The Map And The Territory

Alan Greenspan “The Map And The Territory: Risk, Human Nature, And The Future Of Forecasting” The Penguin Press, 2013, 307 pps  plus 69 pages of appendices and notes

I was very disappointed with this book.  Greenspan apparently wants readers to believe he has just discovered what behavioral economist have known and been saying for years: economic models based on the presumption that investors always act rationally are incorrect and bell curve analysis underrates the true risks.  I’m no Alan Greenspan, but I have been reading about these concepts long before the 2008 crash; in fact, economist always knew this but still thought the mathematical models were good enough at estimating, and still are, during good times, just not during a crash.  (So the models still in use, ignore the S&L debacle of the 80s, the LTC debacle in the 90s, the dot.com crash of 2000—oh, did I mention the 1987 crash?)  Yet, Greenspan does offer one thing I agree with: Financial Institutions like banks must have more equity (capital) to be able to absorb risk and not put the risk on the taxpayers.  Also, too big to fail (or, rather, ‘too interconnected to be liquidated quickly’) needs fixing.  Yet Greenspan claims to be much like the police chief in Casablanca and is shocked at the ‘self-interest of lending institutions and their failure to protect shareholder equity’; this personal shock did not occur until after 2007, not when he was the Fed Chairman.  This probably was a result of the influence Ayn Rand had on him.

I don’t agree that we need less regulation and less taxes for the highest income levels.  We do need to have better regulators who are not captured by those they regulate. I do not agree with his premise that financial risk managers underrated risk and therefore were under-capitalized.  In fact: the job of risk manager was a low-level position, only put out for show.  The leverage and risk is where and why all the money was made (privatized profits) and the risks were just considered worth it as the  private profits were banked and the losses were socialized (read taxpayers and TARP, ETC).

My Notes:

Pg. 10:  The crashes of 1987 and 2000 had comparatively minimal negative effect on the economy.  The severity of the destruction caused by a bursting bubble is determined not by the type of asset that turns ‘toxic’ but by the degree of leverage employed by the holders of those toxic assets.  In short, debt leverage matters. (note: in 1987 the DJI was down more than 20 percent in a single day).

Pg. 14:  From the perspective of a forecaster, the issue is not whether behavior is rational but whether it is sufficiently repetitive and systematic to be numerically measured and predicted.

Pg. 38:  By the time of the Lehman default on September 15, 2008, global losses in publicly traded corporate equities stood at $16 trillion.  But losses more than doubled in the weeks following the Lehman default, bringing the cumulative drop in global equity values to almost $35 trillion, a decline of more than half.   Added to that were trillions of dollars of losses of equity in homes ($7 trillion in the U.S. alone) and losses of nonlisted corporate and unincorporated businesses that brought the global aggregate equity loss close to $450 trillion, equivalent to a staggering four fifths of 2008 global GDP.

Pg. 40:  In the years leading up to the 2008 crisis, the shadow banking system globally grew from $26 trillion in 2002 to $62 trillion in 2007, and following a decline in 2008, reached $67 trillion by the end of 2011.  It remained slightly more than half the size of the regular banking system throughout the 2002 to 2011 period (in the U.S. alone shadow banking constituted $23 trillion in assets at the end of 2011).

Pg. 67:  The true size of the American subprime problem was hidden for years by the defective bookkeeping of the GSEs.  Fannie Mae was unable to get its books certified and had to stop reporting publicly between November 2004 and December 2006, pending an often delayed clarification of their accounts.  Freddie Mac had had similar problems earlier.  Not until the summer of 2007 did the full magnitude of the subprime problem begin to become apparent.

Pg. 78:  Euphoria-driven stock price booms have been remarkably similar through the past century.  In the five years preceding the peak of the October 2007 boom, stock prices rose at a 22 percent annual rate.  The five year boom that preceded the peak of 1987 produced an average rise of 24 percent, and the boom prior to the 1929 crash, an average annual gain of 28 percent. 

Pg. 106:  In late 2008 the U.S. Treasury, through its Troubled Asset Relief Program (TARP), added $250 billion to bank equity, the equivalent of adding approximately 2 percentage points to the equity capital-to-assets ratio.  The effect was consequential and immediate. 

Pg. 156:  Firms designated as ‘systemically important’ are accorded an implicit government guarantee of their liabilities, investors perceive those firms as near riskless and grant them interest rate subsidies.  That accords them a competitive advantage not achieved through enhanced productivity.  Savings are being directed to the politically powerful, not the economically efficient.  Future productivity gains and standards of living are being put at risk.  (In China this is called crony capitalism)

Pg. 193:  In 2013 actuaries determined that Social Security pay-as-you-go will run out of funds in 2033; Medicare will be insolvent by 2026.  To achieve ‘sustainable solvency’ over the long run, they concluded, would require a permanent tax increase on payrolls of 4.0 percentage points (an increase of almost a third), or a permanent cut in benefits of almost one fourth, or some combination of the two.  Every year of delay in implementing a fix will increase the required size of subsequent policy action. 

Pg. 247:  By 2009, according to the CBO, already more than 94 percent of individual income tax liabilities were levied on the top 20 percent of household income earners, up from 65 percent in 1979.  (47 percent of U.S. population currently pays no income tax).

Pg. 269:  Between 1933 and 2008, the Consumer Price Index of the BLS increased more than fourteenfold, an average annual rise of 3.4 percent.  When a country goes off the gold standard, Central banks were as a consequence ceded the role of controlling the supply of money and hence prices. 

Pg. 276:  From the onset of fiat money in 1933 to date, prices have risen at an annual rate of 3.4 percent on average.  Unit M2 rose by an identical 3.4 percent annually.  The two series parallel each other through WWI, the turbulence of the early twenties, the stability of 1925 to 1929, the Great Depression, WWII, the postwar ‘moderate’ inflation (1946-1969), and most of the rapid inflation between 1969 and 1991.  But starting in the late 1980s, unit M2* seemed to have lost its closeness of fit to the price level.  (For whatever reason, the link seems to again be working).

*M2:  A measure of money supply that includes cash and checking deposits (M1) as well as near money. “Near money" in M2 includes savings deposits, money market mutual funds and other time deposits, which are less liquid and not as suitable as exchange mediums but can be quickly converted into cash or checking deposits.