An Engine, Not a Camera

"This is one of my favourite books. MacKenzie is interested in this performativity question – the degree to which markets themselves are formed around economic ideas. The book is about the origins of option trading markets and derivatives more generally. His analysis, like a lot of economic sociology, is historical. It’s looking at the origin of market shifts and market institutions, it’s looking for the role of different actors. MacKenzie focused on the use of the Black-Scholes-Merton equation for pricing options and the role it came to play in building an options market. How did the options market come to be? That’s the point of the book. He shows that a set of innovations took place in the Chicago Board of Trade and Chicago Options Exchange at the beginning to make the trading of options, which are essentially bets on the price of a commodity, legal. Under option laws you actually had to at some point be able to take possession of what it is that you’re buying and the options market started around commodities, so if you bought 100,000 barrels of oil to be delivered in September at a certain price and you pay options to take delivery, theoretically you could take delivery. This created the illusion that options were a form of insurance instead of a form of gambling. In the 1970s people wanted to start buying options on things that they weren’t necessarily going to take delivery of. By the definition of the Securities and Exchange Commission, doing things like this was gambling, so they had to get the government to agree that what they were doing wasn’t illegal. They got the government to agree to let them trade this stuff. But at the beginning nobody could figure out how to price it. Three financial economists, Black, Scholes and Merton, came up with this equation to price options. At the beginning the equation performed very badly, but as people began to use the equation to estimate price, its predictive power grew. If you think about this as a social process, you can have 1,000 traders and all of a sudden a substantial number start using the same equation – the equation actually helps to organise the market. He showed how that happened with Black-Scholes-Merton. It means that markets are constructions, not cameras that capture reality. Let me put this in context: There was a debate for a long time in economics about whether economic theory is real. There were two points of view. One is that economic theory ought to be realistic – in other words, it ought to be a camera that captures the way the world really looks. Friedman argued that whether the world is or isn’t consistent with theory doesn’t really matter. What matters, according to Friedman, is that the theory helps us construct the way the world should be and gives us a way to understand the world. It’s not really a problem, for economists, that their theories aren’t realistic. We can create an engine, like these financial markets, which reflect economic theories and not reality. It lays out how to think about the relationship between sociology and markets. It begins by posing a small set of questions that encompass a lot of what people are doing under the title of economic sociology or the sociology of markets. It tries to think harder about political, social and legal factors in the conception of markets; it tries to include both elements that are more macro, like the role of politics, and then it also tries to consider how particular markets come into existence and become stable by surveying a large variety of studies that we’ve done over the last 20 or so years. Economic sociology can help us understand the roots of the problem. For example, what the firms, the banks were doing, and the relationships between the banks. Most of the analysis that we have didn’t really consider the banks themselves as actors in what happened: They start with financial products or with the financial crisis and they see a liquidity crisis not a sociological one. In fact the liquidity crisis was a result of the way banks were organised and what they were doing to make money. The work that I’ve done looked at the history of the mortgage security industry. What happened in the 1990s was that Wall Street and the mortgage industry converged. The main product that Wall Street sold was mortgage-backed securities and credit-default obligations, MBS and CDOs. We had a merger between the mortgage market and the securities market that set up the climate for the crisis. The commercial banks became investment banks, a lot of mortgage banks became investment banks, the investment banks bought mortgage originators. By the time we got to 2007 the structure of all the banks looked the same. This helps explain why Washington Mutual and Bear Stearns both went bankrupt. They evolved into essentially the same sort of institution. This is what economic sociology can show. What happened in these markets over time was really a social process – banks began to mimic one another’s behaviour and to resemble each other. Regulators by and large either ignored or didn’t understand this process. I called it regulatory capture – the regulators came to think like the bankers. And regulators didn’t really understand what was going on. My best place for seeing this is that in the spring of 2007 Ben Bernanke gave testimony to the American Congress about the mortgage crisis, which was already starting to evolve, and essentially he testified that the mortgage subprime crisis was going to be restricted to the subprime market but there was no way it was going to spread to the rest of the financial business. He didn’t really understand the whole system or that it was a system, that subprime mortgages were the main product of the system at that point. It took another year and a half for him to realise that, which just shows you the limits of economics as a way of understanding these processes. It’s sociology that connected the dots. The field is very vibrant at the moment. Economic sociologists are working in a bunch of interesting directions. People have become less shy about going right into the heart of market processes and finding the social. That’s one of the reasons why I like the Lucien Karpik book, Valuing the Unique . It’s about why one penny is worth one cent and another is worth $5m, why a bottle of wine that [wine expert] Robert Parker says is a 93 [out of 100] is worth $100 and another bottle of wine he says is an 87 is only worth $20. There’s a lot of interest in pushing even further into understanding how valuation works. There’s a lot of interest in seeing how social status affects these processes and how we define ourselves by what we own. There’s a lot of interest in markets and morality, how we limit what markets can and can’t do. There’s a lot of interest in entrepreneurship, how new markets come into existence and their resemblance to social movements. Economics has almost nothing important to say about entrepreneurship and a lot of what’s being said about entrepreneurship comes from sociology. Business schools are increasingly interested in applied economic sociology. Entrepreneurial studies are based on economic sociology. Courses on marketing and branding are infused with economic sociology. The main way in which economic sociology finds its way into the mainstream is through business studies and network analysis. And as for the dismal science of economics, I think reality undermines it every day without this assistance of sociologists."