides said. It would become one of the most significant achievements this year by the White House and the Republicans leading the 106th Congress.

”Today Congress voted to update the rules that have governed financial services since the Great Depression and replace them with a system for the 21st century,” Treasury Secretary Lawrence H. Summers said. ”This historic legislation will better enable American companies to compete in the new economy.”

Here is what may be the defining starting point of the financial crisis. The moment when the tiny little snowball was gently pushed down the hill. It would take 10 years to gather the mass and momentum to destroy our economy, but it had a starting point. I sometimes wish that the New York Times had run this article again in the last few months, just so we could get reacquainted with the individuals – like Larry Summers – and political parties – both – that got Americans into this mess.

Indeed, as an aside, it’s worth noting the degree by which the legislation passed. 90 votes to 8 in the senate. 362 votes to 57 in the House. There was clearly a political price to pay to vote against this bill. Indeed, it fits in nicely with the thesis Simon Johnson outlined in his dark, but important, piece The Quiet Coup:

“…these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector”

Still more fascinating is how accurately the legislation’s detractors predicted it’s dire consequences. Check out Senator Dorgan’s comments at the time:

”I think we will look back in 10 years’ time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930’s is true in 2010,” said Senator Byron L. Dorgan, Democrat of North Dakota. ”I wasn’t around during the 1930’s or the debate over Glass-Steagall. But I was here in the early 1980’s when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.”

Or Senator Wellstone’s:

‘Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,” Mr. Wellstone said. ”Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.”

And of course, it worth remembering what the legislation’s supporters said in response:

Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.

”The concerns that we will have a meltdown like 1929 are dramatically overblown,” said Senator Bob Kerrey, Democrat of Nebraska.”

What is most fascinating about this piece is that it shows us how the financial crisis wasn’t impossible to predict, that it didn’t come out of nowhere and that it could have been eminently preventable. We simply chose not to.

It also goes back to the type of journalism that I believe we are missing today and that I wrote about in my post on the Death of Journalism. Here is a slow moving crisis, one that is highly complex, but not impossible to see. And yet we chose not to “see it.”

This, I believe, has to do with the fact that today, much of our journalism is gotcha journalism (or what Gladwell refers to as mysteries). It looks to finding the insider or the smoking gun that will bust open the story. I suspect that in a networked world – one of increased complexity and interconnectedness – finding the smoking gun is irrelevant. For an increasing number of stories there simple is no smoking gun. There are whole series of cascading action that are what Galdwell calls open secrets. Our job is to “see them” and painstakingly connect the dots to show how our decisions are allowing for the scary and unpredictable event – the black swan event – to become a near certainty.

What the above article shows me is that while the very tools and forces that make these scary events more likely – the internet, globalization our interconnectedness – they may also make the the open secrets easier to identify.

Articles I'm digesting – Feb 13 2009

New Planets & an Unknown Object Discovered Beyond the Solar System

Future telescopes such as NASA’s Kepler, set for launch in 2009, would be able to discover dozens or hundreds of Earth-like worlds. The Space Interferometry Mission (SIM), to be launched early in the next decade, consists of multiple telescopes placed along a 30 foot structure. With an unprecedented resolution approaching the physical limits of optics, the SIM is so sensitive that it almost defies belief: orbiting the earth, it can detect the motion of a lantern being waved by an astronaut on Mars.

The last sentence says it all. My mind = blown.

Fareed Zakaria – Worthwhile Canadian Initiative (via Sameer Vasta)

Canada has done more than survive this financial crisis. The country is positively thriving in it. Canadian banks are well capitalized and poised to take advantage of opportunities that American and European banks cannot seize. The Toronto Dominion Bank, for example, was the 15th-largest bank in North America one year ago. Now it is the fifth-largest. It hasn’t grown in size; the others have all shrunk.

So what accounts for the genius of the Canadians? Common sense. Over the past 15 years, as the United States and Europe loosened regulations on their financial industries, the Canadians refused to follow suit, seeing the old rules as useful shock absorbers. Canadian banks are typically leveraged at 18 to 1—compared with U.S. banks at 26 to 1 and European banks at a frightening 61 to 1. Partly this reflects Canada’s more risk-averse business culture, but it is also a product of old-fashioned rules on banking.

I’ve always thought Zakaria was one of the smartest commentators in the US. I’ve unbelievably excited he has his own show on CNN. Finally a show where real ideas are discussed not by pundits but by actual wonks. His show single-handedly elevates the entire CNN brand. Now he’s saying nice things about us. Hopefully we won’t let it go to our heads.

How the Crash Will Reshape America: The Last Crisis of the Factory Towns by Richard Florida.

When work disappears, city populations don’t always decline as fast as you might expect. Detroit, astonishingly, is still the 11th-largest city in the U.S. “If you no longer can sell your property, how can you move elsewhere?” said Robin Boyle, an urban-planning professor at Wayne State University, in a December Associated Press article. But then he answered his own question: “Some people just switch out the lights and leave—property values have gone so low, walking away is no longer such a difficult option.”

Perhaps Detroit has reached a tipping point, and will become a ghost town. I’d certainly expect it to shrink faster in the next few years than it has in the past few. But more than likely, many people will stay—those with no means and few obvious prospects elsewhere, those with close family ties nearby, some number of young professionals and creative types looking to take advantage of the city’s low housing prices. Still, as its population density dips further, the city’s struggle to provide services and prevent blight across an ever-emptier landscape will only intensify.

Many of the old industrial clusters are dying and we’ll have to manage this decline while helping figure out what the next wave will look like. This is part of the reason why think the federal government’s failure to invest in green technology/innovation will stand as one of the biggest lost opportunities of the century. At the peak of a financial crises and at the moment when our cities – particularly our mid-sized cities – need to think about what their economies will look like for the next 100 years (think renewable energy, green roofs/architecture, mobile computing, next-generation social services) we’ve plowed $30B into 20th century buildings and roads. Hopefully the good news of Zakaria will outweigh the bad news from Florida. I hope so, since it appears this crisis won’t be sufficiently significant to spur us to rethink our future.

CEO compensation – a symptom of institutional decay

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So reading Emergence sprouted another thought regarding the increasingly bankrupt (literally and figuratively) model of the classic bureaucratic organizations. Again I point to Umair Haque’s post on the recent financial crisis:

The first step in building next-generation businesses is to recognize the real problem boardrooms face – that we’ve moved beyond strategy decay. Building next-gen businesses depends on recognizing that they are not about new business models or even new strategies.

The stunningly total meltdown we just witnessed in the investment banking sector – the end of Wall St as we know it – was something far darker and more remarkable. It wasn’t simple business model obsolescence – an old business model being superseded by a more efficient or productive one. The problem the investment banks had wasn’t at the level of business models – it had little to do with revenue streams, customer segmentation, or value propositions.

And neither was it what Gary Hamel has termed “strategy decay” – imitation and commoditization eroding the returns to a once-defensible strategic position, scarce resource, or painstakingly built core competence.

It was something bigger and more vital: institutional decay. Investment banks failed not just as businesses, but as financial institutions that were supposedly built to last. It was ultimately how they were organized and managed as economic institutions – poor incentives, near-total opacity, zero responsibility, absolute myopia – that was the problem. The rot was in their DNA, in their institutional makeup, not in their strategies or business models.

I think Umair is on to something and that CEO salaries may make for a great case in point.

For many years the left has decried growing CEO salaries as a sign of the market’s excesses – or worse, of a broader culture of greed. But excessive senior management salaries are, from an investors perspective, are a symptom of a staggeringly flawed institutional model. If your business depends that much on the one person at the top – if the current and future value of the entire organization rests in the hands of one person… then yikes! Shareholders beware.

The idea that a CEO is worth 1000, or even 100 times more than the “average” workers in an organization isn’t just a problem from a morale or ethical perspective (it may or may not be). If your average worker isn’t contributing that much value in relation to their ultimate superior than you have a massively top heavy – and hierarchical – organization. One where, I suspect, Umair would find there are poor incentives, near-total opacity, zero responsibility, absolute myopia. To be sure, ideas are probably not being floated about, and they are almost certainly not successfully emerging from the bottom up.

In short, it isn’t a happy place to be. And it turns out the markets may not think it is so good either.

The Crash: The beginning of the end…

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The response to the post on complexity theory and the financial crises has been very positive. Been recieving lots of positive feedback, thank you to any who have written or commented.

Several people, including Steven Johnson, the author of Emergence, posted a link to this great piece “The Economy Does not Compute” that I encourage everyone to read.

Dave D. emailed me with this fascinating story from the New York Times that arguably pinpoints the moment the incentives in the market were shifted that started us down the road to the present crises. Entitled Fannie Mae Eases Credit To Aid Mortgage Lending the piece is dated September 30th, 1999. This excerpt below really summarizes the underlying logic and benefits for initiating the change as well as predicts the ultimate catastrophe that it would unleash (remember, written in 1999):

”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

The article shows us the challenges around blaming any one individual – except possibly Blll Clinton – as once the incentives for embracing a higher risk group were altered it vastly increased the chance that more and more people would cater to them and expose themselves to that risk.

The other fascinating thing about this piece is how the web is now getting to be old enough that it is becoming a fantastic tool for historians. Think of how much richer our history is going to be when critical documents like this one are both more accessible and easier to locate.