“In Fed We Trust” Inspires No Trust

April 25th, 2010

David Wessel is the Economics Editor of The Wall Street Journal. This is the most successful newspaper in the U.S. It is the leading financial publication in the world. Economics is to the Journal as algebra is to mathematics. And David Wessel is THE Economics Editor.

 That fact is at least as terrifying and depressing as his account of the financial crisis.

 AIG as “Casino”

Mr. Wessel has recently made the rounds of talk shows promoting his story of how the Federal Reserve and Chairman Ben Bernanke saved the world from the next Great Depression. In Fed We Trust is subtitled “Ben Bernanke’s War on the Great Panic.”

Mr. Wessel clearly believes that the recession and financial crisis are the work of Wall Street. Where did Wall Street go wrong? In outlining the fall of AIG, the insurance firm, Mr. Wessel describes its financial products unit as a “casino.” This is a revealing remark – not for anything it says about AIG, but for what it reveals about Mr. Wessel.

From the context of his discussion in the book and his accompanying remarks on television, it is clear that Mr. Wessel does not mean this word as a compliment. But does the term make any sense as a contextual metaphor? Does Mr. Wessel know what a casino is?

A casino is a commercial establishment in which the patrons play various gambling games. The games have one thing in common – the odds are tilted in favor of the house. The patrons are “risk-lovers,” who deliberately accept losing odds. The house is “risk-averse;” it deliberately strives to avoid fair gambles. (A “fair gamble” involves even odds; the classic example is a coin flip.)

The AIG boys created financial products such as “collateralized default obligations” (CDOs). These are collections of debt securities, packaged together in security form. The idea is similar to the principle underlying mutual funds – blunt the impact of default by diversifying the risk over many firms. In other words, the idea is to reduce risk, not magnify it.

Some people think these products were a bad idea. Those people may be right. Then again, some people always think a new product is bad. Some people thought mutual funds were bad in the 20s and 30s. In the 80s, junk bonds were widely considered “toxic assets.” Today, both are an accepted part of the financial landscape.

CDOs may have been a good idea or a bad idea when they were originally developed. If history is any guide, they were a good idea that was poorly executed or that needed time and modification in order to work well. They were not a toy created by risk-loving fools or madmen. At one time, AIG’s financial-products unit made tremendous profits for the company. Critics like Mr. Wessel seemingly want us to ignore that and focus only on the huge losses that followed. A judicious approach would weigh both episodes. 

Parsing Wessel-speak

If Mr. Wessel knows what a casino is, then he has knowingly misused the word as a metaphor. Mr. Wessel is a professional journalist; carefully-chosen words are the tools of his profession. In other words, he has committed bad journalism even while dealing with a basic concept in his professional specialty.

If Mr. Wessel doesn’t understand the difference between a casino and AIG’s financial unit, then he doesn’t understand the concept of risk. Risk is basic to the study of economics. Mr. Wessel is the economics editor of the world’s leading financial publication. Risk is absolutely central to an understanding of the financial crisis we suffered. That crisis is the subject of the book Mr. Wessel wrote and about which he opines on talk shows. Risk is part and parcel of the thesis Mr. Wessel is promoting in his book. But it appears that Mr. Wessel doesn’t understand risk.

All this does not engender respect for Mr. Wessel’s competence as a financial reporter.

The characterization of financial markets as “casinos” goes at least as far back as Karl Marx. For all his erudition, Marx did not really understand financial markets. He used the word “casino” only to connote a purposeless, heedless promotion of risk. Similarly, contemporary critics like Mr. Wessel want to profit from the vestigial, visceral aversion that the word “casino” instills in the Puritan conscience.

In other words, this use of the word “casino” is ideologically tendentious. It is also cavalier. It allows Mr. Wessel to feel superior to the rocket scientists and financial whiz-kids who make millions while he has to make do on a journalist’s pittance.

One way for journalists to increase their income is to write books. These days, the newspaper business is circling the drain down to oblivion. Columnists and reporters are abandoning the pretense of journalism and frantically trying to make their name known to the public. The pronoun “I” used to be taboo in journalism; now it is a staple among those eyeing a future on the Internet, aspiring to a place on the RSS feeds of the movers and shakers.

The strategy of choice seems to be to hitch a ride on the crisis-of-the-moment. The fact that insurance companies fulfill a vital function and free markets are facing rejection by public and policymakers alike doesn’t register with the Wessels of the world.

Why Should We Care About David Wessel’s Mistakes?

Insurance companies play a vital role in our lives. By bearing and pooling risks that would otherwise prove prohibitive for us, they enhance the quality of our lives enormously. (Should the day ever come when insurance companies are expunged or expropriated, we will look back on the present day with longing and regret.) Demonization of insurance companies will cause millions of policyholders to question the value of their insurance assets. It will make companies less willing to develop new products but more willing to kowtow to politicians and regulators in order to protect those assets.

The academic literature puzzles over the paucity of annuities in American portfolios. Seemingly, investors’ interests would be well-served by annuitization. Demonization of insurance companies would hardly further this objective.

More broadly, studies also suggest that Americans poorly understand the concept of risk. They inordinately fear some categories of risk, such as death from dog bite or epidemic, while underrating others. Insurance companies solve problems posed by risk. It is hardly necessary to overlook errors or whitewash corporate misbehavior in order to do justice to this vital role. All that is required is a sound grasp of fundamentals.

Caveat Viewer

Once upon a time, journalists who wrote books had reputations to protect. This protected them from their worst instincts and precluded the kind of ghastly, self-indulgent mistake Mr. Wessel made. That is no longer true. Now a viewer or reader can take nothing for granted, not even simple competence.

Like it or not, that is the Brave New World that we inhabit. Seekers after economic enlightenment must face this fact.

Category: Annuities, Economic Analysis, Economic News, Retirement Planning, Risk | Tags: , , , , ,

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