Thursday 10 May 2012

Financial crises, ethics and academics: A bit more Mea Culpa would help

Joris Luyendijk, the anthropologist who interviews finance professionals for The Guardian has recently published an interview with an London based academic who  is a quant "of sorts".  Joris, as an anthropologist, has been trained to interview people and distinguish the wheat from the chaff, and appreciate when they are constructing myths to protect their psyche from unpalatable truths.

One unpalatable truth that (primarily Anglo-Saxon) academics have to face up to is their role in the current financial crises that have ravaged first the Atlantic nations and now the Mediterranean ones, but not much elsewhere.  The first myth in relation to the crisis is that it was all "evil bankers". This was created not by academics but governments whose hands were covered in the blood of Mortgage Backed Securities, sub-prime lending (and borrowing)  and Private Finance Initiative securitisation.

However, possibly more guilty, but less exposed, are academics in finance and economics.  If it wasn't so worrying it would be hilarious that in 2008 UK Economics was judged to be the jewel in the crown of British academia which lead the monarch to ask the obvious question, why did none of the brilliant economists (advising her government at least) see the crisis coming?

Eugene Fama has recently explained that (his) economics never failed.  The didactic joke is "A psychotic builds castles in the skies, a neurotic lives in them and a psychiatrist collects the rent", on this basis Fama seems to be both psychotic and neurotic, though I don't think he's paying any rent, suggesting his psyche is already shot and doesn't need any protection.

More rational economists look to the large slow moving targets, in this case mathematics.  One of the most influential making this case was the Adair Turner, trained in economics and history and the Financial Services Authority's Chairman.  Lord Turner put the blame on "a  mis-paced reliance in sophisticated mathematics"
The increasing scale and complexity of the securitised credit market was obvious to individual participants, to regulators and to academic observers. But the predominant assumption was that increased complexity had been matched by the evolution of mathematically sophisticated and effective techniques for measuring and managing the resulting risks. Central to many of the techniques was the concept of Value--at--Risk (VAR), enabling inferences about forward-looking risk to be drawn from the observation of past patterns of price movement. This technique, developed in the early 1990s, was not only accepted as standard across the industry, but adopted by regulators as the basis for calculating trading risk and required capital, (being incorporated for instance within the European Capital Adequacy Directive)
This is good rhetoric:  start with a statement that no one would quibble with, follow this with something that slips into conjecture and then conclude with something that is base opinion, but carries the weight of deduction.  I would suggest an over reliance on lax thinking, like this, has been more of a problem.  The Financial Times was not impressed.

The  lecturer seems to be following this line, it is the "mathmos" with vaguely Aspergers like qualities who could not communicate in banks that caused the problems.  Does he mean  Ed Thorp? James Simons? Antony Ledford?   In my experience, I worked in industry before taking my PhD, it is the students who have social skills that leave the cloistered world of universities and go into the more corporate, collegiate atmosphere of the work place.  Is the criticism of quants in the work place a case of projection?

Having identified the problem personalities we move on to the philosophical
I do research and I teach. When I see my students go off on careers in the City I do wonder: can't society make better use of all that talent?
What would be a better use of their talent?  Working for British Aerospace building weapons and bribing governments?  Maybe working for Novartis developing drugs and suing health boards for using cheaper alternatives. There is a tendency amongst academics to be unable to recognise that their students may not want to imitate their teachers, and don't want to ensconce themselves in academic ivory towers.  The exaggerated difference between the salary rates is the protective myth: I if it were not for filthy lucre, my students would follow in my footsteps.

Commenting on both these issues, of social skills and use of talents, go back and read about Newton at the Mint.  A grumpy academic but a personable financier, and in the opinion of Maynard Keynes, as important as a financier as a physicist.

The University of London is very difficult for students to get into, probably harder than Oxbridge for flagship degrees.  Investment Banks usually recruit BScs/MScs at £32k-£40k and have around 40% attrition after 3 years, English universities, charging £27k for a BSc or £20k+ for an MSc, don't like to highlight these unpalatable facts to students trying to get onto their courses.  Rather, they attract students with the promise of stellar salaries if you make the grade and get a place.  Academics are responsible for accepting students onto their degrees and are responsible for what they teach and how they teach it.  The "the recruitment circus that banks and financial firms roll out" is not that different from the hoops the elite universities make applicants jump through.

If you get AAB at A-level with an A in mathematics you can come and study Actuarial Science at Heriot-Watt.  If you get an average grade above around 65% in your degree you will graduate with a full set of exemptions from the basic actuarial exams, you graduate "part-qualified".  A part-qualified actuary earns between £25k-£32k.  Around 92% of our students go into graduate employment, the same rate as the LSE (according to the Sunday Times rankings), though only about 60% will be working as part-qualified actuaries.

When I talk to prospective students they ask about their "personal statement" , which, along with the interview is a big part of the UL application that they will make to us alongside Warwick.  At Heriot-Watt there is a tradition of taking anyone who meets the grade, we don't read personal statements ( a student from the local Currie High School is unlikely to have had the opportunities to pad out their statement that a student from Heriot's or Fettes would) and the "interview" is an opportunity for the students to learn about us, not for us to judge the student.

English students are the customers, they are paying the universities.  The government has no cap on universities taking students with AAB, that means an AAB student is "pure profit" for a university and the universities should be competing for them, not AAB students competing for the university (or this is what neo-classical economics would posit).

Our London academic argues
There is a generation gap between students and professors, clearly. Many of my colleagues conceive of a university education at least partly as Bildung, an opportunity for young people to discover, develop and realise themselves, and we believe society will benefit from that.

Most of our students could not care less about all this. They conceive of us as a hurdle; a selection station to get through. They aren't here to learn, they are here to pass
If this is really the case, the academic should make this clear to applicants, you are paying us lots of money "to discover, develop and realise" yourself, rather than you are paying us lots of money to buy a lottery ticket for a position at a bulge bracket bank.  At Heriot-Watt we are honest; come here and become an actuary.

The interview begins where I shall end: ethics.  Academics decide what to teach, and it is generally academics who have decided not to teach ethics.

There are two ways to look at money, as a 'convenient' commodity to facilitate exchange, or as a representation of a 'social relation'.  Money is gold or money is credit.  If money is nothing more than a commodity then its key feature is scarcity, if money is credit the critical variable is trust.  For centuries the 'City of London' has been associated with   the concept that "my word is my bond'', giving a clear indication as to where the City's financiers thought the emphasis should be.

The breakdown of this ethos did not begin, as many imagine, with Thatcherite policies or Reaganomics of the 1980s.  In 1950  a case was heard in the British courts,  Buttle v Saunders.  Saunders managed a trust for Buttle, and had agreed to sell a piece of land owned by the trust for £6,142 to a Mrs Simpson.  Before the transaction had become legally binding, another person offered the trust £6,400 for the land.  However, Saunders believed ``my word is my bond'' and declined the higher offer in favour of the original agreement with Mrs Simpson.  The beneficiary of the trust, Buttle,  took Saunders to court, and the court ruled in favour of Buttle
 The only consideration which was present to [the trustees] minds was that they had gone so far in the negotiations with Mrs Simpson that they could not properly, from the point of view of commercial morality, resile from those negotiations.
'Commercial morality' was not a valid consideration  and the sale to Mrs Simpson was declared null and English home-buyers could never again be certain that a purchase would be completed, 'gazumping' had arrived.

Three years after Buttle v Saunders Milton Friedman published  The Methodology of Positive Economics that begins with a reference to Neville Keynes's The scope and method of political economy.  The implication that Friedman offers the reader is  that ``Keynes called for'' the ``construction of a distinct positive science'' is somewhat mischievous.  Neville Keynes distinguished the `positive' economics from the `normative' economics ``an ethical, realistic, and inductive science'', principally advocated by the German Historical School
The school explicitly calls itself ethical; it regards political economy as having a high ethical task, and as concerned with the most important problems of human life. The science is not merely to classify the motives that prompt to economic activity; it must also weigh and compare their moral merit. It must determine a standard of the right production and distribution of wealth, such that the demands of justice and morality may be satisfied. It must set forth an ideal of economic development, having in view the intellectual and moral, as well as the merely material, life; and it must discuss the ways and means such as the strengthening of right motives, and the spread of sound customs and habits in industrial life, as well as the direct intervention of the State by which that ideal is to be sought after. ...
However, unlike Friedman, Neville Keynes sees the two approaches as, at least, complementary
The method of political economy cannot adequately be de-scribed by any single phrase; and accordingly no one method will be advocated to the entire exclusion of other methods. It will, on the contrary, be shewn that, according to the special department or aspect of the science under investigation, the appropriate method may be either abstract or realistic, deductive or inductive, mathematical or statistical, hypothetical or historical.
Positivism, the idea that science is an "impersonal way of arriving at the objective truth about natural phenomena'',with its associations with 'Baconian science', 'knowledge is power', and empiricism, became a doctrine attached to many branches of science by the mid-1960s.  This doctrine was taught in universities, particularly in the English speaking world}, and it is hardly surprising that if educators are removing ethics from university science, then there will be a breakdown of ethics in society.

Our academic argues its difficult to teach ethics to the Asperger's types that he has to deal with, because it involves complex issues and debates.  I disagree.  Virtue ethics, as promoted by Deidre McCloskey, with its blending of the seven virtues in an alchemical manner is easy for Asperger's types (like myself) to deal with. The problems come with consequentialism, which again is popular with academics because it allows them to blather for ages without coming to a definite answer. 

There is an alternative view of ethics and quants, and that was written by the mathematician with a background in the humanities, Steven Shreve.  Shreve, a leading financial mathematician who is behind Carnigie-Mellon's prestigious Masters in Financial Engineering writes
 we need people with integrity managing our financial systems. Teaching ethics is difficult, and guaranteeing that listeners will implement those teachings is impossible. It is not easy for a quant to sound the alarm that his models are being stretched beyond their limits, knowing that if he is taken seriously it will result in the loss of business to competing firms and may result in the loss of his job. We cannot instil in sixteen short months behaviour that properly requires years of nurturing and mentoring. We do what we can, leading by example, penalizing students for academic dishonesty, setting and enforcing rules for ethical conduct when interacting with potential employers, posing ethical dilemmas for classroom discussion, and encouraging our graduates to consult with fellow graduates when facing tough ethical decisions.
This is the response of a quant, the problem is difficult, but we do what we can, recognising the limitations.


  1. I don't think he was LSE - the blog only says "an institution in London" and from the things he says in comments (citing a load of econophysics and agent-oriented papers well out of the mainstream) I would have guessed Imperial would be more likely.

  2. Very nice article, thank you. Including this to my weekly linkfest.

  3. Interesting piece. I definitely agree with this statement: "One unpalatable truth that (primarily Anglo-Saxon) academics have to face up to is their role in the current financial crises". I am not sure why there is not a bit more humility here....
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