Predictive Markets

My brother referred me to this article on Forbes.com about Peter Thiel, uber-rich investor guy and hedge fund manager, who accurately predicted the exact order of bank failures based their partisan makeup. It’s an interesting read, but the basic theory was that the most Republican firms would fall first. He attributes the uncanny partisan trajectory of the meltdown to one of three therories (he’s not sure which one).

1. A hostile federal bureaucracy. Despite a Republican in the White House, the bureaucrats who staffed the regulatory agencies, the Treasury and the Fed remain unfriendly to the GOP. Consciously or not, they proved unforgiving toward Bear, Lehman and Merrill but sympathetic toward Morgan and Goldman.

2. An inability to accept reality. At the most Republican institutions, the principals believed in free markets–only too devoutly. Even Milton Friedman would never have argued that markets work perfectly all the time, only that they work a lot better than government intervention. But at Bear, Lehman and Merrill, folks became convinced that the markets possessed almost magical properties. When trouble started, they literally couldn’t believe it.

3. Uncoolness. All the investment banks recruited at the same elite universities, and political correctness at such schools is profound. (If you want proof, just look at the last election cycle. The faculty at Harvard contributed to Democrats over Republicans by a ratio of 93 to seven.) At Yale and Berkeley and Wharton–at all the elite schools–the Democratic Party is cool; the Republican Party, decidedly not. The least Republican investment banks were therefore able to snap up the best talent, leaving the most Republican firms to pick through the leftovers. “In big financial institutions,” Peter said, “it could be that a Republican profile now correlates with technocratic incompetence.”

Reason #2 sounds most plausible to me of those listed; Republican ideologues like Donald Luskin were writing extended editorials extolling the strength of the economy as recently as mid-September. That said, I don’t think it’s the whole story.

If there was in fact some causality — not a given in light of the less than robust sample size — it would seem that an inverted version of Reason #1 may have played a role as well. That is, it would be tough to fault right leaning firms for assuming that help from the right leaning federal bureaucracy would help hedge their bets. It certainly would have been consistent with the pervasive cronyism and special interest favoritism that defined the Bush Administration’s domestic policy. In any event, what they probably didn’t expect was that Republican technocrats would be so heavily influenced by their own misguided faith in free market Darwinism as to let them fail for the sake of market purity (Lehman, cough, cough).

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