Category: Books

The authors are Kal Raustiala and Christopher Sprigman, and the subtitle is How Imitation Spurs Innovation.  Here is one excerpt:

During the postwar heyday of the one-liner, there was no strong norm against imitating another comedian.  In fact, comedians copied one another shamelessly, joking about it as they did so.  And the type of comedy prevalent then permitted and even encouraged this practice.  Comedians were telling largely interchangeable generic jokes that a wide audience could appreciate.  Comics differentiated themselves by their performance style: who delivered the joke better, timed the audience better, was able to compile and assemble from a repository of jokes a subset that fitted the particular audience.  Many comedians based their acts on a blend of stock jokes, purchased jokes, and copied jokes.  There was not much investment in the kind of personalized material that dominates today.  Given the system at the time, this made sense.  One-liners were easy to copy; delivery, however, was relatively more difficult to steal.  Post-vaudeville comedians were incentivized to invest in their delivery, not in writing new jokes.

Now compare those comedians with their modern counterparts.  Contemporary comics invest far more in original and personal content.  The medium is no longer focused on reworking preexisting genres like mother-in-law jokes.  Nor is it just about slinging in one funny joke after another.  Comedy today is more personal, more story-telling in orientation, and more consistent with a real or assumed stage persona.  In short, comedians in the post Lenny-Bruce era invest in a personality, and their comedy reflects that personality.  They create a comedic brand of sorts.  And to protect that investment and that brand, they have developed a system of social norms that punishes copying.  At the same time, comedians invest less in some of the performative aspects of their work: many today stand at a microphone, dress simply, and move around very little, with none of the more elaborate costuming, mimicry, musicianship, and play-acting that characterized the post-vaudeville comics.

The book is due out in September.

Rather than demanding an end to default-prone subprime lending funded with hair-triggered short-term debt, bank critics have, ironically, demanded an end to proprietary trading, which they view as unnecessarily risky, but which was inconsequential to the cause of the Crisis.  In a world where banks underwrite and trade risk, what constitutes proprietary trading?  When a bank takes credit-default risk by making aloan, is it taking proprietary risk?  It is, without a doubt.  But loaning money is what banks do.  When a bank like Goldman Sachs seeks to unwind that risk by shorting mortgages prior to the downturn, is that proprietary trading?  Yes.  So is borrowing short and lending long.  With banks now primarily underwriting, pricing, and trading risk rather than merely funding loans, restrictions on proprietary trading unnecessarily imperil banks and distort capital markets to restrict banks to only the long side of the trade.  restricting banks to long-only positions substantially increases withdrawals in the event of a panic.

I would stress that the real problems come when the overwhelming majority of banks go heavily long on some fairly simple assets — usually real estate — in an overly optimistic way.  Think Ireland, Iceland and the United States during the last crisis, among many other instances.  Once the short-term debt behind those banks starts to unravel, all hell breaks loose and the central bank can at best limit but not stop the carnage.  That is the main problem financial regulation should be trying to address and it isn’t easy.

I am much less worried about “rogue trades” or “rogue investments” at individual banks (or non-banks), even very large ones.  Such trades surely exist: think LTCM or even Continental Illinois.  Ex post, there is usually a way to plug the gap, if only by having the Fed backstop a deal.  After all, the rest of the banking system is sound in these scenarios.  Prop trading may increase the chance of this second problem, but arguably it decreases the chance of the first and larger problem.

You can buy Conard’s stimulating book, Unintended Consequences, here.  Conard, by the way, does object to how the government implicitly subsidizes the short-term debt of the major U.S. banks and he views that as the root of the problem behind proprietary trading, not the trading itself.

Edward Conard, author of Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong, offers a hypothesis.  He suggests the underlying cause is the (relatively recent) prevalence of risk-averse foreign capital:

With an abundance of risk-averse offshore capital, the constraint to increase investment and risk taking has been the capacity of risk underwriters, not capital providers.  Today, Wall Street uses financial innovation to decouple risk from investment capital and predominantly sells risk to risk underwriters, which is no different from an insurance broker or insurance company.  Wall Street deconstructs, prices, underwrites, syndicates, trades, and makes markets for risk.  Because Wall Street now performs the more abstract function of syndicating risk rather than merely raising capital, people — even people as well informed as former president Bill Clinton — have naively concluded that these transactions serve “no economic purpose.”  Risk underwriting is every bit as important as funding investment, perhaps even more so in today’s economy where the trade deficit leaves us awash in risk-averse short-term debt to fund investment provided someone else underwrites the risk.

So far I find parts of this book brilliant and other parts dead wrong.  In any case it is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.