Economical With The Truth – Christmas Naivety

It’s over 4 years since the financial crisis began, and by now you would have thought that we would understand all the factors that drove the building of, and since 2007, the destruction of the foundations of world economic growth. Over the last few weeks the events have been analysed by a series of economic programmes on the BBC.

Not surprisingly, many of the players, the mistakes, the events and the dramas were plain to see, especially with the benefit of hindsight. From a bond holder’s point of view, we knew that companies could be opportunistic, rating agencies conflicted, and regulators under-resourced. These themes played out through the course of this week’s programmes.

One programme, however, the Oscar winning Inside Job, brought to light my continued naivety with the help of some of their cleverly edited sound bites.

A particularly interesting section of the film was dedicated to examining the academic profession. I naively thought that the point of academia was to study, develop arguments, and search for the truth. George Soros (1hr 19mins into the film) sees things slightly differently – “Deregulation had tremendous financial and intellectual support because people argued it for their own benefit…..the economics profession was the main source of that illusion”.

You obviously expect some bias with economics and the study of the financial system, whether it’s the economic arguments leading the political arguments (or vice versa) from both the left and the right. However what I had missed was the conflict of interest that frames the whole economic and regulatory debate.

The carousel of regulators, politicians and academics was something that had previously passed me by. The intellectual framework for regulation was heavily influenced by sponsorship of academia by interested parties. An example of this was where a professor (and ex central banker) had been paid to write a financial report on the stability of the Icelandic financial system by the Icelandic Chamber of Commerce. The report that he was paid in excess of $100,000 to write came out favourably; unfortunately reality did not. Events always appear clearer with hindsight. Mind you, the CV of the economist who wrote the glowing report on Iceland may have benefitted from hindsight more than it really should have. A “typo” appears to have occurred at some point which changed its title from a report on stability to one examining the instability of the system (1hr 24mins in).

Now we as investors know the conflict that rating agencies may face when rating the firm that pays the fee, but had not spotted who else was conflicted.

Why should we care? Well sadly it means the system is weaker than we thought.  The politicians and regulators look for independent analysis from academia to drive us forward, however that analysis may well be severely conflicted. To get rich quick, the academics, central bankers and regulators have an interest to keep filling the punchbowl, as they too are drinking from it.

The supposed benefit of appointing professors to run central banks is the concept that we are getting independent, intelligent individuals who have the ‘general good’ as their goal – a type of benevolent dictator. Maybe, however, part of their rise through academia came through the money that Wall Street threw at themselves, their departments and their universities.

The thing that amused me most in the interviews with these potentially conflicted economists was that they had trouble understanding where the conflict of interest lay (1hr 22mins). If any profession should know how incentives work then surely it is the economists.

If the intellectual and political establishments are too beholden to the system they are meant to control then we have yet another new problem to add to the list. What else will we learn next year?

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Richard Woolnough

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