Cathy O'Neil on Wall St and Occupy Wall Street
Feb 11 2013

Cathy O'Neil, data scientist and blogger at, talks with EconTalk host Russ Roberts about her journey from Wall Street to Occupy Wall Street. She talks about her experiences on Wall Street that ultimately led her to join the Occupy Wall Street movement. Along the way, the conversation includes a look at the reliability of financial modeling, the role financial models played in the crisis, and the potential for shame to limit dishonest behavior in the financial sector and elsewhere.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Glenn Donovan
Feb 11 2013 at 8:58am

Having sold trading systems and risk mgmt systems to big trading firms for years (including AIG’s market risk system), I have to say that her characterization of the “culture” of Wall Street strikes me as reductionist, populist nonsense. She seems shocked that firms are trying to “sell” things to their clients. She seems shocked that people don’t make investment decisions based on the risk numbers some quant produces – really?

I’ve been told to watch my “tone” on this site and I will try. But I’ve been in the same exact places she’s been and have an utterly different view. My view is based on an understanding of the incentives capital markets players are responding to versus her random opinions based on her impressions at DE Shaw. She does mention incentives, but only in an offhanded way. She seems shocked that economic actors would behave in the system set up by government in ways that profit them.

Interestingly, she’s only skimming the surface. The failure of models in finance is due to the application of the math of physics to finance inappropriately in the first place. She should ask herself what the “unit” is in finance? What are the constants? No, she does none of that and instead just moves on to bashing bailouts.

Russ treating her as though she has some valid insight is truly mind-blowing to me. She belongs in OWS with the rest of the hyper-political,Utopians. But she has very little of value to say about Wall Street.

To make a substantive point, let’s talk about the ratings agencies. Why do the originators pay? What is the value of a AAA rating? Could it be that by banking regulators insisting that AAA rated securities by 3 agencies are the best form of capital to be in bank balance sheets is part of what’s motivating folks? Does she know anything about banking capital adequacy regulations?

She calls Jamie Dimon “a jerk” – hmm, according to the moderator here if I made that kind of comment about her, I’d be banned. She also misrepresents OWS utterly. It was a creature of anarcho-capitalists that tried and failed to create populist uprising based on class resentment. They aren’t open to dialog, it isn’t a discussion – I’ve been there too and nothing of the sort was on offer.

So I ask, what is she doing here on EconTalk? She’s comes off as an angry leftist who knows a little math and finance – nothing to see here folks, move along.

Greg G
Feb 11 2013 at 10:17am

OK Glenn, so you sold AIG its market risk system. How’d that work out? I’m guessing fine for you but, for the rest of us, not so much.

I agree that we should blame the regulatory regime (and not the ever present “greed”) for the worst excesses of the housing bubble. But then let’s also remember to credit the regulatory regime that was in place in the half century before Continental Illinois with having a lot to do with the spectacular success in that period of banking history.

John Barker
Feb 11 2013 at 10:57am

I think Russ’s tone with her was appropriate mainly because I feel she is still forming views on all this and I think Russ could bring her over the the good side. She could then maybe act as a chain to her OWS crowd for the education they were talking about in the podcast.
One other comment is that not only banks, but everyone is forming policy, lobbying, etc. Banks just get a bad wrap because they make a lot of money and people are jealous, but steel lobbying or auto or farming, etc. is “good” for the USA.
Another problem is people do not want to listen there are bankers now trying to warn the world of the next crisis and to protect yourself with assets beside cash. People do not listen, they do not care, because government will “save” them. I have told my own parents to hedge themselves against possible inflation. Do they, no. My dad’s answer was our 401k’s made 13% this year and it looks like they are going up.
I would say people get what they deserve and that sadly includes my parents, who have done everything “right” except listen to their son, lol.

Andy Kneeter
Feb 11 2013 at 11:40am

The essence of the problem is there are too many government guarantees & regulations, so nobody takes responsibility of their own assets or actions.

Depositors are technically lenders, but they don’t care how their deposited money is managed, because it’s 100% guaranteed by government deposit insurance (with premiums that don’t adequately reflect the the lending risk, typical of government insurance programs).

Investment managers share in the upside, but don’t reimburse their investors on the downside (“Heads I win, tails you lose”).

The answer is simple: evaluate how much of the owner/managers’ net worth is invested in the equity of their institution (“Skin in the game”). Private rating agencies, competing to produce the most accurate evaluations, would fight for this.

Also, any lender/investor (even depositors) would be 100% responsible for their assets, so they’d demand credible ratings of anyone holding their assets. If depositors don’t trust bank lending practices, their account assets wouldn’t be lent. If they did want their assets lent, the terms would be contractually stipulated for both the lending & borrowing parties. Under these truly free market conditions, demand deposits couldn’t be legally lent. Fractional reserve banking would disappear & 100% reserve banking would quickly emerge.

In a truly free market, people could freely choose what they’d use for currency when they transact with each other & what they’d do with their assets. Both sides of every transaction would keep everyone accountable (out of necessity). Reputations would be critically important again.

Government-induced business cycles would be eliminated.

Feb 11 2013 at 11:40am

Great episode Russ. I love these types of episodes because I can often get people who would never listen to something like Econtalk to listen to it.

Ryan H
Feb 11 2013 at 11:49am

The fundamental flaw in her stance from my point of view is that the middle class is supposed to get some sort of pass on the dangers of life. They are just supposed to be allowed to follow the conventional path of college and career (any old one will do) and go about their life without a care in the world and that the purpose of government and business is to facilitate that strategy. Her statement at the end about insurance was telling. I wish you had more time to delve into that topic. It was clearly the point where your ideology would exclude you from OWS.

Justin P
Feb 11 2013 at 11:50am

“But then let’s also remember to credit the regulatory regime that was in place in the half century before Continental Illinois with having a lot to do with the spectacular success in that period of banking history.”

Where the evidence that it was the regulatory regime that is to credit for the successes? That’s like saying we should credit the Fed for the Great Moderation, when we know that it was just a farce?

I was hoping Russ would talk more about economic models with O’Neil. The models used to say that “the grass is growing” again. This goes to the Romer stimulus model, a model that failed misserable, but the measure of it’s success is based on the use of the same model. It’s like in grade school when they tell you to no use the word your trying to define. We are using the same models that failed to gage how well we are doing, be it Romer or the simple Dow (if the Dow is up, the economy must be doing good). Well the Romer model didn’t work. The Dow was up, right up until it dropped.

I’d love to see O’Neil talk with Nassin Taleb.

Steve Sedio
Feb 11 2013 at 12:23pm

Cathy seems a bit niave.

It is fascinating that the regulators that should have been interested in Cathy’s insights, wasn’t. Was she unaware of what happened when Brooksley Born (a regulator) tried to warn congress?

The “too big to fail” customers didn’t care about the risk, unless they had their own money in the game – who would have guessed? 😉

The PhD standard….., just another safety net.

She was surprised that people around her thought “we’re smart, we deserve to take money from stupid people”. That applies to a lot of businesses, we usually call it competition.

They hired young men that adopted the culture, in contrast to hiring those that would argue with them?

Finally, her goal is to add yet another layer of protection for the consumer. Seems she doesn’t understand removing risk was a significant part of the problem.


Cathy was pretty vague how Occupy would fix I wish you would have bounced your “solutions” off Cathy to see how many she agreed with. I would have been interested in what she objected to.


Feb 11 2013 at 12:32pm

Steve Sedio,

What solutions would you recommend?

or are you using “solutions” ironically?

Glenn Donovan
Feb 11 2013 at 12:33pm

[Comment removed for rudeness.–Econlib Ed.]

Greg G
Feb 11 2013 at 1:00pm

Glenn, I don’t doubt that you and the quants at AIG had a reasonably good idea of the limited usefulness of those risk models. I just don’t think that top management at AIG wanted those models in order to reduce risk.

I think they wanted those models in order to increase risk far beyond what regulators or the public would have tolerated if they had understood them. The models were the thing they pointed to in convincing the critics that they just didn’t understand how safe this all was and why we should leave it to the experts and quants.

Short term compensation was so high at AIG for the top people that they only needed this to work for a few years for it to make them very rich even if they did blow up the company.

Feb 11 2013 at 1:10pm

@Glenn Donovan,

Respectfully, given how complicated and interwoven our “financial system” is, the notion that we have nothing to learn from someone close to the matter, simply because we disagree, seems closed-minded to the point of being dangerous.

IMHO, there’s plenty to learn from CO’s experience and from her opinions about both the culture and the quantitative side.

Feb 11 2013 at 1:34pm

I bet that if the OWS people started an investment bank they would fund solar start ups and other PC ventures and it would not turn out well and so I would not want them to run a government that runs a monetary system. Yet as voters we all run the monetary system, something we unqualified to do. To me that is the problem the Government runs the monetary system and they periodically make mistakes and are slow to adopt long term fixes that might work. the system have a bad free back problem. Since the Government took over the issuance of money we have had:

Depression in the 1890s
A Financial panic in 1907
A depression in 1929
A depression in 1936
An inflation in the 1970s
A long and continuing period of un-employement since 2008

They thought that they could design a system that they did not understand. The system that they created has bad feedback problems.

IMO free banking would have been less bad.

Feb 11 2013 at 1:35pm

@ Steve Sedio

I see a qualitative difference between trying to make the best product so as to make as much money as possible and just trying to make as much money as possible (within the law).

Feb 11 2013 at 1:49pm

Russ (and the Econtalk community as a whole),

You said that “they are going to destroy the it.” (35 minutes into the podcast).

In that context “They” seems to be ‘bankers and politicians they control’ and “it” seems to be “the financial system”.

This seems to be one of the most important issues you have raised in your podcasts.

Could you please elaborate on what you meant?

Also, I would be very interested to hear practical solutions. Cathy presented some that you disagreed with. Your solutions seem to be “Just say no to bailouts” and “it is possible that the best solution to all of this is better morality.”

Do you see any practical way to implement those solutions before “they” destroy the system?

I would be happy to hear anyone else’s proposals, too. We all agree that this is a very serious problem. We need to find some ways to improve it.

Feb 11 2013 at 1:49pm

At about 35 minutes, there’s a discussion on the role of profits and losses. Cathy says:

So, what would you have? You would have them fail, but where people weren’t getting their payroll. What would–I mean, there would be problems.

Russ — In your response, I think you focused primarily on the pain and suffering. But, that assumes that we start time at the point of the financial crisis. Like the point you make often, without the bailouts, there’s more prudence that helps prevent us from getting to the brink in the first place. Instead of blindly trusting a risk assessment because it comes from PhD’s, all of us are a bit more skeptical on the front-end and try to recognize and avoid such risks. With more prudence, there’s less pain and suffering. Less malinvestment and bust.

Mike S.
Feb 11 2013 at 2:19pm

I just listened to this on my way to work. I love this podcast in general, but the only thing I really got from this episode is a substantiation of my superficial observation of many of the OWS crowd.

They’re mad about the current system and expect their anger and activities to provide an undefined “change in the system” to lead to a vague “better result” without concepts or fundamental principals. They also are happy to consort with people that are clearly enemies of freedom and property rights. I don’t believe that trying to find common cause with them will ever lead to anything productive. She claimed that people should have a lot less certainty. It is pretty clear historically that certain ideas don’t work and we can be certain that going down that path is counterproductive.

Having not listened to all of the previous podcasts, I wish I would have selected differently. Surely any of them would have been more worthwhile an informative.

Feb 11 2013 at 2:29pm

Russ, keep inviting people with diverse points of views. I think we all benefit from this interactions.
Based on the picture she painted of the firm, it seemed to resemble a lot of where I work at even though is a completely unrelated field. Just wanted to add to Cathy O’neal’s perspective on the macho culture, that as the only woman engineer in a firm of about 15 engineers, it seems to be a widespread phenomena. Those kind of dynamics are the ones I found in my workplace. Seems pretty primal, when you get a bunch of dudes together in a competitive environment, they try to display their superiority. And who “wins” doesn’t have to do with who displays the highest mastery as much as it has to do with good old “showing off, and taking other people down” attitude, pretty high schoolish, interestingly enough. So I don’t think this issue is very relevant to the government/banking/wallstreet cozy relationship that could literraly bring unimaginable economic problems to the average American. If this is how “dudes” tend to behave, you know, not perfectly rationally, well that’s human nature. So we need a system that:
1. If possible, were incentives are constructed so that their self-interest, aligns with the long-term well being of their companies. Where are incentives messed up right now? What kind of changes or corrections in the law can be proposed to address this?

2. If not enough can be done through “modifying incentives”. Then we need to try and set up a system that if they mess up, the amount of damage they can cause is limited.

If elements of the left and right can agree on this. Then maybe coalitions of voters can be made to try to influence things.

I know most likely will fail but, what else?

I think libertarian leaning people need to get more involved in trying to influence legislation and be part of this process, us messy, imperfect and impractical as it is.

Eric Falkenstein
Feb 11 2013 at 2:48pm

Russ is certain this was simply moral hazard from the Jimmy Caynes of the world, those exploiting the call-option payout of a large bank. I think that’s really misleading, because most bank managers lost a large fraction of their much more modest wealth in the subsequent downturn via their stock options. I don’t think they were gaming the system in this simple way, so this story is not The Key (the key to me would be that no one though residential real estate would decline across the board, an assumption shared broadly by regulators, legislators, academics, bankers, home-buyers, and investors).

As to Cathy O’Neil, she sounds incredibly naive. She was shocked that the banks were not making decisions from the reports she was initially put in charge of. PhDs generally, especially PhDs new to the field, create useless reports, and not just in finance. She states that the JPMorgan hedge group was outside of control ‘because it lost $4B.’ That’s not evidence of being out of control, perhaps it was a hedge (JPMorgan is a 100B market cap company). Not that I think it wasn’t a simple bet and not a hedge, but her supposition that losing money implies it was outside of controls makes me think she never even considered the portfolio context. It wasn’t a nuanced or data-based criticism, just a reflexive dislike of rich people that many conflate with moral righteousness.

She dismisses economists for not understanding finance, but I didn’t hear any specific alternative to any popular theory, just that everyone else in charge is wrong, greedy, and immoral. Everyone’s wrong, we have to rethink this. How? Her idea for banks to stop lobbying is incredibly naive. But that’s ok, she’s going to regulate the generation of information on the internet. Good luck with that.

Feb 11 2013 at 3:19pm

“Interesting. I’m interested in that idea.”

That quote said it all. It was the first time she had even heard or considered that point of view.

Great episode.

Mads Lindstrøm
Feb 11 2013 at 3:50pm

bltn77 wrote:

O’neal’s perspective on the macho culture, that as the only woman engineer in a firm of about 15 engineers, it seems to be a widespread phenomena. Those kind of dynamics are the ones I found in my workplace. Seems pretty primal, when you get a bunch of dudes together in a competitive environment, they try to display their superiority. And who “wins” doesn’t have to do with who displays the highest mastery as much as it has to do with good old “showing off, and taking other people down” attitude, pretty high schoolish, interestingly enough…

I have no idea of your current work environment, so I may be way off. But your description sounds like a misunderstanding women often make about men group behaviour. Often your will find men have a “competition of wit” or who can make the most funny (often in a degrading manor) remark about another man in the group. Your average male will not take the remarks seriously, nor will they feel hurt. The game is only funny if other people respond in kind, which is good sense all men do obviously not enjoy this game of wit. Just think of this game as a way for males to bond.

Feb 11 2013 at 4:21pm

Expanding on Mads Lindstrom’s point about the commonality of a friendly verbal challenge among male colleagues, there is a formalized version among African-Americans known as “the Dozens”. Once you understand this, the popularity of rap music makes perfect sense.

Walter Clark
Feb 11 2013 at 4:27pm

No commenters here came to the aid of Russ on her looming privacy issue with the internet. Consider this. If the monopoly on coercive force is not allowed to act on mined data, in what way can it be abused? The example she gave about hiding pre-existing is easily dismissed.

Mads Lindstrøm
Feb 11 2013 at 4:42pm

I did like the podcast and your guest Cathy O’Neil. The discussion works well when you have some common ground, but not too much. That said, either I missed the point or some early remarks seemed like misunderstandings of how markets work:

In the two years I spent at the hedge fund I don’t think I ever heard someone say: Let’s allocate this capital better. It was all about: let’s anticipate what dumb people are going to do so that we can make money off of them. And there was this dichotomy, like dumb versus smart money. We’re smart money; they’re dumb money. We are so smart that we deserve their money. It was essentially kind of an entitlement. And it was really unattractive to me. I spent a lot of time at lunch trying to understand the mindset of, like, how does being good at math give us the right to do this? Because it’s legal? That didn’t seem right.

This could be the description of anybody trying to speculate in the stock market. Everybody is trying to pick the stocks that is underpriced or going short in a stock that is overpriced. They are trying to be smarter than the other speculators. And if they did not believe they were smarter, they would not speculate.

Why is it OK to try to outsmart less smart people in the stock market? Because everybody is there voluntarily and is also trying to outsmart you. It is like playing poker. Yes I may believe that I am the superior poker player, but so do the other guy. While it is not transparent who is the best player, we both know that I think I am, as well as we both know that he think he is.

Regarding the social good. It does not matter that people do not think of themselves as “allocating capital the best”. The intentions are not important. What matters are the results. And the very process of everybody trying to predict the future price of stocks (by outsmarting others), is what makes markets good at setting fair prices. The market works by giving more money (and thus more market power) to the good players and taking money from the bad players.

Now I realize that the quote continues with:

And it was particularly jarring to go through this kind of discussion when the world was collapsing. When every kind of assumption that we were making about how smart we were actually didn’t seem that smart. We were losing money. We were bleeding money.

That would be the very system at work by making your company loose money, except for all the bailouts. And again it do not matter that your quant colleagues sounds deluded. What matters is whether the process works.

Sorry about the long comment 🙁

David Barber
Feb 11 2013 at 5:12pm

Several issues seem to jump out at me as I read these comments.

I did my undergrad in pure maths, and certainly saw the male culture referred to by this week’s interviewee. I sincerely hope none of the comments here are intended to deny that such a ‘macho’ culture exists, or to deny that they are hugely problematic.

In re: the general response to OWS, I’m curious why so many of you seem to be against it. From a perspective of freedom, protest would seem to be very high on the list of things we hope are allowed, even encouraged. To deny that OWS changed the conversation on the financial crisis is to deny reality. Long term effects? Maybe nothing – but I think we’re still seeing this play out (else why is she a guest, and why are we all discussing it?)

There’s also something terrifically revealing about talking so someone who initially drank the kool-aid. Conversion stories have power, in myth and reality.

I’m saddened that anyone here would say ‘so what’ about her realizations – the only thing worse than complaining about someone who complains, but doesn’t propose a solution, is doing it without yourself proposing a solution. OWS, regardless of what else you say about them, was full of solutions. You may not agree with their solutions – you might think they were insane (many of them were). But that’s not the same as not proposing a solution. E.g.: Jubilee.

I think it goes without saying that I disagree with 80 percent of everything I hear on this podcast. But I’m listening. Are you?

Jim Feeely
Feb 11 2013 at 7:26pm

Dear Russ,

Whilst Cathy O’Neil and you spent considerable time discussing ‘inappropriate incentives’, the real problem is that the financial industry collaborated in outright fraud, what ever stimulated that fraud. The fraudsters won and continue to win.

And the fraud is legitimised by the acceptance that, because of the reverence we have for ‘markets’, that a massive betting scheme on transactions in which the hedge fund is often not even directly involved is alleged to be good for society. I am yet to see any compelling evidence that this betting system produces any real good for society as a whole.

The comments here that defend this system on the naive delusion of caveat emptor should note that not even the bosses of these banks understand the exotic products they sell. For example, read House of Cards by William Cohan for the ignorant lunacy that was considered BAU at Bear Sterns.

And here is where Russ and I absolutely agree – if we must be so devoted to corporate capitalism, then let it work, let failure be real and punish fraud.

It is not just western society that has suffered because of the great scandal that is the ‘GFC’. It is this corrupt financial system that is the dominant influence in world affairs, particularly through the IMF that continues to peddle its crucification economics to the victims of international finance.

The staggering complacency of western governments in taking the unpalatable steps that are crucially necessary to reform the rotten corruption in finance guarantees the ultimate and uncontrollable collapse of the finance system and that will produce a lot more agony than would have been the case if the corrupt financial institutions were allowed to collapse in 2008.

And please, don’t leave the solution to ‘experts’. The experts got us here.

Jim Feehely.

Feb 11 2013 at 8:03pm

The only meaningful solution she recommended was barring the revolving door, which in a way Glenn Reynolds (Instapundit) has also suggested. However, if the banks get around capital requirements, they’ll find a way around this.

Simply Google-images Occupy Wall Street. Does this look like a movement about reorganizing banks? I do not get the link up between the 99% rhetoric of the Occupy movement, and meaningful reform.

When she said something to the effect of, would you let those people go without a paycheck/starve, I was reminded of the Austrian answer to a woman asking, “Should we do nothing?” He said, “We should have started doing nothing several years ago.” There is a history of Moral Hazard, which seems to grow larger every crisis. Can that problem be solved by more intervention?

Alternative banking is already here. It’s called a credit union. They have lower fees, are friendlier, and are owned by the people who use them. ‘Merica.

When she talks about the hedge fund, I won’t defend her perception of her coworkers mindset or their actions. However, I work in sales with a group that is mostly males. There is a lot of machismo, chest thumping, and possibly even a bit of misanthropy between sales. However, Customers still buy (and enjoy) products and services. Just because people perceive themselves as Ubermensch doesn’t mean they don’t perform a valuable service to society. A lot of “jerks” perform valuable services, look at certain professional athletes.

On a lighter note, thinking about her description of her coworkers makes me think of my coworkers cast in the Big Bang Theory.


Michael Tolhurst
Feb 12 2013 at 12:33am

I liked the discussion of morality at the end. I do see the Occupy Wall Street movement, while I sometimes find its specific ‘solutions’ non-starters, as a great outlet for folk’s ‘moral sentiments.’ As someone who is a Smithian/David Humean,I think it is valuable to let those in business and gov’t know that the moral sense of the community has been gravely offended. I see that as a real substantive common ground between Russ and the guest. Morality is important and both the business community and governments need to recognize that in considering their practices and internal culture. (and there is no true divide between the Smith of the Wealth of Nations and the Smith of the Theory of Moral Sentiments)

I think where Russ and the guest diverge is how the fallout from bad behavior should be allocated. Russ is willing to accept the fact that many who were ‘innocent’-ie. did not make the improper decisions- would suffer in the short term. Cathy by contrast wants to have a tidier moral resolution with the harm more squarely falling on the shoulders of the responsible parties. I tend to agree with Russ though that the ‘cure’ to this understandable moral conundrum might be worse than the disease.

Feb 11 2013 at 9:40pm

Russ, you’ve mentioned multiple times that “banks make money at our expense as taxpayers”. I can’t understand this statement — not from a public choice perspective.

I think the typical (i.e., median) American and European taxpayer has done very well for himself out of his banks. He votes to push the banking sector towards oligopoly, then taxes the heck out of the excess profits financial firms and employees make as a result of operating within that competition-sheltered environment.

I’m not defending this arrangement. I think it’s atrocious. But as clever public choicers, it’s our job to figure out where these incentives are ultimately coming from. You’ve mentioned before that “The average American likes intervention”. Yes, indeed, and in the financial sector more than any other.

Feb 12 2013 at 3:46am

I’m a bit skeptical of the guest’s hard stance against using mathematical modeling for questions of moral importance. It seems to me that our own moral intuitions boil down to a kind of calculus of right and wrong.

For example, most of us would consider stealing an item from the store out of laziness (because perhaps waiting on line takes too long) to be worse than stealing bread to feed one’s starving child. And we’d consider both of those to be better than stealing from said child.

Isn’t that a kind of mathematical inequality? Why shouldn’t we create mathematical models of moral utility? Keeping in mind, of course, the possibility that emergent systems (such as free markets) create higher moral utility in the long run than those explicitly designed.

Simon C
Feb 12 2013 at 7:05am

I second most of what Mads said above. I’d like to understand why Cathy saw a distinction between trying to improve the efficiency of the market and trying to make money from people making stupid orders in the market. I also work in this type of algorithmic trading and it’s absolutely true that we look for people making bad decisions and we try to pick up the money that they are giving away. Still, in the big picture I think our actions lead to a more efficient market. The reason I think we don’t ever ask, “how can we make this market more efficient?” is that it’s not as easy connect that question directly to a strategy. If you ask, “what orders look foolish today?”, you see what you need to do. But the outcome is the same, the efficiency of the market is improved. And indeed, for people that are making apparently foolish orders, their losses are reduced by the fact that we are competing to take the other side of their trades.

I’d like to hear what distinction Cathy sees between the two approaches and also what she wanted to work with the regulator to prevent.

Justin Mirgeaux
Feb 12 2013 at 9:22am

Great interview. I agree w/ Ms ONeil when says there are lots of problems. I’m skeptical that mathematics are the solution to the lack of a moral compass in finance, IT or any other industry for that matter. She seems to gravitate towards math because it’s “clean” and there are absolute proofs. Personally, I think that smacks of hubris, and frankly the rest of the world doesn’t quite work that way.

The bailouts are a tough nut to crack. So many complexities that there can never be a definitive final word on whether on not the gov’t did the right thing by saving what remained of the financial sector during the credit crisis. There probably is no 100% “right” answer. Modern banking is more akin to a public-private partnership rather than a private enterprise. Not sure if moving away from fractional reserve solves more problems than it creates.

In the meantime, be grateful that we live in a world where none of us is forced to conduct our business w/ any of these TBTF institutions. If you feel any single bank is repugnant, then borrow your money & deposit your funds elswhere.

Pete S
Feb 12 2013 at 10:36am

Great discussion! For your intelligent interviews on important topics you, Mr. Roberts, are a national treasure.

Steve Sedio
Feb 12 2013 at 10:54am

There have been comments about why the financial sector didn’t try for a more efficient market. Didn’t they, from their point of view? They needed more AAA paper, they hired experts in math to combine low risk and high risk loans in a way that (supposedly) reduced risk to create more. They created insurance to reduce risk further. They grew the housing market so fast that even liar loans had no risk (they could sell the house for more than the loan balance).

They learned from the bubble, that growth had to be based on real value, what could be more real than real estate?

The economy was booming, without inflation (except for houses) – this is the opposite of stagflation – the ultimate in financial efficiency.

Until it wasn’t.

What surpriced me what the whole industry missed that this was a simple economic exercize called “The Beer Game” developed (popularized?) by MIT. I recognized it having lived through the tech crash (another beer game – I recognized that as it was happening – the tell is when everyone is saying “we need to build more capacity”).

Lag time matters, a whole lot! (Austrian’s get it).

Feb 12 2013 at 11:11am

I thought that the whole conversation around morality was correct but not the issue. In a fascist system where there is this partnership of the cartel of banks, that institution licensed to create money out of thin air, and government, that institution that uses force to create the cartel and prevent competition, then this exact system will attract those who are least interested in morality and most interested in using the political system to ensure cartel profits.

If you want more moral people then start with those people between the ages of birth and 5 years old and eventually you will create a more moral society as the immoral people die off.

In the mean time the only solution to this mess seems to be to stop the theft by inflation in the banking cartel and force them to actually make money using the entrepreneurial process and not the political process. Certainly adding more noble regulators is only going to make matters worse. And there will be pain especially for the lower classes but the current system of inflation and cheap money hurts the lower classes the most anyway.

And as for Spain, their young have been conned into believing that by following government advice they would be successful. That whole scheme is dead. It is also dead in the USA as well. Again the solution there is to get rid of government and allow the young to use their entrepreneurial drive to remake the economy for the betterment of humanity instead of for the betterment of a bunch of government retirees.

Feb 12 2013 at 12:38pm

To piggyback Mads’ comment, ‘let’s anticipate what dumb people will do so we can make money from them’ is another way of saying, ‘let’s allocate capital better.’

Just turns out, that the particular folks Cathy worked with weren’t as smart as they thought they were, which as Mads’ points out, is the market working to allocate capital better — until you distort it with bailouts.

Feb 12 2013 at 1:05pm

Excellent discussion. Both sides’ humility before a enormous problem was refreshing.

I would have been interested in hearing more of Russ discussing why a truly free market would prevent a bank from becoming too big to inflict massive damage on the wider economy in the event that it failed. I see no reason why the market left to its own devices would not produce huge, dangerous banks.

To propose “just let them fail” as a solution always seemed to me to be like saying of a person who keeps attempting suicide “he’ll never learn his lesson until we let him pull the trigger”

Feb 12 2013 at 1:56pm

I was interested in her comments about PhD’s being hired for “window dressing” and clients not caring about truth or accuracy. As an academic she assumed people cared about these things, but in the real world appearances and socially constructed norms are far more important than scientific truth.

Many industries hire experts for their stamp of approval, not their expertise. The thing is, for most people in corporate jobs quality is a hazy and distant outcome. You exist in a chain of incentives based on what your clients and/or supervisors demand, those are your immediate concerns. If you appear to be doing your job, you are doing your job. So they are just as happy to pay for appearances as reality. Most people are just trying to get through another workday so they can get home to the things they actually care about.

Lucas Hills
Feb 12 2013 at 5:30pm

I thoroughly enjoyed this discussion and commend Cathy on voicing her own personal experiences here. I thought her point about coming into finance after she’d matured into her own personality was very telling, you never hear that sort of opinion from people who have been moulded by years within the industry.

Reading the other comments above.. you always know there’s going to be some haters in the comments, but you can literally hear the ‘macho’ bravado come of the page in some spots, it’s very amusing.

@Russ – On a more serious note though, you really should do a follow up to Cathy’s comments about the modern insurance industry and how it has changed in recent years due to access to private personal data. The repercussions of where she was going with that argument are definitely valid and worth discussing.

Feb 12 2013 at 6:11pm

Did not like Cathy’s dramatics toward the end of the episode, made her seem juvenile. Sure we have a lot of problems, Spain has a lot of problems, but it’s not “going to blow”. Lets maintain some perspective. We are still living in the first world and enjoy a million pleasures a day because of it. The fundamental reason for apathy about the financial crisis is that life is still very good in the U.S. In the grand scheme of things the thievery on Wall Street is pretty minor.

Companies all around the world get rich at taxpayer expense, for all the reasons Russ likes to list. It has ever been thus. Many countries have much more direct government interference into the market, support of particular companies (e.g. Samsung in South Korea, Toyota in Japan). I see it more as just inefficiency that slows down down growth, not some kind of impending disaster.

Feb 12 2013 at 9:27pm

Jamie Dimon might be a “jerk” but I’m quite happy with the services his bank has provided me over the years. By all accounts Steve Jobs was something of a jerk but I need my iPod and iPad. The managers of my 401K mutual funds can be greedy misanthropes, for all I care, as long as they stick to the fund’s investment policy. Luckily I don’t need to count on selflessness of my service providers for the goods and services I need. “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest,” as it was famously put 236 years ago. Would that be a revelation to Cathy O’Neil and the Occupier? What I do have a problem with is when my butcher, or brewer, baker, or banker get a subsidy I’m paying for, or an exclusive government-granted license, a regulatory sweet deal (thanks to his high-priced lobbyist), a special tax break or Federal guarantee.

Regarding insurance: does the industry really depend on ignorance? If my genome were public information, would I be uninsurable? I’m not so certain.

Steve F
Feb 13 2013 at 3:50am

I appreciate Cathy sharing her experiences. From reading four books concerning the 2008 financial crisis and several books on the history of the stockmarket, I learned fiction is stranger than truth about investment bank governance, perverse incentives (creating and selling toxic securities for enormous returns), … Therefore, I believe many of her experiences to be accurate though I don’t have direct hedge fund experience.

However, her sharing really demonstrates her naivete and ignorance about capitalism and free enterprise. I believe she said some things without understanding the whole story. I have worked the last 15 years in trading and financial markets in Chicago, I can tell you academicians and politicians don’t understand it’s culture, language, or it’s operations. Trading markets is money used to make money–capitalism. Money raises ones’ sensitivity to acute levels with the complete range of emotions, rational and irrational ideas. Why quants, like two friends of mine who have PhDs in theoretical physics, do so well is that they always approach their problems with the tools of physics which has no room for feelings, morals, or emotions. Cathy appeared to be full of morals and emotions. The USA is not a socialist economy. Cornering the market is illegal, but hard work and honesty is free enterprise, no laws are broken. As I have a friend who is a respectable hedge fund manager, he has a team of smart, hard workers that hustle for new ideas to make money. This is the result of the trading markets becoming digitized. As hedge funds haven’t made killer profits over the last few years despite having the smartest and most resourceful research teams, there must be other ways to be successful that haven’t been discovered yet. We are in a trading markets revolution with this digitization and it takes time to adjust and accept. I do agree people involved in the financial crisis should be severely punished for abuses and derelict of duty.

Brian Rosen
Feb 13 2013 at 7:02am

I enjoyed this conversation (as I do pretty much every podcast) but I wish Russ pushed for more specifics from O’Neil. Also, her suggestion that the revolving door is a problem is, in my opinion, naive and simplistic. I wish more regulators had actual experience. I can’t tell you how many times I’ve tried to explain to a career government beuarocrat why a policy adds value but because they have no practical experience they go back to some desk drawer rule (these are rules beurocrats have created, either capriciously or, more often, after a perceived problem, but are not technically laws – you could easily sue and win but that would poison the well so no company does) that hasn’t made sense for 50 years and just say no. They don’t even try and understand.

In support of an earlier comment, I too would love to see a discussion on insurance (health, life, LC, etc) and evolving medical knowledge. I think O’Neil is dead wrong when she comes out against insurers adjusting price based on medical knowledge (I think it creates the right kind of incentives) but I’m sympathetic to concerns about pricing out people with genetic diseases and would love to hear more from all sides.

Also, I would love to hear alternatives to the rating agencies and government regulation on what is safe. Even without financial regulation you would want, from a risk management perspective, to have different levels of capital and reserves for various risks. Having government floors helps to level the playing field. I often quibble with those floors (that’s why we have lobiest) but getting changes is painfully hard (as it should be). So while I agree reform is necessary I’m loathe to toss out the baby with the bath water as I think there is economic value to having rules around risk based capital. That doesn’t stop companies from holding more then is required. In fact most do hold more and those that don’t have to pay higher interest rates. But you start at a fair, if somewhat capricious, starting line and that restricts (doesn’t stop) overly creative quants from getting cute with their models. I think that CDO’s would have happened without rating agencies and without government regulation. Maybe without past bailouts people would have been more prudent but I don’t believe that either as many institutions with skin in the game (pension funds and town boards) did review these products carefully and found out later they were wrong. LOTS of entities that bought these products weren’t bailed out and have no history of being bailed out so had the right incentives to be judicious. I think that gets missed sometimes. Maybe that’s ok but doesn’t change my critic of bailouts being the main culprit behind excessive risk taking. I think it may contribute but is one of many players/factors.

Anywho, LOVE the show and the conversation.

Feb 13 2013 at 11:29am


Great Show. You should consider inviting Satyajit Das on this show. His 2006 book Traders, guns and money certainly seems to corroborate what your guest had to say.

Feb 13 2013 at 11:40am

I’m not a fan many of the Occupy movement’s ideas, but I am sympathetic to any good idea I hear.

Russ says he wants to focus on fixing the broken political system. Cathy says the political system is being controlled by large financial institutions who have power over them. (They can’t punish people who are money laundering for terrorists! A small fine is just the cost of doing business and getting caught for these people.)

Thus, O’Neil has me convinced that the biggest problem with the political system (in regards to big banks) is the banks themselves. If they control the system, they’re the problem. If they’re the problem, that’s where we should start with our reforms, isn’t it? Perhaps there are other ways to solve the problem, but one sure way (and a way that would ultimately be most likely to gain enough public support to override a back-door bank-led ‘veto’) to do that is to break up the big banks.

After that, let’s fix the cyclical system that rewards losers with taxpayer bailouts. But we can’t fix that system if the people getting bailouts are in charge behind the scenes. The only thing we can do is pass laws that make it look like something is being done while the cronyism continues as usual. It’s got more lipstick on it, but it’s still a pig.

Brad Hutchings
Feb 13 2013 at 12:05pm

Here is the conundrum. The devil we know is probably a lot better deal than the regulatory devil that’s coming over the hills. That applies equally to Wall Street and the Internet.

Until there is consensus that government ought not be subsidizing, directly or implicitly, overly risky behavior, and policy proposals reflect that, we’re better off with the status quo where we understand how they do it than with even more arbitrary rules that put government and regulators even more in charge.

This realization is, of course, the ultimate trump card for those who have already gamed the system. It only works as one because it’s dead on accurate.

big al
Feb 13 2013 at 1:24pm

great interview – i want to second the comment by Lucas, that Dr O’Neil definitely merits a followup interview, covering the data exploitation issue, as well as data science in general. and just in general because she is so interesting and articulate.

Feb 13 2013 at 2:23pm

I’m a bit late to the party, so apologies if I repeat what’s already been said.

First off, kudos to Russ for ‘walking the walk’ as regards offering Econ Talk as a forum for diverse views. Your treatment of Ms. O’Neil was exemplary. I’m skeptical that 99% people who think like her would have extended you the same treatment, but that’s by-the-bye I suppose.

As regards Ms O’Neil’s performance, I found it an anthropological curiosity. I didn’t really believe people like she existed, a caricature of the modern American left, exhibiting every pathology of the type: She’s smarter and morally superior to everyone else, yet the corrupt, testosterone-laden, greedy capitalist world fails to recognize her brilliance. Her references to ‘average people’ barely obscured an evident contempt for same, and her overdeveloped outrage and indignation were frankly boring.

The kicker was in her naive, and at the same time foolish, proposals for solving whatever problems she perceives ail Wall Street/America/ the World, e.g. we can fix imorality/moral hazzard/rent seeking behavior in the financial indusstry if we “Don’t ever let (a favorite formulation of modern liberals) bankers be lobbyists and vice versa.”

She reminded me of myself at nineteen years old, long on ideas and righteousness, but short on knowledge and wisdom.

So, even if an all powerful and wise government could somehow close the lobbyist/industry revolving door, why would we want it to? I don’t want, for example, doctors regulated by people who have never practiced medicine. Why would we think that people who have never worked in banking would do a good job regulating it?

A noble gesture, Russ, but Ms. O’Neal contributed very little to my understanding.

Keep up the excellent work in Econ Talk, pls!

Steve Sedio
Feb 13 2013 at 3:26pm


I see a chicken and egg situation between politics and banks (and corporations in general).

Government has to have a level of power before they can threaten, or benefit, a large corporation. Politicians benefit from that power through campaign contributions, lobbying positions, seats on the board, etc. Corporations see it a “return on investment”, because it doesn’t take a lot of money to keep 1000 or so politicians happy.

Once government has a bit of power, they can grow it quickly.

Once government has the power, it can eliminate competition through regulation. That has far more value to corporations than tax breaks. All funded by the consumer.

Even though the additional perk of bail outs may not have been “front of mind” while the bankers were raking in the money, I have a hard time believing that safety net wasn’t considered in their risk anaylsis.

How to fix? Consumers are limited by regulation, on voting with their money.

Voters, so far, are not regulated against voting in a smaller government. Yet. But with 47% of the population not paying income tax, 20% collecting SSI, and another 20% working for the government, and the media spin machine, it is going to be pretty hard.

Politics (the egg) has to be fixed before corporations (the chicken) can be changed.

At least, that is how I see it.


Patrick R. Sullivan
Feb 13 2013 at 7:47pm

I agree with Glenn Donovan (and think it a shame Lauren deleted a later post by him).

Jamie Dimon is a jerk?

Maybe he is, but his bank weathered the storm better than anyone else’s. In large part because, when he became CEO of JPMC, he had his risk management people take a long hard look at their sub-prime portfolio. He decided to they needed to get out of it. So, maybe there some value to mathematical modeling…in the right hands.

As to the London Whale losses, well, they were overshadowed by other department’s successes, as overall the bank netted a profit. Doesn’t Dimon get credit for the successes too?

Great irony; ‘the worst are full of passionate intensity’. Doesn’t that pretty well nail OWS?

Jeffrey James
Feb 13 2013 at 11:05pm

A model is only useful insofar as you’d bet your personal funds on its predictions. Most models fail to meet that test of utility.

Any degree of confidence in a model is common sense in a quantitative wrapper.



Feb 14 2013 at 10:21am

I’m a bit surprised on this very Hayekian web site that no one has identified Wall St as an emergent system. Mr. Dimon is simply one example of an emergent leader from that emergent system — a type of leader who possesses the skills and temperament required to succeed in that system. A call for Mr. Dimon to display “morals” seems to be beside the point. If we could call upon our economic and political leaders to display morals, well, notions like central planning would become much more feasible.

On a more positive note, it was very nice to hear the surprisingly applicable Yeats quote. Russ is probably one of the few who could pull this off.

Mike G
Feb 14 2013 at 10:50am

On Russ’s comment about crony capitalism – has there ever been a country during some period of time in which “true” capitalism reigned? Bailouts seem to be as old as banks.

People can’t seem to stomach the “loss” part of profit & loss when it happens on a large enough scale. We hate to think of everyday people having their futures severely damaged / destroyed as a collateral consequence of bad banking decisions. Maybe there are ways we can mitigate that damage without creating perverse incentives, but the possibility of financial ruin is part of what makes the system work, and that principle seems to apply regardless of the scope of the damage.

You don’t have a right to your own family. You don’t have a right to financial security. I don’t know what would happen if they let Bear, ect. fail, but I think life would go on, and more likely than not we would be better off in the long run. If bailing out corrupt financial institutions generation after generation is necessary to maintain our high standard of living, then I reject that standard of living.

Patrick R. Sullivan
Feb 14 2013 at 11:22am

Well, Mike G, we didn’t bail out financial institutions in the 1930s. That was a disaster, worse, by far, than what we’ve suffered recently.

Further, the responses by FDR to the Depression contained the seeds of much of our current trouble. Most obviously the creation of several housing agencies, FHA and Fannie Mae, that grew into behemoths of mortgage finance, without which it’s hard to see how the housing bubble that began in the 1990s could have gotten off the ground.

For a good blow by blow description of how it all evolved (long before Wall Street quants began to dominate things) see James Hagerty’s The Fateful History of Fannie Mae.

Competition for the good things in life is a given. It happens in finance, sports, politics, business…. When governments create potential power that can be used to further someone’s ends, you can bet someone will discover it and attempt to use it for their own selfish purposes.

Feb 14 2013 at 11:34am

I would like to second Nick’s comments above.

As someone who has spent many years in and around trading organizations I am astonished, first, that someone who’s sum total experience is two years with a hedge fund as a quant feels sufficiently informed to comment authoritatively about what goes on in financial markets. I worked for Enron and I personally knew many of the people who later became household names. I left Enron (well before its demise) after a dispute with Jeff Skilling over the morality, ethics and efficacy of things I observed, but even my view of the people involved is more nuanced than Ms. O’Neil’s perspectives of people she never met and whose jobs she doesn’t appear to understand. It seems to me that she is expounding on a cartoon version of reality.

The faith so many have in the government’s ability to deal with the imperfections of real life would be touching if it weren’t so dangerous. I watched –from the outside, thankfully – the full weight of the law fall on an entire industry in the immediate aftermath of Enron and it was anything but justice being applied. I have a friend who spend five years in a federal penitentiary, went bankrupt defending himself and lost his wife and family. His crime was misreporting a single price to a publication; a price which the publication never reported. And he was hardly alone. When the dust finally settled a bunch of the guilty went free and many who were innocent or who had committed minor infractions were ruined. The government didn’t care because the prosecutors were there to make their careers, and they succeeded.

“…the worst are full of passionate intensity” just about sums it up.

Rucksack Revolution
Feb 14 2013 at 11:35am

I’ve read Nate Silver’s “The Signal and the Noise” and I think this conversation strongly mischaracterized his thesis. The book is as much about the limits of prediction as it is about the triumphs of prediction. Nate writes explicitly about the failures of prediction in complex systems with nonlinearities. He describes how more data actually increases the likelihood of overfitting a model. He also repeatedly identifies the influence of incentives on predictors. In the chapter on meteorology, for example, he describes how govt. weather forecasts are often more accurate than private ones because of some interesting incentives that lead to overestimation of inclement weather in the private case. I don’t think that Nate would appreciate the way his thesis was presented in this discussion.

Feb 14 2013 at 1:33pm

WOW! That was a fun listen!

Russ, your comment, “I’m a capitalist; I love profit; and I love loss. And profit without loss is the most destructive thing you can probably imagine.” Hit me like a hammer. Well said!

Love the quote by Yeats too, “The best lack all conviction, while the worst are full of passionate intensity.”

Cathy O’Neil’s comment, “We’re keeping something that should be dead, alive,” was great too. As was her statement, “We have a lot of skepticism to sew.”

Smart guest. Although it needs to be said that her proposed protections (mostly implied in this interview) for the “average person” are the source of everything she is railing against.

Excellent interview. Thank you.

Mark Milton
Feb 14 2013 at 1:54pm

I enjoyed the episode overall, but I had an issue with the underlying sexism..she acts as if women are incapable of having hubris and being intransigent..She uses the word “Macho” as if being male is inherently bad..The President of Argentina Cristina Kirchner is a shining example that having a woman in power doesn’t automatically change the politics/economics of a nation to a positive.

Mads Lindstrøm
Feb 14 2013 at 3:53pm

Mr. David Barber wrote:

the only thing worse than complaining about someone who complains, but doesn’t propose a solution, is doing it without yourself proposing a solution.

I would have to disagree with that. When you criticize people for not providing solutions, while not providing any yourself, you are in effect proposing the status quo. The status quo is most often better than unspecified change. As an example, Communist criticized capitalism without solutions that had the level of detail or realism, that it was usable. I would claim that the person who criticized communism for lack of detailed solution (and realism), while proposing nothing but the status quo himself, was a lot more clever than the communist.

Mr. David Barber continues:

OWS, regardless of what else you say about them, was full of solutions. You may not agree with their solutions – …

I do not think people criticized OWS for not proposing any solutions. Some did not have any solutions, but just criticism of capitalism or banking. But plenty had solutions. However, the solutions varied wildly and there seemed to be no common ground. Compare it to Vietnam war protested – nobody had doubts about what they wanted. Or compare it to the Tea Party. You may or may not like the Tea Party politics, but they did consolidate their opinions to a degree that they could propose and elect Tea Party candidates to Congress.

Adam Baum
Feb 14 2013 at 4:29pm

“I thought of as beautiful and clean and I like the fact that you couldn’t really disagree with the answer”.

“that just enraged me”.

“I was really quite naive”.

“We must be god-like because we are so smart”.

“They weren’t interested in me”

Once again, we are treated to an exhibit that intellect is not maturity or wisdom.

Daniel D
Feb 14 2013 at 5:40pm


Hearing her speaking, especially in the second part of the program, I had in mind the tents and the signs in Finsbury Square in London. Where intelligent and well educated people like Cathy had signs with, frankly useless, messages reading things like “capitalism is crisis” and “love grows on trees, money doesn’t”.

Like the people in Finsbury Square, your guest seems to me naïve and poorly informed. In her website she’s campaigning against HSBC because of the drug money scandal and the only thing she has to say about this organisation is: “I think it’s the largest European bank”!??!

She vaguely complains about the problems and does not really provide any solution. She briefly mentions the Volker rule, which is very debatable whether it would be of much use.

I think that the only concrete solution that was discussed is that a person should not be allowed to work for a regulator and for a financial institution in her (or his) career. Really? The “revolving doors” problem is real: An inspector easily finds himself auditing former (or future) colleagues and employers, a situation that is clearly not ideal, but do you really want someone who has never worked for a bank to assess if a bank is operating within the rules?

Patrick R. Sullivan
Feb 14 2013 at 6:16pm

It’s not like it’s impossible to come up with actual specifics either. Charles Calomiris latest does just that, for example, regarding the ratings agencies;

2. Reform the use of credit ratings of debt instruments to require NRSROs to predict the probability of default, rather than give letter grades, and hold NRSROs accountable for accuracy using “sit outs.” Specifically, for each class of rated debt (e.g., credit card securitized debts) BBB would be defined as an estimate of a 2% 5-year PD, and A as an estimate of a 1% 5-year PD. If a 5-year moving average of actual PD for the rated BBB instruments in this class exceeds 4%, then the NRSRO will have a six-month “sit out” in rating that class of debts. If a 5-year moving average of actual PD for the rated A instruments in this class exceeds 2%, then the NRSRO will have a six-month “sit out” in rating that class of debts.

That’s a lot more useful than whining about machismo (which, btw, is not restricted to finance professionals).

Lucas W.
Feb 14 2013 at 6:16pm

@Steve Sedio:

She was surprised that people around her thought “we’re smart, we deserve to take money from stupid people”. That applies to a lot of businesses, we usually call it competition.”

I think what she’s talking about is here:

a lot of these funds — and one of the reasons people think of them as “dumb money” is that they’re actually required by contract, by the prospectus of the fund, to trade in a certain way, to have certain kinds of things in their portfolio, especially near the end of the quarter. So the idea would be to anticipate, like, how they would not trade at all because they’re lazy for most of the quarter, and at the very end say, “Oh, oh, jeez, I should probably do some trading,” and then sort of in the last three days of the quarter or something probably true up their portfolio. And that’s when we would anticipate that, if we could. […] I just felt like I was doing something immoral. I was taking advantage of people I don’t even know whose retirements were in these funds. […] So anyway, the average person puts this money in once a month. Wall Street takes it and skims off. With the help of hedge funds, but also with just the help of poor trading and bad decisions, it just skims off a certain percentage every quarter, so larger percentages every year. At the very end of somebody’s career, they retire and they get some of that back. I mean, it just seems like such a wasteful system in the sense that this is this person’s money, and it’s just basically going to Wall Street.

There’s a sense in which this is “competition”, though it’s not a particularly useful sense. What they were doing probably shouldn’t be illegal, but I can see calling it immoral. The average person has virtually no way around this sort of “tax”, and there is no real value created. It’s a zero-sum game which the hedge fund wins and your retirement account loses.

Bryan Mackinnon
Feb 14 2013 at 7:04pm

One major contribution to the ongoing economic problems was not discussed and has nothing to do with the 2007-2008 financial crisis: the shift of wealth and jobs from the West to the East. Fixing all of the underlying causes of the crisis will not address this other issue.

Bryan Mackinnon
Feb 14 2013 at 8:02pm

Were it not for the low cost labor available in the East, unemployment in the West may be half what it is now and the discussion between Russ and Cathy would seem less poignant.

Mike G.
Feb 14 2013 at 11:15pm


I don’t think we know how to prevent financial panics. I don’t think we know why the Great Depression was so bad for so long. Economies are unimaginably complex systems. This podcast emphasizes the limits of what we can know (and what a relief it was to find such a perspective).

Bailouts create perverse incentives and make future crises more likely. That’s Russ’s story. I don’t know if he’s right, but he’s done a lot to convince me.

Banks aren’t like other firms – they deal in the very promises that keep people going about their lives. But they’re run by humans, so we know they will make mistakes. So how do we minimize the collateral consequences of their mistakes? I think that’s the key question, and no bond rating scheme is going to answer it.

Patrick R. Sullivan
Feb 15 2013 at 10:40am

Mike G, we’ve known since Friedman and Schwartz that the Great Depression lasted so long mostly because of perverse monetary policy. Scott Sumner has been making an increasingly powerful case for that being the reason for this one being so drawn out too.

Banks are different because of the way they expand the money in circulation (by extending loans). Which is why ‘bailing them out’ (but not saving their owners from losses) can have benefits for everyone. That isn’t true for other industries.

When we let the banks fail, without regard for the repurcussions, in the 1930s, that was a disaster. Bernanke well knew that, so he acted to prevent another 1930s style disaster.

It’s always a good idea to ask, ‘Compared to what?’ when discussing economic phenomena.

Dave D.
Feb 15 2013 at 12:04pm

[Comment removed pending confirmation of email address and for policy violations. Email the to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.–Econlib Ed.]

John Berg
Feb 15 2013 at 1:10pm

Cathy need not worry about the privacy of an individual’s computerized record. Since The Privacy Act of 1974 any record held by an agency of the government which could be associated with an individual was,in effect, made the property of that individual and the government was obligated to protect it.

It also permitted an individual to refuse to disclose that great linker of computer records, the Social Security Number, to anyone. Of course the law also contained exceptions, exemptions, and ambiguities that permits more efficient processing of records.

John Berg

Feb 15 2013 at 8:45pm

Free markets are very efficient at finding optimal solutions and the financial industry is a perfect example. When Government insures deposits and back stops losses then high leverage and more risk taking is optimal. Those that buck that trend will lose market share.

The problem with the system is Government promises protection from extreme swings, something it can’t do. The solution is eliminating Government guarantees and back stops so that the optimal solutions will be less leverage and more prudence to earn the confidence of depositors and investors.

There is nothing wrong with people’s “morals”, the problem is with the way Government has misaligned incentives.

Feb 15 2013 at 11:01pm

@ John Berg

Actually, she is absolutely correct about the data privacy issues. You cite govt agencies with access to personal information. That is hardly the issue.

Private data aggregators exist that merger people’s online activities with their purchasing via credit cards and debit cards. Those profiles are then sold to companies for marketing purposes, just as she described with the potential that insurance companies review an applicant’s prior year’s worth of transactions to identify purchases that might raise the risk for a given individual. That is real. It happens every day. In some ways it is convenient, like how certain ads pop up in my Amazon page because of my prior purchase history. However, I think none of want to provide a listing of every single purchase we’ve ever made to a company deciding our health care.

Ultimately, it is more honest to simply assume all of our activities are public and that any consequences are our own responsibility, but most people don’t want to live that way.

Feb 16 2013 at 1:02am


I have a huge amount of respect for you and econ talk. I think you have done a wonderful job with it, and I look forward to it every week. This podcast for me, however, was quite an outlier (on the wrong side of the distribution).

I have worked as a quant in the hedge fund industry for quite a while now – currently in quant futures trading. It definitely won’t be a perfect intersection with what Ms. O’Neil was working on, but it’s going to be quite related. While I don’t doubt the facts from her story, I would strongly second guess her interpretation and conclusions drawn from the experiences she had.

1) “It was all about: let’s anticipate what dumb people are going to do so that we can make money off of them. And there was this dichotomy, like dumb versus smart money. We’re smart money; they’re dumb money.”
My only possible explanation for this statement is that Ms. O’Neil took what she was told on her first day, and decided to never learn more or dig more. There is a HUGE amount of literature on expected returns. For Ms. O’Neil to reduce it to smart vs dumb money (probably some weak understanding of a potential return source from trend models and crowding) is simply wrong and a mischaracterization of what quant hedge funds do.

2) “We are so smart that we deserve their money. It was essentially kind of an entitlement.”
I have never heard that one before. Not sure there’s many quant hedge funds out there who think they deserve someone’s money (or, more strongly, are in some form entitled to it). They compete for it by offering a product that they believe is superior (just like any other market maybe!).

3) “So in 2009, I decided, now that I’m sort of an expert on algorithmic futures–I was a quant in the futures group”
SORT OF AN EXPERT? Two years. In two years you’re “sort of an expert”??? I guess that makes Cliff Asness a god.

4) “Well, they weren’t interested in me. It took me a couple more years to figure out why. Which is to say that they actually just didn’t want to solve those problems.”
What kind of evidence is this conclusion based on? Are we supposed to think that they didn’t hire a self-proclaimed expert because they didn’t want her to expose the kind of mess that existed? Because I’ve got a much simpler story that may not boost Ms. O’Neil’s ego as much…

5) “And I realized that I could spend the rest of my life doing mathematically improved models, but if no one actually looks at the numbers, at the end of the day there’s no point.”
I know some people who have been turned off by their first job in finance, and I often try to convince them to look around a bit before giving up (because often the reason applies to the small subset of companies they have been exposed to). I would have said the same to Ms. O’Neil at the time, but I think she was too busy confirming her biases.

6) “we’re smart, so we get to take money from stupid people.”
So either we’re back to point (1), or Ms. O’Neil is referencing the “Dumb money” vs “Smart money” as simply terms for less informed allocators (basically like passive indexing, but applied to the hedge fund world) vs more informed allocators who really dig down to pick and choose their portfolio of hedge funds. If it’s not (1), then she’s using those terms too literally when constructing the conclusion “we get to take money from stupid people”. Otherwise, see (1).

7) “They’d care about the look of the report rather than what the actual numbers were.”
So those banks are huge, but somehow Ms. O’Neil thinks she’s talking to the person in charge of risk, and all they care about is the look of the report. I worked early in my career in a bank’s risk department, and there were some very sharp people there who loved math and risk and modeling. And I have plenty of friends who ended up in risk departments. But someohow Ms. O’Neil, after a span of less than 1 year (the first year she was helping build the models), has decided that she has enough evidence to characterize the banks as mostly caring about the look of the report?

I was not a fan of this podcast. I believe Ms. O’Neil’s experience and depth was severely lacking to discuss the subject matter. Said another way, there are usually experts on this show.

Feb 16 2013 at 3:16am

I see the importance of such podcasts in deromanticizing of the finance career for young aspiring students.

During economics classes and bank presentations on campus your hear a lot about the importance of banks and finance in the economy. It is like bankers create much more value for people than the engineers, scientists, doctors, i.e. people who actually produce value for other people.

I am a little bit worried that more and more people choose to just launder money and do nothing creative; I totally agree with Russ, that the issue is in our deteriorating culture and not in the sphere of economic policy.

Shayne Cook
Feb 16 2013 at 8:09am

@ Russ:

One of the things Cathy mentions here is her perception that economists in general do not understand the financial system, particularly the U.S. financial system – how and why it exists and how and why it works. Suffice to say, that is my perception as well.

With that in mind, I’ll reiterate my previous recommendation that you invite Fredric S. Mishkin in for a podcast session. I suspect that might enlighten you, Cathy and quite a few others of us who enjoy your podcasts.

Patrick R. Sullivan
Feb 16 2013 at 11:33am

FriscoX, well said. My reaction to her was, Vicki, Cristina, Wall Street.

Patrick R. Sullivan
Feb 16 2013 at 2:07pm

Providentially, here’s a new scholarly explanation of why Cathy doesn’t get it;

…liquidity can be beneficial by encouraging large shareholders to form in the first place, and by allowing shareholders to punish an underperforming firm through selling their stake. More broadly, the paper contributes to a recent literature on the real effects of financial markets. The traditional view (e.g. Morck, Shleifer, and Vishny 1990) is that financial markets are simply a side-show that passively reflects firms’ fundamentals – for example, a fall in the stock price reflects a deterioration in firm performance. This newer literature, surveyed by Bond, Edmans, and Goldstein (2012), shows that stock prices actively affect a firm’s fundamentals – a fall in the stock price exerts governance on the manager by worsening his compensation and reputation; the threat of such a fall induces the manager to exert effort. Thus, policymakers should take into account the effects of financial markets on real economic activity when designing regulations.

I.e., be careful what you regulate for…you might regret what happens.

Paul S
Feb 17 2013 at 7:46am

Calling someone “naive” is the height of arrogance and reflects the name-caller’s own insecurity.

Smart people v. Dumb people – Exactly why Stieglitz won the Nobel Prize – Fake capitalism thrive on ignorance – True capitalism thrives on competence

Who gets hurt – Such a telling interchange revealing the bankruptcy of conservative thought. It doesn’t matter to Russ that a the elderly lose their life savings or their lives – its all part of the “true pain” that will cure the ills of our economic system.

It is clear that in a right-wing utopia the those who feel the pain are to be powerless. It is this broken link that makes the conservative model fail, time after time. Pull the lever to stop the pain – oops the lever is connected to nothing.

Russ Roberts
Feb 17 2013 at 11:12am

I fear that many of you have confused Cathy O’Neil’s attitudes with her insights. They are potentially related, of course, so you wouldn’t want to ignore her attitudes entirely when evaluating her insights. But I think some of you have missed a learning opportunity.

I learned a lot from her. Yes, the smart/dumb distinction is not common in the business world–Steve Jobs had that arrogance as well. But it can be corrosive to be in such an environment or it can be exhilarating. It depends on how the products turn out. I think the main lesson is that financial modeling can be window-dressing rather than anything remotely akin to science.

Another insight of hers that I believe bears repeating and remembering is the source of the imperfections in the financial models in the run-up to the crisis. Many people blame the crisis on hubris and overconfidence in the models. I think O’Neil makes a very deep point when she argues that the bad models were an effect rather than a cause. Read her post on Nate Silver. It’s superb.

I think Occupy Wall Street has it half-right–Wall Street’s rules are not the same as those that apply to the rest of us. I think that outrage is very well placed. That does not mean that everyone in the financial sector is a jerk or a parasite. But we also don’t want to pretend that “they are just playing by the rules.” Even if we ignore the role of the participants in writing the rules, they’re bad rules.

Glenn Donovan–you’re point about the incentives facing the ratings agencies and those who paid for the ratings comes up in the conversation and is a common theme here at EconTalk.

Chris writes:

I would have been interested in hearing more of Russ discussing why a truly free market would prevent a bank from becoming too big to inflict massive damage on the wider economy in the event that it failed. I see no reason why the market left to its own devices would not produce huge, dangerous banks.

The main way that banks get large is through leverage–by borrowing rather than using their own capital to grow. It is that leverage that makes them fragile–prone to insolvency from relatively small swings in asset prices. The potential for a bailout of creditors makes creditors comfortable lending into such fragile situations. Without bailouts or the expectation of bailouts, creditors would have no incentive to create such leveraged institutions. And if they did anyway, despite the risk, they would learn a very painful lesson because they would lose most of their money when those they lent the money to, failed.

For more on these incentives, see my paper on the crisis.

Paul S. thinks I want to see the “elderly lose their life savings or their lives.” Huh? Why is letting the large financial institutions that financed Bear Stearns and others bear the cost of their mistakes rather than taxpayers a “conservative” position? What does it have to do with killing the elderly? The interventionists have made the richest people in human history even richer. That’s the “liberal” position?

Patrick R. Sullivan
Feb 17 2013 at 1:14pm

With all due respect, Russ, just because several of us have commented on Cathy’s off-putting, ‘It’s all about me.’ attitude, doesn’t mean our real problem isn’t with her ‘insights’.

As Milton Friedman like to quote a DuPont from 18th century France, ‘Bad logicians have committed more involuntary crimes than bad men have done intentionally.’ Cathy is a bad logician.

More recently, as the late congressman Sonny Bono once told Chris Matthews on Hardball (shortly before his death in a skiing accident); ‘It would be better if there were more people like me [with hardscrabble backgrounds] in congress.’ Because, he knew that ‘there are people who will game any system.’

Yes, there is venality in the world (Cathy’s gripe), but there always has been…and probably always will be. We need to ‘keep our eye on the ball’, i.e. the incentives we create by regulations like the CRA, HUD’s Best Practices Initiative, and Basel II (which weakened American banking capital standards).

Or, even the creation of MBS in the first place, which originated, in the 1970s with government insured loans. The financial crisis is a, ‘For want of a nail…’ story. The politicians who took that nail are far more deserving of blame than the jerks Cathy worked with on Wall Street.

Dylan Wiliam
Feb 17 2013 at 3:44pm

Another great podcast. I happen to think that the OWS movement is hopelessly naive, but clearly, Cathy O’Neill does not, so it would have been interesting to hear her views on the idea of the 99% and the 1%.

In terms of the responses to this podcast I was surprised that

(a) no-one mentioned George Box’s insight that “All models are wrong; some are useful.” If applied mathematicians spent as much energy testing the reasonableness of their assumptions (think Long-Term Capital Management and their assumptions about liquidity) as they do developing their models, maybe they would be a bit more cautious about believing their own predictions.

(b) so many of the commentators on this podcast were critical of the lack of solutions offered—surely the fact that we don’t know how to solve the problems is the whole point. My own solution would include phasing out federal guarantees over (say) a ten year period for all deposits over a certain modest threshold. When more people have skin in the game, there is a chance for the market to do its work.

Russ Roberts
Feb 17 2013 at 3:48pm

Patrick R. Sullivan,

I think you have misunderstood Cathy O’Neil’s argument (and mine).

She isn’t blaming the jerks for the crisis. Nor does she want to prevent the next crisis by getting nicer people on Wall Street. Read her blog post.

Her argument is that the incentives facing Wall Street are unhealthy and that large banks didn’t act prudently because of those incentives. Her argument is that the system is corrupt and that as a result, it serves the players within the system rather than other goals.

I think she is right. My argument is that those incentives were corrupted by past bailouts and the expectation of bailouts–an expectation that was largely realized. When you reduce or remove the risk from creditors, they will lend more recklessly.

Bogart in the first part of his comment above has it right–in a system that rewards recklessness, it is foolish to expect it to attract prudent people.

john berg
Feb 17 2013 at 4:31pm

Prompted by Dr. Roberts, I read in Cathy’s blog on Nat Silver the following:

“It’s not a new question, since PR men disguising themselves as scientists have been around for decades. But I’d argue it’s a question that is increasingly urgent considering how much of our lives are becoming modeled. It would be great if substantive data scientists had a way of getting together to defend the subject against sensationalist celebrity-fueled noise.”

Of course she’s right: I point to the Wizard of Oz and the deeper meaning in that book by Baum. As Patrick R. Sullivan reminds us, someone will always game the existing common knowledge. My comments about the Privacy Act of 1974 was to direct our attention to the good (and bad) that has resulted from it over the last 40 years.

John Berg

Paul S
Feb 18 2013 at 12:15am

Of course, in driving my point, I do not for a minute believe Russ would like to see the elderly suffer, yet that is the logical extension of all right-wing arguments: people only change behavior due to self interest and negative consequences. Again, one can keep ignoring my reference to Stieglitz, but the truth is, there is no transparent information available on which to make that decision to learn a lesson from getting burned. As so many have pointed out, even the banks can’t see through the complexity they have woven, and you expect grandma to?

Patrick R. Sullivan
Feb 18 2013 at 12:40pm

Russ, the more of Cathy I read, the more I appreciate Tom Wolfe’s, “Moral indignation is a standard strategy for endowing the idiot with dignity.”

I think you’re reading things into Cathy’s writings that aren’t there. Take a look at her pictures on the blog, especially the HSBC ones. She is calling them., literally, the equivalent of terrorists.

Jed Trott
Feb 18 2013 at 1:59pm

I want to echo a comment above. I would really like to see a discussion between Taleb and O’Neil moderated by Roberts. My first choice, if it could happen, would be to see a comprehensive platform for banking reform to which all three could agree. That would be a thing of beauty.

Trevor C
Feb 19 2013 at 10:35am

I can confirm her story.

I work for a company that bought another a couple years ago. They make software that analyses risk for banks etc.

When we were initially meeting with them they said many clients were on Wall St. We asked them how their predictions worked out with regards to the collapse.

The software worked as it should have but they said that the banks simply chose to ignore the parts they didn’t like.

A. Zarkov
Feb 19 2013 at 1:32pm

[Comment removed for ad hominem remarks.–Econlib Ed.]

Brendan Hodge
Feb 21 2013 at 10:50am

Very late to the game here, but FWIW:

I enjoyed this as I usually do when Russ interviews someone with radically different views from his own. The one thing I thought that would have been helpful here to focus on a bit more is how the Smithian mechanism of the market doesn’t require that people be acting in good faith or seeking to fully understand the situation. One of the things that seemed to really shock Cathy was that the people she dealt with in the hedge fund world often didn’t care about the fundamentals of the company or the fundamentals of the fund, so long as “smart” bets were being made that eked out some profit. The beauty of markets is that that is okay. People don’t have to be making their choices based on a full understanding of the information in order for the market to work and find prices. It’s okay that her co-workers weren’t saying “let’s figure out how to best allocate this capital” because the mechanism was doing that even with their less noble and less aware actions.

John Thurow
Feb 21 2013 at 12:33pm

Here is something that should be obvious:

the root of the problem is regulation and the Federal Government’s interference thereby.

Get rid of regulation and

1) no revolving doors
2) no need for lobbying
3) no need to change laws to benefit your specific interest
4) no need to give congress $$$$$$$$$$$
5) no need to have your “man” as treasury secretary

Liberty works. Let these companies stand on their own and live or die by their decisions. Let the market be the regulator and not men.

John Thurow
Feb 21 2013 at 2:22pm

In answer to Paul S.

Why do you think the elderly put so much of their life savings into the market to lose -are they relying on Government regulation or Government bailouts? Does Government regulation make them feel more secure in their investment? Without government interference would they invest all their savings in the market or be more cautious? Are the elderly all dupes with their own money? Who do you trust more: a regulator or yourself with your money? Do you think the elderly aren’t hurt with 0% interest rates or with inflation?

Paul S
Feb 21 2013 at 11:33pm

Response to John Thurow –
The elderly in my grandfather’s day didn’t have to look toward casino capitalism to lead a respectable life in their declining years. They had pensions. It was the right wing phony supply side market-worshipping philosophy that left the elderly no other choice.

Its the same mean-spirited philosophy that blames the homeowners for “irresponsible borrowing”. The term itself is a repulsive oxymoron. It was the banks that irresponsibly lent money to folks knowing full well that they could not afford to repay – it didn’t matter to the banks, who promptly securitized, sliced and diced to the point that true risk (knowledge of which is critical for a free market) was so obscured that they were able to off-load the bad loans and skim the spread.

There is no such thing as a “free market” and, if folks are as open minded as they claim, at least have the courage to read some of the modern economists rather than participating in the right-wing echo chamber. Start off with Stieglitz “Free Fall”

Paul S
Feb 21 2013 at 11:44pm

Response to Brendan Hodge –
Its such an attractive notion, the “market” is totally self-organizing for the good of society. Regulation is seen akin to messing with the ecological balance in nature. But you are wrong Brendan. The market chokes on lack of information. How can you possibly say that ignorance is irrelevant given the current meltdown? A meltdown that even conservative economists blame on the incredible complexity in the casino’s you call “markets”. Come on conservatives – you are supposed to be rational! The market certainly has its place and can accomplish things the gov’t cannot. Don’t you guys have the guts to look at the evidence and modify your convictions. At least Russ has the intellectual honesty and courage to do just that.

Russ Roberts
Feb 22 2013 at 12:28pm

Paul S,

The world is a complex place and it is difficult if not impossible to draw causal inferences from a narrow set of events. So it is not clear what lessons are to be learned from the recent meltdown or the changes in retirement savings away from pensions toward self-directed investments. No one was in charge of these things and they are not a simple result of a particular ideology or set of principles. So please don’t blame “the market” or “worship of the market” for either of these things.

Those of us who are fans of leaving things alone don’t get our way. The politicians who quote us or invoke our arguments rarely adopt our principles or advice.

The key point for me is that government policy has removed many of the feedback loops that normally work to create responsible and prudent lending and investing. This point may not be decisive as a causal force (see my first paragraph.) But that does not mean you can ignore it or neglect it. It certainly contributes to the problem even if it is not decisive.

The rescue of large financial institutions and the insulation of those institutions from much of the risk they should be facing has created an incentive for inter-relatedness and complexity. I would not take those two aspects of the current system as given or natural.

Tom Heller
Feb 23 2013 at 9:58am

Steve Sedio wrote:

She was surprised that people around her thought “we’re smart, we deserve to take money from stupid people”. That applies to a lot of businesses, we usually call it competition.

That’s too dismissive of a *system* that simply ran out-of-control. All you’re doing is cheerleading a textbook-bound concept.

Other systems in the economy also run out-of-control, typically fueled by a lot of easy money flushing around. Those systems include education, higher education, military expenditures, government programs of all sorts and per Steve Brill’s lucid reporting in Time magazine (“Bitter Pill”), the entire health-care system in the U.S.of A.

This isn’t the result of market competition, but the ‘entitlement’ of “smart people taking money from stupid people”.

Tom Heller
Feb 23 2013 at 12:37pm

Now, after having read the entire comment thread, I’ll listen to the interview.

P.S. I concur fully with Russ’ point about the near-absence of “feedback loops”.

Feb 24 2013 at 11:58am

Glenn Donavan commented above that OWS “was a creature of anarcho-capitalists”.

It’s official: I have now heard everything.

What a baffling observation. I am stumped.

(I just probably have just posted “Huh? Wait, what? WHAAAAaaaat?!”)

Feb 26 2013 at 5:37am

Dear Russ,

It was (again) a very insightful discussion on the financial crisis. People are stupid when they deny that markets fail from time to time but they are extremely naive when they believe that quick state interventions will always fix the system. Very often, such interventions accelerate or even provoke the failures. Government failures are typically more frequent and more severe (although less acute in the short run and more difficult to reveal) than market failures. The financial crisis was mainly caused by a poor regulatory framework. First, there was very light, if no, regulation on the US mortgage brokerage industry. Second, the US federal agencies (Fannie Mae and Freddie Mac) acted as buyers of last resort and subsidized the mortgage market heavily. Third, investors were incentivized to (over)rely on rating agencies. All these three factors have deep political roots. Everybody knows that greed is a deep, natural, human motivation: for better and worse. This is no big surprise. But the regulatory environment must not make greed (almost) riskless (or less risky than it must be). The solution is not to ban speculation, which lies at the heart of the creative destruction process. The key is to prevent financial institutions from generating negative externalities. If they do not internalize such externalities, they must ultimately fail and feel the pain and suffering that unsophisticated investors and homebuyers have been feeling since 2008.

Thank you again for these podcasts which I recommend quite often on my blog/website. The reason is simple: Deep respect for those who do not share the same view than yours (and sometimes – not often – I am among those who do not 🙂


Feb 26 2013 at 3:32pm

[Comment removed for irrelevance.–Econlib Ed.]

Feb 28 2013 at 11:34am

As always, this interview was fascinating and educative.

Unfortunately, it was also a big let-down. Russ and Cathy agree that the system has serious flaws. They even agree on the precise nature of some of these flaws and on the kinds of changes that need to be made to improve the current system. Where they disagree is on the question of Occupy and Cathy’s participation therein. This is where I hoped the conversation would focus, but unfortunately very little serious attention is given to the question of political strategy in the interview.

Russ, you see problems and seem to have some proposals for change, but you present no analysis of the kind of political strategy necessary to get us there. From comments here and there, it is obvious that you disagree with the strategy taken up by Occupy Wall Street activists, yet you never tell us why their strategy is flawed, whether or not some other form of mass mobilization is a critical element in the political strategy you have in your head, or whether mass mobilization cannot play a helpful role. Yet it is precisely these questions that must take center stage in any good discussion about political strategy to affect the kinds of policy and structural changes that you both seem to agree on.

Russ, at one point you say in passing that the images you saw of Occupy on television made it look like a camp-out or something like that. You also ask Cathy whether or not you’d be comfortable at one of her weekly community meetings that she continues to attend. But who cares about these things? Maybe you would not feel comfortable at one of these meetings, but that tells us nothing about the political effectiveness of building community meetings and networks in the process of affecting social change. Sure, the occupy camp in lower Manhattan probably seemed a little like a camp at times, as people sought ways to entertain themselves and get to know each other over the long hours of occupation, but this hardly means that occupations are ineffective tools for change.

I’m not suggesting that Occupy has the correct strategy or that Cathy’s weekly meetings are the most effective tool to create the kind of change she and her fellow meeting-goers desire. Instead, I’m saying that the interview neglected to ask all of the right questions on the important point of political strategy. Russ, if you think the bail-outs should not have happened and should not happen again, what needs to be done in order to ensure that this will occur? More to the point, what needs to be done in a context where the only two political parties don’t want to take your proposal seriously? Surely any solution needs to involve the generation or organization of sufficient power to make political parties and other powerful actors take your proposal seriously… which begs the question of strategy.

Thanks again for a stimulating podcast!

Mar 5 2013 at 5:55pm

Agree with other commenters that she was very naive. Guess what, hedge funds are in the business of making money.

I would say that her point that the models were not to blame for the crisis was good, except that I don’t think anyone halfway knowledgeable holds the other view so it’s rather trivial.

Hopefully Russ planted a seed of thought in her mind.

Dave Chisholm
Mar 7 2013 at 12:51am

Wow, Excellent podcast and yes please have her back for a discussion on internet data mining.

There are so many comments to comment upon.

Firstly I was saddened by the number of comments calling Cathy out as an “interventionist” or for being an arrogant elitist with presumptions of having “all the answers”. I don’t remember her advocating anything of the sort. Her main message was that it is complex, it was broken and it is still broken so people should be looking for a fix. She didn’t advocate any solutions let alone interventionist ones. When asked she bent over backwards to qualify her statement that there are lots of ideas floating around and that a few are worth looking into more, such as controls against revolving doors.

Seems to me that those comments must have been based more on the bias of the commenter rather then anything said by Cathy.

Russ, you say:

The world is a complex place and it is difficult if not impossible to draw causal inferences from a narrow set of events. So it is not clear what lessons are to be learned from the recent meltdown or the changes in retirement savings away from pensions toward self-directed investments. No one was in charge of these things and they are not a simple result of a particular ideology or set of principles. So please don’t blame “the market” or “worship of the market” for either of these things.

When you say “no one was in charge”, did you mean the drift away from pensions towards self-directed investments? Because my memory is that this was very much a conscience and deliberate political movement. I remember Bush’s slogan about the “Ownership Society”. But I believe it started earlier with Thatcher.

The Philosophical basis for it was that an individual is the best steward of their own assets. Others called it a plot to steal power from activist Union Pension funds. Either way I think it is wrong to say “no one was in charge” when in fact it was a very central plank in the conservative platform.


“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest,”

I agree 100% with Smith. However, What happens when a butcher decides that given his dire financial situation it is in his best short-term interest to sell sub-prime meat? Especially when it was he, the butcher, that wrote the regulations concerning what constitutes sub-prime meat. And knowing that even if a number of his customers die and he is found to have been acting with wonton disregard for their lives, he knows that he will not be shut down because he is too big to fail because he is the only butcher in town.

It is fine to say that the market will punish him and that no one will buy meat from him again. Heck they might even shut him down and throw him in jail. But after this happens a few times the meat buying public freely associate and decide that they are tired of their friends dying from tainted meat so they decide as a group to only buy meat from suppliers that meet certain standards. In fact they decide that they will run any butcher out of town that refuses to abide those minimum standards. Viola! The modern liberal democracy!

There might be good public policy and regulation and there might be bad public policy and regulation. But to argue for NO public policy and regulation! That is the height of naivety.

Dave Chisholm
Mar 7 2013 at 1:14am

A few commentors mentioned that they wished there had been more discussion concerning OWS and the 1%. There is a short graphing video available on YouTube that compares what people “think” the distribution of wealth in America is, to what they think an “ideal” distribution would be, to the “actual” distribution. It is a a rather interesting view of the numbers.

[html fixed per commenter–Econlib Ed.]

Dave Chisholm
Mar 7 2013 at 1:34am


I am a little bit worried that more and more people choose to just launder money and do nothing creative; I totally agree with Russ, that the issue is in our deteriorating culture and not in the sphere of economic policy.

Culture starts at the top. Are CEO’s paid the big bucks because of intense technical knowledge of the businesses they are running? Or are the paid so much because of their leadership abilities?

I believe it is their leadership abilities. Their ability to lead 10’s of thousands of people in their company by creating a corporate culture that succeeds.

But we have created a corporate framework that defines that success in terms of short term results. The leaders create cultures of greed is good. That rules are for the weak and for the “interventionists”. So why are we surprised when people within that culture bend or break the rules? (libor, money laundering, gaming the system to take more risk)

Culture starts at the top, both corporate and public. Those leaders have to be held to a higher standard then the rest of us, but instead we are holding them to a lower standard. How many bankers are in jail?

You want to fix your deteriorating culture? Hold your leaders to account.

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Podcast Episode Highlights
0:33Intro. [Recording date: January 25, 2013.] Russ: I ended up at your website, mathbabe, somehow, I don't remember how; and I ended up reading a long post you wrote about Nate Silver's book, The Signal and the Noise, and your views on models and data, particularly the financial sector, how we should think about them. And those are topics that come up often on this program. Two things jumped out at me as I read your words: one is that we had very similar views about the problems on Wall Street. And the second was that we had very different ideas, radically different, about what to do about those problems. You're involved with Occupy Wall Street. Maybe I should be, too. Or maybe you shouldn't be. But there's something weird going on there. The first three-quarters of your post or so could have been written by me--though I don't know if I could have written it as well. And I just disagree with the last part. So, what I want to do in this conversation is to look at where we agree and why we disagree. And I want to start with your story, which begins of all places on Wall Street. How did you end up there, why did you leave, and how did you finally end up at the other end of town, you could say--at Occupy Wall Street? So, start with how you got to Wall Street to begin. Guest: Okay, sure. I was a mathematician. Ever since I was 14 at math camp I wanted to be doing mathematics, because I thought it was beautiful and clean and I liked the fact that you couldn't really disagree with the answer, once you knew it, you had the proof. And it was about as clean as you could get. But when I got to being a professor at Barnard College I realized that for various reasons it wasn't suiting me, my personality. The feedback loop was very slow; people sort of judged you not on your actual merits but on the reputation you had, or the fact that you are a woman--various things like that, that just enraged me. And I just realized I should be in business, I should be somewhere that uses mathematics because that's what I'm good at; I should be somewhere like where the metric of success is completely clear. And that's one of the reasons that working at a hedge fund attracted me. I didn't know much about--in fact, I was really quite naive about what hedge funds did. But, it was 2006, and I applied, and I was a professor of math and had papers published and I could solve all their puzzles. Russ: They love people like you. They do. Guest: Yes, they did seem to. And they offered me a job, and I took it. And I started in June 2007. And basically exactly right before the credit crisis started. I entered in June, and by August there were major tremors, like at D. E. Shaw, the hedge fund I was working at. And I sort of witnessed the crumbling of the world around these people in this hedge fund. It was amazing, an amazing sort of front row seat. And one thing I realized over the two years I was there was that there was nothing clean about it. The way mathematics was being used, the way the Ph.D.s were being trotted--I mean, they weren't being trotted out because there was actually no public face to the hedge fund, but the way we were sort of thinking about ourselves and valuing ourselves because of our mathematical background, our Ph.D.s in physics and mathematics. It wasn't like a rational, logical thing. It was more of a cultural decision. Let me try to be more precise about that. So, when you first go to a hedge fund, you might suspect--if you are really naive--that a hedge fund is actually supposed to find the correct price for the market. That we actually provide a service, and the reason we make so much money is that we are providing a service and of course we should make money if we are doing something good. Or, we're helping--another thing that you hear is we're helping--it's usually some of the same things--we're helping money where it should go. Russ: Allocate capital to its highest use. Guest: Yeah. Thanks. I spent four years in finance altogether. In the two years I spent at the hedge fund I don't think I ever heard someone say: Let's allocate this capital better. It was all about: let's anticipate what dumb people are going to do so that we can make money off of them. And there was this dichotomy, like dumb versus smart money. We're smart money; they're dumb money. We are so smart that we deserve their money. It was essentially kind of an entitlement. And it was really unattractive to me. I spent a lot of time at lunch trying to understand the mindset of, like, how does being good at math give us the right to do this? Because it's legal? That didn't seem right. And it was particularly jarring to go through this kind of discussion when the world was collapsing. When every kind of assumption that we were making about how smart we were actually didn't seem that smart. We were losing money. We were bleeding money. We had no idea why. There was just this complete cataclysmic event that did not follow any of our models. Our internal models to ourselves were: we are very, very smart; we are very, very rich; we must be, you know, God-like, because we are so smart. And it was just the overall thing, like the emperor has no clothes kind of event for me. And I just didn't want to be part of it. So in 2009, I decided, now that I'm sort of an expert on algorithmic futures--I was a quant in the futures group--maybe I should talk to the Commodity Futures Trading Commission (CFTC) or the Securities and Exchange Commission (SEC) or the NY Fed and ask them if they want me to help fix this mess. And so I applied to all those regulators. None of them-- Russ: I'm glad to see that your innocence survived the hedge fund experience. Guest: Well, they weren't interested in me. It took me a couple more years to figure out why. Which is to say that they actually just didn't want to solve those problems. So, I still didn't know what exactly was going on with fixing the problems. But I knew that I wanted to be part of fixing the problems. And so the best job I could get where I thought I could be part of that was at a risk firm, called RiskMetrics, and I was put in charge almost immediately of fixing the credit default swap model for VAR, Value at Risk. And I worked for quite a while on that. And after a year, I thought I'd done a pretty good job; there were lots of caveats but I thought it was well-understood in the system, in the market, by the clients. Then I got put on a job where I answered the phone to the clients. And that's when my eyes really opened, and I realized that the too-big-to-fail banks, the clients of our risk firm, were using us as a rubber stamp. They weren't even looking at the numbers. And the only people that were seriously looking at the numbers, which were few and far between, were quantitative hedge funds--which, they were actually risking their own money. Or cared enough about the money they were risking to actually care about the risk. Like, the very people who really should be caring about their risk simply didn't care. And I realized that I could spend the rest of my life doing mathematically improved models, but if no one actually looks at the numbers, at the end of the day there's no point. And that sort of opened my eyes to a larger thing, which goes to my Nate Silver post, which is that a lot of the Ph.D.-like jobs you can get out there, in finance especially, are window-dressing jobs. It's basically a company where they open their door to the client and then they point to a back room filled with Ph.D.s working furiously; they say: Oh, don't worry about our product; you can have faith; we have Ph.D.s. And it goes two ways. On the one hand, the product doesn't have to be any good, because we already had the badge of authenticity coming from the back room. On the other hand, half the time the clients are also not--they don't care if the product is good. They're like: All I really need is to be able to tell my clients that I'm using products that have Ph.D. back rooms. So it's this crazy farce. And that realization made me just leave finance altogether, early 2011.
9:57Russ: So, before we go on, I wanted to ask you just a little bit about the culture in those places and your reaction to it. Of course, it's easy to overdramatize moral and emotional issues after the fact, in hindsight. But my suspicion is that when you were at lunch and worrying about the things you said you were worrying about--were you kind of alone? Did you find any people who sympathized with your concerns? What do you think their attitude is toward these issues about smart money and dumb money, and just being window-dressing? Do you think they feel that way, or do they think you're crazy? Or do you think they are self-deceiving? Guest: Well, there's a few issues. First of all, I want to say that I never witnessed any actual illegal or criminal activity, at D. E. Shaw. What was unappealing to me about being there was the arrogance and the greed and the mindset that I discussed. Not everyone was as intense about this idea--we're smart, so we get to take money from stupid people. The thing I really want to mention, though, is the people that were most intense about this were people who honestly seemed to me--I mean, I pitied them. I don't want you to think it was like an intense and negative, hostile conversation. It was more like me realizing that these people were actually afraid. They were like somehow afraid--I sort of think of them as survivalists at this point. They probably have land in Utah somewhere. They were like actually worried--and would say so--that the whole system is going to break, any second, and when it breaks, I'm going to have enough food and I'm going to have enough money for my entire family. We're not going to have to worry. So it was kind of a bunker mentality. And I was definitely--I stuck out like a sore thumb, for more reasons than one. Number one, I was a woman--I was the only female quant there. I was one of the few people that had children. And I also was one of the people that was hired later in life, so I already had developed my own kind of--I totally had developed a personality. And moreover, as a mother, I was used to being a person that created culture; and the culture there, like if you sent absorbing young men into the culture, men are sort of chameleons inside a culture and I was just simply not having that. So I never sort of felt at all like I fit it. I just want to throw one last thing in there, which is that having spoken to a few people from D. E. Shaw, even the ones I disagreed with, none of them actually ever felt like they fit in. I think that was one of the characteristics of working at a hedge fund, that the competition inside the workplace is so fierce that everyone kind of feels like an outsider all the time. Russ: Yeah. There is a certain macho swagger--at least, that's the reputation such places have. I have a few friends who work in that industry; at various times in life, they've had that swagger. Maybe they always do. I don't know. But it's certainly something I think is harder when you are younger, and, as you say, if you don't have children, you are a different kind of person than someone who is older with children. Male or female. Guest: Yeah. And I also was Larry Summers' quant when I was there. And he's a pretty fierce person. I guess one of the things about me is that I'm not intimidated by people. So, for me it was like an opportunity to study like major league macho behavior up close. But he didn't even impress me among the people I worked with. He was kind of middle of the pack in terms of macho behavior. But that's the kind of thing I'm talking about, where people were constantly posturing and trying to be as clever as possible and trying to best each other in conversation. Russ: So, lest our listeners accuse you of a holier-than-thou attitude or sour grapes, do you want to say anything good about it? Guest: Yeah. One of the things I loved about it was the care of statistical modeling. It's a craft. And they really taught it to me. And I really enjoyed that. Intellectually it was very stimulating. And that's one of the reasons that, when I left finance altogether, I started my blog. Because I thought to myself, it's almost like a guild--like you go into finance, you learn the craft of being a quant. Like a guild. But why should it be closed? So, I resolved to open up some of the statistical methods. And I've been doing that on my blog. And I've also been doing that as being a data scientist. Once I left finance in 2011, I needed to figure out what to do with myself and how to make money. So, I got a job as a data scientist in tech. And I realized that a lot of the quant skills I had developed were very translatable into modeling[?], not with financial data, with time series data, but rather into cookies, trying to predict whether people are going to click on an ad, and whether they are going to purchase. So that stuff has almost the same underlying statistical methods. Russ: Sorry, I lost you. You said "translated into" what? Guest: To translate my quant skills into data science skills. Russ: Now, one of the things you said that is a little bit horrifying, but not particularly surprising--to me, and maybe it's my bias--or yours, so I'd like to hear you clarify it, is: You said when you were answering the phone that you'd get these calls from the clients, the too-big-to-fail banks, and you had the feeling they didn't really care about the data in the models. They just wanted to hear the answer and move on. Obviously that could be because they're not sophisticated enough to understand it. That's what they're paying you for. Could you elaborate on that and why you think that was the case. Because usually when you sell somebody something, they want to make sure it's good. They're paying for it, after all. So, where does that feeling come from and what do you think was going on there? Guest: Well, that feeling came directly from the kind of questions that the people who were in charge of the risk reports from the too-big-to-fail banks would ask when they called. They would ask questions like: could you make this font bigger? Could you change this from blue to red? They'd care about the look of the report rather than what the actual numbers were. And moreover, there were models they used that we later found out were broken and were giving actually nonsensical numbers, but they didn't notice. We found out because one of the quantitative hedge funds tried the model and said, Oh, this model is even worse than it used to be; we're not using this. And we were like, Oh my God, other people are using that model; they've never noticed. You definitely get a lot of evidence when you are on the phone with the clients. You get a lot of evidence about when they are looking at the actual report. As for why that's true, that's completely clear. The taxpayers bailed out the banks; they're massive; no one actually understands the portfolios involved. By the way: not all the portfolios were even on the system because they had just too much stuff going on at those banks. And a given person in a risk office does not feel personally liable to understand what's going on. And that was clear. And why should they?
18:40Russ: And that to me--those incentives are the root of the problem. If you don't have the incentive to pay attention, you won't. So, that's kind of straightforward. Although others may argue it was just simply a failure of command and governance. We can get into that maybe a little bit, but let's move to your comments on Nate Silver. I don't want to pick on Nate Silver. I've asked him to be on the program and it hasn't worked out; maybe it will down the road. So, we're not going to pick on his book per se. But he's not alone in arguing that the financial crisis was to a large extent simply the challenges of modeling complex phenomena, like various Wall Street products. It's just a question of doing it better; we've just got to put our nose to the grindstone and we need more data; and the people who built those models were well-intentioned. You think that's the wrong perspective. Why? Guest: I do. So, two things. First of all, it's a common misconception that bad models created the financial disaster. In fact, corrupt financial institutions forced the models to be bad. Because the corrupt financial institutions had the power over the quant teams and over their work and basically would not allow for a model that did not give them what they wanted to see. So it's almost a completely cause and effect being confused there. So, that's one thing. And I can give examples of that. The other thing is that yes, I agree that there's no reason to pick on Nate Silver. It's a common mistake that people make, and Nate Silver made it because he is essentially an expert in sort of finite game strategies. Finite game--by that I mean something like baseball or chess or poker, or even polling, where you know exactly what you are trying to do and you know if you've succeeded. And you've succeeded if you've won the game or if you have a statistical edge over other baseball teams. But the actual data--there's just no question about what the data is. Like, we all know whether someone actually got to first base or not. It's publicly available. On the one hand the data is publicly available, results are completely are completely clear--you either won the game or lost the game. Russ: There's some complexity about defensive fielding statistics, pitching, fielding, luck. There are issues, but-- Guest: I'm not saying it's easy. It's clear whether you are successful. If you have a statistical edge over somebody and pick better triple-A players--over time. And there's no proof in statistics, there's only evidence. But over time it can be in evidence that you have a better system. And everybody knows it because those people actually cause you to win more games. So, I'm just pointing out that the metric of success is kind of public. The metric of success is win or lost games. And similarly in chess, you win the game or you lose the game. And in poker, same thing. In polling, you predict what's going to happen in the poll, in the election. So all these are kind of finite games where your incentives as a modeler are to be as accurate as possible every single time. Whereas in finance--and this is where he sort of--Nate Silver and other people--generalize to a place where it's not a finite game, it's actually an incredibly complicated game inside a political system with lots of pressures--in that system your incentive as a modeler is not necessarily to be accurate. Your incentive can be to not get fired or to get a big bonus. And that is often, in fact, what your incentives are. So, for example, if you are talking about credit rating agencies, modelers, their incentives were clearly to come up with a rating that they were being paid to give. Russ: How surprising. One of the strangest aspects of the financial crisis is the people who argue that it's the rating agencies' fault because they rated junk highly. That was what they were paid to do. Why would you expect them to do otherwise? And they were paid to do that because partially, the government created a monopoly--a duopoly of rating agencies basically, and then privileged through regulation certain types of assets that got certain types or ratings, which allowed you to be more leveraged, such as AAA. There wasn't enough triple-A to go around. So, that's life. Because AAA means really safe, and by definition there's not a lot of really safe stuff. So Wall Street found a way to invent really safe stuff, which is very clever. But they needed somebody to stamp it. And so they found them. It's kind of straightforward. Guest: It really is. And you said it better than I. I just wanted to add one other thing, which is that they get paid by their clients, rather than by some third party-- Russ: Right-- Guest: For some true rating. Russ: Who would be so stupid as to think it's an objective rating? What savvy investor would trust those ratings given that the incentives were to pay them for--the client paid for them. Guest: No, agreed. Agreed. So really, we're agreeing. Really, what I'm calling for with this post and with many other posts on mathbabe, is for people just to be more skeptical. To be more skeptical of systems. Because in my opinion, systems, like the Federal rating agency within the financial system--they are models. In some sense; they are not mathematical models, they are political models. But they are modeling, like, how can you make a financial system with trust, so that you don't have to do your own due diligence? So that's what that model is. And it's a bad model. It's really misleading. But I would also like people to be skeptical of the underlying math models. They should understand that it's all about the incentives in the system. That the underlying math models might be bad, but there's a slightly larger model within the system that's actually working very well for some people. So, for some example--we already did the credit rating agency. The credit rating agency model relied on poor mathematical models, but the larger model was: These bankers sell this crap with good ratings, and they get paid, and they send some of that money back to the credit rating agencies. So that was a successful model if you are in the larger definition of models, to allow for political models. It's a success for the bankers, who still have that money that they got bonuses from. And it's success for the credit rating agency--as long as it lasts. And now they have--some people might say they have lost because of the reputational risk that they took on and they look bad, but there still exists--you know, the system hasn't even been changed. It would actually be a good thought experiment to try to say what it would mean for a model like that to fail. The banks still exist. The credit ratings still exist. And the whole system is still intact. And that brings me to why I'm in Occupy. I'm in Occupy because it's bad enough for us to realize in retrospect how much we should not have trusted the system, which we did trust; how much more skeptical we should have been. But it's another thing altogether to allow it to continue to be so ridiculous and not to now demand a better system.
26:50Russ: I just want to add a footnote to that. Which is: even executives whose banks got swallowed up, such as Jimmy Cayne at Bear Stearns--you hear, he lost--at the peak of the market he was worth about $1.5 billion. With a 'b'. And then after the crisis, when Bear Stearns was sold to J.P. Morgan Chase, he was stuck with a mere $500 million. So the claim is he lost a billion dollars. So obviously he paid a price. But he didn't plan on losing a billion. And Jamie Dimon didn't. Other people who rolled the dice didn't. And the point is that in the run-up, he got to keep $500 million. That's really not a bad day. And he says so. He says you can't think about anything awkward about his lifetime achievement when you can pocket $500 million dollars. So his price--it was a pretty good deal for them, those who "lost". And those who gambled and won--not only do they get to keep the billion plus, but they get to swagger and feel good like they did, and feel smarter than those other people. And that was the game they were playing. There were some winners and losers, but the losers aren't on the Street. Five hundred million is not on the Street. It's a pretty easy life. Guest: Yeah. And it's continuing now. Look at Jamie Dimon, who apologizes for the London Whale, and then says, Oh, but we had record profits this quarter so everything is okay. He didn't actually say that 'everything's okay' part; I'm throwing that in because that was an implied idea. I just want to say to Jamie Dimon: No, the fact that you guys have no controls and that you are highly profitable is exactly consistent with the system not being fixed and with the taxpayer bailout continuing. Russ: He's gambling with my money. And yours. Guest: And he got into trouble, which means he only got $11 million instead of $22 million this year. Thank you. That's a serious punishment. Russ: Explain what the London Whale is, and I want to comment on that. Guest: So, there was an office in London called CIO, Chief Investment Office, part of J.P. Morgan Chase, that was supposed to literally just prevent--they were supposed to hedge their portfolio. So, to prevent losses in the bank. That was their only job. It was supposed to be the safest office in the bank. And instead of being safe, they actually lost billions of dollars. I don't even know what the current amount is--something like $9 billion. With a 'b'. And they basically cornered a part of the credit default swap market, and people realized it. It doesn't even really matter, like, what. And by the way, it also doesn't even matter whether that was intentional or not. Like some people claim that the Dodd-Frank Bill might have made it a little bit harder to make proprietary trades, so they were hiding proprietary trades in the CIO office. That's possibly true. I would give that a 75% truth. But it still doesn't matter, because it just shows you that there's no controls in that bank. That Jamie Dimon does not have control over his bank. And that no too-big-to-fail bank is small enough to be understood and to be controlled. But moreover I'd like--the scary part of it is--I would love to stop thinking about Jamie Dimon since really he's a jerk and I'd love to stop being in charge of being in charge of that guy and all of his jobs-- Russ: And why should you? You could argue he lost $9 billion dollars of his money; that's his problem just like any business that makes a bad decision. That's the whole beauty of the business world. You make good decisions, you make a lot of money; you make bad decisions, you lose money or you go out of business; and that's their problem, let them fix it. Guest: Yeah, right. And if we had a world where we could ignore people who take on jobs that they can't do, or in fact that no one could do, I would love that. But that's not where we are right now. Instead where we are is that the United States is bending over backwards to foam the runway for the banks to resolve their problems. And we are stuck with the bill if they screw up. Which they do, consistently. And we also can't--by the way, this is going to the HSBC debacle--we can't actually punish them when they do criminal activities. That's our stance, anyway. Russ: What's the HSBC debacle? Guest: So, HSBC is a bank, I think it's the largest European bank. It has recently been, it has been agreed, that it has been laundering drug money as well as terrorist money, for the last 10 years. And the U.S. government sort of slapped it on the wrist with a large fine. The fine itself is being paid by the shareholders and is not enough to actually, compared to the amount of profits that they made on the actual deals; and moreover, no one is going to jail. So that's an example of our government sort of throwing up their hands and saying: If we actually try to get you guys in trouble for doing this criminal activity, then we would be threatening the financial stability and we can't possibly do that. Again, the point is that we don't deal with the actual problems when they occur. But we also ignore them after they've occurred. We don't fix the actual underlying problems. And the biggest underlying problem is how big these things are, how interconnected they are, and how, when the next problem comes, we won't be able to handle it. 3311 Russ: Well, we've created, through public policy, an incentive for them to get big and to become entangled. In a different world that would be a bug. It's a feature right now for them. And so everything pushes--I'm not saying there is a sinister conspiracy. Every once in a while I wonder if there is, but I'm not saying there is. But the natural incentives, the political processes put in place, have been encouraging both size and entanglement. I just want to say--I say this every once in a while but I think it's important to say it again: I'm a capitalist; I love profit; and I love loss. And profit without loss is the most destructive thing you can probably imagine. And so a political system that has banks that make money at our expense as taxpayers and don't bear the losses is pretend- or crony-capitalism, and faux capitalism. And those of us who love capitalism shouldn't be defending their right to make profit, or defending them by saying, well, they are just playing by the rules. They help write the rules; they help make the rules; they influence the rule-makers as much as they can. And we can debate whether they are immoral or not, or evil, or dark, or unethical. All those things. Or even something minor, like jerks. That's not the key issue. To me the key issue is: The system itself is not healthy in the way that capitalism should be. And don't defend it. Those of you out there--they are going to destroy it. So I think it's important to expose it for what it is, not pretend it's something else, or it's almost capitalism. It's not. And so even though I'm not in favor of breaking up the banks, to me breaking up the banks would be better than the current situation, which is: fake capitalism where they make money at taxpayers' expense. And by that I don't literally mean just the bailouts. It's the opportunity to borrow money at low interest rates, be highly leveraged, which are things that wouldn't exist in a normal free market. So, I think that's just incredibly important for those out there who are "on my ideological side."
35:21Russ: Now, Cathy, you are not on my ideological side, so I want to move to the next issue, which is: Occupy Wall Street. Those of us who are not sympathetic to the entire idea of it--although I might be sympathetic to parts of it, as I just said. I don't know much about it. We see them on TV. It looks like a camp out experience. But that's not exactly what it is. So talk about what it is and why you think it's important to continue it. Guest: Okay. So, I just want to throw in, just referring to the last comment, which is that I'm okay with either breaking up the banks or forcing the banks to be utility banks. I think we agree almost completely on the problem with the banks right now. Russ: Well, my preference right now would be to just stop bailing them out and stop subsidizing them through artificially low interest rates by the Fed, and stop having them serve on the Fed's boards. And let's get to real capitalism. My tolerance for breaking them up or making them utilities--that horrifies me. But not as much as the current system horrifies me. That's my only caveat. Guest: So, what would you have? You would have them fail, but where people weren't getting their payroll. What would--I mean, there would be problems. Russ: Yes, there would be. There would be pain. There would be pain and suffering, and just like we have pain and suffering now, the question is who would pay for it and how long it would last and whether it would repeat. So in my view the current system is poised to be a continuing boom and bust of irresponsible decision making. And I would add--this part is equally depressing and hidden, equally hidden--which is that as we joked about earlier on that you didn't feel like you were allocating capital to its highest use, we have a system that explicitly allocates capital not to its highest use. We've just spent trillions of dollars building more houses and bigger houses over the last 10, 15 years. Bad idea to incentivize people to do that. We helped create that incentive through a whole bunch of public policies. That makes us poorer. Capital is scarce and valuable, and we treat it badly. So, I believe that--I agree that the transition from this current world we are in to a better world is not going to be painless. Unless you could make a credible promise, which is going to be hard to do. And I'm not suggesting that politicians could do what I'd like them to do. But that would be my preference. Guest: Interesting. I'm interested in that idea. I think the difference between you and me is that I worry about--I worry more--let's say it this way; you can disagree. I worry more about the average person who has nothing to do with the financial system, has nothing to do with that mess, and is not going to get paid. And by the way, the system as it is now just sucks. In going to Occupy, I am--first of all, there is a lot that happened at Occupy even in the encampments that people didn't see. Because clearly--this should make sense--the people who didn't have a whole lot of time, who had jobs, who had children, such as myself, we didn't have a lot of time to spend at Occupy. Didn't sleep there. I went there, had discussions with other people. It was a place for people to meet who did not think that the current system was working. In that sense, it worked extremely well. Other things about the encampment were not successful, and there were a lot of people who were just there for free food. But what it did very well was create a central location for meeting like-minded people, and in that sense just created a network of people who wanted to think about this, wanted to discuss this. And I think it's a continuing--you know, we don't have the encampments any more, but we have a continuing mindset. The mindset of Occupy is perfectly exemplified by Occupy Sandy relief. Occupy Sandy sprung up because there were enough people who still had that idea, like, we can't wait around for a corrupt system to come help. We are going to do what we need to do as human beings with moral purpose, at this moment, right now. And that's what happened. And that's the beauty of Occupy. And even if its name gets changed, it's going to continue in my generation and the generation that's younger than me as this is something that has nothing to do with corporate America, this is not government controlled, this is because it's a good idea, we are doing this. So, for me, Occupy is kind of a wonderful thing. It's a little bit of a hippy thing. But that doesn't mean it's a bad thing. Russ: So, why would I, as a--I just have to mention, by the way: I think we're equally concerned about average people. I think the current system, over the last 10 years, had a brutal effect on average people. It encouraged people to buy houses that they thought they were going to be able to pay back, and they couldn't. Loans they couldn't pay back. Destroying savers' incentives to save. Making people poorer in all kinds of ways and it ultimately ended up in a recession that pushed unemployment over 10%. So, I don't think we disagree. I think we might not be equally confident on the benefits or costs of various policies to get us to a better world. But let's go back to Occupy. So, you go to regular meetings, still, correct? Guest: Yes. We have weekly meetings for the alternative banking group. Russ: And what do you do there? Would I be happy there? Or would I be uncomfortable. Guest: I don't know. I think you'd be interested. I would be interested in having you. We talk about latest outrages; we talk about HSBC; we'll come up with events, planning. We have various audiences for our group. We've been putting a lot of public comment letters together for the Volker Rule and for general Dodd-Frank issues. We've been writing letters. So, for public consumption, to the Senators, asking them to get a good Treasury Secretary, something that doesn't represent the banks. We're trying to set standards that I think you could get onboard with. As you said: let's not have the people who are in charge of the banks also be in charge of regulation. That kind of thing. And we talk about how we can educate people. To some extent I really think that education portion is over. I really haven't met people recently who don't understand that the financial system is corrupt. They seem to be doing our job for us. In the sense that we want to talk. In two senses. The first is that we want to explain that the system hasn't gotten better. And we don't have to because, you know, HSBC news comes out. And most recently we've heard that Deutsche Bank is getting in trouble for manipulating the energy market in California in 2010. These are things that happened way after the London Whale. Way after the credit crisis. So there are just example after example of things that are happening now, so that we can see that the system is still messed up. The other thing is that it's no longer an Occupy issue. I read articles on Bloomberg and the Wall Street Journal on a daily basis that I did not read 5 years ago about the moral bankruptcy of the current system. So, I feel like the education part is somewhat--we could put a little check mark next to that. I think what we are trying to focus on in Occupy is: What do we do? How do we--what are the pressure points of policy makers? How do we get the average people to feel empowered to demand change. We had Sheila Bair come talk to our group; we've had Neil Barofsky come to our group. I'd love to get Elizabeth Warren come talk--she claims to be the godmother of Occupy, so I'd love to talk to her. We want to hear from those guys, in terms of--they are insiders to Washington. Like, how do you actually get something done? I know that's a huge question; everybody would like to know the answer to that. So that's one issue. But the other issue is: How do we get the 99% to not just be disgusted with the system but to make a better system?
44:15Russ: Yeah. Well, I interviewed Neil Barofsky for EconTalk, and we talked about your naivete a little earlier and he displayed his as well. He displays it in his book. He went to Washington and actually thought that the people who worked there would be trying to make the world a better place. He found a lot of them mainly cared what their office looks like. I think--obviously there are interesting issues here of, not tactics, but what can be realistic about fixing a system where all the incentives are not so healthy. It's easy to say: We just need to change the incentives. But the people who are in charge of changing those incentives kind of like the current system. It serves them. And it's not obvious how you solve that. One way you solve it, it seems to me, is outrage or disgust. I'll half-agree with you about the education idea. I do think we've made some progress on education. But I'd say one of the groups we've made the least progress with is my profession. Economists generally--there are exceptions, obviously--but a lot of economists think that the bailouts were a good idea. That we didn't have a choice. That we shouldn't endure any pain. That the Fed is necessary, that the Fed does crucial work in keeping the crisis from spinning out of control. And of course economists, I think, are compromised in their ability to speak openly and honestly about these things because they have a financial incentive like everybody else, most of them, many of them. And so, I think the attitudes of the average American are going to make it harder for the next generation of politicians and Secretaries of Treasury to send goodies to Wall Street. But a lot of the elites are very tolerant of what Presidents Bush and Obama did. And I think what they did was awful. And so it's interesting to see whether the combination of Occupy, Tea Party, and the people who aren't paying attention at all--which is most people, obviously--whether they'll support policies as we've had. You know, when Hank Paulson said the world was coming to an end if we didn't get the Troubled Asset Relief Program (TARP) money, I think it scared a lot of everyday people who of course can't pay attention enough to know whether he's telling the truth. And to be honest, I have no idea whether he was right. Of course, they didn't pass it right away; the world didn't come to an end. But we still passed a horrific bill with all kinds of bizarro stuff in the middle of it that had nothing to do with the financial crisis. Guest: Wow, there's a lot there. I don't want to say about economists is that my experience with economists is that they don't actually understand how the financial system works. So, of course, it's easier--as you said, they also have their own incentives to keep the status quo. It doesn't surprise me, considering those two things at the same time. Why even learn how the financial system works if you are going to learn that it's impossibly complicated and you can't expect it to just continue as is? So, they are left sort of with an enormous amount of authority, not much understanding. And so the best they can do is make these meta-economic models that they have very little economic evidence for. And I don't want to dismiss all economists all at once. But that's sort of what you see a lot, is the way I should say it; and what you see a lot at the same time is economists saying: Oh, yeah, the banks are as bad off as they were, and our economy is slowly getting healthy. There's incredibly surface descriptions. The metrics of health. Russ: Yeah. It's naive, too. Guest: It's very naive, because what you have is a festering wound underneath the surface that is being fed by the Fed. The rates, and stuff. It's only even moving, it's only alive because of these drastic measures we are taking. We're keeping something that should be dead, alive. And we're looking a few feet above ground and saying: Hey, grass is growing, really slowly, and that's good news. I don't see much good news. And I sort of see economists as a whole as just simply--their job simply is for the most part to talk about how good the news is. Russ: I think we're the physicists[?] in the back room for the political process, actually.
48:52Russ: Let's close by talking about experts. You criticize Nate Silver for--he wrote the following:
This is neither the time nor the place for mass movements--this is the time for expert opinion. Once the experts (and I'm not one of them) have reached some kind of a consensus about what the best course of action is (and they haven't yet), then figure out who is impeding that action for political or other disingenuous reasons and tackle them--do whatever you can to remove them from the playing field. But we're not at that stage yet.
So, that viewpoint I think is a very common viewpoint: We just need to get the smart people in charge and we'll get this thing fixed. And you obviously disagree. Guest: Listen, I'm smart. You know. One of the reasons I disagree is because I'm smart and I don't know what to do. And I know a lot of awfully smart people who don't know what to do. And I know a lot of slightly less smart people who claim to know what to do. So really what it comes down to for me is, I want there to be a strong way of asserting: I don't know. I want there to be like a really macho approach. Because I think macho is kind of a key element in all this. You know, you don't get listened to unless you are screaming. You get listened to if you are screaming the world's going to end or the world's going to be great. That's what's called 'news.' Russ: Or: I have the answer. Guest: I have the answer. And if you are saying: I don't know the answer and we have to think about it, and we have to make sure the incentives are right and we have to make sure that the average person is protected from starvation, and it's going to be hard, and the people who are in power now are going to have less power and they are going to have less money--that doesn't sound like a very, you just don't get play on that. But I do think that the 'I don't know' somehow needs to have more cultural weight. And I think part of that is--starting this, that's how I've chosen to start. I've chosen to start by saying: Distrust the expert. To be a skeptic. I want to first promote skepticism. Because once people sort of look under the covers to these mathematical models or whatever other models--political models--they realize that people are inside those. The systems are simply acting in their own best interests, almost all the time. And then people will start saying: Wait a second; that's not working. What should we do? And that's when they'll come to--in an ideal world they'd come to this moment of: I don't know. And they'd admit that they don't know. And we'd actually get somewhere with our conversation. Russ: Well, 'I don't know' is sort of the watchword of this program. As long-term listeners know. If you want to dress it up a little bit, you can dress it up in Hayek's 1974 Nobel Prize address, "The Pretence of Knowledge." I think there's a lot of pretense of knowledge. When you said that about admitting you don't know I was reminded of "The Second Coming," by Yeats. We don't get to quote Yeats much on this program, so I'm going to read the first verse.
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
And that last line of that verse, "The best lack all conviction, while the worst Are full of passionate intensity," that to me is a big problem we have with experts. Guest: Yeah. And we have a lot to do. We have a lot of skepticism to sow. And then we have a lot of coming to the realization that we have to rethink this. And then we have a lot of work to do to actually fix it. And it's going to be interesting to watch. Personally, I think it's not going to really start happening till we see another crisis. Russ: I think that's plausible. The only interesting question for me--if that crisis is 25, 30, 40 years away, I don't think it will have much of an impact. If it's 3 months, 3 years away, I think it will have a huge impact. As well as this lingering economic mediocrity that we've got right now. The high unemployment rate I think is part of the problem and part of the signal that people are taking that things are not healthy, though people might say they are. Guest: I've got my eyes on Spain. Russ: Why? Guest: Well, I just feel like there's kind of two universes. And it's not just Spain, but Spain is where I'm looking. The diplomatic economic leadership universe, where they constantly have meetings. And then there's the street. And it's a totally different place. Like, agreements that you make up in the diplomatic regions, what does that mean to a person who doesn't have a job, did everything right, went to college, can't get married and have children, and can't find a job. What does that mean to that person? Russ: And you mentioned Spain because their unemployment rate is 26%, I think? Guest: Right. Exactly. Huge unemployment rate, even worse. And I just feel like that's going to blow. And that's going to have a lot of repercussions. I don't know when, though. And I don't know it's going to. I guess my feeling is that it's worth keeping a watch on. Russ: Well, those diplomatic meetings, those politician meetings you are talking about, of course those are exercises in pretending that you know everything and you have to put the brave front on it and smile and say how it's going to work out, and everything's fine. You are reassuring constantly. Guest: Illusion of control, illusion of understanding. Russ: So, for me the lesson is we need a different political system. One where there's less power for those people and more power out here. That's also where I think my views and your probably dovetail, but we might have a different ideal of what that might represent. Guest: Yeah. Russ: You want to say anything about your ideal? What would be your ideal relationship between, say, government and the financial sector? Guest: Well, I don't know exactly how it would look, because I actually have--I don't have a specific framework in mind. There's plenty of frameworks that I would be happy with. Let me characterize frameworks I would be happy with: One where there's actual separation. So, Sheila Bair actually came up with this idea as a demand for Occupy, which I think is a good one, where if you work as a regulator, you never work as a banker. Like there is a strict line. And you've said: I'm a public servant, I'm working for regulation, and I'm never going to go work for the bank. Because the revolving door is an enormous problem. Russ: This is the Bair Rule. Guest: And the lobbyist of course is a different kind of revolving door problem, where you have people working on the behalf of the banks and then they have lots of connections with politicians. So, they could be ex-politicians, for example. And there, I would love to see much stricter rules on how much money banks put into lobbying. Actually, even better, I'd love to see banks say: Hey, nobody trusts us; they think we're bad guys? We're going to stop lobbying. We're not going to put any money into lobbying. That would go a long way toward helping me start forming a trusting relationship with banks again. Russ: Yeah. Guest: I don't see that happening.
57:01Russ: Shame would be a good thing. And it's remarkably scarce in modern America. Guest: Right. So, bring back the shame. For me, Occupy is a moral issue. And that's why--I would consider myself kind of a perfect person to talk about the emptiness of mathematical modeling. As a mathematical modeler, I can tell you it has nothing to do with morals. You can model anything you want. And you can make it fancy and you can make it Markovian and you can put uncertainty into the model and make it sound like you've done all sorts of things. But in the end, we're trying to make decisions about people's lives. And it's a moral decision. It's not a mathematical decision. Mathematical models are for the most part not useful and shouldn't be used. Russ: I couldn't agree more, in the sense that it is possible that the best solution to all of this is better morality. More shame. Less exploitation of the system. I know the incentives are otherwise, but we don't respond to every incentive that we have. It's sometimes a bad idea to do that. It may be natural, but it's not good. And it's by far the cheapest way, to monitor bad behavior is morality. Guest: We have to depend on people to be moral. Russ: Say that again? Guest: At this point I'm no longer willing to assume that people will act morally. Russ: Oh, I couldn't agree more. But if I want to think about what might lead us to a better world, it would be a world where people felt guilty about exploiting such a system as we have. That would be much better than trying to change it politically. And just a different approach people like you and I might think about as a way to make the world a better place. We're always thinking about the political solution, either more government or less government as a way to make it better. And some of what we need is, not better human beings, but human beings with maybe a culture that we inhabit that maybe would have more shame and guilt at taking advantage of other people. Guest: And by the way--I don't want us to be too idealistic. My new thing, you know, having left finance I now work in the Internet tech scene. Modeling there is potentially even worse than the financial modeling, the financial crisis. The potential for affecting people's lives negatively and the predatoriness of the modeling, and the secrecy of it, make it--it's a kind of a really toxic combination, in my opinion. Like on the one hand, you might have enough public outcry from Occupy and Tea Party and other people about bailouts. I can't imagine a world where the bank CEOs in the too-big-to-fail banks say: You know what? We're cutting ourselves down to size and we're not going to do lobbying any more. I can kind of imagine that. But I cannot imagine is the people who work on the dark side of information warehousing on the Internet, that are selling information about people to make a quick buck, saying: Oh, I shouldn't do this because it's not a good idea. That's not going to happen. And that's where we might really differ. Because I am calling for strong data privacy laws to disallow that kind of behavior. Right now there's basically no regulation on information on the web. Which means you can buy a persona of a random person from a data information seller. And that person has no legal justification to prevent you from doing that. Here's an example. If I'm an insurer and I want to do the best job I can in pricing somebody's benefits, or policy, I'm going to see what they've been searching for. Have they been searching for HIV treatments? Have they been buying wheelchairs? Like, I can figure out a lot about somebody from looking at-- Russ: Ordering a lot of french fries from Peapod. Guest: Exactly. Buying cigarettes or something. The point is, at this point there's no pushback to exploiting people's private behavior. And that would be one thing if it was just: who do I want to offer a deal for going to Miami on United Airlines? Which most people think about when they think about this kind of segmentation modeling on the web. But when it comes to things like insurance--it actually defeats the purpose of insurance, which is supposed to be pooled risk. If as an insurance provider, I can actually pinpoint how risky you are, and I charge you accordingly, then I'm going to be charging the very people who need insurance the most. And it won't be insurance any more. Russ: Well, I think that's a long and interesting topic maybe for another time. I do think, though, that your point about skepticism, about the ability of people to self-monitor their misbehavior, is probably correct. And it ties into the earlier point you made, which is: If we had a little more transparency and education about what's going on, for the prominent people at least, there would be some hope of shame. Rather than those folks getting honors. So, I think that's where maybe there's some hope. Guest: Yeah. Well, I'm not going to wait too long for Jamie Dimon. I just don't think that guy has shame.