Some of Fixed’s assertions are a bit outdated, particularly the notion that the less wealthy are disadvantaged by fixed administrative costs that hobble the establishment of small accounts, and that “large portfolios can be more easily diversified.” Many brokerages now allow the purchase of low-cost total-market ETFs, the epitome of diversification, with no account minimum. Even more dubious is their claim that the “exclusive” products available to wealthy “accredited investors” provide them with an unfair advantage, an assertion that would be news to practitioners who correctly view such vehicles as compensation schemes. Likewise, their discussion of the “annuity puzzle” settles on a recommendation of deferred annuities, which ignores the fact that these maximize both credit risk and inflation risk. (The preferred solution of most pension authorities, the inflation-protected annuity, disappeared from the US market in 2019 for the simple reason that annuity purchasers prefer the money illusion supplied by the higher initial payouts of level-benefit nominal annuities.)
Other arguments will annoy some practitioners. The authors, for example, describe how private investments benefit university endowments, an assertion with a verb tense problem. They’re also too credulous about the predictive value of valuation metrics such as the Shiller CAPE. Naïve ex-post analysis of this metric is indeed impressive. Ex ante? Not so much: Analyses show that when one formulates valuation-driven trading rules at any given point in time, the forward-looking results often disappoint. The reasonable observer, for example, would have concluded in 1990 to avoid stocks when the CAPE exceeds 20–25, which would have kept her out of the market most of the time thereafter.
More substantively, in the authors’ telling, the failures of the current financial system stem from three basic sources: the mendacity of the financial services industry, poor investor education, and the recently well-documented failures of human rationality and quantitative reasoning. As such, all three of these failures fall squarely within the confines of either classical finance or neuropsychology.
True, as far as it goes. Unfortunately, and perhaps unsurprisingly, the authors, as financial economists, ignore finance’s social psychology and political economy.
In the first place, finance suffers from what might be termed its “original sin,” namely that the people attracted to it are not, in the current parlance, “mission-driven.” Put more simply, people do not go into finance for the same reasons that they become social workers, elementary school teachers, marines, or Jesuits. Like Willie Sutton, they’re attracted to the field because that’s where the money is. (Sadly, it also seems that economic training makes people less likely to contribute to the public good, at least in the experimental setting. Asked one peer-reviewed article, “Do economists make bad citizens?”)
More importantly, the authors avoid the political milieu that surrounds state supervision. Neither Fixed’s text nor even its encyclopedic references contain any mention of economist Mancur Olson’s seminal work on how policy gets made. Two of his concepts lie at the heart of any understanding of just how governments around the world tolerate so much financial malfeasance.
First is what Olson called “the logic of collective action.” Since small groups are less affected by free riding than society at large, they can more effectively cooperate to secure favorable treatment from the legislative and executive branches. Want to know how the insurance industry gets away with unethical sales practices? Look no further than the fact that only one business group, the pharmaceutical industry, spends more on lobbying.
Olson’s other insight was what has been called “demosclerosis,” the tendency of stable and prosperous nations to gradually accrue, like barnacles on a ship, layers of special interest groups that sap ethics and economic efficiency. (This phenomenon is not confined to the financial industry; witness the explosion of homelessness driven in part by the NIMBYism of neighborhood groups opposed to housing construction.)
Many, if not most, of Campbell and Ramadorai’s well-designed suggestions for financial reform stand little chance of implementation if not backed by effective political action and reform, arenas in which economists have demonstrated little expertise, and which look, at least at present, to be nigh impossible.
The sad history of the early twentieth century gives some hint of how things will play out. As in The Gilded Age, government regulators have turned an increasingly blind eye to financial abuse, a process that has accelerated with the near abolition of the Consumer Financial Protection Bureau, the SEC’s benign toleration of manifestly lethal products like leveraged and inverse single-stock ETFs, and a Wild-West cryptocurrency scene that in no small way directly benefits the president, his family, and friends. The Crédit Mobilier scandal, after all, only involved both of Ulysses Grant’s vice presidents, not Grant himself.
As the old saying goes, it’s unwise to predict both a price and a date. At some point, a blowup seems likely. When such a blowup occurred in the wake of the abuses associated with the 1929 crash, significant reform followed in the form of the Pecora hearings and the 1933, 1934, and 1940 acts.
One can only hope that if and when the blowup occurs, legislators and regulators have read Campbell and Ramadorai’s book.
