Calvin Trillin (in the NYT) has a conversation with some man at a bar. They talk about the crisis. Trillin says:
“So what happened?”
“I told you what happened. Smart guys started going to Wall Street.”
“Why?”
“I thought you’d never ask,” he said, making a practiced gesture with his eyebrows that caused the bartender to get started mixing another martini.
“Two things happened. One is that the amount of money that could be made on Wall Street with hedge fund and private equity operations became just mind-blowing. At the same time, college was getting so expensive that people from reasonably prosperous families were graduating with huge debts. So even the smart guys went to Wall Street, maybe telling themselves that in a few years they’d have so much money they could then become professors or legal-services lawyers or whatever they’d wanted to be in the first place. That’s when you started reading stories about the percentage of the graduating class of Harvard College who planned to go into the financial industry or go to business school so they could then go into the financial industry. That’s when you started reading about these geniuses from M.I.T. and Caltech who instead of going to graduate school in physics went to Wall Street to calculate arbitrage odds.”
“But you still haven’t told me how that brought on the financial crisis.”
“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn’t have done the math.”
“Why do I get the feeling that there’s one more step in this scenario?” I said.
“Because there is,” he said. “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”
“So having smart guys there almost caused Wall Street to collapse.”
“You got it,” he said. “It took you awhile, but you got it.”
James Kwak at The Baseline Scenario:
I read somewhere that of the CEOs of the largest banks, only Vikram Pandit at Citi was a true “quant,” and he only came in when Citi bought his hedge fund in 2007, after the bulk of the damage was done. (I’m not endorsing Pandit’s job as CEO, only saying that the mess was there before he arrived.) So there probably was this situation where the executive ranks were filled with old-style relationship-builders and dealmakers, and the increasingly quantitative traders were doing things they didn’t understand. A similar story has been told about Salomon under John Gutfreund in the 1980s (and LTCM under John Meriweather in the 1990s).
Technology firms also face a similar problem. In technology, as in most businesses, the way to make it to the top is through sales, so you end up with a situation where the CEO is a sales guy who has no understanding of technology and, for example, thinks that you can cut the development time of a project in half by adding twice as many people. I have seen this have catastrophic results. Even when you don’t have the generational issue that Trillin talks about, the problem is that the sociology of corporations leads to a certain kind of CEO, and as corporations become increasingly dependent on complex technology or complex business processes (for example, the kind of data-driven marketing that consumer packaged companies do), you end up with CEOs who don’t understand the key aspects of the companies they are managing. And the underlying problem is that, for all the blather that CEOs and boards spit out about succession planning and the importance of people, the fact remains that the market for CEOs is deeply flawed, as shown for example by Rakesh Khurana.
In fact, even the bankers from the upper third of the class — the likes of Bob Rubin, who famously had no idea what liquidity puts were until a bunch of them exploded right underneath him — fell into this trap: in his case, he was both the smart and scrappy arbitrageur who thought that he could turn brainpower into billions, and the baffled senior risk manager who gave his underlings far too much ability to blow up his bank.
Banking isn’t for outright dummies — conscientious underwriting, for one, is a difficult and highly-skilled job which requires good, well-paid professionals. But far too many bankers thought of that kind of income as boring money, and were much more excited by the higher rewards and sophisticated risk management being shown them by the rocket scientists on the structured-products desk. Maybe in future they’ll be more suspicious of things they don’t really understand, but I’m not holding my breath. That’s what regulators are for.
John Carney at Clusterstock
Matthew DeBord at The Big Money:
The same dynamic is now happening in the auto industry. Actually, it’s not even the auto industry anymore: It’s “transportation” or “mobility.” When the auto industry in the United States was stronger and contributing to the national reputation in meaningful ways, it also attracted workers who just wanted to work, engineers who’d gotten their start in high school shop classes and under the hood of some old Dodge in the garage, and designers who spent geometry class furiously doodling their vision of the next Camaro. The really smart kinds didn’t dream of going to Detroit and disappearing into General Motors (MTLQQ). And that was fine, because it kept GM in reasonable touch with its customers and their needs.
Toyota envy was the thing that upset this sensible balance. Japanese management theory (“They have a theory?”) appeared to have created cars that never had any problems, so the executive layer in Detroit flocked to learn Toyota’s secrets. Meanwhile, everyone who had majored in business was getting an MBA, so Detroit was inundated with executives of pedigree, rather than execs who had scrapped their way up through various company divisions, perhaps even starting at an actual car dealership, selling actual cars to actual customers.
UPDATE: Noam Scheiber at TNR
UPDATE #2: Paul Krugman
UPDATE #3: Daniel Drezner
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