Thursday, December 20, 2012

Inside the Great Vampire Squid

Review of Why I Left Goldman Sachs: A Wall Street Story, by Greg Smith (New York: Grand Central Publishing, 2012)

Earlier this year, Greg Smith, a young financial industry executive, announced his resignation from the giant Wall Street firm Goldman Sachs, where he had worked for twelve years, mostly in New York. But he didn’t send his Goldman supervisors a standard resignation letter.

Instead, he worked secretly for months on an essay “to distill into simple terms exactly what I felt was wrong” (p. 236). After confirming Smith’s story, The New York Times published the essay just days after he cleaned out his desk late on a Saturday night. (Readers of this blog might recall this posting about the op-ed on the same day it came out.)

Smith writes that “Goldman would later tell me they had surveillance video of me walking out the front lobby with my box and backpack. They thought I had larceny in my heart, when all I had was freedom” (p. 243).

Smith’s ticket to freedom--the op-ed piece explaining why he was leaving Goldman--attracted so much attention that he was reportedly offered a $1.5 million advance to publish a book.

But reviews of his quickly published memoir have been mixed. The New York Times’ James Stewart complained that it “was curiously short on facts.” Not surprisingly, The Wall Street Journal sided with Goldman Sachs and said that Smith deluded himself into “taking his dissatisfaction [with his pay] as a betrayal by the firm he loved”—something that Smith explicitly denies (p. 241). Forbes said that his “story just doesn’t add up” or “make any sense.” These judgments, as I’ll show, are unfair and miss the point.

Instead, I think this book is an interesting glimpse inside a company that Rolling Stone magazine’s Matt Taibbi famously called “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

BusinessWeek’s reviewer, Bryant Urstadt, offers a more sympathetic reading, comparing this Wall Street memoir to Michael LewisLiar’s Poker, a tell-all story of Lewis’ time at the former Salomon Brothers company that I described last year as “a hilarious send-up of the big shots who ran Salomon by someone who saw their greed and recklessness firsthand. Lewis was close enough to be on the inside, but critical enough to keep his distance; his account turns out to be a readable introduction to Wall Street, specifically the bond market, in the 1980s.”

Like Lewis, who was an art history major at Princeton, Smith was recruited out of an elite school (Stanford). But Smith was an economics major who was passionate about comparative advantage and about making money. Lewis, the liberal arts student, by contrast, seemed unimpressed with money and bemused by investment bankers.

Lewis was also modest about his own ambitions as a twenty-something young person. Greg Smith, however, comes across as an earnest over-achiever who was proud of making it in the competitive world of Goldman Sachs. To cite one example, he stresses how rigorous the recruitment process was, pointing out that only 2.2 percent of people who apply for internships or full-time positions get an offer (p. 9). He was clearly pleased to be in the 2.2 percent. By contrast, Lewis “takes his own advancement as a sign that something’s not right at Salomon Brothers” (to quote Urstadt's review). A little humility would have helped Smith’s case.

And he’s not nearly as entertaining a writer as Lewis. Smith narrates at least two brief conversations with Goldman big-shots happening at urinals, and it just sounds weird. Lewis, a born storyteller, would have made more of this material.

Whereas Lewis quits after seeing the absurdity of Wall Street’s bond market, Smith only gradually sees Goldman’s greed and ethical shortcomings. For years, he doesn’t ponder the absurdity of profiting from complex financial instruments that few people understood. Instead, he was so gung-ho about Goldman that he did corporate recruiting for them.

Still, even if it lacks drama, Smith’s story of growing disenchantment with an employer he loved does tell us something about Wall Street's role in the global financial crisis. We can profitably read Why I Left Goldman Sachs as an accurate picture of a typical young person who entered Wall Street in the early 2000s. And we should read the details, while not bombshells, as significant indicators of the corrupted culture of Wall Street, from a highly sympathetic source. 

What follows are a few glimpses inside the “great vampire squid’s” way of doing business, by one who was there and saw how it contributed to the global financial crisis.

Goldman Sachs became a hedge fund rather than a trustworthy adviser. A number of reviewers have glossed over this important point, but it seems central to Smith’s departure. As he puts it, “a fiduciary stood in a special position of trust and obligation where the client was concerned. This role was applicable when the firm was advising the client about how the client should best invest its money versus pushing the client into investments that generated the largest fees. . . . This ideal of doing what is right for the client, and not just what is right for the firm, was there, prescribed in the 1970s by former senior partner John Whitehead in his set of 14 Principles” (p. 111).

So what had changed? Goldman had been privately held until 1999, and its partners could maintain control of the firm. Once Goldman went public, issuing stock in 1999, the pressure to generate ever-higher profits increased, and the partners lost control. Instead of investment banking, “proprietary trading” became the profitable service to sell. And sometimes Goldman would become a co-investor in such trades. “In the old days,” writes Smith, “the firm would advise a client to invest its own money in something; in the new universe, the firm could now invest its money in the same thing” (p. 113). The problem, however, was “when the firm changed its mind (or masked its intentions) and made a bet in the other direction from the client’s” (p. 113).

In other words, Goldman might advise a client to buy into a complicated scheme and then turn around and bet against that scheme. Such conflicts of interest became more common, but Smith trusted his bosses “for a long time” (p. 114).

By the end of 2008, however, Smith says that he was growing wary of a corporate culture that promoted a trader to managing director who was gouging clients (pp. 154-55).

When Senator Carl Levin of Michigan held public hearings in 2010 on a famously “shitty deal” that Goldman advised its clients to buy—the perfect example of a conflict of interest and what Goldman called an “axe” (see below)—Smith watched them on TV in Asia, where he met with a client the next day. When the client said that he couldn’t trust Goldman, Smith’s instinct was to think of how to fix the problem (p. 186). But the high-level Goldman partner working with him didn’t seem to care and was only interested in making money in the short-run. “Maybe this was an isolated example, but it was not what I expected from a partner” (p. 187).

However, other evidence from the book suggests that this was not an isolated example.

PATC meetings or Bonus Day
Smith explains how a ten-minute meeting each December would decide each employee’s Per Annum Total Compensation (PATC). Informally, Goldman people called the ritual Bonus Day. As he puts it, “there was an absurd amount of emphasis placed on these meetings. For many people, the session determined a person’s entire self-worth” (p. 119).

On Bonus Day 2006, when he was in his mid-20s, Smith was told that he would make “close to half a million dollars” (p. 119). And, even though he had also been promoted to becoming one of thousands of vice presidents, he was disappointed!

Later, he describes how the compensation system became “largely mathematical: you were paid a percentage of the amount of revenue next to your name” (p. 233). Naturally, “the problem with the new system was that people would now do anything—anything—to pump up the number next to their name,” which poisoned “young minds” (p. 233).

An excessive focus on individual compensation, regardless of how well you served your clients, surely helps to explain the problem, even at Goldman, which was widely considered to be the best-run, most ethical Wall Street firm. No less than authority than Nouriel Roubini contends that compensation was a root problem in the crisis (Crisis Economics, pp. 68-69, 184-91).

Even if Smith is motivated by sour grapes, which he denies, the problem of compensation, attached to booking profits without regard to consequences, remains.

Elephant Trades and GCs
Amid growing uncertainty in 2007, Smith also explains a growing emphasis on making huge “elephant trades” that made Goldman a million dollars or more in profit. “When you executed one of these trades, the revenue would go next to your name in the form of a gross credit, or GC” (p. 126). Later in the book, he describes the focus on GCs as corrupting Goldman’s culture (pp. 190, 229, 234). He tells how his supervisor, Georgette, came to his desk and said, “The only time I want to hear from you is in the form of a one-line email that states how the big trade was and what the GCs were” (p. 225). This emphasis confirms the impression that profit crowded out care for clients and corroded Goldman’s organizational culture (Smith’s primary grievance).

While others think Smith is naïve to complain about this—we are talking about Wall Street after all—he is documenting an important shift in Goldman’s culture. And it’s a story connected to larger cultural shifts (from Enron to professional sports and beyond). As profit becomes everything—or the only thing—communal trust is corroded. 

“Structured derivatives” and selling tuna
Smith describes how the complex financial products called derivatives could harm real people. For example, the city of Oakland bought a swap from Goldman that was designed to hedge against interest rate increases. “The product ultimately backfired, and is now costing the city millions of dollars” (p. 152). He likens Goldman’s sales of derivatives to a company that sells tuna:

The can clearly says, “Bumble Bee tuna,” and features a cute little logo. You go home, and most of the time you enjoy some delicious tuna. But let’s say you get home one day and find dog food inside the can. How can this be? you wonder. They told me it was tuna. But then you look at the back of the can. There, in print so tiny as to be almost unreadable, is printed something like “Contents may not be tuna. May contain dog food.” (p. 153).

Unfortunately, “most clients pay as close attention” to “the fine print of the ten-page disclaimer at the end of the contract” as “you do when you hit the Accept button before downloading music from iTunes”(p. 153).

Clients beware?
A reasonable person might therefore counter that buyers should be aware of what they are buying, especially when they are investing millions of dollars in pension (or other) funds for someone else. But Smith contends that Goldman preyed on the “Client Who Doesn’t Know How to Ask Questions.” Such clients were “the perfect target to sell a type of derivative known as an exotic—a very complex product that could be made to look much simpler for the client when dressed up with enough bells and whistles as a structured product” (p. 163). In other words, they were buying tuna cans that might have dog food in them, but they had no idea.

Smith says that some of these clients would end up on Goldman’s top 25 clients list, as ranked by the fees they paid to Goldman. “There is something highly disconcerting,” he writes, “about seeing a global charity or philanthropic organization or teacher’s pension fund in the top twenty-five of a firm’s clients” (pp. 163-64). In other words, Goldman profited from the naïveté of these non-profit clients.

Selling Axes
Smith says that he was bothered by pressure to sell risky investments or positions that Goldman wanted to axe from its books, even though it knew that these investments would harm clients. Here’s how Smith nicely describes the problem:

The firm believes, deep down, that one outcome is going to transpire, yet it advises the client to do the opposite, so the firm can take the other side of the trade and implement its own proprietary bet. One way to understand this is to think of selling donuts. Say you own a Krispy Kreme doughnut store, and you have too many doughnuts in stock and need to sell them before they go bad. In order to drive up sales, you could say “Our doughnuts are fat-free!” That would technically be a lie, but it wouldn’t get you sent to jail. It might open you up to legal action, but who really wants to go to court? Suddenly people would be rushing in to buy these delicious Krispy Kreme doughnuts, convincing themselves that if a brand as reputable as Krispy Kreme is saying the doughnuts are fat-free, then it must be true. Axes are something like surplus Krispy Kreme doughnuts that Goldman wants to clear from its inventory, making a compelling, but not always completely accurate, case for clients to buy them. (pp. 230-31).

The most famous axe of all was the notorious Abacus/Timberwolf deal made famous by Senator Carl Levin in the following interchange with Goldman witnesses.

The problem with this deal was that Goldman could “see what both buyers and sellers [were] doing” (p. 185). It knew that the Timberwolf investment was a bad one, and advised clients to buy it, yet at the same time that it was also betting its own money that Timberwolf would crash in value.

This problem of “asymmetric information” means that Wall Street firms like Goldman are like casinos that can “effectively see everyone’s cards” and even determine which cards you get (in complex, unregulated derivatives. “Certainly not much scope for the casino to lose in this scenario” (p. 248).

Working in London, Smith was involved in selling dubious products akin to the “fat-free” Krispy Kreme donuts to “the national banks of sovereign nations, countries with millions of citizens who were depending on their governments to get their shit together” (p. 232).

Goldman Sachs’ behavior had terrible real-world consequences for governments in Europe and around the world. Ripping off these central banks is hardly ethical business, and Smith is right to be upset about this.

A whitewashing self-study
Smith describes how Goldman went through a year-long Business Practices Study, ending in January 2011, which appeared to be more of an exercise in PR and spin than a genuine attempt to learn lessons from the crisis, dashing his hopes (pp. 192, 218-19). In a follow-up seminar to discuss the study a few months later, Smith says that he suggested to a high-level partner that managing directors needed “to be held accountable” and reforms be put into practice, but the partner “looked at me with a blank stare and nodded wordlessly, almost robotically” (p. 230).

We shouldn’t be shocked that Goldman failed to police itself as it ripped off its own clients. “This was happening all over Wall Street,” writes Smith, “but Goldman Sachs was supposed to be a leader” (p. 241).

Or maybe it really was just a huge vampire squid.

Either way, Greg Smith is free now.

Monday, December 3, 2012

Mashup: Twitter, Celebrities, and the Middle East

First it was Paris Hilton and now it's Kim Kardashian. When reality TV celebrities with Twitter accounts are unleashed on Middle Eastern shoppers, you can expect controversy. But this is not a simple story of hatred of the West. Rather, globalization is the issue.

In case you missed the last week's worth of celebrity news, Ms. Hilton and Ms. Kardashian are both branching out into global retail. Neither of them, however, expected to generate a backlash when doing PR for new stores opening in the Arab world. But they did.

When Ms. Hilton recently tweeted, "Loving my beautiful new store that just opened at Mecca Mall in Saudi Arabia!", she immediately generated a firestorm of comments against the commercialization of the holiest site in the Islamic religion. It's true: the Saudi regime has allowed all kinds of commercial development within the precincts of the holy city, and this is actually the fifth Paris Hilton store in the country.

"Everything that is holy is profaned," wrote Marx and Engels. But even they might have been appalled by this extension of global commerce into sacred territory.

 And now Ms. Kardashian has provoked a demonstration in the tiny island state of Bahrain, where she was invited to promote the opening of a new store in a chain that sells milkshakes. When she arrived in the country, she tweeted, "I just got to ! OMG can I move here please? Prettiest place on earth!"

Despite this seemingly positive spin on Bahrain, Ms. Kardashian's visit generated protests, which may have required some tear gas to be put down.

Why would her visit provoke a riot? Do Bahrainis hate reality TV or milkshakes? Wouldn't they be flattered that an American celebrity loved their country? She also visited Kuwait, and there were no protests there.

Well, it turns out that Ms. Kardashian was being attacked on Twitter by Amber Lyon, an ex-CNN journalist who reported some of the most damaging stories on the Bahraini government's crackdown on pro-democracy protesters and who won a number of admirers among the Bahraini opposition. Ms. Lyon's take helps us understand how Bahrainis might see it.

Here were Ms. Lyon's responses on Twitter, escalating the rhetoric:

  • Kim K doing more PR for dictator RT: ":Thanks Sheikh Khalifa for your amazing hospitality.I'm in love w/ # Bahrain
  •  .'s tweets supporting regime are so ignorantly reckless, she is now complicit in doing PR for dictators 
  • Hey ,since ur now 'besties' w/Bahrain dictators, plz ask them to stop torturing & murdering journalists, doctors. Thx. 
My guess is that Ms. Lyon's efforts helped to spark some of the outrage, although Ms. Kardashian's utter ignorance of Bahraini politics may have been enough.

Either way, however, Twitter is helping to fan the flames of  existing conflicts, speeding up the response of audiences across the world. And if nothing else, this silly little media firestorm illustrates the globalization of media.

We live in a crazy world.

Monday, October 29, 2012

A Visit With Friends

Readers of this blog may recall how, during the so-called Arab Spring, our Bahraini friend, Shubbar, was first arrested and arbitrarily detained, only to be released after fifty days, by which time the government of Bahrain had arrested his father-in-law and two brothers-in-law.

Yesterday, even as Hurricane Sandy was blowing in to our region, we had the privilege of meeting with him and his wife, Hajar, for an all-too-brief lunch here in the States. And we are delighted to report that he and the family are doing very well. Shubbar is enjoying his freedom.

However, his father-in-law received a ten-year sentence from the Bahraini government last year--merely for expressing his political opinions non-violently. Hajar and Shubbar are trying to tell their story and raise awareness of what the government of Bahrain is doing to continue to crack down on the majority population of the country (the Shia, who make up around 60-65% of the population).

Whether Romney or Obama is president for the next four years, I hope either administration will put pressure on the Bahraini government for its ruthless crackdown on peaceful dissent in the spring of 2011. 

Hajar's father's case is being appealed, and there is a chance that a judge might release him or reduce his  sentence. That would be a good sign for the future reconciliation of the Bahraini people--something we should all hope for.

Wednesday, September 12, 2012

Upward Mobility in America? Maybe Not.

Inspired by old Horatio Alger tales, Americans tell themselves that anyone can work hard and succeed here. But is that true? 

One of the most important policy questions for the United States is whether young people from less-privileged backgrounds have the opportunity to go to college. All they need is pluck and determination. But is that true? 

Looking globally, Americans also think that upward mobility is more common here than in old Europe, which traps people in dependency on government welfare states. Americans tend to think that the European countries have static class systems that keep people in their place, while we have an open system that allows people to rise or fall based on individual accomplishments. But is that true?

Maybe not. A recent report on education from the Organization for Economic Cooperation and Development (OECD), which is basically an international club of rich country governments, suggests that the United States lags behind other wealthy countries in educational opportunities for mobility. 

Consider the following striking chart from the OECD education report (on page 102 in the original PDF).

This is a complex graphic, so here's the official OECD explanation for how to read it:
The chart shows the odds of someone from a low educational background attending higher education. The odds ratio is calculated by comparing the proportion of parents with low levels of education in the total parent population to the proportion of students in higher education whose parents have low levels of education. Taking the results for the United Kingdom as an example: 25% of all students in tertiary education have parents with low levels of education (light blue bar), while 42% of the parent population have a low levels of education (dark blue bar). This results in an odds ratio of 0.61 (dark triangle). If young people from a low educational background in the United Kingdom were as likely to attend higher education as those from more educated families, 42% of the student population would come from low educational backgrounds, giving an odds ratio equal to 1  (p. 102).
Now let's look at the United States (on the far right hand side of the chart). Roughly 18% of the population of parents in the United States has a low level of education (defined as not completing high school). But only a tiny percentage of this group's kids--kids who are now between the ages of 25 and 34--have gone on to participate in higher education. Now, in fairness, the report adds a note that Australia, Canada, New Zealand, and the US may be under-reporting their numbers, so they could be skewed low. We should also look at historical trends.

But the larger point remains, and the numbers reinforce common sense: in the United States, if your parents dropped out of high school, it is highly unlikely that you'll go on to college. 

And we're not even talking about completion of a degree program (whether a two-year associate's or  bachelor's). Even if a child of high school dropouts starts college, it is unlikely that he or she will finish. Across the whole OECD, an average of only 20% of the kids of high school dropouts ever get a post-secondary degree, and the US, Italy, Portugal, and Turkey fall well below this average. In fact, according to the report, over forty percent of the current batch of children of high school dropouts (currently aged 25-34), in both the US and those other three countries, haven't even completed high school themselves!

From firsthand experience at universities like my own, faculty and staff know that many "first-generation college students" (which includes children parents who have finished high school and/or completed some college classes) struggle to figure out how to navigate the system and graduate within six years. 

Responding to these concerns, the Gates Foundation recently funded a website that focuses on college completion. The idea is to figure out who is doing well and who is doing poorly at getting their students to finish with a degree. If completion is the goal, why not focus on measuring it?

Imagine yourself as a poor American kid from the country or from the city whose parents dropped out of high school. You hear people telling you to work hard. But you're in a school system that lacks resources or in a family that is struggling to get by. You can succeed, but only against a host of sociocultural forces working against you. You don't Horatio Alger tales; you need major support.

The contentious debate over "education reform" is driven partly by a desire to help kids like this, partly by a desire to promote justice and equal opportunity, and partly by a desire to gain economic competitiveness in an age of fierce competition and globalization. 

No matter the motivation, Americans have a lot of work to do in making the rhetoric of upward mobility a reality. 

Tuesday, September 4, 2012

The Outsourcing of Labor and Dis-Integration of Production

Yesterday was Labor Day--a great time to pause and think about how work has changed from the good old days of unions and posh benefits. Outsourcing and global production have undermined corporations and workers alike. But they empower those who can take advantage of the new game.

The extreme edge of this new game can be understood in a provocative thought experiment posed by professor Gerald Davis of the University of Michigan Business School in a recent conference paper (thanks to this New York Times blog for first alerting me to the paper). Professor Davis imagined how you could create a killer new iPhone app called "Remote Drone Assassin" along with actual drones that you could sell to mercenary companies, "without leaving your couch."

First, he wrote, you could go to the Plug and Play Tech Center and rent a  desk and fancy mailing address. (Why bother with a real corporate HQ?)

Second, you could "incorporate online in Liberia for $713.50" through the Liberian Registry site. (Who needs lawyers in Delaware?)

Third, you could fund your idea through the crowdsourcing site Kickstarter. (Who needs venture capital anymore?)

Fourth, you could hire programmers to actually design your software app through ODesk, "the world's largest and fastest-growing online workplace." (Who needs to hire people you even know?)

Next, you could hire a low-cost Chinese manufacturer to make your drones through (Who needs to make it at home?)

If you don't want to sell through the Apple Store or Amazon, you could arrange payment through Square, which allows you to charge credit cards through your iPhone or iPad. (Who needs to work directly with the credit card companies?)

Finally, when it comes time to ship the goods to the mercenary company, you could use Shipwire. (Why bother with the biggies like UPS or FedEx?)

You never left your couch, and you managed to employ a bunch of subcontractors to bring your drone and its app to market. Still, what have you actually contributed to the US or world economy? Did you actually work? You never left your couch.

An extreme scenario, perhaps, but it illustrates the loss of the ideal of craftsmanship--the satisfaction of being involved in the whole of a process, from beginning to end (a key theme in chapter 5 of my book). Professor Davis' scenario also helps us understand the puzzle of the jobless recovery. Profits and economic growth occur all along the way, but no U.S. workers are employed. Except for maybe one couch potato.

Thankfully, this is an absurd extreme, but it does suggest that if we are not careful we may outsource ourselves to death.

Tuesday, August 28, 2012

Jobless Economic Growth?

Note: This blog took an unofficial summer sabbatical, but I hope to start posting again as the school year gets rolling.

Why does a company like Apple boom at the same time that few jobs are being created?

Over the last few years the U.S. economy has been growing (according to GDP figures) and corporate profits have been solid (record-setting, in Apple's case). But job creation is stagnant. What gives?

One big reason is the spread of automation, outsourcing, and cloud computing (using networks of others' computers to complete tasks). Today's New York Times ran a prominent  story on Amazon's cloud computing services with two rather telling quotes in it.

First was a quote from the founder of a young company called Cue, which scans huge amounts of data and provides personalized services with it. Its founder said,
I have 10 engineers, but without A.W.S. [Amazon Web Services] I guarantee I’d need 60,” said Daniel Gross, Cue’s 20-year-old co-founder. “It just gets cheaper, and cheaper, and cheaper.” He figures Cue spends something under $100,000 a month with Amazon but would spend “probably $2 million to do it ourselves, without the speed and flexibility.”
So his company may become profitable (as will Amazon) but he can employ a fraction of the engineers he once would have needed.

Another quote reinforces the point. This was from the CEO of Good Data, a company that sifts through data to help with sales:
“Before, each company needed at least five people to do this work,” said Roman Stanek, GoodData’s chief executive. “That is 30,000 people. I do it with 180. I don’t know what all those other people will do now, but this isn’t work they can do anymore. It’s a winner-takes-all consolidation.”
From 30,000 to 180. And we wonder why profits and unemployment (even among tech-savvy groups like engineers) are both up at the same time?

Monday, May 21, 2012

The Arab Uprisings: 1848 All Over Again?

“I believe that right now we are sleeping on a volcano . . . Can you not feel . . . the wind of revolution in the air?” Shortly after a perceptive political observer uttered these words, the uprisings began. Unemployed workers, radical university students, reform-minded middle class workers, ordinary peasants and even women and children marched toward the square outside the parliament to demand reform.

But they were met by government forces manning barricades, and bloody clashes soon broke out as the crowds surged against the barriers, eventually pushing through. After attempts to placate the crowds with half-measures for a few critical days, the head of state was forced to flee the country in disgrace. Revolutionaries across the region took heart and charged into the streets, threatening their regimes with massive protests.

This was  not Egypt and the Arab World in 2011 but France and Europe in 1848, and the perceptive political observer was none other than Alexis de Tocqueville.

What similarities and differences can we observe between this earlier revolutionary wave and the “wave” of revolutions that swept across the Middle East and North Africa region in 2011-12? This latter wave ousted regimes in Tunisia, Egypt, Libya, and Yemen; it destabilized those in Syria and Jordan; and it left no country in the region unaffected. By contrast, only France’s monarch was removed in 1848. 
Sites of major uprisings in 1848

What contributed to the uprisings of 1848? How do they compare to the Arab uprisings? And what might the comparison teach us about globalization and political change?

To answer these questions, I picked up a recent book, Mike Rapport’s 1848: Year of Revolution (Basic Books, 2008), and compared it to Robin Wright’s Rock the Casbah: Rage and Rebellion Across the Islamic World (Simon and Schuster, 2011), Marc Lynch’s The Arab Uprising: The Unfinished Revolutions of the New Middle East (Public Affairs, 2012), and James Gelvin’s The Arab Uprisings: What Everyone Needs to Know (Oxford University Press, 2012). Reading these together offers several lessons about rapid political change in a globalized world.
1. Comparing 1848 to the Arab Spring
Mike Rapport identifies several trends that had emerged by the mid-nineteenth century to make possible the fast-moving diffusion of revolutionary protests in Europe, and each of these has analogues in the Arab world today.

a. Increasing literacy rates and the growth of civil society leading to imagined unity
By 1848, Prussia had an impressive 80 percent literacy rate and France’s was 60 percent. More broadly, Europeans had embraced the ideal of civil society, “a cultural and social space independent of the state, where individual citizens could engage in discussion, debate and criticism of everything from art to politics” (p. 22). Embracing this ideal of civil society helped Europeans to imagine themselves as sharing something in common. If only for a moment, they were united. As an example, Rapport cites a Polish Democratic Society appeal to France on the basis of “the will of peoples—and not that of the cabinets usurping their rights—as the basis for international relations in the future” (p. 412). Both Polish and French liberals saw themselves as united.

Similarly, Marc Lynch builds on his previous book, which argued that the emergence of an Arab public sphere, seen mostly clearly in the widespread popularity of the Al Jazeera Arabic television channel, allowed ordinary Arabs to imagine themselves as part of a larger Arab public. Egyptians, Yemenis, or Libyans viewed themselves as connected to their Tunisian brothers and sisters. If anything, an Arab public space emerged more easily than a European public space, due to a common Arabic language across the region. Lynch notes in passing how the “Arab cold war” of the 1950s was inflamed by Egypt’s Voice of the Arab radio station and its appeals to the Arab masses. Thanks to al Jazeera, however, the “Arab uprising [in 2011] unfolded as a single, unified narrative of protest with shared heroes and villains, common stakes, and a deeply felt sense of shared destiny” (Wright, p. 8).

b. Widespread pressures for political reform, combined with economic crisis (Rapport, p. 105)
Across Europe, the old regime had failed to accommodate increasing desires for political and civil rights or national autonomy. But a global economic (food) crisis, combined with rapid technological changes, was disrupting lives across the continent. Regimes can easily put off political reform when people are well-fed and confident about their economic future. But when people are hungry and the economy goes sour, incumbents are in trouble. The incumbents in the European case, like Hosni Mubarak in Egypt, had been around for over thirty years.

The importance of economic crisis is evident in the catalyst for the current wave. Everyone agrees that the December 2010 self-immolation of Mohamed Bouazizi, a twenty-six year old fruit vendor in a poverty-stricken townin Tunisia, was the spark that kindled the revolutionary fires and was motivated by poverty and despair (see Wright, pp. 7-8). Young people across the Arab world shared his frustration with the economic and social status quo--a frustration noted in the Arab Human Development Reports of the last decade. Adding political frustration over corruption to economic despair, young Arabs were ripe for revolt.

c. Technology that speeds up communication
As Rapport puts it, “In 1789 it took weeks for news—carried, at its fastest, on horseback or under sail—for the fall of the Bastille to be relayed across Central and Eastern Europe. In 1848, thanks to steamships and a nascent telegraph system, reports were being heard within days or even minutes” (106). These dramatic technological changes help explain why a revolt that began in late February in Paris could inspire movements in Berlin, Vienna, and Venice within weeks. Globalization itself doesn't cause revolt, but it speeds up the process of change.

Although James Gelvin is skeptical about the “wave metaphor” (pp. 30-31, 155-56) and about the role of technology in the Arab protests, Marc Lynch describes a flurry of self-declared “hashtag revolution” protest days that were announced on Twitter between February 3 and March 24, 2011. While no serious scholar would argue that technology causes revolutions or obviates traditional political structures, it is obvious that technological innovations like Twitter, Facebook, and cellphones sped up communication. Gelvin writes that “there is no evidence to demonstrate that social media have played any more of a role in the current uprising than the printing press and telegraph played in earlier uprisings” (158). But this does not deny that communications technologies have played an important role and that they hasten the networking of revolutionaries. Lynch and Wright are the better guides on this issue.

d. A crisis of confidence among (some) leaders (Rapport, pp. 107, 410)
Rapport notes that several of the leaders hesitated in the face of widespread popular protest, agonizing over using force against their own citizens and wavering between cracking down or granting concessions. Notable among them were the French monarch, King Louis Philippe Bourbon; the Austrian Chancellor, Prince Clemens von Metternich; and the Prussian king, Frederick William IV. (Only the latter survived the crisis.) By contrast, the Russian tsar, Nicholas I, never hesitated in cracking down on liberal and nationalist reformers in his domains, and he intervened militarily to crush revolts in Romania and Hungary. Other leaders, notably in the Netherlands and Belgium, “made timely concessions before anything like a groundswell of opposition could pose a serious challenge” (98).

The parallels to leadership strategies in the Arab uprisings are nearly exact. Consider the three major options for leaders in 2011:
  • Neither all carrot nor all stick, or those who wavered and were lost:  Presidents Mubarak of Egypt, Ben Ali of Tunisia, and Saleh of Yemen.
  • The stick strategy, or those who cracked down and survived (thus far): the Al Khalifa family of Bahrain, King Abdullah of Saudi Arabia (in Bahrain), and President Bashar al Asad of Syria.
  • The carrot strategy, or those who made pre-emptive concessions and survived (thus far): King Abdullah of Saudi Arabia (internally), Sultan Qaboos of Oman, King Abdullah of Jordan, King Mohamed VI of Morocco,
The major exception here is Libya, where Muammar Qaddafi tried the stick strategy and was defeated by rebel forces, assisted by NATO airpower (Lynch, who advised the White House during the uprisings, reviews this case well.)

e. The importance of coalitions (Rapport, pp. 108-9, 261)
Rapport contends that the uprisings in 1848 temporarily united disparate political forces: poor urban workers who wanted better economic conditions, rural peasants who were desperately poor, and middle class liberals who wanted political and civil rights or national autonomy. When these three groups could stick together and cooperate, they tended to get more results, but the conservative regimes were often able to regain the loyalty of the peasantry by abolishing serfdom and rallying the newly liberated peasantry around religious or national symbols.

Although we do not yet have detailed studies of the coalitions in the Arab uprisings, we will likely find similar coalitions of disparate groups with clashing interests and identities in the thick of it. We do know from journalists that young people, secular liberals, Islamists, and unionized workers (especially in Egypt) are key players in the revolutionary coalition.

2. Lessons about globalization and political change
Rapport’s history also yields a few lessons for those of us in the business of making sense of globalization and Middle East politics.

a. The illusion of simple narratives
As Anne Applebaum noted in Slate last year, the uprisings of 1848, like the Arab revolts, occurred for a myriad of local reasons. We must be careful to see the local and contextual factors--not just the global "wave" (and here Gelvin's cautions are warranted). While there is no question that the inspiration for revolution spread between countries, specific political grievances drove the process of change within each country. Bahrain’s fragile sectarian balance, for example, with a minority Sunni regime governing a Shiite majority, is quite different than Syria’s, where an Alawite minority ruled a restive Sunni Arab majority and pro-regime Christian minorities. Libya's regional and tribal differences are critical to understanding the opposition to Qaddafi. In short, the story is complicated, as it was in Europe. And all the politics were local, even if the mediascape was global.

b. The illusion of major change and permanent unity
Rapport borrows the term “lyrical illusion” from a French historian, Georges Duveau. Duveau contends that the revolutionaries acted on two illusions in 1848: first, “the idea that the people had indeed triumphed over the old regime and even defeated its armed forces;” and second, “the idea that the revolutions marked a new beginning, one in which the unity of all classes and people could nurture the delicate growth of a new freedom and a new, liberal order” (pp. 110-11). Neither of these ideas proved to be true in 1848: the armed forces and most regimes kept their power, while the revolutionary coalition was picked apart and peasants started backing the monarchs. As a result, the revolutions of 1848 failed to topple regimes except in France.

In the heady days of Tunisia’s Jasmine Revolution or Egypt’s Tahrir Square uprising, many shared the “lyrical illusion.” But 1848 reminds us to be humble about the prospects for change. The counter-revolutionary forces triumphed at the time, even in France (when the new president of the Republic, Napoleon III, made himself into a monarch within a few years). Likewise, it is not yet clear that the armed forces in Egypt have truly relinquished power. The upcoming presidential elections there will be an interesting test, and it’s quite likely that the winner will be an army-friendly member of the old regime.

c. The difficulty of keeping radicalism at bay and constructing a new order
Once the forces of change are unleashed, it can be hard to contain them. An American diplomat watching events in Vienna in 1848 noted that “the moderate supporters of the constitution were fighting a ‘double conflict . . . first, that of the people against the old form of government; secondly, that of the new form of government against the Radicals, or enemies of all government’” (Rapport, p. 227). Rapport counts this as “one of the great tragedies of 1848: that the social and political unity that had secured the victory of the opposition in the initial revolutionary outbursts proved to be so fragile” (p. 406).

Similarly, the transitional regimes in both Tunisia and Egypt have struggled to deal with continued protests from those unhappy with anything less than radical change. With the remnants of corrupt regimes often remaining in place, is moderate reform enough? The dangers of being co-opted by those remnants remain. It is difficult to construct a new regime in the midst of pressures from both radicals and old regime supporters.

As historian Jonathan Steinberg put it, “it is easier to overthrow the old regime than build a new one.” 

Nevertheless, a major lesson of the crises of 1848 is that a short-run victory for the forces of counter-revolution might only postpone a reckoning with the forces of change. Russia managed to stave off pressure in 1848, but the pent-up frustrations contributed to revolution in 1917. Prussia saw the ascent of a counter-revolutionary leaders in Bismarck, but the pressure to liberalize continued. Bismarck, despite being a conservative, instituted a welfare state in Germany as a classic “carrot strategy” to pre-empt protest. Social and economic change occurred, even when regimes stayed in place.

The Arab uprisings of 2011 have already ousted more old regimes than the European wave of 1848. And this story is far from over.

Wednesday, May 16, 2012

A Financial Thriller?

Review of Robert Harris, The Fear Index. New York: Alfred A. Knopf, 2012

Several months ago, some members our family were settling down for a Friday movie night and a guest asked what we were going to watch.

"Margin Call," I said.

"What's that about?" our guest asked.

"It's a financial thriller."

"What's a financial thriller?" said the guest.

That was a great question. It's not exactly a familiar film or novelistic genre.

But the recent global financial crisis has spawned a few engaging stories, both fictional and journalistic, that also educate us a bit on the world of high finance (many of them reviewed in this space).

For a recent case in point, consider English novelist Robert Harris' most recent book. The Fear Index tells the story of Alexander Hoffman, an American physicist turned hedge fund trader, whose life is completely upended when a computerized algorithm invented by Hoffmann starts acting autonomously. This algorithm, called VIXAL, threatens to take over Hoffman's life and business. It all comes to a head in a crazy twenty-four period that begins when Hoffmann receives a rare first-edition copy of a book by Charles Darwin in the mail from an anonymous source.

Although the plot is "wholly implausible," as the Economist reviewer put it, the novel weaves together three main questions into a truly page-turning and engaging read. First, a classic science fiction strand: what would happen if machines, which dominate our lives, start taking autonomous action? Second, an interesting thought experiment: what if those machines followed Darwinian logic and sought to dominate the world? (It's significant that quotations from Darwin's works head nearly every chapter.) Third, a straightforward teaching function: what are hedge funds and how do they work?

It's this last point that interests me the most here. The Economist, which knows these things, says that "as a guide to what hedge funds actually do, [the book] is surprisingly clear and instructive." 

Two passages in the book illustrate this teaching function. First, in a few colorful (and creepy) sentences, Harris manages to explain hedging strategies of traders in a way that makes sense. Alexander Hoffmann, the main character, has just met an English financier who wants to recruit him to start a hedge fund. Hoffman asks, "What's a hedge fund?"

The English financier tells him to look across the room at a woman. He says that he is absolutely convinced that she is wearing black underwear, and he wants to bet a million dollars that he is right.
The trouble is, if I’m wrong, I’m wiped out. So I also bet she’s wearing knickers that aren’t black but are any one of a whole basket of colours—let’s say I put nine hundred and fifty thousand dollars on that possibility: that’s the rest of the market; that’s the hedge. . . . Now, if I’m right, I make fifty K, but even I’m wrong I’m only going to lose fifty K, because I’m hedged. And because ninety-five percent of my million dollars is not in use—I’m never going to be called on to show it: the only risk is in the spread—I can make similar bets with other people. Or I can bet on something else entirely. And the beauty of it is I don’t have to be right all the time—if I can just get the colour of her underwear right fifty-five percent of the time I’m going to wind up very rich. (p. 177)
That's what hedge funds do. They leverage their money across multiple risky bets, while hedging those risks to try to limit the damages if their bets about the future are wrong. And they may be speculating over very intimate details of our lives. (The creepiness of speculating on the color of a woman's underwear is essential to the character that Harris is sketching here. He's not condoning it so much as trying to depict how a real hedge fund trader would talk.)

The second example comes late in the book, when the VIXAL program appears to be running out of control:
That VIXAL was purely mechanical and possessed no emotion or conscience; that it had no purpose other than the self-interested pursuit of survival through the accumulation of money; that it would, if left to itself, in accordance with Darwinian logic, seek to expand until it dominated the entire earth—this did not detract for Hoffmann from the stunning fact of its existence. He even forgave it for the ordeal it had subjected him to: after all, that had purely been for the purposes of research. One could no more pass moral judgment on it than one could on a shark. It was simply behaving like a hedge fund. (pp. 262-63)
"It was simply behaving like a hedge fund." And how does a hedge fund behave? Like the machine, it has "no purpose other than the self-interested pursuit of survival through the accumulation of money."

Most ordinary people have no idea that the hedge fund world even exists. But the recent news about J.P. Morgan's two billion dollar loss in a risky hedging trade reminds us that overly aggressive risk-taking can be disastrous for banks and the ordinary people who use them.

Still, despite the crucial importance of risk-taking in the global financial system, "financial thrillers" will always attract a small audience. Our guest stayed to watch Margin Call, but fell fast asleep halfway through. 

Wednesday, March 14, 2012

Money or Service? Goldman Sachs Exposed

After almost twelve years at the Wall Street firm Goldman Sachs, Greg Smith resigned yesterday.

People quit jobs every day, but this executive director at one of the biggest global financing firms published his complaints against his former employer on today's op-ed page of the New York Times. Needless to say, he's making a splash in the world of high finance.

One way to interpret what he's saying is that the film "Margin Call" could have been a documentary. In that minor Hollywood release, Jeremy Irons' character (John Tuld) utters a memorable line (a far more subtle one than Gordon Gekko's famous "greed is good" from Oliver Stone's Wall Street):
"There are three ways to make a living in this business: be first, be smarter, or cheat."
According to Smith, this ruthless logic has taken hold at Goldman Sachs.

Consider this exchange from Margin Call:

Sam Rogers [Spacey]: And you're selling something that you know has no value?
John Tuld [Irons]: We are selling to willing buyers at the current, fair market price.

This kind of mindset, according to Greg Smith, has taken hold at Goldman Sachs, which was once the envy of the financial world for its customer care, humility, and integrity.

According to Smith, Goldman is now morally bankrupt.  As he puts it in today's Times (underlining is mine),
Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. . . .
It makes me ill how callously people talk about ripping their clients off.
. . .
These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave.  
. . .
I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer
This is exactly the heart of the problem (as I've put it before): the pursuit of money, a good external to the actual welfare of one's customers, is trumping the goods intrinsic to the pursuit of one's business, which would be devoted to providing the best service to one's customers.

Smith is right--and we should all applaud him. He didn't just tell the boss to "take this job and shove it." He blew the whistle on corruption at the heart of Wall Street, while pointing to a better way.

Saturday, January 28, 2012

American Manufacturing and Globalization

Jason Reed/Reuters
Yesterday in a speech at the University of Michigan, President Obama stated that "when manufacturing does well, then the entire economy does well." He's trying to press colleges to lower their costs and make higher education more affordable, in the hope that they'll train more wealth-creating workers. Leaving the domestic politics aside, it was an interesting week to make this case, because two stories highlighted how globalization and technological change are hurting American workers.

Maddie Parlier at Greenville Standard Motor Products
Photo credit: Dean Kaufman for Atlantic Monthly
First, the current issue of the Atlantic Monthly ran an excellent story by Adam Davidson on how difficult it is for moderately educated workers to compete in an increasingly global, increasingly automated manufacturing workplace. Davidson, my favorite economics journalist at NPR, focuses on the plight of a 22-year old single mom named Maddie Parlier who has two kids and no college education. She's working an entry-level job at a plant that makes fuel injectors, making around $13 an hour, with little prospect of advancement.

In order to move up a level on the payscale to "Level 2" and boost her pay by about half, Maddie would need to learn a lot more in order to have the necessary skills to program the machines she currently mans. As Davidson puts it,
It feels cruel to point out all the Level-2 concepts Maddie doesn’t know, although Maddie is quite open about these shortcomings. She doesn’t know the computer-programming language that runs the machines she operates; in fact, she was surprised to learn they are run by a specialized computer language. She doesn’t know trigonometry or calculus, and she’s never studied the properties of cutting tools or metals. She doesn’t know how to maintain a tolerance of 0.25 microns, or what tolerance means in this context, or what a micron is.
Maddie's plight illustrates why President Obama is pushing college affordability and job-training programs.

And Davidson's piece reminds us why workers with limited skills are struggling to keep up these days. Their jobs are being replaced by machines and/or Chinese workers.

Second, speaking of China, the New York Times ran two stories this week in a series on "The iEconomy." The first one, "How the U.S. Lost Out on iPhone Work" made quite a splash, while the second one will disturb anyone who's bought an iPad.

In the first story, the most striking passage captured why China (and not the U.S.!) is getting so many jobs out of the explosion of demand for iPhones:
Apple executives say that going overseas, at this point, is their only option. One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.
A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.
“The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”
I'm afraid the executive is half right. American plants could probably match the Chinese speed and flexibility, but they would have to pay their thousands of workers a princely sum to be ready at a moment's notice. And then they would have to pay overtime to convince workers into grueling shifts. We just can't match China at a cost-effective rate.

Apple is currently the most valuable U.S.-based company and the symbol of American ingenuity, but it "employs 43,000 people in the United States and 20,000 overseas, a small fraction of the over 400,000 American workers at General Motors in the 1950s, or the hundreds of thousands at General Electric in the 1980s" (Duhigg and Bradsher).

Globalization of the manufacturing process is not creating enough American jobs to absorb workers with lower skills. How do we get out of this mess?

I'm not sure anybody's figured that out yet. And even if someone did figure out how to start fixing this deep-seated problem, can our politicians implement such policy solutions without politicizing them?

I guess we'll see in the next few years.

Thursday, January 19, 2012

The "Leap Second" and the Flatness of Modern Time

Today's New York Times reports on a contentious issue looming at a UN-related agency known as the International Telecommunication Union: should the world do away with the "leap second?"

The leap second is an additional second that the keepers of the atomic clocks have added every few years since 1972 to keep those extremely precise clocks in line with the earth's rotation "which [as the Times reports], sadly, does not  run quite like clockwork."

Who knew that such an obscure practice of timekeeping could be divisive?

It turns out that U.S. experts are worried that inserting an occasional extra second could mess up global computer networks. Even that one second could crash servers around the world, and computers don't like such randomness. Therefore, the U.S. wants to stop adding the leap second.

But their opponents--including China, the U.K., and Canada--worry that abolishing the leap second would create a divergence. By the year 2112, they contend, there would be a full minute gap between the official, atomic clock and the earth's rotational one. And eventually, after 100,000-plus years, the official atomic noon would occur at sunrise. Sounds like a crisis, eh? It's keeping me up at night!

On a more serious note, the whole debate illustrates how the world has become flattened and globalized through increasingly precise measurement, standardization, and networking. As chapter 1 of my book points out (and as the Times story reports), this movement to standardize time took off in the late nineteenth century, with the advent of railroads. The effort culminated in the global system of time zones that still governs us today. And the current system goes a step further, down to worrying about the effects over millennia of adding a second of time every few years.

I probably won't be watching on June 30 of this year when the atomic clock gains a second. But I'll continue to be amazed at how humans have taken time--a precious gift of God, a mystery of fullness--and flattened it into an object that they can precisely measure and seemingly control at will.

Despite our brilliant ability to fathom the complexities of earthly, chronological time, we need to grasp the fullness of kairos time if we are to live peaceably during our days and years on earth.