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Irrational enthusiasm

Banking Essentials Newsletter - November Edition

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Irrational enthusiasm

Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.

It has been seldom in recent memory that I have applauded the folks who award the Nobel Prize for two years in a row. Remember, these are the same people who gave the coveted Nobel Peace Prize to both Barack Obama (way too early and for no discernible accomplishments) and to Aung San Suu Kyi — a.k.a. "The Lady" — who was meant to be the democratic savior of Myanmar and the tamer of a military dictatorship but has since been an enabler of a brutal status quo. And in other disciplines, the Nobel Committee has seemed at times to reward obscurity and anti-Western thought to the exclusion of relevance and in strict adherence with the prevailing rules of political correctness.

That's why I was so blown away by the awarding of the Nobel Prize in Literature in 2016 to Bob Dylan — an award that proved to be both controversial and troublesome in its aftermath. (Like they thought that he would actually show up for the awards ceremony and say normal stuff?) But as any child of the '60s would agree, Mr. Dylan long ago went beyond the definition of singer/songwriter and into the realm of poet and societal seer, and his words — set to music or not — presaged some of the American challenges and attitudes that prevail to this day. And while Jimi Hendrix may have done a better job with the musical end of "All Along the Watchtower," Bob Dylan's words are what we remember when we think about the folly of the Vietnam War.

The economic picks of the Nobel Committee have been some of its most forgettable, as it has historically rewarded the prize to economists who have written on some of the more obscure areas of economic research and whose work does not seem to be highly relevant to today’s major economic issues. For example, the 2016 Nobel Prize in Economics went to Bengt Holmstrom and Oliver Hart for their work on contract theory — important stuff, I know, but not something meant to appeal to economic generalists (like me) and not a line of study that tells us much about today’s challenges of persistently low inflation and stubbornly high income inequality. Unfortunately, some past winners have taken their Nobel Prize as license to speak about all things economic — witness Dr. Krugman, who has become a harsh critic of many of his peers and their work (and pretty much everyone else who disagrees with him) in spite of his fairly narrow focus on the theories of trade.

So I was delighted to see that Professor Richard Thaler of the University of Chicago had won the Nobel Prize in Economics in 2017 for his long-heralded work in behavioral economics. Yes, that is the study of how people actually behave — in the real world — and I can think of no better time for this gentleman (and I use that word sincerely) to receive the acclaim that has long been his due. A great article in the October 9 Chicago Tribune summarized his body of work this way: "Unlike historical economic theory that assumed humans were well-informed and perfectly logical when making decisions, Thaler’s work showed that not only is that not the case, but people can be irrational in systematic ways. Accounting for those patterns can help explain why people seem to act against their best interests..."

Well, no kidding — and why has it taken so many years for this in-your-face truth to find a large following in the economic community? My theory is that the classically trained model-driven economists have simply not been able to deal with the fact that many times their models do not work, and if you need any proof of that, then let me direct your attention to the big white building in Washington, D.C., where some are having trouble figuring out why inflation is not going up. My Thaler-esque answer would be — have you been to a Walmart lately and seen that global oversupply and cut-throat competition in retail just keeps making stuff cheaper? And that a graying population in America is doing exactly what it has done in Japan for so many decades? (Not buying so much stuff, that is...) You really need to get out more, Board of Governors ...

Anyone who has been in the financial services industry and has been around the equity markets for any length of time has seen irrational behavior at its finest and knows there are few ways that human actions can be shoehorned into any kind of predictive model. I cannot recount all the sad stories that I heard in the dark days after the Financial Crisis of people who had cashed out at the bottom, unable to withstand the stress and fearful of further losses that would end in penury. And these people were market professionals — not amateurs — who theoretically should have known that the likely policy response would have been a massive unleashing of liquidity into the markets and other actions to reflate asset prices. But in that moment of truth, they just could not stand the pain, and that was the moment that counted.

Dr. Thaler and his fellow behavioral economists must be in economic hog heaven right now, with so much irrational behavior — much of it coming right from the top — to observe and to codify. How can anyone — Nobel economist or otherwise — normalize an economic outlook that includes a tweeting President, the very real possibility of war, the possible abrogation of important global trade agreements, the rise of populism (which is by its very nature irrational in many respects), and on and on. I am one of those who believes that the world has largely lost its mind, and I have spent a lot of time wondering recently if there is any rational response to any of this. (Holding excess cash and getting off social media platforms only gets you so far...)

I am sure that the Nobel Committee must be happy with its selection of Dr. Thaler, as he has been thoughtful and magnanimous in his public commentary since his win was made known and has shown a droll humor throughout the media grind. He has, of course, been asked his opinion of the tax plan that the White House has put forth, and his response was so funny and so low key that I had to write it down: "Its ratio of certitude to knowledge is nearing record highs." (Burn!) Dr. Thaler also apparently writes a column — called "Anomalies"— for the Journal of Economic Perspectives, which the Financial Times calls "witty and sharply reasoned, highlighting strange features of the economic and financial world that standard economics could not explain, and rigorously debunking unconvincing attempts at rationalization." Maybe not so dismal a science after all...

I've been listening to big-bank earnings for the last few days, and I'd love to hear Professor Thaler's take on banking. Like how to explain the reluctance of depositors to demand a greater return on their deposits as rates go up, and the reasoning behind the propensity of bankers to want to push more credit cards and auto loans out the door even as an economic cycle goes into extra innings.

One thing is for sure — there is no model that predicts behavior in the banking industry, and thank God for that. Banking systems run on irrational enthusiasm, and that's what keeps bankers (and bank analysts) in business.