0spinboson's Reviews > ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism

ECONned by Yves Smith
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Jan 25, 12

bookshelves: growth-crisis, paper
Read from January 21 to 26, 2012 — I own a copy

If you're interested in getting a decent high-level understanding of the financial instruments created by the financial sector in the past decade or two, and in the changes in the incentive structures at banks and other financial sector players, this book is highly recommended. It will provide you with accessible explanations of the various instruments they thought up, as well as how those relate to each other (though slightly less detailed when it comes to the exact reasons why the instruments created worked the way they did). Reading it should give you a good feel for how much all of this activity still had to do with things going on society (hint: both fairly little, and very much). Let me briefly mention two points I think worth noting.

An important sub-theme of the book is the question what role current macroeconomic theory played in the crisis. As such, the second and third chapters are devoted to discussing what role the currently dominant economics paradigm -- neoclassical economics -- played in all of this. One thing that's important to realize is that neoclassical economists tend to make all kinds of extremely unrealistic assumptions in order to make it easier for them to "model" economic activity; without these assumptions, they cannot model anything -- and this bothers them even though their models do not really refer to anything in reality.
Yet even though basically none of the assumptions made is in any way applicable to real life, so-called DSGE models are widely used by regulators and governments to determine how their economies are doing, and whether they are still stable. (Peculiarly, DSGE models ignore the financial sector's existence entirely, making them blind to the mere suggestion that the financial sector could create macroeconomic instability.) This leads those regulators, as well as economists more broadly, to uncritically accept even those ideas that are blatantly false, such as the idea that all market participants have access to all information, and that, therefore, large-scale frauds are impossible to perpetrate -- because this implies that it is impossible for wannabe-frauds to lie to a large number of people without being called out or found out immediately.

Another section I found particularly interesting was the account of the historical changes that occurred from the 1970s onward, and how this changed the way banks behaved, and how they treated their clients. For instance, one major change was that banks stopped investing in relationships with their corporate clients, and instead started focusing ever more on maximizing the gain from individual transactions. These changes were caused in part by certain regulatory changes that made it easier for corporate clients to ask for quotes from multiple dealers. Paradoxically, because every bank had so much competition, they felt less of a need not to screw their clients, as they figured there was a large chance they would be going to a competitor next time anyway. (Not exactly what efficient market theory teaches you, though it should probably be noted that most of these deals are fairly opaque to non-specialists -- meaning most people in the world -- so that it would be difficult to tell how badly you are being screwed.)
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