Practical analysis for investment professionals
22 April 2015

Scapegoat: Who or What Should We Blame for Breaking the Post-Crash Economy?

Posted In: Economics

Puzzlement abounds as to why the zero-interest rate economy, not only in the United States but everywhere else, remains essentially broken. A technocracy of central bankers has thrown everything it’s got at the problem since 2007, yet in 2015 abnormalities are visible everywhere. The leading countries remain spectacularly indebted, the global economy is anemic, socio-economic inequality is headline news, and the whole framework of global capitalism appears dysfunctional.

This is an intractable problem whose solutions so far seem to have made things worse. It’s a problem in need of a scapegoat in fact, something to blame, whether justified or not, in order to help us feel better about it. With that laudable goal in mind, here are some suggestions for suitable scapegoats:


Robert D. Arnott, chairman and CEO at Research Affiliates, speaking at the recent CFA Institute Fixed-Income Management Conference, suggested that demographic influences slow real GDP growth. “When measured according to the Consumer Price Index (CPI), the United States has shown real GDP growth averaging 2.7% annually over the past 50 years. The working range for real GDP growth today is between 1% and 2%, and the working range approaches 1% 10–15 years from now,” said Arnott. Arnott argues that the debt burden must be addressed, defining debt not just using official measures but also considering the value of promises — entitlements such as public sector pensions and health care.

From a contrasting perspective, in a presentation at the CFA Institute European Investment Conference in London, Amlan Roy of Credit Suisse Securities (Europe) Limited, linked demographics to a long list of the most prominent economic issues and conundrums of our time. “Now, look at what I connect to demographics: discount rates, geopolitical risk, commodities, growth, debt, longevity, inflation, women in leadership, asset prices, and retirement,” said Roy. “It is all about consumers and workers. It is not long term; it is in the present and in the near future.”

Declining productivity over the long term is a lingering concern for most commentators. Unlike in the last century, an aging population is not supplying ever-improving labor force quality. Nor does immigration from developing countries — a potential quick-fix solution — seem to be adequately filling the gaps. This suggests a combination of even deeper systemic reasons for economic malaise.

Systemic Failures

As financial markets and the economy come under stress, there is a corresponding increase in the burden on the existing mechanical arrangements — the “plumbing” — safeguarding global capitalism.

CFA Digest recently summarized a wide-ranging study in the Journal of Banking & Finance by Luci Ellis of the Reserve Bank of Australia, Andy Haldane of the Bank of England, and Fariborz Moshirian from the University of New South Wales. The authors posit that as the financial markets become increasingly interconnected, international cooperation is ever more crucial. If some banks are held to weaker standards, an uneven playing field is created that prompts regulatory arbitrage. The diversity of the financial system means no single measurement of systemic risk, such as leverage ratios, has universal utility. The authors suggest governance reform can reduce the chances of regulators “chasing risk” from one jurisdiction to another around the globe.

At the CFA Institute European Investment Conference, Lord Adair Turner, a member of the independent Systemic Risk Council (SRC), a joint initiative of CFA Institute and the Pew Charitable Trusts, argued for the creation of infrastructure to better manage credit creation. “As for tools, these should include measures focused on lending, such as higher capital requirements and stricter countercyclical capital buffers. But the measures should also include actions that directly address the bias in the system toward real estate lending,” said Turner.

In “The Case for Long-Termism,” summarized recently in CFA Digest, Keith Ambachtsheer of the Rotman School of Management, University of Toronto, outlines the need for a better alignment of principal–agent incentives in the political, commercial, and financial spheres. Ambachtsheer considers that Institutional investors, led by the pension fund sector, are best-placed to play a leading role in addressing the challenges of short-termism.

Financial Education

A country’s human capital, just like strong demographics, a robust systemic risk infrastructure and entrepreneurial ideas, is an essential input to economic success and the fruitful allocation of resources. The state of financial comprehension skills in the general population plays a large but relatively unrecognized role. In 2007, Nobel laureate James Heckman famously suggested that some 20% of Americans, slightly less for Europeans, are actually functionally illiterate and innumerate and quite unable “to determine the correct amount of medicine from information on a bottle of pills.” Capitalism’s weakest link might well comprise a portion of the population unlikely to be saving and investing rationally and optimizing their own interests, if they are saving at all.

A trio of authors from Harvard Business School, the Federal Reserve Bank of Chicago and Wellesley College recently considered three large datasets, among them US Census and credit bureau data, to investigate the impact of education on financial outcomes. They find better-informed and educated consumers tend to make more prudent financial decisions, boosting their wealth and avoiding bankruptcy.

Using data from the Swedish Twin Registry, Henrik Cronqvist, of the China Europe International Business School, and Stephan Siegel, of the Michael G. Foster School of Business at the University of Washington, explore whether investment biases such as poor diversification and over-trading are nurture or nature. After controlling for individual characteristics, up to 45% of the remaining variation may be attributable to genetics. This has implications for education, the design of market incentives, and public policy.

Another recent study of Chinese individual investors, entitled “Trading for Status,” suggests that investor behavior, including excessive trading in small local stocks, varies by location and can be attributed to peer influences.

Some Less Serious Reasons for Economic Malaise . . .

Recent research from David Yermack at New York University Stern School of Business finds connections between CEOs’ absences from the headquarters and the flow of corporate news — something useful to securities analysts. In particular, CEOs spent less time away from the office if they had more personal wealth tied to performance. On average, CEOs spent a surprising 17 workdays at their vacation homes, a metric potentially linked to weaker corporate performance and hence economic profitability.

Open-plan office layouts, just like any immovable objects and structures in the built environment impacting our lifestyles, can provoke strong reactions. Recently they were the subject of an article in the Harvard Business Review, summarized in CFA Digest, blaming the open-plan office format, in part, for an ongoing “assault on privacy” and increased rates of distraction in the workplace. With parallels in ideas propounded by English social theorist Jeremy Bentham and his notion of the Panopticon, the layout of open-plan offices is likely to remain controversial.

Recent CFA Digest summaries and CFA Institute Conference Proceedings for interested readers to research are summarized below:

  • The Case for Long-Termism: Short-term forces are an impediment to long-term investment, which is critical for wealth creation. When these short-term forces are moderated, implementing long-term investment strategies that generate positive long-term excess returns becomes increasingly possible.
  • Smart Money? The Effect of Education on Financial Outcomes: Individuals’ investment and credit management decisions can be affected by their level of education
  • Trading for Status: An evaluation of household stock trading trends in China provides insights into risk taking and investor behavior. The authors examine the role that status plays in explaining puzzling retail investor behavior, including excessive trading in small local stocks. Location plays an important role and can lead to increased risk taking.
  • Tailspotting: Identifying and Profiting from CEO Vacation Trips: Exploring connections between CEOs’ absences from the headquarters and the flow of corporate news, the author finds that the number of companies’ news announcements is significantly lower when CEOs are away from headquarters. Companies tend to disclose favorable news just before CEOs leave for vacation. The stock price volatility remains low during CEOs’ absences from the office and then increases when the CEOs return to work. There is also an abnormal positive return a few days before and after CEOs return from vacation.
  • The Genetics of Investment Biases: The authors use a comprehensive list of investment biases and find that genetic differences account for as much as 45% of the remaining variation across individual investors after controlling for observable individual characteristics.The Genetics of Investment Biases
  • Systemic Risk, Governance and Global Financial Stability: Systemic risk can result in severe negative consequences for the real economy. Too-big-to-fail institutions have historically been subject to various government reforms; however, governance has not been properly addressed by regulators, despite the link between governance and risk taking. Some possible solutions to strengthen bank governance include increasing the capital base, reforming the compensation of managers, implementing resolution regimes, and reforming the structure of company law.
  • Balancing “We” and “Me”: An open office plan is touted as a panacea for corporate interiors. But when implemented incorrectly, it does not provide the desired results. The authors discuss the various forms of individual privacy and organizational strategies for maintaining it.
  • Managing Credit Creation—Beyond Inflation Targeting: Bank capital and derivatives regulation are not sufficient to avert another global financial crisis, primarily because of a buildup of excessive bank lending in real estate. Future policies must prevent the buildup of real economy debt and leverage to excessive levels. Monetary policy and macroprudential policy together must play a role in constraining and influencing both the quantity and the allocation of credit within the economy.
  • Why Global Demographics Matter: GDP, Debt, Inflation, and Asset Prices: To move forward in today’s investment industry, practitioners need to rethink their understanding of demographics and avoid some common but costly mistakes. Aging populations, youth unemployment, and the lasting effects of the 2008–09 financial crisis are reshaping the investment landscape. To be successful, practitioners must move away from the traditional equity/bond split of the past and toward a multi-asset-class, risk-managed, global portfolio mindset.
  • Whither Bonds, After the Demographic Dividend? Deficits, levels of debt, and demographics are deeply interrelated. Demographics have a major impact on GDP growth as well as on investment returns. The long-term headwind that can be expected in the 21st century compared with the demographic dividend, or tailwind, of the 20th century has serious implications for bond investing. But there are still investment opportunities that can be found today.
  • What Is Next for Bond Yields? The Fed is planning a lift-off of rates that, because of the unprecedented circumstances, it does not know how to do. At this difficult juncture, with the Bank of Japan and European Central Bank running accommodative policies, forecasting bond yields requires more than analysis of cyclical data. A deeper understanding of what is driving rate expectations and the yield curve is necessary.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, was director of journal publications at CFA Institute, where he supported a suite of member publications, including the Financial Analysts Journal, In Practice summaries, and CFA Digest. He has more than 12 years of investment experience as a portfolio manager and securities analyst. Harrison is a graduate of the University of Oxford.

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