Frankfurt, Germany, January 2008
“The market is inefficient”. There I said it. I know that I am committing an inexcusable act of apostasy, especially for a master of business administration. But volatility in the world financial markets this week brings the issue into focus. Even the liberal bastion, the Financial Times, is musing about the meaning of these convolutions.
By declaring that the market is inefficient, I am not saying that the boons, monopolies and charters of the Ancien Regime were more efficient. Nor am I hectoring for the return to good old central planning on the Napoleonic or Soviet models. What I am saying is that the market is driven by greed and greed is not a good organizing principle for society. Some would maintain that greed is just the extreme manifestation of self-interest and, as every utilitarian from Adam Smith to Milton Friedman has known, self-interest creates the greatest good through the mystical workings of the ‘invisible hand’. Sure, a smart guy named Albert Einstein didn’t believe in ‘action at a distance’, but Einstein must have been wrong about something.
Other people will counter that these are short-term corrections and that over the long-term these oscillations will tend back towards the norm. But most human beings live in the short term – eating, drinking, sleeping, working, playing — what the new age philosophers call “the now”. The long term is very abstract and Puritan and does really affect people’s immediate needs and emotions. So I subscribe to Keynes’ read on secular trends that “we will all be dead in the long term”.
This debate over market efficiency is extremely important in that is what most clearly separates the right from the left . At the very root of every right/left debate is where to fix the line between the freedom of the bazaar (funny how that synonym of market does not conjure up the image of efficiency) and the need to control the “animal spirits” ( read, greed). Lurking behind this tussle over freedom and control is the struggle between privilege and fairness that underlies every meaningful political debate.
I believe that the recent events in the financial sector will undermine the long-term credibly of the ‘reform’ movement – this is a European euphemism for Anglo-Saxon utilitarianism in contract to Continent Napoleonic centralization.
Some people now blame the ‘sub-prime’ crisis on the intervention of government. As Alan Abelson of Barron’s ( the only reason to buy the magazine) aptly calls him, ‘easy money Al’ (Greenspan), he who presided over multiple financial bubbles, triggered the meltdown by lowering interest rates to 1% in the cause of getting his fellow Republican, George W. Bush, elected for a second term. No doubt there is some truth to this conspiracy theory and fantastically low interest rates definitely exacerbated the situation, but the real culprit lays in unmitigated, old-fashion greed. Any simpleton knows that ‘no money down’ on a piece of real property is either fraud or a con job. Coupled with ‘come on’ introductory rates and negative amortization, the greed of mortgage brokers to earn commissions propelled this bubble to majestic heights. The other day a twenty-something mortgage broker bemoaned to me his paradise lost of 1% commissions selling ‘no money down’ resets.
Further up the chain the value chain, white collar crocks from elite university’s designed stochastic models capable of repackaging folly into investment grade paper; all for the certainly of paying off enough of their student loans to be able to afford a 1,000 square foot apartment in Manhattan. At the top of pyramid, the venerable Standard & Poors and Moody’s were taking payola to certify the rationality of this pyramid scheme.
The symbolism of the Chairman of Merrill Lynch getting paid $160 million for losing $8 billion in the sub-prime crisis will fester in the public imagination. Having worked for Stan O’Neal at General Motors when he was an anonymous Assistant Treasurer, I can vouch for the fact that mortgage banking is near to his heart. He spearheaded GMAC’s foray into mortgage banking in 1985 with two bold acquisitions and apparently maintained a keen interest in the sector throughout his long career. So Stan O’Neal was not a victim of happenstance, he created the very financial monster that eventually eat him alive.
Stan now faces a Herculean dilemma. He can keep the money and go down in history as a symbol of corporate greed (which would be a tragedy for this great, and I really mean, great American) or he can give the money back. Asking someone to give back $160 million is either chutzpa or stupidity, but I am beseeching Stan to give back the money and reclaim his name.
Stan could return the money in either an act of capitalist rectitude, i.e., give it back to the shareholders of Merrill Lynch in a special dividend, or an act of altruism, by creating a scholarship fund for the sons and daughters of manufacturing workers like himself.
In life and this column eventually everything comes back to the local level and the issue of the role of the market in arbitrating outcomes is no exception. When I look back at our recent struggle in Dobbs Ferry with the Stop & Shop project, for me, the dividing line in the debate came down to: do you trust the market to make the right long-term decision for Dobbs Ferry or not. The Republicans generally trust the market, while the Democrats recognize the reality that all things require a good dose of regulation to maximize the public good.
As the Gateway project was debated in a series of workshops, the citizens of Dobbs Ferry were told by the consultants hired by the Village government dominated by Republicans that the project had to conform to the dictates of the local real estate market to be realistic. This truth was taken to be self-evident by the experts and their Republican handlers. But in reality the local real market was just an outward manifestation of greed. The real estate moguls had only one real goal, to maximize their profit. They were not particularly concerned with maximizing the long-term joy of living in Dobbs Ferry.
At one meeting, I put forward a reasonable proposal that the Village consider an office park that would share a parking lot with a cultural center. The rationale behind this proposal is that an office park has the minimum impact on community services in terms of traffic, sanitation, law enforcement and schools while bringing shoppers and diners into the downtown during the day. In the evening, the same parking facilities could be shared by a cultural center, for example the Moliere repertory theater (just kidding) that would bring shoppers and diners into the downtown at night. This idea was dismissed by the ‘f(r)ee’ market consultants because the rent per square foot for office space in Westchester was less than that for residential or commercial properties. It would be interesting to see if this price discrepancy is, in fact, still true. The problem with the consultants’ line of reasoning is that the other types of properties – residential and commercial — require real services that will cost the Village more money than the Village would bring in from additional property taxes. These particular consultants had no expertise in the arcane field of Village finance , so they could only figure out one half of the equation – the new tax streams – not the offset of new service costs.
In addition, the committee that studied the effect of a park in the Gateway on surrounding real estate values found that a park would increase surrounding real estate values substantially. The consultant for the real estate developers never showed what effect a box store or housing complex would have on surrounding real estate values. I think that every new project in the Village should be evaluated partially based on its effect on surrounding real estate values as well as its net contribution to Village finances. Any project that lowers surrounding real values and/or is a net drain of Village finances should be rejection.
So, in this case of the Gateway, so far, the market was and continues to be inefficient. The market does not care about the long-term impact on Dobbs Ferry of a Super Stop & Shop because the market does not have to pay for externalities like traffic, pollution, law enforcement and more students in the schools nor the negative impact on surrounding properties.
The market only responds to short-term greed.