When it pays to be crazy

In the irrational, out-of-control world of the financial markets, acting rationally loses money rath

As recent events indicate, financial markets seem incapable of self-regulation, and instead swing headily from irrational excesses to violent crashes. But it’s unlikely that governments could do a much better job of avoiding financial crises, as the job of creating wise and effective regulation may just be too difficult to perform. Nevertheless, when banks crash, it is the public purse that has to bail them out. The solution to this problem? Governments need to make sure that, during times of plenty, they make enough out of the financial sector to prepare for the bad times – for, as we’ve seen, days of plenty are always numbered.

The events of the past two weeks are instructive. Bear Stearns was a venerable Wall Street bank that kept on trading all the way through the Great Depression. In 2007, it was voted Fortune magazine’s “Most Admired” securities firm. Now, after the self-destructive excesses of the sub-prime mortgage bubble that has burst, it lies in ruins: sold over to JPMorgan Chase, via a government bail-out, at a mere $10 per share – a pale comparison to its market capitalization at $170 per share as recently as January 2007. The bigger problem is that no-one knows which venerable old institution will be next to implode.

The US Federal Reserve has had to stump up a massive $30 billion in order to smooth the sale of Bear Stearns, and who knows what kinds of additional largesse will be demanded of the world’s treasuries and central banks before the losses can be stemmed (if they can be). The financial system relies on trust; and once it is lost, trust – like innocence – is difficult to regain. Things could get much, much messier before they start to get better.

The origins of the current crisis lie in the short-sightedness, greed and poor regulation of the world’s markets in securitized credit instruments – the ever more exotic march of acronyms of CDOs (collateralized debt obligations), MBS’s (mortgage backed securities) and the like.

The world’s commercial banks have spent five years borrowing cheap money, lending it to (often poor) people for near-to-zero margins, and then marking their books with a repayment probability of 100 percent. Credit spreads narrowed to absurd levels, long term rates fell below short term rates (you actually got lower interest rates if you locked your cash up for longer) and the weakest, most brittle CDOs and MBSs could get an AAA rating from supine, eager-to-please rating agencies.

It was the fantasy world of “mark to market” accounting practices that destroyed Enron, and in consequence their file-shredding accountants Arthur Andersen, when the last bubble burst, but memories seem to be short when there’s money to be made.

It was obvious that the liquidity bubble was going to burst sooner or later. So, one might ask, why didn’t the grotesquely well-paid analysts at Bear Stearns and elsewhere urge caution instead of the full-steam-ahead lemming sprint to the cliff’s edge? The answer is a disturbing one – in an irrational market, rational behaviour loses money rather than making it. The first bank to have pulled in the reins in the credit markets would have lost out as everyone else made a quick killing from the irrationally-rising market.

When a price bubble is inflating, there is massive money to be made from buying high, but selling higher. There is a classic co-ordination problem here. It is rational to act ‘irrationally’ as long as the crazy folk around you keep driving the market up; it becomes rational to act ‘rationally’ only when your rationality is contagious, or when everyone can see that the cliff edge is now in sight.

Anyone who thinks that financial markets can be successfully self-regulating hasn’t understood the way that acting crazy can be the way to make massive profits, as long as you’re not the only crazy one. Added to this, of course, is the problem of the time horizons of the people who actually work for investment banks. They’re so well paid that they don’t need to care about their position in 7 or 10 years’ time. If this year’s bonus can buy a townhouse, then there’s no need to sacrifice current margins to vague concerns for future stability.

The truth is that the players in the world’s financial markets find themselves in a classic Prisoners’ Dilemma. It’s rational for any fund manager to join in with the latest unsustainable get-rich-quick scheme, because he’ll make more money than if he shows restraint. But if everyone joins in, then you create an unsustainable bubble, and everyone loses out in the end. It’s collectively rational for the financial market to show restraint, but individually rational for each of the players in that market to (within limits) throw caution to the wind (especially while everyone else is doing so and the bubble is inflating). But there’s just no way of getting from individual commercial decisions to the collectively rational and restrained equilibrium.

So, the financial markets are structurally incapable of self-regulation. The obvious alternative is state regulation. But there are two massive problems here. The first problem is one of technical know-how. The world’s investment banks spend billions on wages to get highly technically gifted people to devise ever more complex financial instruments and strategies. Crashes and bubbles can happen in unpredictable ways, and it would take even greater resources and expertise to design the surgical regulation needed to head-off every possible disaster. States lack the capacity to stay one step ahead of these out-of-control financial behemoths.

The other problem, of course, is that states face a Prisoner’s Dilemma of their own. Tighter regulation or higher taxes in London drives the banks to Geneva, and it’s better for the state to get inadequate scraps than nothing at all. It would be collectively rational for states to co-ordinate their tax and regulatory activities but, yet again, individually rational for each individual state to defect and undercut the competition.

Both these problems have solutions, though. If ‘surgical’ regulation is too difficult, then perhaps governments need to treat the periodic expansions and contractions of the financial sector as an unavoidable evil, and simply make sure that they extract enough in the way of taxes when times are good. (Although there’s no doubt that some forms of regulation that would have headed-off the current crisis are shockingly simple – for example, imposing a maximum income-multiple on new mortgages, with tighter standards for income certification.)

Moreover, governments are much better situated for co-operation than are private players in the financial system. If tax flight is a problem, then governments need to get their heads together, and do more to impose uniform tax treatments of financial institutions and their employees. Co-operation at the European level is especially urgent, and realizable. Some of these forms of co-operation could be politically popular throughout the continent. The EU would be much more popular if it was seen taking a stand against the cynical and leaching Swiss treatment of hedge funds, or Monaco’s scandalous position on tax exiles. It’s high time that the hard working people of the continent stopped being exploited by tax havens.

At the moment, we have a horrible imbalance of power. When things are going well, the bankers take the spoils. When they fail, the state – and its taxpayers – pick up the tab. If we can’t control the irrational oscillations of world finance, we should at least make sure that its benefits are distributed more justly.

Martin O’Neill is a political philosopher, based at the Centre for Political Theory in the Department of Politics at the University of Manchester. He has previously taught at Cambridge and Harvard, and is writing a book on Corporations and Social Justice.
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An English hero for the ages: Ian Botham at 60

Botham blends his sportsmanship and deep-seated passion for cricket with a lust for life.

Begging W H Auden’s pardon, it is possible both to honour and to value the vertical man, and in the case of Ian Botham, who turned 60 on 24 November, it is our bounden duty. No sportsman has given Britons so much to enjoy in the past half-century and no sportsman is loved more. Two decades after he retired from first-class cricket, his reputation as one of life’s champions remains unassailable.

No mere cricketer is he, either. Botham is a philanthropist, having raised more than £12m for various charities, notably Leukaemia and Lymphoma Research. In December, 30 years after his first walk from John o’Groats to Land’s End, he will set off again, in South Africa, where England are on tour. And he really does walk, too, not amble. As somebody who accompanied him on one of his dozen walks said: “You can’t keep up with him. The man is a phenomenon.”

Of all postwar sportsmen, only Bobby Charlton and, at a pinch, Henry Cooper come close to matching Botham’s enduring popularity. But Charlton, a shy man who was scarred by the Munich plane crash of 1958 (and may never have recovered from its emotional effects), has never comfortably occupied a public stage; and Cooper, being a boxer, had a solitary role. Botham, by contrast, spoke for England. Whenever he picked up his bat, or had a ball in his hand, he left spectators in no doubt.

Others have also spoken for England. Bobby Moore and Martin Johnson, captains respectively of England’s World Cup-winning football and rugby teams, were great players but did not reach out to people as naturally as Botham. Nick Faldo, Lester Piggott, Sebastian Coe and, to bring us up to date, Lewis Hamilton have beaten the best in the world, but they lacked those qualities that Botham displayed so freely. That is not to mark them down. They were, and are, champions. But Botham was born under a different star.

It was John Arlott, the great cricket commentator, who first spotted his uniqueness. Covering a match at Taunton in 1974, he asked the young colt to carry his bags up the rickety staircase to the press box, where Arlott, wearing his oenophile’s hat, pulled out a bottle of red wine and invited Botham to drink. Forty years later Botham is a discriminating wine drinker – and maker. Along with his friend and fellow England great Bob Willis, and their Australian wine­making pal Geoff Merrill, he has put his name to a notable Shiraz, “BMW”.

Arlott, with his nose for talent and good company, saw something in the young Botham that Brian Close, his captain at Somerset, was beginning to bring out. Later, Mike Brearley, as England captain, drew out something even more remarkable. As Rodgers and Hammerstein wrote, you’ve got to be carefully taught. And Botham, a fine team man as well as a supreme individual performer, has never withheld praise from those who enabled him to find his voice.

If sport reveals character, then cricket is the game that reveals it most clearly. In no other sport is the individual performance rooted so firmly in a team context. Every over brings a contest of skill and intelligence between batsman and bowler but only a team can win the match. “A cricketer,” as Arlott said, “is showing you something of himself all the time.”

Cricket also reveals national character more than any other sport. Football may be the most popular game in the world but cricket, and cricketers, tell us far more about England and Englishness. It is instructive, in this regard, to hear what Philippe Auclair, a French journalist and author long resident in London, has to say about Botham: “He is essentially an 18th-century Englishman.” In one! It’s not difficult to sense a kinship with Tom Jones, Fielding’s embodiment of 18th-century life, who began his journey, as readers may recall, in Somerset.

A country boy who played for Worcestershire after leaving Somerset, and who lives by choice in North Yorkshire, Botham is an old-fashioned Englishman. Although nobody has yet found him listening to the parson’s sermon, he is conservative with a small and upper-case C, a robust monarchist, handy with rod and gun, and happiest with a beaker in front of him. He represents (though he would never claim to be a representative) all those people who understand instinctively what England means, not in a narrow way, but through something that is in the blood.

Above all, he will be remembered for ever as the hero of 1981. Even now it takes some believing that Botham bowled and batted with such striking success that the Australians, who were one up after two Tests, were crushed. Some of us who were actually at Headingley for the famous third Test – thousands who claim to have been there were not – recall the odds of 500-1 on an England victory going up on the electronic scoreboard that Saturday evening.

Botham made 149 not out as England, following on, beat the Aussies by 18 runs. For three hours the country seemed to stop. In the next Test, at Edgbaston, Botham took five wickets for one run as Australia fell under his spell. Then, at Old Trafford, on a dank Saturday afternoon, he played the most memorable innings of his life and one of the greatest innings ever played by an Englishman: 118 magnificent, joyful runs. Joy: that’s the word. Botham brought joy into people’s lives.

Yet it was the final Test at the Oval, which ended in a draw, that brought from him a performance no less remarkable than those from before. He bowled 89 overs in that match, flat out, continuing to run in when others withdrew with injury. That was the team man coming to the fore. Little wonder his comrades thought the world of him.

Modest, loyal, respectful to opponents, grateful to all who have lent him a hand, and supported throughout a turbulent life by Kath, his rock of a wife, and their three children, this is a cricketing hero to rank with W G Grace, Jack Hobbs, Wally Hammond and Fred Trueman. A feature in the lives of all who saw him, and a very English hero. 

This article first appeared in the 26 November 2015 issue of the New Statesman, Terror vs the State