#HBRLive: What We've Retained Since the Financial Crisis

0:00When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsored jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments.

0:35It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. And today we are having a conversation with HBR Editorial Director Justin Fox. We will be previewing Justin's article in the November issue of the magazine, which takes a look back at the 2008 financial crisis and asks what, if anything, economists have learned.

1:17Before we get started, just a few programming notes. You can ask questions in the chat on your Google Plus page, and you can also follow us on Twitter using the hashtag HBRLive. And with that we will get underway. Justin, thanks so much for talking with us today. Thanks for having me, Sarah. Now I want to just start with the bald question, because when we posed the question on Twitter, you know, what have we learned since the crash, a lot of people said, we haven't learned anything. So tell us, have we or have economists learned anything at all? Yeah, they have. And I ended up defining things pretty narrowly for this article because otherwise, first First of all there are a zillion people writing five year financial crisis anniversary pieces, most of them which are already out.

2:00And also just to make it, to be able to say anything interesting, I basically spent my time reading economics and finance journals, the editions from the past five years and just trying to see what was different in focus and in approach. And it's different, it is a little bit different. Well that's interesting. So let's talk about in that case what have we learned? What are the differences? The ones I ended up focusing on, and I'm sure another person with different priorities could have found other things to focus on, but I mean one big one, and this one has been talked about to some extent in the wider world, I don't think it's fully understood, is that macroeconomists, the people who study the movements of national economies, the global economy, they had spent the past 50 years not paying much attention to financial markets and definitely not paying much attention to the possibility that dysfunction in financial markets could cause real economic problems.

3:02And that is back with a vengeance. I mean it happened in a big way back in the 1930s in the Great Depression. I think people, I don't know if they thought the problems had been solved or they came up with other explanations for the depression, but just sort of this idea that strange things going on in the stock markets and especially debt markets could have real economic consequences had just people weren't paying much attention to it and now they definitely are. Definitely. Well, so that sort of begs a question or raises a question that someone actually on Twitter asked us before we got going today, which was, you know, is this really – what is the impact of this?

3:40I mean, is this all kind of economic eggheads talking to each other and writing long books that no one reads? Or when economists shift their views, what's the impact of that on sort of real business, you know, the jobs we all work in every day? Well, there were sort of two things about which there was something close to a consensus among mainstream economists, basically economists who could get hired at the Federal Reserve or the Council of Economic Advisors or at central banks in other countries. And one of them was that beyond the sort of automatic stuff you get, like when there's a downturn and more people go on unemployment insurance and there's a downturn and tax revenues go down, which sort of automatically causes deficits to go up, which creates a certain amount of government stimulus.

4:31People had sort of come around to the idea after the experience of the 70s and also a lot of economic arguments by Milton Friedman and then Robert Lucas of the University of Chicago to the idea that it didn't really make sense when you fall into a recession to suddenly be trying really hard to stimulate the economy. That it was better to just let the automatic stuff happen, let the central bank do a little bit to lower rates, and then just... When you need to build up your team to handle the growing chaos at work, Use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more.

5:12Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean.

5:51And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. You know, let free markets take care of it after that. And I think there's still, most people believe that in normal times that's what you do, but it's clear that there are these moments. Paul Krugman like 10 years ago called it the return of depression economics, that there are these moments where suddenly there's no inflation threat, it's all deflation, and the real danger is just unused economic capacity. and in that case that government stimulus actually can do something.

6:31And I think that's something, you know, it's not in political circles in the U.S. There's definitely no agreement on it. But if you look at economists who study these things, especially the place like the IMF, so sort of younger and mid-career economists who study this stuff, they've all kind of scratched their heads and said, wow, okay, there are times when stimulus efforts work. So that's one obvious one. The other one is about financial regulation. There was this consensus and I think Alan Greenspan expressed it the best several times. Basically it's not that he doesn't believe financial markets can't go crazy, can't have bubbles, but he just thought it wasn't in the end he couldn't as a central banker do anything about it.

7:18His job was to clean up afterwards, not try to stop bubbles. And now there are people, including Jeremy Stein, a Harvard economist who's on the Fed now, on the Federal Reserve Board, are making these arguments that there's this thing they can do called macro prudential regulation, where you basically, while in regulating banks and other financial institutions, you pay attention to their impact on the overall economy. If you think they're getting too frothy, you do something about it. And in some countries, like India and Canada, this was already being done, but in the U.S. and the U.K., it had sort of become accepted that, no, we can't do anything about it.

7:56So that's interesting, and there's a lot in there that I kind of would like to unpack. And one piece of that is the idea that you mentioned in sort of the first piece of that answer, which is that economists have really decided that this whole sort of the evil must be purged naturally from the system, and you know, you should just let the markets take its course. That's been basically refuted. economically. But yet politically we still have a lot of these debates and you know I was just hearing on the radio this morning a in the context of this shutdown, one of the legislators was saying well he feels in his heart that this is the right thing to do.

8:33And that was in reference actually to the debt ceiling and it's a little bit like well okay so if economists are over here sort of looking at these models and doing it all very intellectually And then the sort of politicians are over here saying, well, I feel in my heart that this is the right approach. I mean, it seems like these are just kind of two groups of people on different tracks, and those of us who are just living in this country are kind of left somewhere in the middle. So have there been any attempts by economists to really inject themselves into the debate about policy? Well, first of all, I don't want to give the economists too much credit in this diverging world view picture that you give, because I think over time they have very often sort of ended up on focusing things, especially in macroeconomics where sometimes it's really hard to get at the truth because it's just you don't know what's causing things to happen.

9:29But I think the economists many times have been focusing on things because they feel like it's the right thing, not because there's clear evidence. But I will say economists have this tendency when really big stuff happens in the world that has to do with the economy, they react to it. And it's not necessarily the older economists who espouse the theory that now seems discredited. It's often younger people pushing new ideas, but they do respond to empirical evidence. That's a really great thing about economists. When you need to build up your team to handle the growing chaos at work? Use Indeed Sponsored Jobs.

10:06It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at indeed.com slash podcast. That's indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra.

10:44Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. I think some people in public life prefer not to. And I don't know what you do about it. It is interesting, the disconnect between this debate sort of going on in global economic circles at the Fed, at the Bank of England, other places, at the IMF, about the pros and cons of stimulus versus austerity. and the fact that in a large part of political life in the U.S., I mean, it's not even that people are disagreeing with these views.

11:29They just don't even know about this discussion. They're paying no attention to it. And that's a hard one. I don't know what – I mean, it has a lot to do with the fracturing of the news media. It has a lot of causes. I mean, I feel like there's more good economic analysis out there than there has ever been before, that economics journalists are more sophisticated and there are all of these economists who know how to write, trying to explain their views. And so, you know, with the right set of people to follow on Twitter and the right blogs to read and a couple of right newspapers, you can get a pretty good picture of how economic opinion is both shifting and is also in some cases still, you know, a lot of dispute.

12:11But you can also, if you choose, completely ignore all of that. Well, it raises an interesting point, I think, because most of the economists you hear about in public debate are kind of Adam Smith or John Maynard Keynes or Milton Friedman you mentioned earlier. These are not exactly sort of young economists on the cutting edge. I mean, some of them died a very long time ago. So do you think that's something the field of economics needs to address, kind of saying, hey, we've moved beyond some of these people who you still talk about on a sort of more frequent basis? Well I mean with Keynes what's really fascinating is how I think a lot of economists would have said they'd move beyond him and then in the middle of a crisis found themselves grasping for him again.

12:57I mean I had this email exchange with Robert Lucas who sort of thought for a while that he had killed Keynesian economics in 2008 and he made this crack in an email that I guess everyone's a Keynesian in a foxhole. And so that's been interesting how that came back. I mean part of it with both Keynes and Friedman is they were both so good at expressing themselves and Friedman there was the added thing that he was so clear, had these very straightforward clear views, whereas Keynes is sometimes a little harder to parse. There are you know obviously there's Paul Krugman, there's somebody there are much younger economists like Justin Wolfers who's trying to use every means of communication available to him from Twitter to writing columns for Bloomberg to doing whatever else to get his views out.

13:50But I think it's sort of natural in the discipline that partly it's that Keynes and Friedman and Adam Smith are all sort of shorthand for ideas that are still being debated and it's partly just, you know, it takes a while to get prominent enough that people refer to you. So let's bring it back now a little bit to what's going on in companies. I know one of the other sort of good questions we got from our audience was about sort of the role of corporate governance and maybe how that's changed in the last five years. Have you seen a change in anything happening at that level? Well that was the third part of my article and I'm going to totally grant that it's possible there's some element of wishful thinking in the third part of the article.

14:33But what I was making this argument is that the view of what a corporation is for and how it should be governed, that is really gained widespread acceptance in the U.S. over the past 20 or 30 years, is this purely economic view that the job of somebody running a corporation is to maximize the value of that corporation. Every decision should be made with that value maximization and view. And, yeah, it's great if you're maximizing longer. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications and more.

15:13Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean.

15:51And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. term value than short term, but you know it's value maximization. And my sense is that that turns out to be an almost entirely useless guide to action because it's really hard to tell often what maximizes value over the long run. And if you're looking at the main measure available of whether you're maximizing value right now, the stock price, you're often going to get misled. And so we had this kind of what seemed to be simple rules for governing corporations which was basically pay attention to the stock market, do what makes your stock price go up.

16:34And I think there's this widespread realization that actually that doesn't work that well. And definitely in the pages of HBR over the past five years, there have been tons of pieces about, okay, this is wrong, we need to think of another way to think about what corporations are all about. The thing is, is they're not all converging in one place. And so one of the things I was doing was thinking, well, maybe are we about to move away from economics and go to some other discipline like sociology to get our ideas about corporations. And I found this quote from a few years ago from Neil Fligstein, a sociologist at Berkeley, who was talking about how he was out to knock the economists off their pedestal.

17:11And I emailed him this summer and he said, yeah, I haven't done that yet. I haven't made much progress there. So I think there's a huge amount of ferment in that area. And the people who run corporations and give advice to people who run corporations, and a lot of people who join corporations are really struggling with this idea of what are we here for, what are we trying to do. And I don't think the simple, the standard jargon term for it, principal agent model from the economists really answers everything for them anymore. What about something like risk management? I mean that's something it seems like five years on, you know, lots of volatility, uncertainty, some of it self-inflicted but some of it not.

17:54There's a lot happening in that area. Has anything changed in companies' approach to managing risk? I'm sure some has and there's definitely a lot more focused on what they call tail risk, basically the possibility of really unlikely, really big bad things happening. And there's more and more understanding that the sort of standard bell curve statistical statistical tools aren't as helpful as they seem in assessing the risks that really matter if you're running a corporation or a financial institution. I think the interesting thing is because I was thinking that would be a major part of this article and maybe with much more time and talking to a lot more people I could have figured it out.

18:33But one of the first interviews I did was with Aaron Brown who's the risk manager at AQR, a hedge fund in Connecticut and has written a couple of wonderful books about risk management. And his first words to me was like, oh we didn't learn anything new from this crisis. We just learned that more things could combine into a bigger mess, but all sort of the key problems that happened had all been learned over the past 20 years. So lots of new things were learned in the 1987 crash, lots of new things were learned in the sort of interest rate spike in 1994, lots of new things were learned when long term capital management fell apart.

19:07All that happened this time is that they got sort of combined into a bigger disaster, mainly just because there was so much real estate debt out there, but that there wasn't any great new lesson for how to think about risk management. So big disaster, that phrase reminds me of another question that came in over Twitter, which was that now some of these banks are even bigger than they were in 2007 or 2008 when they were considered too big to fail. Do you see in your work, is that a problem that people are thinking about? What do we make of that? Well, the main way from the perspective of academic finance that people are approaching is it's not necessarily the size of the institution, although this is tied into it.

19:51It's not the size of the institution that matters. It's how leveraged they are. Because I guess one of the issues is, and this happened with long-term. When you need to build up your team to handle the growing chaos at work, Use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications, and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply.

20:27Need a hiring hero? This is a job for Indeed Sponsored Jobs. This episode is brought to you by Palmolive. Family time isn't just the big moments. It's weeknight dinners, sitting around the table, everyone talking all at once. So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. Capital management back in 98, it wasn't that big an institution, but it was being imitated by every other hedge fund and the trading desks of all the big investment banks.

21:12So when its strategy turned against it, it ended up causing these major market dislocations. And I think that can happen sometimes where it's not the fact, it's not so much the size of the institution, it's how many people are using the exact same strategy to fight risk. So, one thing that comes out of this is there's been this big focus on trying to reduce the leverage, reduce the indebtedness of financial institutions. It's being fought tooth and nail by those financial institutions. There's been some progress made on it. There's pretty widespread agreement among people in finance that, yeah, that would reduce the risk profile a bit.

21:49One of the more interesting things that I discovered doing some research is that bank Bank regulators over the past 20 or 30 years have been trying to, when they're looking at the riskiness of a financial institution, they look at it completely separate from the overall market. That's been the traditional way. And so they'll look at some bank with a whole bunch of mortgage loans all concentrated around one city and they'll say, oh that's dangerous. That's a lot of risk for your institution. What you should do, and I don't know if they actually told them to do this or this was just sort of the natural lesson.

22:22What they ended up doing is okay we'll just buy these mortgage backed securities that are backed by mortgages all over the country and that will be safer. Maybe if you take that one bank in isolation it's less vulnerable to a real estate downturn in its local area, but what you end up doing is making the portfolios of all the banks across the country and to a certain extent the world look more similar. So when something goes wrong with that market they all go down at the same time instead of, okay, we had a little crisis in this part of the country and that part of the country. So what regulators have been doing over the past 20 years made the situation worse.

22:58And that lesson is definitely clear in a bunch of academic work. I don't know the extent to which the regulators have wised up on that. Well, so looking into the future on something like that, I mean, are there sort of trends you see emerging that weren't quite strong enough to make it into the piece as like this is definitely happening, any sort of things that were nascent or anything that you wish were a trend that you sort of would like to see? One of the really interesting, because I've spent a lot of time for a book I wrote a few years ago and other things reading through finance journals, you know understanding maybe 20 % of what I was reading but nonetheless you know reading all the headlines trying to get through it.

23:42And I've read them going back decades. And starting in the late 70s, they started finding all these interesting odd things that financial markets did that didn't quite fit with the theory of perfectly efficient rational markets. And they kept doing all this research and found all these interesting things and there was never any attempt to put it all together. And I don't know that there ever is going to be some amazing brand new theory of dysfunctional financial markets, but there are a lot of people who have been doing this work realizing after the financial crisis that wow this stuff I've been studying actually has these really big impacts on the economy.

24:22I should be trying to put those two things together. And I just can't say at this point where all that's going to end up, but to me that's this enormously positive development that these people who really understand certain things about financial markets are kind of stepping back and saying okay so what does this mean more broadly? And I think that's really healthy. That's interesting. That's interesting. Okay. So now we've been, I want to shift gears just slightly. We've been previewing your article in the forthcoming issue of HBR, the November issue. I know right before I sat down for this Google Hangout, I saw an email.

25:01This episode is brought to you by ChatGPT. Hey, it's Bill Simmons from the Bill Simmons Podcast. Have you guys heard about ChatGPT work? It's the new way to use ChatGPT for bigger multi-step projects. And when you need more than just answers, give ChatGPT work access to your apps and files, and it can create real work documents like spreadsheets, slides, and structured reports. Get started at ChatGPT.com by selecting work mode available on Plus and Pro plans. I smell from you saying that you've actually just written a blog post for HBR.org that kind of tackles some of where we are right now in terms of the debt ceiling and the shutdown on and it could be published already we've been chatting so I'm not sure or it could be this afternoon but can you give us a little preview of that of your sort of latest thinking around where we are now well I keep trying to find ways to write about the debt ceiling and learn things about the debt ceiling that don't just make me angry and go why are we doing this and so the one I was just think what I sort of got me going today is a few people including Larry Weiss accounting professor at Tufts on HDR, he wrote a piece that I edited saying that really this idea, we're not likely to default on our debt if we run into this debt ceiling.

26:14It may be unpleasant, but at least if it's lifted relatively soon, the government can just reprioritize and make sure they pay any interest due on debt and stiff social security recipients or whoever else they want to. And so I just sort of, you know I think at some level that is a choice of priorities that might have to be made, but the question is can, I mean Treasury Department has been saying all along well we're not sure we can do that. We pay 80 million bills a month, we're not sure we can pay the right ones and hold off on the right ones. And I have no idea, I've never worked in the Treasury Department, don't know what's true there.

26:53But I just started thinking about, okay, so what is the – how do you think intelligently about the risks that something like this would happen. It's clearly not zero. The people who are saying there's no danger at all are just blabbing. But it's not 100 percent, you know, they could work it out. They could fix something even if Congress doesn't lift the debt ceiling. And so really my post is just another – I'm sort of talking about how you use Bayesian and statistics to think about these things. And that's about as far as it goes. I offer no good answers. Sorry. You know, it seems like one of those things that, you know, to go back to my favorite Donald Rumsfeld phase, we have the known knowns, the known unknowns, and the unknown unknowns.

27:37And it seems like in some ways the debt telling is this unknown unknown where we're sort of not really exactly sure what would happen. Well, I think it's a known unknown because we're actually talking about it. Yeah, it's true. I guess that's fair. There's an unknown unknown we wouldn't be discussing, it would just sort of blindside us in three weeks. True. And maybe I'm sure there are some of those out there. I mean I love that taxonomy, it doesn't answer everything but it's actually a helpful way of okay so what are we talking about here and this is a known unknown where we know there's something coming up but it really is pretty unknown what the ramifications are.