Noah Smith’s Economics Books of the Year:  Anyone’s list of best books of the year is going to be incomplete and biased. Mine, for example, is weighted toward books about economic theory and the financial industry. That means that 2015 is the perfect year for me to list my recommendations, since this was a particularly epic time for books about the discipline of economics. In no particular order, here is a short list of good ones:

“The Courage to Act: A Memoir of a Crisis and Its Aftermath” by Ben S. Bernanke.  The story of the housing crash, the Lehman shock and the global financial crisis is by now common knowledge. What’s less known is how modern economic theory guided the thinking of the elites charged with halting the crisis. “Courage to Act” tells this story.

Ben Bernanke was the right man in the right place at the right time. He was by training an expert on the Great Depression who just happened to be chairman of the Federal Reserve during the onset of a new and similar crash. He was one of the only mainstream economic theorists who had thought deeply about the connections between finance and the macroeconomy. No person was more suited to the job than Bernanke. Very few would have had the “Courage to Act” as he did.

Bernanke is too modest to say this. It is only by reading his memoir that one gets a clear sense of his thoughtfulness, intellectual humility and powerful intelligence. This stands in strong contrast to the confused, ad-hoc decision-making apparatus of the Treasury Department, regulators, the large financial institutions and Congress. “Courage to Act” is a reminder of why an independent Fed, staffed with our most thoughtful and humble macroeconomists, is an important institution.

“Economics Rules: The Rights and Wrongs of the Dismal Science” by Dani Rodrik.  As mainstream economists go, Dani Rodrik is a reformer. He is one of the only top scholars in the field to have questioned the hallowed pro-free-trade consensus, and to have explored the taboo idea of government industrial policy that targets industries and infrastructure to promote growth. So Rodrik is in a unique position to write a book about the economics  profession and its discontents.

The central tenet of Rodrik’s book is that economic models are basically just fables. For any phenomenon — for example, the housing market — there are many alternative models. Each one represents a different way of thinking about this market — a different simple, imaginary world that hopefully sheds light on one thing that could be affecting housing. Economics, Rodrik asserts, is a craft, not a science — the key to being a good economist isn’t to find the right model, but to wisely pick from among the menu of available alternative models in each situation.

This vision of what economists do is familiar to anyone who has worked in the profession, but will be startling and — I predict — a little off-putting to outsiders who are used to getting more concrete results from science. In my opinion, it underrates the importance of the empirical revolution taking place in economics, which promises to help us choose between economic models not based on plausibility, but on evidence. “Economics Rules” is a must-read for critics and defenders of econ alike.

“Misbehaving: The Making of Behavioral Economics” by Richard Thaler.  Richard Thaler is another rebel economist. In the 1970s and 1980s, the profession began discarding its long-cherished assumptions of perfectly rational consumers and producers, and toying with ideas from psychology. Thaler was one of the people at the forefront of this effort, and in “Misbehaving,” he narrates the history of the behavioral mini-revolution.

This story is engaging because it shows how scientific fields change direction. If you’ve ever read the philosopher of science Thomas Kuhn, you’re familiar with the idea that anomalies accumulate and slowly poke holes in the dominant theory until a crisis is reached. Thaler’s memoir recounts the process of anomalies piling up. It is fundamentally a story about how the economics discipline collectively realized that it was wrong about some things. It isn’t the story of how a new paradigm arose to replace the old one — in fact, that hasn’t happened yet. Eventually, we will get a more complete understanding of how economic agents make decisions, but these things take time.

“Chicagonomics: The Evolution of Chicago Free Market Economics” by Lanny Ebenstein

The so-called Chicago School of economics was the last great political-economic school of thought to emerge in the U.S. It blended libertarian political ideas with simple mathematical modeling, all organized around one central principle — that markets work. Many influential ideas and schools have emerged since the Chicago School, but all of them have been either limited in scope or have avoided mixing political ideology with assessment of the facts. Chicago was grandiose, sweeping and uncompromising. It attracted some of the nation’s brightest minds, and had a huge and lasting impact on our economic policies. In “Chicagonomics,” Lanny Ebenstein, a historian of economics, tells the tale of how this intellectual movement came together and found its destiny.

“Superforecasting: The Art and Science of Prediction” by Philip E. Tetlock and Dan Gardner.  The books in the list so far have been all about theory — about how economists and policy makers hunt around in the dark for something that seems to make sense. But it’s nice to know that sometimes, social scientists can actually predict the future. Phil Tetlock and Dan Gardner have written an excellent book about the times that forecasting has worked. Drawing on lessons gleaned from observing individuals who have been remarkably successful at predicting political and economic events, Tetlock and Gardner offer their scholarly insight into how forecasting should best be done.

Forty-two percent of corporate fraud is detected by tips.  Insiders know better than anyone what is going on at Volkswagen, for instance.  Since the 2007-8 financial crisis, whistleblowing is on the increase.  How it is treated by the governments of countries varies enormously worldwide.

Some countries like Canada have weak laws protecting whistleblowers. Turkey has strong ones.  Yet whistleblowers have more protection in Canada.  The laws do not always indicate the degree to which it’s safe to suggest corruption.

After a whistleblower in Britain revealed corruption at HBOS, he suffered severe emotional consequences.  As a result, British regulatory authorities have insisted that companies they oversee have provisions for employees to safely report transgressions directly to the regulators and that companies have a post for a “whistleblower’s champion.”

Germany and Switzerland are particularly tough on whistleblowers.  Germany is now covered by the best practice guidelines from the Council of Europe, a group of 47 countries in Western and Eastern Europe.

The US, with strong protections, has a very uneven record.  The strength of the banking lobby in the US makes whistleblowing risky if you want to keep your job.

Mrs. Clinton is ducking the big issues about big banks.

William Cohan writes:   The new movie “The Big Short” dredges up a lot of bad memories of how badly the country was screwed by Wall Street. It goes into what went horribly wrong inside the big banks seven years ago and how a small group of clever traders made fortunes betting on the crash of the American economy. After they figured out that Wall Street bankers and traders had stuffed one bad loan after another into the mortgage-backed securities they sold as solid investments the world over, the guys devised the Big Short to bet against this crazy behavior. When the economy collapsed, they cashed in. And those were the good guys. It’s not just the movie, of course, that brings back unhappy times. Judging from the kind of rhetoric being bruited about on the campaign trail, you would think Wall Street might be just a little antsy about public sentiment—starting with Bernie “big-banks-are-always-bad” Sanders and his astonishing rise in the Democratic race against Hillary Clinton. Even top GOP candidates like Donald Trump, Marco Rubio and Ted Cruz have been at it, channeling Elizabeth Warren’s populist message against the Street.

But the truth is, Wall Street isn’t the slightest bit worried these days. Indeed, it is happily making plans for the future, no matter who becomes president: Highly paid bank lobbyists are working overtime to gut Dodd-Frank regulations (as part of riders on the year-end budget bill). And what makes the elite of the Street most happy is they are hearing all the right things from Hillary Clinton, the near-certain Democratic nominee with an excellent shot at the White House.  Why Wall Street Isn’t Worried about the Political Class

 

 

Should the mandate of the US Fed be re-written?

Often we hear the Fed Chairperson say that their policy is being effected in order to fulfill their mandate to keep employment high in the US.  Realistically, in a changing world in which most jobs are service jobs and require education, this mandate should perhaps be dropped.

President Obama and his Secretaries of Education well understand the need to educate for jobs.  Political correctness sometimes masks the basic requirements for change. No one thinks the US Fed can help this process.

As we wait for the anticipated tiny rise in the interest rate, but at least a rise, the power of the Fed is patently clear.  The real question we should be asking is: Has the Fed become too powerful in the US?  Who is benefitting from Fed policies?

In the important new film “The Big Short” on character notes that Ben Benanke has just left the White House.  The character remarks:  “There’s going to be a bailout.”

On the one hand, no one stepped up to plate to address the economic crisis in 2008 except the Fed.  In anticipation of future crises, small and large, does it not behoove legislators to think about and act on a new leadership role when these inevitable events occur?

Preetinder Singh “Preet” Bharara is an Indian American attorney and the U.S. Attorney for the Southern District of New York. His office has prosecuted people worldwide and has prosecuted nearly 100 Wall Street executives.

Bharara has won nine out of 10 cases against a parade of disgraced Albany lawmakers since taking the helm of the Southern District of New York in 2009, prevailing in three trials and garnering six guilty pleas.  In his crosshairs were two of New York’s biggest political animals: former Assembly Speaker Sheldon Silver and former Senate Majority Leader Dean Skelos.  He has won convictions against both of them.

Mr. Bharara may also be hunting the biggest game of all in New York: Gov. Andrew Cuomo, whom he has criticized for disbanding the Moreland Commission on public corruption. Last week, word broke that Mr. Bharara is investigating $1 billion in funding provided by the governor to help revive Buffalo. Mr. Cuomo said over the weekend that he had no role in awarding the so-called “Buffalo billion” to bidders.

Aggressive and media-savvy, Mr. Bharara portrays himself as the white knight cleaning up the “cauldron of corruption” in Albany. Even in the case he lost, the defendant ended up behind bars. In 2011, a federal jury found William Boyland not guilty, but the Democratic assemblyman was convicted three years later, courtesy of Mr. Bharara’s Eastern District counterpart Loretta Lynch, who is now U.S. attorney general.

“Bharara is on the warpath,” said James Cohen, a criminal-defense professor at Fordham University Law School. “He thinks the whole thing is a sewer, and he’s in a position to make some change.”

To do it, the prosecutor has used techniques perfected in fighting terrorists and organized crime, employing stings, wiretaps, video surveillance and undercover FBI agents to catch politicians in the act.

He then uses his perch to wage a media campaign that generates momentum and sets the stage for a trial or, in the majority of cases, a guilty plea. He has used similar tactics to snare miscreants on Wall Street, where his track record is even more impressive, winning more than 80 convictions and guilty pleas, although one of his insider-trading victories was thrown out on appeal last year.

Bharara has won 11 corruption cases against state legislators by following the money.

In the NY Assembly the Chairman of the Ethics  committee has never been allowed to hold a hearing.  If you are allowed to have outside income, you can hide it as a bribe.  If you oppose one of the leaders you are banished.

But you can not trade in exchange for getting something to line the pockets of yourself or a family member.  You take an oath of office to serve the public.  You are guilty of public corruption.  Bharara is making sure these laws stick.

Of the three remaining mainstream Democratic candidates, all three propose changing rules for the financial sector.  Only Mrs. Clinton would not re-instate Glass Steagall, the wall her husband broke down between investment and commercial banking activities.  It is well  to remember that both Clintons have made  fortune lecturing to the banking industry and that the Clinton campaign is based on contributions from banking.  The Clinton son-in-law runs a hedge fund that was set up for him by Goldman Sachs.

Simon Johnson writes:  The three candidates disagree on whether there should be legislation to re-erect a wall between the rather dull business of ordinary commercial banking and other kinds of finance (such as issuing and trading securities, commonly known as investment banking).

This issue is sometimes referred to as “reinstating Glass-Steagall,” a reference to the Depression-era legislation – the Banking Act of 1933 – that separated commercial and investment banking. This is a slight misnomer: the most credible bipartisan proposal on the table takes a much-modernized approach to distinguishing and making more transparent different kinds of finance activities. Sanders and O’Malley are in favor of this general idea; Clinton is not (yet).

This argument that some financial firms that got into trouble in 2008 were standalone banks like Lehman or an insurance company like AIG.  What happened “last time” is rarely a good guide to fighting wars or anticipating future financial crises. The world moves on, in terms of technology and risks. We must adjust our thinking accordingly.

At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks – such as Citigroup – built on the premise that integrating commercial and investment banking would bring stability and better service. Sandy Weill, the primary architect of the modern Citigroup, regrets that construction – and regrets lobbying for the repeal of Glass-Steagall.

Second, leading representatives of big banks argue that much has changed since 2008 – and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.

Ensuring a financial system’s stability is a multifaceted endeavor – complex enough to keep many diligent people fully employed. But it also comes down to this: how much loss-absorbing shareholder equity is on the balance sheets of the largest financial firms?

In the run-up to the 2008 crisis, the largest US banks had around 4% equity relative to their assets. This was not enough to withstand the storm. (Here I’m using tangible equity relative to tangible assets, as recommended by Tom Hoenig, Vice Chairman of the Federal Deposit Insurance Corporation, and a beacon of clarity on these issues.)

Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets – that is, they are 95% financed with debt. Is this the major and profound change that will prove sufficient as we head through the credit cycle? No, it is not.

Finally, some observers – although relatively few at this point – argue that the biggest banks have greatly improved their control and compliance systems, and that the mismanagement of risk on a systemically significant scale is no longer possible.

This view is simply implausible. Consider all the instances of money laundering and sanctions busting (with evidence against Credit Agricole and  Deutsche Bank and almost every major international bank in the past few years).

This is the equivalent of near misses in aviation. If the US had the equivalent of the National Transportation Safety Board for finance, we would receive detailed public reports on what exactly is – still, after all these years – going wrong. Sadly, what we actually get is plea bargains in which all relevant details are kept secret. The regulators and law-enforcement officials are letting us down – and jeopardizing the safety of the financial system – on a regular basis.

The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity. We should ensure that various activities by “shadow banks” (structures that operate with bank-like features, as Lehman Brothers did) are properly regulated.

Building support for legislation to simplify the biggest banks would greatly strengthen the hand of those regulators who want to require more shareholder equity and better regulation for the shadows. These policies are complements, not substitutes.