Response to Greed or Stupidity, D. Brooks, New York Times

April 3, 2009
My letter to David Brooks, of the New York Times, about his editorial “Greed and Stupidity”:

Dear Mr. Brooks,
You put the entire picture of the causes of our financial crisis or collapse very succinctly. I really appreciate that. The complicated nature of it all explains why Americans and the new President are
having a difficult time figuring out what to do. They are still looking for a formulaic explanation, as if there is a recipe and they left out an important ingredient. In a way they are right. The recipe included responsibility and integrity but I guess they thought that was
optional.

From the editorial by David Brooks - NY Times - 4-3-09:
The best single encapsulation of the greed narrative is an essay called “The Quiet Coup,” by Simon Johnson, (former chief economist of the International Monetary Fund or IMF) in The Atlantic.
Mr. Johnson says:
“The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says Johnson, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak
freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true
depression, we’re running out of time.”
Johnson begins with a trend. Between 1973 and 1985, the
U.S. financial sector accounted for about 16 percent of domestic
corporate profits. In the 1990s, it ranged from 21 percent to 30 percent. This decade, it soared to 41 percent. In other words, Wall Street got huge. As it got huge, its prestige grew. Its compensation packages grew. Its political power grew as well. Wall Street and Washington merged as a flow of investment bankers went down to the White House and the Treasury Department.
The second and, to me, more persuasive theory revolves around ignorance and uncertainty. The primary problem is not the greed of a giant oligarchy. It’s that overconfident bankers didn’t know what they were doing. They thought they had these sophisticated tools to reduce risk. But when big events — like the rise of China — fundamentally altered the world economy, their tools were worse than useless.
Many writers have described elements of this intellectual
hubris. Amar Bhidé has described the fallacy of diversification.
Bankers thought that if they bundled slices of many assets into
giant packages then they didn’t have to perform due diligence on each one. ...the formula that gave finance whizzes the illusion that they could accurately calculate risks.
In Wired, Felix Salmon described the false lure of the Gaussian copula function, the formula that gave finance whizzes the illusion that they could accurately calculate risks. Still, one has to choose a guiding theory. To my mind, we didn’t get into this crisis because
inbred oligarchs grabbed power. We got into it because arrogant
traders around the world were playing a high-stakes game they
didn’t understand.
We should return to the day when banks were focused institutions — when savings banks, insurance companies, brokerages and investment banks lived separate lives. We can agree on that reform.
Again, from Johnson at the Atlantic:
“Typically, these countries (those that go to the IMF for help)
are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks... ......With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced
to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah.”
There is a “disturbing similarity” to a banana republic in our
own crisis: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the
inevitable collapse.”

In wrapping up Mr. Brooks comments and those of my other sources for the essay above, it is obvious that strict regulation is
necessary and obligatory now, for the banking industry and other
financial institutions. That is clear. Whether or not this President
can do enough remains to be seen.