Monday 4 November 2013

Mathematics for New Economic Thinking

Last week, INET and the Fields Institute brought together economists and mathematicians in Toronto. The results were certainly interesting... with several economists paying their homage to Wynne Godley, including Stephanie Kelton, Marc Lavoie, Peter Skott and Randall Wray. It was interesting to see these economists play the same stage. Some speakers felt that bad economics had tainted mathematics: fewer believed the reverse.

I am drawn to Wynne Godley’s models: at least, those versions influenced by Minsky. Naively, perhaps, I was hoping that a new paradigm would emerge from the ashes of the 2008 crisis. Far from it... put two economists together and you get more than two theories... like politics, economics is messy and confrontational. At this conference, the data were sometimes assumed and the theories were more often debated.

There were some contrarians. Perry Mehrling made an eloquent plea for better data on the stocks and flows, something that would surely reinvigorate deductive and descriptive economics. Alan Kirman called for models that explain crises and inequality, rather than such awkward complications being exogenous. The questions were direct: what if the far right interpret MMT as a reason for states to abandon the Euro or, even, their credible commitment? As I write this, I wonder about the symmetry to Perry’s liquidity put at the Fed: countries, like India, where the central bank has placed a liquidity call and speculators are making ‘carry trade’ profits.

There was even a model that confirmed Keynes’ insight that 'there is no limit to the amount of bank-money which the banks can safely create, provided that they move forward in step' (John Maynard Keynes, 1930) . Sometimes, this emphasis on banking left me wondering if the model had lost sight of the instability… with banking assets taking precedence in crises and equity holders absorbing the losses. Stability is not destabilizing, if you have a central bank behind you.

Of the more empirical papers, Didier Sornette gave an excellent presentation that showed few bubbles are preceded by volatility. The relatively simple maths suggested that leasehold assets have a safety valve built-in. Yet the politics are very different if the leaseholder is the Duke of Westminster, or the Chinese government. Either way, if you were to 'deflate the bubble’ by playing with the terms of the lease would you simply turn a financial bubble into political turmoil?

Sadly, not every presenter showed their love of math as simply as Edward Frenkel had the week before. Some of the pleas seemed unnecessary... why would I want to calculate inflation using dynamic field theory? My love, and hatred, of math is because numbers are also social... we irrationally fear Friday 13th, and in the UK we stick doggedly to the penny long after it has any monetary value.

As Matheus Grasselli told me, so eloquently, the Plano Real was essentially social and synthetic, but was able to calm hyperinflation in Brazil by giving an alternative unit of account. Sometimes the simplest maths can improve lives.

Tuesday 30 July 2013

Should Barclays borrow more without conditions?

Would you unconditionally invest billions more in Barclays, knowing your equity was at risk and your loan would not be re-paid if the bank got into trouble? Since you get all of the downside, what return would you be looking for? 5%? 8%? Would you want the 14% that was given to Abu Dhabi and Qatar investors in 2008... a deal that is apparently under investigation by both the Serious Fraud Office and the Financial Conduct Authority? Or would you ask for the kind of conditions that the rest of the country has to accept, in particular pay restraint?

I should declare my link to Barclays: I worked at Barclays Global Investors (BGI) until 2007. Then, we were doubling in size every year and the culture had been risk averse. After all, we were playing with someone else's money.

But my last project was different: it had Bob Diamond and 'casino banking' written all over it. We were going to replace the tiny bit of cash in your pension with 'synthetic cash' that was made up of unintelligible, but AAA, bonds. When I questioned it, I was told that everything was going to be fine and this really did matter more than anything else. We were told to do similar things with 'synthetic ETFs' backed, not with real assets, but a promise to pay from an investment bank.

So I resigned. To be fair, it was messy and we spent some time seeing if we could sort things out, but like any failed marriage neither of us was going to change. A former colleague told me those unintelligible AAA bonds lost BGI around £200 million and, after a bit of soul searching, they lost their enthusiasm for 'synthetic ETFs'. By then, Bob Diamond had sold BGI for £8.2 billion. The jewel in the Barclays crown, so to speak, had been sold.

That left Barclays dominated even more by the investment bank. You might thing that £8.2 billion from Blackrock and £4.75 billion from Qatar would plug a pretty big hole in the balance sheet. Yet the annual bonus pool is up to £2 billion and there has been one provision after another: £1.5 billion for mis-selling interest rate derivatives, £2.6 billion for mis-selling PPI and £290 million fine for manipulating LIBOR.

So would you lend more money to Barclays? If they were a relative, and every time you lent them money they spent it, wouldn't you be a little bit more strict? OK, so Bob Diamond has left but is it really sensible to lend to the current management team without any conditions?

There's a double moral hazard in banking. First, the central bank steps in as 'lender of last resort'. Second, the industry turns to itself for funding via the capital markets. Yet there's a real economy outside London that needs investment but is constantly being told to minimise pay rises, accept less favourable employment contracts, find new markets and learn new skills. With other bankers and investment managers making the decisions, will those same conditions apply to Barclays?