Robert J. Shiller & George A. Akerlof “Phishing
For Phools: The Econoimic of Manipulation & Deception” Princeton
Univ. Press, 2015, 179 pp. plus 53 pages of notes
Adam Smith’s classical economics is under modification
today. It is now recognized that very
few, probably none of us, actually react rationally in the world of
economics. We have biases that sellers
systematically exploit through manipulation and deception. Markets are not just
about supply and demand and the resulting equilibrium; markets are inherently
filled with tricks and traps and will “phish” us as “phools.” This book describes this tendency of the market
to trick and trap us. Too many spend
money up to the limit, and then worry about how to pay the next month's bills.
The financial system soars, then crashes. We are attracted, more than we know,
by advertising. Our political system is distorted by money. We pay too much for
gym memberships, cars, houses, and credit cards. Drug companies ingeniously
market pharmaceuticals that do us little good, and sometimes are downright
dangerous.
George A. Akerlof
is University Professor at Georgetown University and the winner of the 2001
Nobel Prize. Robert J. Shiller is Sterling Professor of Economics at Yale
University, the winner of the 2013 Nobel Prize in economics, and the author of
the New York Times bestseller Irrational Exuberance (Princeton). Akerlof and
Shiller are also the authors of Animal Spirits: How Human Psychology Drives the
Economy, and Why It Matters for Global Capitalism (Princeton).
My Notes:
Pg. xi: “phish: this
book expands the meaning from perpetrating a fraud on the Internet in order to
glean personal information from individuals, esp. by impersonating a reputable
company to a definition that does not confine itself to phishing as
illegal. This book employs the term to getting
people to do things that are in the interest of the phisherman, but not in the
interest of the target. And, a phool is
someone who is successfully phished.
Pg. 5: Back in 1776, the
father of Economics, Adam Smith, in The Wealth
of Nations, wrote that, with free markets, as if “by an invisible hand …
[each person] pursuing his own interest” also promotes the general good. According to the modern version, a
competitive free-market equilibrium is “Pareto optimal.” That means that once such an economy is in
equilibrium, it is impossible to improve the economic welfare of everyone. Any interference will make someone worse
off. The modern theory does recognize
some factors that might blemish such an equilibrium of free markets. These factors include economic activities of
one person that directly affect another (called ‘externalities’); they also
include bad distributions of income and firms that are large in size may keep
markets from being wholly competitive. Thus it is common for economists to believe
that, those few blemishes aside, only a fool would interfere with the workings
of free markets.
Pg. 17: A recent survey of U.S. consumers determined
that less than 50% of respondents replied that they could not, or probably
could not come up with $2,000 if needed.
Also, a recent economics article on hand-to-mouth consumption shows that
in 2010 the median US working-age family held less than one month’s income in
cash, or in checking, savings, or money market accounts; in addition, the
median direct holdings of stocks or bonds was exactly zero.
Pg. 19: John Keynes in 1930 projected that in 2030
the standard of living would be eight times higher. For the US as of 2010, real income per capita
was 5.6 times higher than 1930. So it
appears Keynes’s projection will be remarkably close by 2030. However, Keynes also projected that leisure
time would also increase along with the higher incomes. This did not happen and now two income
families is the norm, not the exception and we have created many more wants
into necessities.
Pg. 30: Rating agencies changed in the 1970s, when
for the first time Moody’s began charging the investment banks for doing the
ratings. But back then banks depended
above all on their reputations and wanted the ratings on issues to be totally
scrupulous. (Also, investment banks were
then partnerships with partner’s money at risk). Now the money at risk is not the partner’s
money and they will shop the agencies until they get the needed rating for
their issues. (For instance, Moody’s
gave 45,000 mortgage-related securities a triple-A rating between 2000 and
2007; that generosity for the mortgage-backed securities contrasts with only
six US companies that were similarly rated AAA [in the later year 2010]). (The conflict of interest from ratings paid
for by issuers of securities remains today, 2016).
Pg. 36: Investment banks
cannot go into Chapter 11 like United Airlines did in 2002 when it sloughed off
its defined pension benefits on the taxpayers and got unsecured creditors to
settle for four to eight cents on the dollar.
Investment banks financing is different, they fund large parts of their
trillions of dollars of liabilities overnight.
Also those overnight agreements specify the collateral to be forked
over, should the bank not pay the next day.
So the short-term creditors have a much better option than to wait for
the Bankruptcy Court to prescribe their share of the haircut. They can take their collateral and walk
away. But then the bank will not open up
the next morning because it will still be short of funds. No one will be foolish enough to give the
loans necessary to keep it in business.
This dependency on short
term borrowing explains why the financial system was on the verge of total
collapse when it was discovered that the mortgage-backed securities were rated
much too high. There was a myth of the
new economy that the complex mortgage-backed securities were tailored in such a
way that risk had disappeared. The high
ratings offered by the ratings agencies fenced the myth. While the myth remained unpunctured, phishing
for phools was as profitable as it ever gets.
Pg. 70: Interchange fees
that a merchant pays credit card companies for credit card usage at their
business are illustrated by a Freakonomics student’s calculations. He calculated the interchange fees that a
merchant would pay if you handed her your Citicorp Visa Rewards Card. For a $1.50 pack of gum purchased at
convenience store, the fee was 40 cents; for a $30 tank of gas, $1.15; for $100
grocery purchase, $2.05. One gauge of
the size of those fees is to compare them to the merchants’ profits. For convenience stores they were 2.25 times
the annual profits of the store. As
another gauge, with a 2 percent charge in the supermarket, the credit-card
companies are taking almost one-fifth of the typical average markup on
groceries. (Interchange rates vary from card issuers—American Express is one of
the highest).
Pg. 118: In the early 1980s inflation in the US had
risen to 13.5 percent. Paul Volcker, the
chair of the Federal Reserve, addressed the problem by squeezing the
economy. He let interest rates soar; the
rate on three-month US Treasury bills went to 14 percent in 1981. In this war against inflation the country’s
S&Ls, which financed home purchases, were collateral damage. They had been giving out thirty-year
fixed-rate mortgages at 5, 6, and 7 percent.
The money flowing in from the payments on the mortgages could not meet
the money needed to go out to attract the deposits needed to fund those
mortgages.
Pg. 134: Many now believe the government intervention
in the 2008 financial panic was a mistake.
They believe that the expectation of intervention at the time of the
crisis was its primary cause. The
failure to see the necessity of quick and immediate intervention in financial
crisis is based on an economics that fails to take account of such factors as
looting, reputation mining, and irrational exuberance. It’s based on a faulty logic that would also
tell us to do away with fire departments, because there would then be no fires
since people would be more careful. We
tried slow intervention once, the depression of 1930 resulted.
Pg. 151: There is a significant period in US history,
from approximately 1890 to 1940, called the Age of Reform. Three separate movements are identified with
this reform: the agrarian Populism of the 1890s, led by William Jennings Bryan;
good-government Progressivism from 1900 to 1920, led by Theodore Roosevelt; and
New Deal experimentalism, led by Franklin Roosevelt. At the end of the Reform period, there had
emerged a new, more expansive view of the role of government, at all levels—but
especially at the federal level—than that of our forefathers back in 1890. Government was now viewed as a useful
counterweight to the excesses of free markets.
But this all changed
with Reagan’s January 1981 Inaugural speech: “The
economic ills we suffer have come upon us over several decades. They will not
go away in days, weeks, or months, but they will go away. They will go away
because we as Americans have the capacity now, as we've had in the past, to do
whatever needs to be done to preserve this last and greatest bastion of
freedom.
In this present crisis,
government is not the solution to our problem; government is the problem.” And then the problem, inflation, was solved
by Volker’s government fight against inflation.
Regan’s statement, however, with “in this present crisis” left out,
continues in the deregulation pendulum swing.
Pg. 154: For people over 65, Social Security is the
dominant source of unearned income. Not
counting earned income and other government transfers such as veteran’s
benefits, it is 94 percent for those in the bottom kl20 percent in the income
distribution; 92 percent, in the twentieth to fortieth percentile; 82 percent,
in the fortieth to the sixtieth percentile; and 57 percent, in the sixtieth to
eightieth percentile. Only for the top
20 percent is Social
Security less than half
of unearned income. But even for this
top category it is still 31 percent.
Take away their Social Security income and the poverty rate of Americans
over 65 would rise from 9 percent to 44 percent.
Addenda:
I
have a hard time squaring some of Shiller’s pessimism with today’s WSJ
(6/22/16):
Stephen Rose, an economist at the Urban Institute, finds in
new research that the upper middle class is larger and richer than it has ever
been, expanding to a record 29.4% of the population as of 2014, from 12.9% in
1979.
“Any discussion of inequality that is limited to the 1% misses a
lot of the picture because it ignores the large inequality between the growing
upper middle class and the middle and lower middle classes,” said Mr. Rose. The
Urban Institute is a nonpartisan policy research group.
There is no standard definition of the upper middle class. Many
researchers have defined the group as households or families with incomes in
the top 20%, excluding the top 1% or 2%. Mr. Rose uses a more dynamic method,
similar to how researchers calculate the poverty rate, which allows for growth
or shrinkage over time, and adjusts for family size.
Using Census Bureau data available through 2014, he defines the
upper middle class as any household earning $100,000 to $350,000 for a family
of three: at least double the U.S. median household income and about five times
the poverty level. At the same time, they are distinct from the richest
households. Instead of inheritors of dynastic wealth or the chief executives of
large companies, they are likely middle-managers or professionals in business,
law or medicine with bachelors and especially advanced degrees.
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