Finale: Orthodox Icons – Risky Or Rewarding?

Stepan Shukhvostov (1821-1908). Church of St. Alexis in the Chudov Monastery of the Moscow Kremlin (1866)

Stepan Shukhvostov (1821-1908) Church of St. Alexis, Chudov Monastery, Moscow Kremlin (1866)

Part 3

Alan Greenspan no longer has access to the tools he once used to control the global economy.  Of course he never really did control the global economy, but he did exert a fair bit of influence for a time.

As the elder statesmen of U.S. monetary policy, Alan Greenspan and Paul Volcker are smart people who are worth listening to on occasion.  Mr. Volcker famously beat the high inflation that had plagued the U.S. for quite some time, and Mr. Greenspan in his heyday received a hagiographical focus unrivaled by any economist before or since.  And yes, that includes Friedman, Keynes or anyone else you might like to throw at the Cowboy (in his humble opinion).

Mr. Volcker is in the thick of things, with little time for public reflection, one might assume.  So of the two that leaves our once-beloved Mr. Greenspan to sit on the porch pondering things.  We might even dare to call him Alan these days.

The Cowboy was once a passionate Objectivist, like Alan.  Or at least like Alan is widely acknowledged to be.  Even though Alan hung out with Rand in their über-geek salon and mosh-pit, he might have just been in it for the romance.  Who knows how ardently Objectivist he still is.  That brings up a logical next question: how Objectivist is anyone after a while?

In the Cowboy’s case, he was 15 years old at the height of his Rand-y fever, a few years younger than Alan when he was all hot and Rand-y.  The nuclear-physicist father of the young Cowboy’s best amigo gave him one of Ayn’s tomes, which he then passed on to me.  Several of us eventually became followers of a sort, fancying ourselves intellectual Übermenschen (Nietzsche came later for the Cowboy however).  We were probably the only ones in our milieu who had ever read, much less heard of Ayn, including the folks who taught us our three “Rs” (Ridin’, Ropin’ and Ranglin’).  This just added to our self-imposed sense of John-Galt-like mystique.  Though at the mere mention of an atlas of any sort, most of our contemporaries would offer a shrug at best.

A year later the Cowboy left the homestead of his birth and rode off to see the world.  It wasn’t long at all before the Cowboy realized that he was just a simple cowhand – more Untermensch than Über.  Experience has a way of bringing humility to those who like a challenge.

As for Objectivism, it all came to seem rather 2-dimensional –  a Flatlanders philosophy in a 3-dimensional world (Why is time never appropriately considered a dimension in the common vernacular?).  To this day, it is hard to think of Objectivism or Rand-iness without thinking of the irrational exuberance of youth.

Which brings us back to dear Alan.  On the range, a wise and humble cowboy admits his mistakes.  The Cowboy tries to be both wise and humble though he probably comes up short on both accounts.  Now discredited for allowing asset bubbles to form (dot-com followed by real estate), Alan has looked back at his views and policy actions of the time, and written that more should have been done by the Fed to burst bubbles.  Perhaps this coincided with the bursting of his Objectivist bubble.  Or perhaps not.

The Cowboy finds this intellectual honesty in the public forum to be refreshing.  It also increases Mr. Greenspan’s stature in the Cowboy’s eyes.  It seems to be all the rage to blame our troubles on him, just as it was all the rage to idolize him.  I’m not sure that the Cowboy ever worshiped at an icon of Mr. Greenspan, but neither is he so willing to dismiss him.  Is there an icon restorer in the house?

Can you please restore this icon?

Mr. Greenspan has been writing somewhat regularly in the FT over the course of the crisis.  He obliged us with an opinion piece last Friday (here it is without having to register) and another on Monday.

In Friday’s piece, he paints a very clear picture of what went wrong with our ability to assess risk, and how to fix it.  The Cowboy finds his analysis very compelling, and it is definitely worth a read. Money quote:

“All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions. For generations, that premise appeared incontestable but, in the summer of 2007, it failed. It is clear that the levels of complexity to which market practitioners, at the height of their euphoria, carried risk-management techniques and risk-product design were too much for even the most sophisticated market players to handle prudently.”

Once again, much of the hand-wringing over the crisis reverts to simplistic, easily digestible answers.  One of the currently popular themes is that free market capitalism is a dead idea.  By contrast, Mr. Greenspan thoughtfully looks at the interplay between markets and regulation.  It is a balancing act that requires nuance and adaption to new lessons.

The Cowboy agrees that the pricing of risk is inelegant at best.  Despite incredibly complex modeling techniques, we are still not particularly good at anticipating the future, much less Black Swan events.

As for Monday’s piece (here without registration), Mr. Greenspan provides a fascinating macroeconomic perspective on the nature of global debt, equity and derivatives.  He then argues, as the Cowboy believes, that a recovery in the equity markets, though modest, will presage a broader improvement in economic fundamentals.  While this may sound like a fairly conventional, even trite, observation, the path by which he reaches that conclusion is interesting:

“I find it useful to think of the world economy’s equity capital in the context of the global consolidated balance sheet. All debt (public and private) and derivatives cancel out, leaving intellectual and physical assets at market value on the left-hand side of the balance sheet and the market value of equity on the right-hand side. Changes in equity values result in equal changes on both sides of the balance sheet. Debt and derivatives are best seen as a grossing up, reflecting the degree of intermediation or leverage.

The consolidated global equity is also, by construction, the sum of the separate but additive equities of all individual corporations, other businesses, households and governments. At some point, global stock prices will bottom out and rise. A rise in global private sector equity will tend to raise the net worth (at market prices) of virtually all business entities. In a bull market, the vast majority of stock prices rise. Newly created equity tends to be arbitraged across global businesses. In the current environment, new equity will open up frozen markets and provide capital across the globe to companies in general, and banks in particular. Greater equity, after addressing the shortage of bank net worth, will support more bank lending than currently available, enhance the market value of collateral (debt as well as equity), and could reopen moribund debt markets. In short, liquidity should re-emerge and solvency fears recede. Restoration of normal global lending could be as effective a stimulus as any fiscal programme of which I am aware.”

The Cowboy thinks we should distrust those who put all of their faith in icons, but we should also avoid tossing those same icons in the fire.  The Cowboy knew a Russian icon restorer once, albeit not especially well; he married into a family with which the Cowboy has long been friendly.  It’s an interesting occupation.

Well, the Cowboy is ready to restore the Greenspan icon.  It’s been with us for a while, but it’s still beautiful to look at.  Okay, lovely to listen to.  Ahem…   Nice to have around.

Getting back to the theme of this series, how does this relate to the Geithner bailout plan?  Mr. Greenspan gives us a nice macroeconomic context for the history and future of the crisis.  And ultimately, we get back to price.

Whether you are buying an icon, betting on orthodoxy, or looking for black swans, there is always risk.  It is the price that determines whether the endeavor is rewarding or not.  The events of the past few years will teach us much about pricing risk.  We will remember some of those lessons and forget many more.  But we will steadily improve our abilities in this regard, in the Cowboy’s humble opinion.

In order to get some semblance of normalcy to our pricing, we need to restore faith.  Geithner’s plan, and our icons, can help us do that.  In the end, however, it comes down to the sum of our individual beliefs about our salvation.  If we can believe, we can be saved.

Adios Cowboy!

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Published in: on April 1, 2009 at 20:51  Comments Off on Finale: Orthodox Icons – Risky Or Rewarding?  
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