Stress Tests - A Case of Grade Inflation
Friday, 05/8/2009 - 8:13 am by Eric Liu | 2 Comments
When it comes to the stress tests, is grade inflation a good thing?
I’m no expert in financial wizardry. But I do know something about public psychology. And for me, the stress tests raise a question both deeply philosophical and urgently relevant: What is anything worth? What is the true value, say, of a derivative composed of slices of slices of pooled mortgages, themselves based on hype and hope?
When so many assets are so essentially imaginary, how does one rate a bank’s stress-resistance except relative to expectations? And doesn’t the act of conducting a stress test and saying a bank has passed actually alter those expectations?
The stress test exercise reveals that a complex national economy is, to such a great extent, a collective and mutual agreement to pretend that things are worth something. That web of mutual pretense is strong when invisible but surprisingly fragile when seen. And so recovery relies in good measure on the very dynamic that got us into recession: wishful thinking.
I don’t say this to be critical of the administration. Faith is very much like wishful thinking, and Geithner is trying to get us to believe in recovery, so that the belief itself inflates the value of assets and becomes self-fulfilling. It can work. But if it works, it’ll be because of the compounding nature of confidence — not because we’ve truly changed the underlying bad habits of overleveraged overconsumption that got us here.
If we come out of this period and look hard at all the short-sighted behaviors and choices that created the cascade of crisis — and change those habits — then good. But if a recovery serves only as a breather before we return to those bad behaviors, then a day of reckoning still awaits. Grade inflation can’t last forever.
Braintruster Eric Liu is an author and former Clinton domestic policy adviser and speechwriter.
Over the last 20 years, this country’s growth has depended increasingly on the financial industry. We have been world leaders in creating new markets and new financial instruments. At the same time, our industrial base has lost its stature in the world’s economy.
The problem with being financial leaders was that the markets and financial instruments we created that were so innovative were also incredibly risky. No one seemed to take that into account. There was a bubble mentality until of course it all popped.
It’s easy to see while Geithner wants to try to re-inflate this bubble. What else does this country have as an economic engine besides its financial markets? Not a whole lot.
Geithner is attempting to pretend everything is really OK and just needs to be patched before it’s good as new. I don’t see how this can work. The bubble burst. You can’t blow it up again. Instead of happy talk, phony accounting, and empty “stress tests,” we need to think about creating a different and more stable economy for this country. That conversation isn’t taking place.
Posted by SAR | May 8th, 2009 at 1:46 am
My 22-year-old son was too clever by half in high school where everyone called him a genius. He went to a prestigious school near NYC (but not in NYC) and found his roommate to be a true genius. Two years younger and a math wizard, his roommate was a 2nd generation Indian immigrant whose father was a nuclear engineer. The kid was offered full scholarship beyond his financial aid by the Physics Department because of his science prowess. For a school that hosted Albert Einstein for nearly 3 decades, that was no small feat. However, in the summer after his sophomore year, the kid landed a summer intern job at a Wall St. quant firm and made $30K in two months while my son made a measly $500 after deducting room and board in the campus lab. He immediately switch major to Economics and got an offer from the same company who hired him before he graduate this coming June with a jaw-dropping starting salary of $100K+ plus sign up bonus. He told my son that he plays video games all day since the skills requires for his class and job were like child’s play compared to Physics. And his dad was so proud of him and had zero remorse about him giving up the possibility of becoming a great scientist.
The saddest thing is that when I told this story to my friends they all felt that it was a shame to lose a scientific mind but no one would behave different if they and their kids were in the same shoes. And I have to agree with them if my now-humbled son gets to choose between the same paths.
When a system incentivizes the brightest of our future generation this way while exporting middle-class, non-service jobs, I don’t see how it is possible for this country to maintain its competitiveness down the road - with McDonald waiters servicing Walmart clerks?
Posted by Jay | May 6th, 2010 at 1:46 pm