Neo-classical Economists as fifth column of financial oligarchy

Medium

When I heard that Ben Bernanke was taking a second advisory role, at PIMCO, as well as his first job out of the Fed, at Citadel, I kind of nearly dropped my morning latte in surprise. If I was PIMCO, I would not be wanting an advisor to Citadel to be coming within a hundred yards of my trading floor.

Why not? Well, the way that PIMCO works, as Felix Salmon explained a few years ago, is very dependent on their ability to execute changes in their view in a very, very efficient manner - quickly, and without too much impact on the market price. Given that, if I was PIMCO, I would be super super paranoid about allowing anyone near me who was also going to be talking to one of the world's sharpest and most aggressive hedge funds.

Obviously, Bernanke is a) a man of pretty unquestioned integrity, b) aware of the clear potential for conflict of interest and c) neither a spring chicken nor a pushover. He will be aware of the danger of having one of his two clients out-traded by the other. So, although I doubt that will stop the Citadel traders trying, he will already be pretty resistant to questions of the following kind:

"So, what do they think up in Newport?"

"What's Andrew Balls saying?"

"Do your other guys like the ten year linked?"

"What's PIMCO holding? Come on, tell me, what have they got? What are we f**king paying you for anyway? Come, you bearded f**k, tell me? No, f**k your Chinese Wall, I've got Ken on my ass here. What are they holding? What are they holding? What are they f**king …" (repeat ad infinitum, some of them can be very persistent and/or aggressive).

In any case, it's unlikely that Bernanke, as an outside consultant, will be reviewing portfolios or directly advising on trades. It's more likely that he'll be a sounding board for general discussions, and/or a brand ambassador, meeting clients of PIMCO for pitch or review meetings. That sounds like less of a problem of conflict of interest, except …

Except that if anything, information about client attitudes to PIMCO is more valuable to a competitor than information about PIMCO's attitude to the market. After all, PIMCO's positions are generally well-known - they're too big and too public for it to be otherwise. But if you ever got a hint that they had received a big redemption or gained a big mandate - well, that would be very useful information indeed because you would know them to be potentially forced buyers or sellers.

At a lower level, traders are always sniffing for information about possible changes of view - whether the holders of a security are confident in their decision and happy to add more, or whether they're doubting themselves and thinking about changing their minds. A fly on the wall at a general sounding board for PIMCO PMs could learn all sorts of useful information simply by being aware of what they were thinking about.

And furthermore, hedge fund traders are in the business of extracting "soft" information and understanding its implications. Being a human antenna for other people's sentiment toward the market is what they do. The best ones - and Citadel doesn't employ many lemons - can make a guess about your positioning and recent performance from the way you say "Good morning". That's why so many of them are poker players, and particularly why they often do well in the big face-to-face tournaments. So the questions that Bernanke really needs to look out for are things like:

"How's California, my man? Still sunny?"

"Jeez, another tour of Asia? Working you pretty hard aren't they?"

"What do you mean you can't do the 15th? Frankfurt *again*?"

"Lighten up, Ben! Looks like someone's been giving you a hard time?"

"Tell me, if we wanted to shift a big block trade in[security] who do we call at PIMCO?"

"Seen the Journal? Brutal. Rather have my performance numbers than PIMCO's huh?"

Even with the best will (and the best poker face) in the world, this dual role looks to me like a possible conduit of information. Bernanke is experienced in keeping his mouth shut, but he's going into a whole new world now, and he's doing so without the benefit of a staff and a press office to protect him. If I was PIMCO, I wouldn't have taken this risk.

Dan Davies is Senior Research Advisor at Frontline Analysts

May 09, 2015 | Medium

In response to Greg Mankiw and the economic ideology of free trade

I've written several times about what I call the Economics 101 ideology: the overuse of a few simplified concepts from an introductory course to make sweeping policy recommendations (while branding any opponents as ignorant simpletons). The most common way that first-year economics is misused in the public sphere is ignoring assumptions. For example, most arguments for financial deregulation are ultimately based on the idea that transactions between rational actors with perfect information are always good for both sides - and most of the people making those arguments have forgotten that people are not rational and do not have perfect information.

Mark Buchanan and Noah Smith have both called out Greg Mankiw for a different and more pernicious way of misusing first-year economics: simply ignoring what it teaches - or, in this case, what Mankiw himself teaches. At issue is Mankiw's Times column claiming that all economists agree on the overall benefits of free trade, so everyone should be in favor of the Trans-Pacific Partnership, among other trade agreements.

This is what Mankiw writes about international trade in his textbook (p. 183 of the fifth edition):

"Trade can make everyone better off. … [T]he gains of the winners exceed the losses of the losers, so the winners could compensate the losers and still be better off. … But will trade make everyone better off? Probably not. In practice, compensation for the losers from international trade is rare. …

"We can now see why the debate over trade policy is often contentious. Whenever a policy creates winners and losers, the stage is set for a political battle."

Yet, in his recent column, Mankiw says that opposition to free trade is because of irrational voters who are subject to "anti-foreign," "anti-market," and "make-work" biases. He doesn't mention what he said clearly in his textbook: opposition to free trade is perfectly rational on the part of people who will be harmed by it, and they express that opposition through the political process. That's how a democracy is supposed to work, by the way.

Mankiw's column is a perfect example of how ideology works. It provides a simple way to interpret the world - people who don't agree with you are idiots or xenophobes - while sweeping aside inconvenient evidence to the contrary. And first-year economics is as powerful an ideology as we have in this country today.

James Kwak is, among other things, an associate professor at the University of Connecticut School of Law. Find more at Twitter, Medium, The Baseline Scenario,The Atlantic, or jameskwak.net.

December 27, 2013 | NYTimes.com

Published: 440 Comments

Signs of the energy business are inescapable in and around Houston - the pipelines, refineries and tankers that crowd the harbor, and the gleaming office towers where oil companies and energy traders have transformed the skyline.

And in a squat glass building on the University of Houston campus, a measure of the industry's pre-eminence can also be found in the person of Craig Pirrong, a professor of finance, who sits at the nexus of commerce and academia.

As energy companies and traders have reaped fortunes by buying and selling oil and other commodities during the recent boom in the commodity markets, Mr. Pirrong has positioned himself as the hard-nosed defender of financial speculators - the combative, occasionally acerbic academic authority to call upon when difficult questions arise in Congress and elsewhere about the multitrillion-dollar global commodities trade.

Do financial speculators and commodity index funds drive up prices of oil and other essentials, ultimately costing consumers? Since 2006, Mr. Pirrong has written a flurry of influential letters to federal agencies arguing that the answer to that question is an emphatic no. He has testified before Congress to that effect, hosted seminars with traders and government regulators, and given countless interviews for financial publications absolving Wall Street speculation of any appreciable role in the price spikes.

What Mr. Pirrong has routinely left out of most of his public pronouncements in favor of speculation is that he has reaped financial benefits from speculators and some of the largest players in the commodities business, The New York Times has found.

While his university's financial ties to speculators have been the subject of scrutiny by the news media and others, it was not until last month, after repeated requests by The Times under the Freedom of Information Act, that the University of Houston, a public institution, insisted that Mr. Pirrong submit disclosure forms that shed some light on those financial ties.

Governments and regulatory agencies in the United States and Europe have been gradually moving to restrict speculation by major banks. The Federal Reserve, concerned about the risks, is reviewing whether it should tighten regulations and limit the activities of banks in the commodities world.

But interviews with dozens of academics and traders, and a review of hundreds of emails and other documents involving two highly visible professors in the commodities field - Mr. Pirrong and Professor Scott H. Irwin at the University of Illinois - show how major players on Wall Street and elsewhere have been aggressive in underwriting and promoting academic work.

The efforts by the financial players, the interviews show, are part of a sweeping campaign to beat back regulation and shape policies that affect the prices that people around the world pay for essentials like food, fuel and cotton.

Professors Pirrong and Irwin say that industry backing did not color their opinions.

Mr. Pirrong's research was cited extensively by the plaintiffs in a lawsuit filed by Wall Street interests in 2011 that for two years has blocked the limits on speculation that had been approved by Congress as part of the Dodd-Frank financial reform law. During that same time period, Mr. Pirrong has worked as a paid research consultant for one of the lead plaintiffs in the case, the International Swaps and Derivatives Association, according to his disclosure form.

While he customarily identifies himself solely as an academic, Mr. Pirrong has been compensated in the last several years by the Chicago Mercantile Exchange, the commodities trading house Trafigura, the Royal Bank of Scotland, and a handful of companies that speculate in energy, according to the disclosure forms.

The disclosure forms do not require Mr. Pirrong to reveal how much money he made from his consulting work, and a university spokesman said that the university believed it was strengthened by the financial support it received from the business community. When asked about the financial benefits of his outside activities, Mr. Pirrong replied, "That's between me and the I.R.S."

Debating to a Stalemate

No one disputes that a substantial portion of price increases in oil and food over the last decade were caused by fundamental market factors: increased demand from China and other industrializing countries, extreme weather, currency fluctuations and the diversion of grain to biofuel.

But so much speculative money poured into markets - from $13 billion in 2003 to $317 billion at a peak in 2008 - that many economists, and even some commodities traders and investment banks, say the flood became a factor of its own in distorting prices.

Others assert that commodities markets have historically gone through intermittent price bubbles and that the most recent gyrations were not caused by the influx of speculative money. Mr. Pirrong has also argued that the huge inflow of Wall Street money may actually lower costs by decreasing what commodities producers pay to manage their risk.

Mr. Pirrong and the University of Houston are not alone in publicly defending speculation while accepting financial help from speculators. Other researchers have received funding or paid consulting jobs courtesy of major commodities traders including AIG Financial Products, banks including the Royal Bank of Canada or financial industry groups like the Futures Industry Association.

One of the most widely quoted defenders of speculation in agricultural markets, Mr. Irwin of the University of Illinois, Urbana-Champaign, consults for a business that serves hedge funds, investment banks and other commodities speculators, according to information received by The Times under the Freedom of Information Act. The business school at the University of Illinois has received more than a million dollars in donations from the Chicago Mercantile Exchange and several major commodities traders, to pay for scholarships and classes and to build a laboratory that resembles a trading floor at the commodities market.

Mr. Irwin, the University of Illinois and the Chicago exchange all say that his research is not related to the financial support.

Underwriting researchers and academic institutions is one part of Wall Street's efforts to fend off regulation.

The industry has also spent millions on lobbyists and lawyers to promote its views in Congress and with government regulators. Major financial companies have also funded magazines and websites to promote academics with friendly points of view. When two studies commissioned by the Commodity Futures Trading Commission, the financial regulatory agency, raised questions about the possible drawbacks of speculation and of high-frequency trading, lawyers for the Chicago exchange wrote a letter of complaint, saying that its members' proprietary trading information was at risk of disclosure, and the research program was shut down.

The result of the various Wall Street efforts has been a policy stalemate that has allowed intensive speculation in commodities to continue despite growing concern that it may harm consumers and, for example, worsen food shortages. After a two-year legal delay, the futures trading commission this month introduced plans for new limits on speculation. Some European banks have stopped speculating in food, fearing it might contribute to worldwide hunger.

Mr. Pirrong, Mr. Irwin and other scholars say that financial considerations have not influenced their work. In some cases they have gone against the industry's interests. They also say that other researchers with no known financial ties to the industry have also raised doubts about any link involving speculation and soaring prices.

But ethics experts say that when academics fail to disclose financial ties, they do a disservice to the public and undermine the perception of impartiality.

"If those that are creating the culture around financial regulation also have a significant, if hidden, conflict of interest, our public is not likely to be well served," said Gerald Epstein, an economics professor at the University of Massachusetts, Amherst, who in 2010 released a study about conflicts of interest among academics who advised the federal government after the financial crisis.

Speculation in the Market

Financial ties among professors promoting speculation and the banks and trading firms that profit from it date back to the beginning of the recent commodities boom, which got an intellectual kick-start from academia.

After Congress and the Clinton administration deregulated the commodities markets in 2000, and the Securities and Exchange Commission lowered capital requirements on investment banks in 2004, the financial giants began developing new funds to capitalize on the opportunity.

AIG Financial Products commissioned two highly respected Yale University professors in 2004 to analyze the performance of commodities markets over a half-century. The professors - who prominently acknowledged the financial support - concluded that commodities markets "work well when they are needed most," namely when the stock and bond markets falter.

Money flowed into the commodities markets, and although the markets have cooled in the last two years, the price of oil is now four times what it was a decade ago, and corn, wheat and soybeans are all more than twice as expensive.

A public uproar about the rising prices became heated in the spring of 2008, as oil soared and gas prices became an issue in the presidential campaign. Congress scheduled public hearings to explore whether speculation had become so excessive it was distorting prices.

Financial speculators are investors who bet on price swings without any intention of taking delivery of the physical commodity. They can help smooth the volatility of the market by adding capital, spreading risk and offering buyers and sellers a kind of price insurance. But an assortment of studies by academics, congressional committees and consumer advocate groups had found evidence suggesting that the wave of speculation that accelerated in 2003 had at times overwhelmed the market.

Financial speculators accounted for 30 percent of commodities markets in 2002, and 70 percent in 2008. As gasoline topped $4 a gallon in the summer of 2008, Congress tried to soothe angry motorists by pushing for restrictions on oil speculation.

Mr. Pirrong jumped into the fray. He wrote papers, blog posts and opinion pieces for publications like The Wall Street Journal, calling the concern about speculation "a witch hunt."

Mr. Pirrong also testified before the House of Representatives in 2008 and, identifying himself as an academic who had worked for commodities exchanges a decade earlier, he warned that congressional plans to rein in speculators would only make matters worse.

"Indeed, such policies are likely to harm U.S. consumers and producers," he said. When oil company executives, traders and investment banks cited speculation as a major cause of surging prices which, by some estimates, was costing American consumers more than $300 billion a year, Mr. Pirrong dutifully contradicted them.

Mr. Pirrong's profile grew as he sat on advisory panels and hosted conferences with senior executives from the trading world as well as top federal regulators. Last year, Blythe Masters, head of commodity trading at JPMorgan Chase, approached him to write a report for a global bank lobbying group, the Global Financial Markets Association.

The report was completed in July 2012, but the association declined to release it. Mr. Pirrong said it was because he had reached the conclusion that banks should be regulated more heavily than other commodity traders. "I wouldn't change the call, so they sat on the report," he wrote on his blog, The Streetwise Professor.

What Mr. Pirrong did not reveal in his public statements about the report is that he had financial ties to both sides of that debate: the commodities traders as well as the banks. Ms. Masters declined to comment. Over the years, Mr. Pirrong has resisted releasing details of his own financial dealings with speculators, and when The Times first requested his disclosure forms in March, the University of Houston said that none were required of him. The disclosure forms Mr. Pirrong ultimately filed in November indicate that since 2011, he has been paid for outside work involving 11 different clients. Some fees are for his work as an expert witness, testifying in court cases on behalf of the Chicago Mercantile Exchange and a bank and a company that makes futures-trading software. The commodities firm Trafigura contracted him to conduct a research project.

Mr. Pirrong is also a member of the advisory board for TruMarx Partners, a company that sells software to energy traders, a position that entitles him to a stock option package.

It was reported in The Nation magazine in November that the University of Houston's Global Energy Management Institute, where Mr. Pirrong serves as a director, has also received funding from the Chicago exchange, as well as financial institutions that profit from speculation, including Citibank and Bank of America.

On his blog, Mr. Pirrong has dismissed suggestions that his work for a school that trains future oil industry executives creates a conflict of interest.

"Uhm, no, dipstick," he wrote in 2011, replying to a reader who had questioned his objectivity. "I call 'em like I see 'em." In a telephone interview last week, Mr. Pirrong said that his consulting work gave him insight into the kind of real-world case studies that improve his research and teaching. "My compensation doesn't depend on my conclusions," he said.

When asked about Mr. Pirrong's disclosure, Richard Bonnin, a university spokesman said only that all employees were given annual training on the school's policy, which requires researchers to report paid outside consultant work.

Professors as Pitchmen

Concerns about academic conflicts of interest have become a major issue among business professors and economists since the financial crisis. In 2010, the documentary "Inside Job" blasted a handful of prominent academic economists who did not reveal Wall Street's financial backing of studies which, in some cases, extolled the virtues of financially unsound assets. Two years later, the American Economic Association adopted tougher disclosure rules.

Even with the guidelines, however, financial firms have been able to use the resources and credibility of academia to shape the political debate.

The Chicago Mercantile Exchange and the University of Illinois at Urbana-Champaign, for example, at times blur the line between research and public relations.

The exchange's public relations staff has helped Mr. Irwin shop his pro-speculation essays to newspaper op-ed pages, according to emails reviewed by The Times. His studies, writings, videotaped speeches and interviews have been displayed on the exchange's website and its online magazine.

In June 2009, when a Senate subcommittee released a report about speculation in the wheat market that raised concerns about new regulations, executives at the Chicago exchange turned to Mr. Irwin and his University of Illinois colleagues to come up with a response.

Dr. Paul Ellinger, department head of agriculture and consumer economics, said, "The interactions that have occurred here are common among researchers."

A spokesman for the exchange said that Mr. Irwin was just one of a "large and growing pool of esteemed academics, governmental editors and editors in the mainstream press" whose work it follows and posts on its various publications. While the C.M.E. has given more than $1.4 million to the University of Illinois since 2008, most has gone to the business school and none to the School of Agriculture and Consumer Economics, where Mr. Irwin teaches. And when Mr. Irwin asked the exchange's foundation for $25,000 several years ago to sponsor a website he runs to inform farmers about agricultural conditions and regulations, his request was denied.

Still, some of Mr. Irwin's recent research has been funded by major players in the commodities world. Last year, he was paid $50,000 as a consultant for Gresham Investment Management in Chicago, which manages $16 billion and runs its own commodities index fund. He noted Gresham's sponsorship in the paper and on his disclosure form, and said it gave him the opportunity to use new data and test new hypotheses.

Mr. Irwin also works for a business called Yieldcast that caters to agricultural producers, investments banks and other speculators, selling them predictions of corn and soybean yields. Mr. Irwin has said he does not consider it a conflict because he works only with the mathematical forecasting models and never consults with clients.

"The debate about financialization is primarily about the large index funds, none of whom are clients," he said.

Mr. Irwin declined to provide a list of his clients, and the university said its disclosure requirements did not compel him to do so.

This article has been revised to reflect the following correction:

Correction: December 31, 2013

An article on Saturday about financial rewards from Wall Street to academic experts whose research supports the financial community's views on commodity trading misidentified a Canadian bank and commodities trader that financed the work of academic researchers or paid consultants. It is the Royal Bank of Canada, not the Bank of Canada, which is that nation's central bank. The article also rendered incorrectly the university affiliation of Scott H. Irwin, a prominent defender of speculation in agricultural markets. He is a professor at the University of Illinois at Urbana-Champaign - not Champaign-Urbana. And a picture caption with the continuation of the article misidentified the subject of one of several pictures. The lower right photograph showed the atrium of the University of Illinois's business school - not its Market Information Lab, which was shown behind Professor Irwin in the photograph at the left.

The House Edge: Off Limits, but Blessed by the Fed (December 22, 2013)
The House Edge: Wall St. Exploits Ethanol Credits, and Prices Spike (September 15, 2013)
Response from the academic criminal: Streetwise Professor

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Neo-classical Economists as fifth column of financial oligarchy

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[May 09, 2015] Ten questions that Ben Bernanke needs to learn how to not answer

Medium

[May 09, 2015] Greg Mankiw Forgot What He Teaches by James Kwak

May 09, 2015 | Medium

[Dec 31, 2013] Academics Who Defend Wall St. Reap Reward By DAVID KOCIENIEWSKI

December 27, 2013 | NYTimes.com

Published: 440 Comments

Related

The House Edge: Off Limits, but Blessed by the Fed (December 22, 2013)

The House Edge: Wall St. Exploits Ethanol Credits, and Prices Spike (September 15, 2013)

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