Monday, January 5, 2009

Mystery achievement

Here's what I want to know: How can it be that I can anticipate so many of the points of one prescient economist (PDF), when I don't have a Ph.D. or even an undergraduate major in economics? Clips (all typos mine since the fricking document won't allow cut and paste):

Competition forces them to flirt continuously with the limits of illiquidity.
My main concern has to do with incentives. ...
First, the way compensation relates to returns implies there is typically less downside and more upside from generating investment returns. Managers, therefore, have greater incentive to take risks. Second, their performance relative to other peer managers matters, either because it is directly embedded in their compensation, or because investors enter or exit funds on that basis.

The knowledge that managers are being evaluated against others can induce superior performance, but also a variety of perverse behavior.

One is the incentive to take risks that are concealed from investors - since risk and return are related, the manager then looks as if he outperforms peers given the risks he takes. Typically, the kinds of risk that can be concealed most easily, given the requirement of periodic reporting, are risks that generate severe adverse consequences with small probability but, in return, offer generous compensation the rest of the time. ...

A second form of perverse behavior is the incentive to herd with other investment managers on investment choices because herding provides insurance the manager will not underperform his peers.
I think it's my constitutional lack of blind obeisance - to Alan Greenspan, in this case - and my hair-trigger bullshit detector.

Not to say that I didn't learn a lot from reading the paper. I did. Not that the financial markets aren't much more complex than I even understand. They are. Nonetheless, I saw the clear outlines and their dangerous implications.

It was probably because I was reading Paul Krugman.

(h/t the estimable Krugman)

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