Iceland’s Meltdown

I’ve written about Michael Lewis’ take on the Wall Street’s meltdown in my post “The Financial Crisis Explained.”  He is one of my favorite commentators and is able to take complex issues and write about them in a way that is comprehensible to the average person.

He recently wrote an article about Iceland’s meteoric rise to prominence in the global world of finance and later its amazing crash when the bubble burst.  His article should be required reading for anyone interested in finance or the global economy.

Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance—resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.

I wanted to focus on an aspect of the article that I’ve written about in my post entitled “The Business School Way of Life.”  Lewis mentions that most, if not all, of the people who were involved in Iceland’s boom and bust had degrees from prestigious American and British business schools.  They learned the Business School Way of Life in America and brought it home to Iceland.  Everyone caught the fever and it has wrecked a once stable country.  Now, the currency is worthless and debt is 850% of GDP, higher than even the highly debt burdened USA’s 350%.

As an example of a person who fell into the Business School Way of Life is Stephan Alfsson. Lewis spends some time interviewing  Alfsson, a fishing boat captain turned financier, in his article.  Here’s Alfsson’s story:

Lean and hungry-looking, wearing genuine rather than designer stubble, Alfsson still looks more like a trawler captain than a financier. He went to sea at 16, and, in the off-season, to school to study fishing. He was made captain of an Icelandic fishing trawler at the shockingly young age of 23 and was regarded, I learned from other men, as something of a fishing prodigy—which is to say he had a gift for catching his quota of cod and haddock in the least amount of time. And yet, in January 2005, at 30, he up and quit fishing to join the currency-trading department of Landsbanki. He speculated in the financial markets for nearly two years, until the great bloodbath of October 2008, when he was sacked, along with every other Icelander who called himself a “trader.

So why would an expert fisherman, who began training to go to sea at age 16, promptly give up his job to turn to finance?  Why did he think that he could work in banks and be a “trader” when he had no experience and no training?  Similarly, who do students who leave business schools believe that they can accurately project risk?  Lewis tried to get Alfsson to answer:

“You spent seven years learning every little nuance of the fishing trade before you were granted the gift of learning from this great captain?” I ask.

“Yes.”

“And even then you had to sit at the feet of this great master for many months before you felt as if you knew what you were doing?”

“Yes.”

“Then why did you think you could become a banker and speculate in financial markets, without a day of training?”

Alfsson does not have an answer and Lewis lets him off the hook, but I think that it was pure greed.  Alfsson and people like him were willing to try to get rich quick.  They saw everyone around them getting rich and decided that they wanted in on the action.  In Alfsson’s case, he saw people younger than him returning from American business schools and starting banks, seemingly making fortunes overnight.  The contrast between the hard work of a fisherman and the paper shuffling that was the Icelandic banking system cannot be any more stark, yet nobody wanted to raise a concern.  As Lewis puts it,

 At the very least, in a place where everyone knows everyone else, or his sister, you might have thought that the moment Stefan Alfsson walked into Landsbanki 10 people would have said, “Stefan, you’re a fisherman!” But they didn’t. To a shocking degree, they still don’t.

We are experiencing this same phenomenon in the US.  Why didn’t anyone try to stop the hedge funds, banks and private equity firms by saying “Hey, you just graduated from college, what do you know about CDOs and assessing risk?”  Why do many people who work in these firms still believe that they can correctly model future risk?  Why do business school students still go into finance without someone asking them questions like this?

The World’s Largest Hedge Fund Is A Fraud

That is the title of a report compiled by Harry Markopolos in 2005 about Bernie Madoff’s fraudulent hedge fund.  He lists 30 red flags and ways for the SEC to verify if these red flags were true.  His report seems to have been almost completely ignored for almost four years.  He states that pretty much everyone knew that Madoff was a fraud, but did not want to risk their careers.  It shows the sad state of Wall Street that I talked about in my post about The Business School Way of Life.  Take the easy money, don’t rock the boat, look the other way, cash your check.

I won’t go into more detail, but the report is truly amazing.  Read it here.

Bill Gates on Disease, Teachers and Mosquitos

Bill Gates returned to TED this year to give an update on what his foundation had been doing for the last year, along with how he thinks the world can start to solve two of the biggest problems in the world today: disease and lack of good education.  Gates’ presentation can be described in one word: Optimism.

Bill Gates’ TED Talk

The first half deals with malaria.  I had not realized that malaria was a problem in the US and other rich countries up until the 1950s.  It killed over 5m people worldwide during the 1930s and was not completely eradicated in the US until the 1970s.  Now, it only affects poorer countries, which happen to be around the equator.  Gates says that “more money is spent on baldness drugs than malaria drugs” each year. 

Most people would agree that our priorities are clearly misplaced.  This situation is a clear example of a problem that the market cannot solve completely on its own.  Poor people cannot provide the profit motive necessary for big drug companies to develop the cures necessary to eliminate malaria worldwide.  The Gates foundation, other charities and some rich governments should step in to fill the void.  Tax credits, grants and other incentives should be used to stimulate innovation in areas where there are not sure economic profits, but provide real social benefits.

I would also like to see a drug company cut their ad budget by 50% and use those billions to invest in a cure for malaria or another one of the treatable mass diseases, as drug companies now spend about an equal amount on advertising as they do investing in new drugs.  Imagine a big drug company cutting half of its Viagra, Propecia or Zantac ad budget to focus on developing a new malaria drug.

Imagine the positive (free) press that a company could get by doing this.  They could craft their new image around being an altruistic drug company and even run ads in the US touting their contributions to global health care.  Even a 25% cut in advertising in the US to invest in Malaria would be substantial.  This solution is probably too controversial for conservative drug companies, but it would be interesting to see.

I would also like to see one car company stop advertising completely and pass on the savings to consumers, or just keep the savings.  Everyone knows cars and brands of cars, so why bother advertising?  But that is another post for another time.

The second half of Gates’ talk focuses on what makes a teacher a good teacher.  Through research funded by the Gates Foundation, they found that a top 25% teacher improves student performance on standardized tests by 10%.  Unfortunately, the teacher’s performance is not rewarded.  In fact, teachers who many not be very good, but want to learn cannot even learn from good teachers because of contracts.

Gates touts the KIPP academy in Houston, another branch of the KIPP School that I talked about in a previous post, as a model for the future.  He says that the combination of giving children a chance to work hard, along with analysis of teacher performance produces results.  96% of children at the KIPP academy in Houston go to college.

I would love to see some sort of reward mechanism implemented for great teachers to help compensate them for their work.  Gates says that the good teachers are more likely to leave their jobs to change profession than bad teachers, so some sort of reward system is needed.  Gates is hopeful that many of these innovations can be brought to public schools in America, which will better help us compete internationally.

Obama’s pick for Education Secretary is Fantastic

I just realized today that Barack Obama’s new Education Secretary is Arne Duncan, the former head of the Chicago Public Schools.  He is a top notch choice who I think will do a great job.

I first heard about Duncan when I read Freakonomics a few years ago. He was the head of CPS when Steven Levitt and Brian Jacob were studying whether teachers were cheating on standardized tests by filling in or changing answers on students’ tests.  They ran some regressions and found a bunch of suspicious answer patters from a surprisingly high number of teachers.  When Levitt and Jacob brought their suspicions to Duncan and the CPS, Duncan ordered audit testing to try to confirm the results.  The retesting confirmed that the teachers were cheating for their students and Duncan ordered the firing of the guilty teachers.

Duncan could easily have swept the study under the rug and not allowed retesting, but he did not.  Instead, he made a tough decision that was unpopular with the teachers and challenged the status quo.  His choice got rid of bad teachers who were masking their poor teaching performance by cheating on tests.  It would be great to see others in government make these kinds of tough choices.  I think every government agency could benefit from people following Duncan’s example.

Hopefully, he can help bring some positive change to American schools with is hard work and innovative approach to public service.