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Archive for January 16th, 2010

Via Mark Thoma come three reviews of one new book, Out of Crisis: Rethinking Our Financial Markets, which is written by David A. Westbrook. The book uses legal and political perspectives to analyze the economic crisis and,

“shows how markets are a form of social and political organization. Consequently, the divide between markets and governments that continues to structure thought across the political spectrum is too simplistic.”

The reviews are very substantive, so I’ll tackle the first today and the other two tomorrow. The first review is from Mae Kuykendall, who frames this book in contrast to Reinhart and Rogoff’s data-driven approach to the crisis:

Westbrook identifies an intellectual problem in the moment and provides a warning about habit. Professionals in finance and law must not assume a reversion to the mean that the idea of crisis can imply, he says…We’re in peril, without a governing paradigm and at risk of letting simple stories substitute for “conceptual renewal.”

Further, Westbrook argues that the prevailing orthodoxy has left us with a reconstruction project. Confidence in markets went too far and burrowed into our institutional design…For Westbrook, “This time the failure is different,” and waiting for a reversion to the mean is to be passive in the face of institutional and, Westbrook tells us, political crisis…

[Rogoff and Reinhart’s] primary message to the reader: “We have been here before.” With centuries of data comes insight. So their biggest plea for the future of sound finance is data…

[Westbrook] gives us prescription at a grand level—a call for conceptual renewal within the “discursive community” of finance and a recognition that finance is now concerned with a web of legal contracts, or words, instead of the tangible things traditionally connected with measuring and preserving value…The grounding insight is that markets are political constructs, like games. So efficiency is not the only concept to gauge a market’s health.

In his theory, Westbrook turns to a factor about which the neo-classical economist has no insight to offer and which has a changing import for the tasks financial elites must master: the language in which we execute and regulate economic life. Westbrook directs us to a critical insight for this crisis: we are collectively enmeshed in a tragedy of language, using it to govern financial exchange in ways that are naïvely representational or, in the alternative, unrealistic about the power of a linguistic construct to constrain the world. Disclosure as a strategy, given to us by our savants of the last finance reset, assumes what the English professors tells us is really a childish idea: that language serves as a window to a real picture…

In our other principal strategy– risk management– language is asked to set up containers for large swaths of poorly described arrays of claims on something real. The tragedy is the contradiction. We believe, like children, in being told what our basket of claims contains, and we rely, like language engineers, on the idea that a big enough basket of abstractions—claims on too many things to try to understand with the faith of children looking through a picture window—is conceptually safe.

The nation—our government, meaning Congress and the administration (Westbrook tells us, the Bush-Obama sequence)– is there when the gears of tragedy grind to an unhappy resolution…

Westbrook warns us about this temptation…To fix the institutions of finance, elites are using words to rearrange and contain…

Westbrook’s tactics are, instead, reconstructive and architectural. Design for failure. Have institutions that can fall on their own…

Remember that markets are constructs, so do design. Match the scaling of architecture to the uncertainty of sustained confidence in price, value, counterparty liquidity.

Bad outcomes call for rewrite, revision, new content…

Macroeconomists have little interest in personality, only in the human folly revealed in a growing data file…

But Westbrook, taken with our time and place, describes the motives and players in the folly we can claim today. And these—the motives and we the players, our meritocratic culture– concern him. Our ideology of the market, and our naivete about the reasons that drive how we participate in, regulate, and analyze markets, are an innocent corruption.

The crux of Westbrook’s conclusion, then, is the concern that:

Few among us have purses lined with the booty from a bribe, but not a few have entered a courtier class, and have found a post in a market of courtiers…

Such a cosseted class might well plot just our recent roadmap for recovery: keep accountability at bay and make risk opaque. If need be, beggar thy neighbor and arm to the teeth

Thinking of markets as social constructs and delving into the representativeness of language are not approaches that neoclassical economists take. What we have here, then, is a very alternative narrative of the crisis, one that delves into root causes that go far deeper than economists dare tread. It seems that Westbrook goes even deeper than the Polanyian notion that markets are embedded in a social and political structure. They are also constructed by society and by language. There is no recourse to the simplistic notion that, “in the beginning there were markets.” Maybe there were markets from an early point in human prehistory, but our markets are just as much a product of our discourse on how economies function as they are a result of institutions.

Granted, it makes my head hurt thinking of the ways in which discourse can define structures, but it is certainly true that contracts and profit are socially constructed narratives in their own right. Choosing to emphasize those things leads to a certain type of economy and a certain type of markets. Our day-to-day language then serves to reinforce those structures. In particular, Westbrook’s so-called courtier class uses the language it chooses to define the future structure of the economy. As the next review will point out, this language leads to a simple (and potentially damaging) narrative of markets versus regulation, but we’ll get to that later…

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