Oxfools or Oxford-Educated Pakistani Economists?
By M. Shahid Yousuf
Bloomfield Hills, MI
Most of us are in awe of someone who wins a Nobel Prize or has been educated at Harvard University. One generation earlier "vilayat return" was something of a high honor bestowed on some who had the means and wherewithal to not only go to the UK but to have the sanity to return to one's country of origin instead of becoming lost overseas in alien cultures. Great national leaders arose out of this elite crop of Indo-Pakistanis, e.g. Jinnah, Nehru and others. They wrested control for their own people. With the USA becoming the destination for learning, additional centers of education such as the Ivy League colleges gained prominence and prestige. Being a Harvard graduate is still held in high esteem and one's career path takes a catapulting trajectory. Success is virtually assured. The question one must ask is: are Harvard graduates really brilliant and infallible?
If the Indian Institute of Technology (ITT) is any indication, Harvard and Massachusetts Institute of Technology (MIT) are no longer the standard bearers of intellect and sheer wizardry. It is IIT that is mighty not MIT because ITT rejects are easily accepted at MIT and Harvard. This means that these Ivy League colleges get the desi leftovers while the cream of the crop still resides abroad in India and perhaps this may be true for other countries. It was not long ago (7/11/08) that a Pakistani Samad Khurrum rejected the offer to attend Harvard University on a scholarship from the US Ambassador to Pakistan Anne Peterson. Did Khurrum know something we do not know? Other versions of the same event state that he refused an award and not a scholarship. (1)
All of this brings us to question the very basis of our belief that the West has centers of excellence in all fields and it is here that the worldview is defined. All others are not valid and lack respect and consideration. Particular to the whole world is the much vaunted Nobel Prize. It is the gold standard or perhaps the platinum standard by which the intellectual worth of a man or woman is measured.
If the 1997 Nobel Prize for economics is any guide then one can say with a great deal of confidence that all this Nobel prize giving is a farce. Many of the readers may have been watching "Ascent of Money" on the PBS channels and so will be aware of the foolishness of the whole Nobel crowd in awarding two Americans the Nobel Prize in economics in 1997. The Royal Swedish Academies of Sciences gushed while announcing the Nobel Prize:
"Robert C. Merton (of Harvard) and Myron S. Scholes (of Stanford) have, in collaboration with the late Fischer Black, developed a pioneering formula for the valuation of stock options. Their methodology has paved the way for economic valuations in many areas. It has also generated new types of financial instruments and facilitated more efficient risk management in society."
The mathematicians and economists were falling head over heels in praising the new discovery of managing market risks in arcane topics as calls, puts, options and hedging. It looked as if a new dawn had emerged and one could eliminate risks in the market. Yes, that is exactly what they said. In effect, by using a formula you could make money in the stock market up or down and have no risk exposure. They had invented the "perpetual motion" machine and the praises and emotions matched. They had discovered the fountain of perpetual youth and were walking on water. They were not mere mortals any more.
But what was so brilliant about their work. Well, to put it bluntly they figured that the risk of their model failing was 1 out of 10 raised to the power of 24, a number that is one divided by 1,000,000,000,000,000,000,000,000. What is more they had it all in black and white in the form of a formula to prove their assertions.(2) The whole world was going goo goo ga ga. The world was talking without understanding what it was talking about. This was another case of the king who wore no robes but all and sundry were extolling the beauty and finery of the king’s robes.
The true test of a theory is how it works in practice. To prove their assertions these number crunchers founded a financial firm Long Term Capital Management (LTCM) and started betting in the crap shoot that is otherwise known as the stock market where the innocent are taken to slaughter on a daily basis. LTCM had offices in Greenwich, Connecticut, Tokyo and London and raised some $ 1 billion of working capital from well heeled investors. But these math-gurus were no spring chickens. They were experienced hands and had credentials to prove what they were talking about. They had worked throughout the previous two decades or longer on this equation, and they talked a lot and laughed all the way to the bank. They, i.e. the LTCM, were a cocky lot and used hyperbole to instill confidence in the investors who knew nothing of what they were talking about. Here is an example. "A loss of 50 percent of its portfolio was unthinkably high. According to one of its estimates, the firm would have had to wait 10-to-the-30th days—several billion times the life of the universe—to experience that kind of loss." (3) Not only did LTCM talk big it played big and reached a leverage of 1:100 essentially one dollar controlling $100 worth of risk up or down. After all it was investors’ money they were playing with. Institutional Investor, a publication, called them “the best finance faculty in the world." Myron Scholes himself said that “LTCM would make money by being a vacuum sucking up nickels that no one else could see.”
And then it happened: the mathematical model cracked. Russia defaulted in its debt obligations. The market turmoil bled the company some $45 million a day. Such losses were not sustainable and soon the cookie crumbled needing a consortium of world banks to shore up the LTCM. The bailout was orchestrated by the Federal Reserve Bank of New York. The LTCM which began in 1993 had in a short span of 7 years folded in 2000. It would have folded earlier were it not for the dire predictions that with the failure of LTCM, the financial system would collapse and that the creditors would lose more by not lending additional money to LTCM than by lending. It was a bailout, one of the many to come years down the road. Others were to follow the same path too. They had hired what was described as “Nobel track” mathematicians who were going to wring out the risk in the stock marked through sheer number nudging. Bears and Stearns went down the same path and was sold off to Morgan Stanley at $ 2 per share in a behind the scenes over the weekend moves. Other fell to like dominoes and now the whole economy of the world has fallen into a downward spiral. The origin of the catastrophe can be traced to the new age theories emanating from these very US based centers of learning and excellence. In the ensuing months the greatest transfer of wealth occurred from the developing countries to the US where the derivatives disaster occurred. Indians, South Americans and Chinese investors all suffered in the fallout. They lost money by investing in the USA. Their new found wealth was looking for a safe haven. They put all their faith in the US financial system instead of their own countries.
There is a lesson in all of this for all of us. We are too quick to be awed by any logic emanating from the academics who have high-sounding credentials. We do not look deeper. In the LTCM fiasco, it turned out that the models had taken only 5 years of financial records to fashion the Nobel Prize winning financial panacea. While the hyperbole boasted of several universe lifetimes for failure, the economic theory failed in mere years. It took 70 years of communism to collapse and that too was to be the heaven on earth solution. Mercifully this was mere years.
All the economists in Pakistan have been tutored in the West. The Western centers of learning may have taught these eager Pakistani students how to hold a fork and spoon or they may have taught them other social graces such as how to tie a tie or even shoe-laces. The reality is blind adherence to economic prescriptions has cost the developing world ongoing misery and poverty. Dr. Mahatir of Malaysia caught on fast to the market manipulations by stock market movers and shakers. When the “tiger” economies of the South East Asia were hit by economic crises, Malaysia did not follow International Monetary Fund’s advice. He went the opposite way and imposed currency controls and stabilized the ringgit. The sky did not fall. Malaysia grew out of a homegrown solution and became prosperous once again.
The countries that have followed the West's nasty nostrums continue to be reeling from the debt and constant dependency on West’s consumption of cheap goods and services. Whereas in early fifties without foreign experts the US dollar traded at $3 and change to a Pakistani rupee it is now in the range of Rs 80 to one dollar. With all the advice learned and applied by our World Bank types in Pakistan, clearly their models have failed miserably through successive governments of all political stripes. I ask is it possible that all those Pakistani economists, having being coached in centers of learning like Oxford schools are nothing but Oxfools?
(1) http://www.pro-pakistan.com/2008/06/18/student-samad-khurram-refused-harvard-scholarship/
(2) http://www.math.lsu.edu/~ferreyra/black-scholes-ito.html
(3) http://www.derivativesstrategy.com/magazine/archive/1999/0499fea1.asp
