A Call for Judgment: Sensible Finance for a Dynamic Economy Hardcover – 4 Nov 2010

Amar is an old friend of mine and I read his book knowing his deep knowledge about economics. This is an intelligent read for the hyper-intellectual. Nearly everyone else has written what I would say so I'll save you the time from reading more.
Just buy this book, you won't regret it.

Since October 2008, many have written about the financial meltdown that sparked the Great Recession. Most books and articles were about "what" happened; very few attempted to write about "why" it happened.

These "what" and "why" attempts informed me but I learned little to draw lessons for corrective actions and for the future. These authors were like the proverbial blind men trying to describe the elephant by touching/feeling its different parts. Additionally these authors were academicians, journalists and financial engineers who wrote from limited perspectives of their own domain expertise or experience, mostly in finance, economics and financial journalism. These authors provided subjective views of a vested or inadvertent participant in the creation of the financial bubble.

I needed a detailed, objective view to learn about why financial meltdown came about and how it could be avoided in the future. Amar Bhidé's Call for Judgment went a long way in satiating that thirst.

Amar Bhidé is Schmidheiny Professor at Fletcher School, and has served as Glaubinger Professor of Business at Columbia University. His book is expansive in its scope.

It has broad content, drawing from scholarship and research in Economics, Finance, Government Regulation, Quantitative Sciences, and Innovation. Bhidé uses his deep knowledge of theory and practice in these seemingly disconnected disciplines to support and tear apart deeply rooted contentions and practices.

Additionally, it is expansive in its time horizons. Bhidé is a credible business researcher and historian. He goes as far back as is necessary, sometimes several centuries, to provide details that evolved and contributed to our current situation. It reveals human frailties, how our collective memories can also diminish with age.
Moreover, Bhidé is objective. He displays not only intellectual honesty but also intellectual bravery. He is not afraid to take on some of the sacred idols and expose their contributions to current debacle.
Furthermore, he is not scared of the devil that resides in the details. His approach has logical and systematic rigor.

Bhidé contends that there were several contributors to the debacle. At the top of his list is that Finance had become centralized, mechanistic and detached from its local customers and conditions. Flawed quant models catalyzed centralized decision-making, with microscopic contributions from local judgment.
The centerpiece of this centralized financial decision-making had some fundamental faults in the way their "mathematical economics" foundation and pillars treated "risk" and Knightian "uncertainty". Pursuit of mathematical elegance required some shortcuts that took economics into untestable territories, where hypotheses were unfalsifiable but implausible, with unimagined consequences.

Separately, banking deregulation, cheered on by prevailing economic theories and certifications from the SEC, allowed banks and investment firms to morph into publicly traded monoliths. These firms were led by inactive, arms-length stockholders management, who paid little attention to increasing risk at their firms. This led to a perverse "Heads we win, tails public stockholders lose" attitude to prevail in the industry. The risk appetite of financial firms went up and with it the share of trading at these firms.

On the other side, threatened banks, whose market share had declined, were now forced to look for alternative sources of profits. They created highly profitable and risky products such as derivatives and Credit Default Swaps.
Aided by these factors, the imprudence or chicanery of a few individuals unraveled several firms and caused widespread damage to the global economy

Bhidé has "A Modest Proposal" to pull us out of this morass. It can be summarized by former Citibank CEO John Reed's comment, "I would compartmentalize the industry for the same reason we compartmentalize ships. If you have a leak, the leak doesn't spread and sink the whole vessel."
He recommends that we reinstate Glass-Steagall's wall between investment and commercial banking, to reduce collateral damage from future speculative bubbles.

His fervor for local touch points between banks and borrowers is not lost. He recommends that we reinstate old-fashioned banking where bankers know their customers. Consequently, we would have to decentralize oversight of banking and finance so that conditions, relations and decision-making can be monitored locally.

His proposal allows "casino bankers" (investment firms) to innovate and speculate but with an arm's length from "utility banks".

Bhidé does anticipate that the unwinding and fragmentation of megabanks will be difficult--97% of more than $200 Trillion in derivatives are held by five US banks: J.P Morgan, Bank of America, Goldman Sachs, Citibank and Wells Fargo.

Additionally, government-led solutions to the current crisis may take a long time. The 2,300-page Dodd-Frank bill may appear to some as "refurbishing regulators' deck chairs from the Titanic." However, as historical examples from previous financial crises show, "a weak first bill doesn't have to be the last word" and "reform delayed isn't reform denied!"

I could see why eminent people such as Former Fed Chairman Paul Volcker and Nobel Laureate (Economics) Edmund Phelps and many others recommended the book. A Call to Judgment has great content and is a treat to read. The material, in lesser hands, could have been boring and tedious. Bhidé strikes a great balance between dryness of the subject and popular writing, with subtle, tongue-in-cheek strokes that are rare in such scholarly tomes.

Amar Bhidé's A Call for Judgment is a clarion call for us to be aware and beware of the current structure of the financial--banking and investment--industry. Global governments and investors need to listen to Bhidé and heed his call to action because we are not out of the woods yet.

The insightful book has probably been targeted at researchers, scholars and policy wonks but the rest of us can benefit from this brilliant work too. I know I did.

Professor Bhide is absolutely correct in his prescription for ending the current big banking business and spurring creation of smaller banks. Smaller banks that are more focused on the lending and not speculating in investment securities or selling insurance, can provide much needed boost to small businesses throughout America.

The giant banking enterprises of today have lost touch with lending (their primary function) and have instead focused on offering a whole host of investment and insurance services. The repeal of Glass Steagall in 1999 allowed traditional banks to do investment banking. Banks thereby engaged in high "risk-high-reward" bets tied to mortgages and eventually those bets led to their downfall in 2008.

As a CPA, I see so many businesses hindered by lack of lending. The big banks are simply unable to look beyond highly inefficient quantitative measures of creditworthiness. In addition to quantitative metrics, lending of the past focused on qualitative aspects of borrowers-expertise, experience, industry, competitive advantage etc. The large scale banking of today simply has no room for qualitative judgments as loans have become commodities that are sold on Wall Street.

A return to the basics of lending should help more businesses and individuals qualify for loans and get our moribund economy going. I strongly support Dr. Bhide's call for reinstatement of Glass Steagall, whereby commercial banks are restricted to only accepting deposits and making loans. In Mr. Bhide's words, "we need to separate utility banking from casino banking." Additionally, instead of wreaking havoc over our banking system with excessive regulation, the federal government should encourage creation of smaller banks by resurrecting the wall of separation between commercial and investment banking.

In this book, Professor Bhide does a wonderful job of explaining the history of banking, the causes of financial crises and systemic problems plaguing the system today. It is a must read for anyone seeking to understanding banking in the United States.

Amol Nirgudkar CPA
Managing Partner
Reliance Consulting LLC
[...]

Sometimes, great insights come from those outside a field. Fletcher School professor Amar Bhide's prior writings have been on innovation and entrepreneurship. The strength of A Call for Judgment is in bringing insights from those fields to the financial crisis. Its weakness lies in its lack of grounding in banking regulation.

Bhide begins by noting that finance differs in significant ways from other industries. Non-financial companies tend to be interconnected and personal, rather than anonymous and commoditized, as are financial and textbook capitalism. But drawing on the seminal work of F.A. Hayek, among others, Bhide also notes that well-functioning markets tend to be characterized by decentralized knowledge.

His core insight, which is absolutely correct, is that the replacement of ongoing personal relationships in banking with securitized arm's-length dealing, has increased systemic risk by furthering centralization and reducing the quality of knowledge and monitoring. In discussing how finance evolved in this direction, Bhide recounts how various theories, such as the efficient market hypothesis and Black-Scholes-Merton options pricing, paved the way for the abandonment of relationship banking.

The book also focuses on the role of our securities laws, starting with the 1933 and 1934 Securities Acts. In protecting the small investor and increasing the liquidity of the equity markets, these laws have promoted a diffused ownership of public companies that has also discouraged investors from establishing relationships with management.

Where A Call for Judgment falls short is in its recommendations for reform. Bhide offers one proposal: Return to narrow, "old-fashioned" banking, in which bankers know their borrowers. This would be accomplished by essentially reinstating the Glass-Steagall Act of 1933 and limiting banks to making loans to individuals and non-financial businesses.

But this proposal and its implications aren't really explored; nor is the academic literature on universal banking examined. There is literature suggesting that the more activities banks engage in, the more stable the banking system is. There is also empirical research suggesting that Glass-Steagall was misguided. Universal banks in the 1920s performed better than narrow commercial banks, and the securities underwritten by universal banks also performed better than those by narrow investment banks. Nor is there any discussion of the European experience with universal banking, often practiced in a personal and interconnected manner.

Amar Bhide has written a valuable contribution to our understanding of financial markets. Unfortunately, however, it offers only a narrow analysis of the financial crisis with an equally narrow reform proposal.

Decentralized decision making is essential to capitalism. Entrepreneurial inspiration and innovation can advance society faster than the slow march of a centralized, government-planned economy. But like government bureaucracies that become unmanageably large, oversized banks also can impede progress. Simply allowing market forces to determine the size and scope of the big banks is debatable public policy, but bank mergers have led to centralization and to the mechanization of lending, thus adding systemic risk to the US banking system. This far-reaching book includes a rich history of this industry's development and a detailed account of its destabilizing role in the 2008 financial panic. Amar Bhidé - a business professor and a trader -describes more than he prescribes, and his prescription is as controversial as it is compact: Limit severely what banks can do. getAbstract recommends the book to readers seeking a deeper understanding of how financial institutions drive, and sometimes derail, the entire economy.