Sunday, October 31, 2010

Game On!

Mission accomplished!  I got the summary of the paper submitted to Stanford University, and I have received confirmation of receipt.  I don't know whether I will win the contest, but I feel certain that I'll get the final article published somewhere in the next six months (the hope is for publishing a law review version and a business review version.)  I'll know the outcome in a couple of weeks.

While I still have to devote significant time to writing up the final article, I will be posting on a daily basis from here on out.

Thursday, October 21, 2010

Why Reality Shows Suck

Honestly, I can't fully document all of the reasons why reality shows suck, so I'll stick to just one.

The producers of reality shows profit from human misery and humiliation. 

Yeah, you can argue that the misery and humiliation are the participants' own fault for seeking their 15 seconds of fame (sorry, but that's inflation), but that doesn't wash with me.  The system has been tilted to encourage fools to be fools (and sociopaths to be sociopaths), so I can't blame them for embracing their natural roles.  Leaders, on the other hand, are supposed to lead, which means caring for your followers and helping them to avoid harming themselves and your mutual endeavor.

Leaders exist to serve their followers, not the other way around.  At least that is how I played the game when I was a leader.

Unfortunately, we live in a world shaped by neoliberal ideology where the elite believe it is their duty to exploit the masses instead of serving them.  Perhaps it was always this way.  I don't know.  All I know is that there is right, and there is wrong, and it is wrong to take advantage of people who aren't equipped, for whatever reason, to compete with you.  Dial it down several notches and appreciate the beauty of real people, most of whom live paycheck to paycheck.  Your false wealth is built on the backs of these people, who can just as easily take it away.

Reaping what you sow can be a bitch.

And Now for Something Completely Different: The Fractal Nature of Human Cognition

Below is repost of a half-baked theory of human-managed systems that I developed in July of 2009.

The basic theory is that human beings are really "expectation machines" that compare what they experience to what they expect and adjust their state accordingly.  The function of the expectation machine includes hysteresis (positive feedback) to maintain the current state unless what is experienced deviates from expectations by too far a margin.  In cognitive science and behavioral economics, this hysteresis is known as cognitive bias, of which confirmation bias is but one example. (A good example of how hysteresis is used in electronic systems is the Schmitt Trigger.)  The amount of hysteresis applied to a given decision depends on the level of abstraction/uncertainty involved in the decision.  There's very little hysteresis applied in the decision of whether or not to eat something because that decision is usually based on feeling a physical need to eat something.  There's a LOT of hysteresis applied in speculative endeavors such as "investing" in the secondary bond and equity markets, which can give the impression of manic-depressive market behavior.

The two primary reasons why all mathematical models of economies will fail is: (1) they assume everybody is loaded with the same "expectation function" (e.g., that of utility theory or that of prospect theory) and (2) they model risk without properly considering the hysteresis (a form of memory) induced by uncertainty. 

The fact is, though, that the founders of the neoliberal schools of economics (Chicago and Austrian) knew that their mathematical models were bogus.  Otherwise, they would not have set up think tanks and similar institutions to bombard the public with neoliberal propaganda that shapes people's understanding of reality and, thus, shapes people's expectations.  They knew that economic decisions are not based solely on purely selfish interest but are influenced deeply by societal institutions.  At the end of the day, Mises, Friedman and Hayek were really institutionalist economists who hid behind false mathematical models to mask their neofeudal ideology as the new liberalism.

FYI -- Back in March, attempter (aka Russ) coined the phrase "fractal Walmartization" in a comment over at Naked Capitalism.  I thought it to be an apt description of what he observed, and it is consistent with my half-baked theory.

The Fractal Nature of Human Decision-Making
I spent some of this past weekend diving into George Soros’ The Alchemy of Finance, and I have developed some initial conclusions that I think are interesting.

Before getting into the details of my exploration, I should explain why I’m bothering with Soros at all.

I initially embarked on my present journey by studying the works of philosophers such as Popper, Arendt, and Marx, which led me quickly to other philosophers (e.g., Plato, Hegel, Kant, Smith, Hume, etc.) and economists, which I now call “applied philosophers” (I can’t call them scientists). One of the things that struck me about philosophers is that many of them start out to understand the world only later to shift towards changing the world. They start out by describing the world as they see it (something I viewed as the “descriptive function”) and then turn to prescribing the world as they believe it ought to be (something I viewed as the “prescriptive function”). Marx, a philosopher and applied philosopher rolled into one man, was a perfect example of this tendency. Ayn Rand was another. By comparing what many of these luminaries had to say about the way the world works to empirical evidence to the contrary, I noticed major discrepancies and came to realize that all human beings tend to interpret life rather than experience it, subconsciously applying their “Useful Fictions” and confirmation bias in real time to filter events to shape their understanding of the world.

As the study of philosophy led me to study economics, I ran across Soros’ latest book, which discusses the causes of the current economic upheaval. In that book, he talks about his model of human behavior (he studied under Popper), which was remarkably similar to mine. What I call “Useful Fictions” he calls “Frutiful Fallacies.” What I call the “descriptive function” appeared to be the same as what he calls the “cognitive function.” What I call the “prescriptive function” appeared to be the same as what he calls the “manipulative function.” What he introduced that was different was reflexivity. While reflexivity is similar to confirmation bias, it is actually quite different, at least definitionally. Reflexivity is based on the observation that participants in a market affect the operation of the market and can do so in a manner that makes the market somewhat different than what the participant understood. That is, the cognitive function and the manipulative function act against each other: by successfully manipulating the world, you act to change it into something other than you understand it to be, transforming what was a known known into an unknown known. Markets can be brought to their knees when participants finally recognize that their assumptions were wrong.

I was far more intrigued by the similarity in Soros’ conclusions about human behavior than I was about the causes of the financial crisis. Knowing that somebody who studied under Popper and who has been immensely successful applying his model of human behavior in trading commodities and equities had developed a model of human behavior that was similar to mine encouraged me to continue developing my own model.

So, I delved deeper and deeper into the issue of confirmation bias. Jonah Lehrer’s How We Decide was particularly illuminating of the role that brain chemistry, and especially the dopamine system, plays in decision-making. My interpretation is that the dopamine system does at the physical level what confirmation bias does at the cognitive level. While I think it most likely that most cognitive scientists view the dopamine system as the cause of cognitive bias, I view them as two distinct things despite their striking similarity. The dopamine system essentially engages in real-time pattern-matching that compares actual outcomes to expected outcomes. If everything meets expectations, positive signals are sent. If something is amiss, negative signals are sent. The reason why I believe that cognitive bias arises at a higher level of abstraction is because the possibility of cognitive bias only arises if the dopamine system has alerted the person that something does not quite meet expectations. A strong negative signal would bash through any cognitive bias because, well, SOMETHING IS WRONG!!! The chemical reactions are really strong.

Upon recognizing that confirmation bias is similar to how the dopamine system works but occurs at a different level of abstraction, I struck upon the idea that reflexivity as described by Soros is similar to confirmation bias but occurs at an even higher level of abstraction. Hmmmmm. Isn’t there an example of something that appears similar at every level of detail (i.e., abstraction) and is recursive in nature? Yep, and it is called a fractal.

Once I observed that the dopamine system, confirmation bias and Soros’ reflexivity concept seemed fractal in nature, I started to refresh my understanding of calculus and fractals. Let’s be clear: I don’t believe that any mathematical function can accurately describe human behavior, whether at the micro or micro levels. I do know, however, that “quants” apply fractal algorithms to market data to make buy/sell decisions in the stock market with some success. Could it be that the fractal nature of markets, first observed by Mandelbrot himself, can be explained by the fact that human decision-making itself is fractal in nature? And human decision-making is fractal in nature, could a mathematical model of that fractal at least help identify and agree upon trends that will harm the economy if left unchecked?

While waiting for books to help me bone up my math (I’m still waiting, actually), I decided to dive into Soros’ The Alchemy of Finance in hopes of finding a mathematical expression of the reflexivity function as he saw it. I hoped in vain. In spite of the fact that that the book was first published over twenty years ago, the math explaining it has never been developed. In fact, I believe that the math can never be developed because it is fundamentally flawed.

It turns out that Soros himself offers no mathematical function to support reflexivity, but he does provide examples of how he has detected reflexivity at work in markets and used that fact to make money (lots of money). Others have actually tried to take his narrative description of reflexivity and create a mathematical function, and I think their literal translation of the description into a function was accurate. Unfortunately, the function is wrong because it assumes a constant feedback loop: it assumes that human beings are always consciously comparing reality to expectations. That simply is not the case.

Soros’ examples are based on comparing the price of a commodity to his view of the fundamental value of that commodity over time. By so doing, he can identify a “prevailing bias” and an “underlying trend.” If these two things appear to be “self-reinforcing,” that indicates a boom that can be bought into and sold out of before the inevitable bust. If these two things appear to be “self-correcting,” that indicates a bust that can be shorted.

The problem with Soros’ theory of reflexivity as described is that humans do not constantly consciously compare reality to expectations. The dopamine system does not allow that. The only time that humans check their assumptions is when the dopamine system tells them that something is wrong, and much of the time, the confirmation bias reassures them that everything is alright. The only time that reflexivity comes into play is when social imperatives (i.e., the fact that everybody else seems okay with what is happening) overcome personal concerns that are not tamped down by the cognitive bias. Reflexivity is not a continuous function and cannot be explained by things like stock price. Stock price is, in fact, a derivative of collective decision-making and not a direct indicator of it.

Thus, a better way of expressing of Soros’s reflexivity is as a bias error function that leads to discontinuities (i.e., step functions) in the derivative function that is stock price. And the best way that I can think of to express that function is as a fractal. I don’t expect to succeed in doing that, but I do think that I can make the case that somebody who is actually competent should try to do so. I will explain why later.

Early Thoughts About the Financial Crisis in 2009

I've come a long way in my thinking since this post from March 2009.  At the time, I was resisting the memes of all comers regarding the cause of the financial crisis (e.g., the neoliberal Austrian's "the Fed did it along with all the poor people" and the liberals' "the banks did it"), and I was still thinking like a corporate executive.  I'd say the biggest shift in my thinking is that I used to believe that the banks were effecting the policy of the U.S. government, but now I believe that the U.S. government was effecting the policy of the banks.  Another big change is that I no longer think that the regulation we have on the books is sufficient to control the behavior of banks, who have invented new mechanisms to achieve their fraud, mechanisms not addressed by current regulations.

I also no longer frequent websites like Hullabaloo or TPM because I think they identify too much with the Democratic Party (they're not as bad as Kos, though).
What's Next: Rethinking Economics and U.S. Economic Policy
UPDATED 3/9/09 - While attempting to track down the underlying GDP data, I discovered I had misread the chart in Dean Baker's book, which refers to percentage of corporate profits, not GDP. Because of the contribution of MEW to real GDP over the last eight years, I don't know that this difference will be fatal to my thesis, but I will track the data down and shake things out.

I'm a data junkie at heart. To paraphrase Neo, I need data, lots of data. Why? Because I prefer to figure things out for myself, and the more information I have, the better I can see what others don't.

In my two-month quest to educate myself about the economy, I have gotten my hands on and at least partially reviewed on the order of forty books, some as old and revered as Smith's Wealth of Nations and others that are freshly printed screeds about the current crisis and its origins (e.g., Dean Baker's Plunder and Blunder).

I've also become something of a econ blog junkie. I visit my favorites many times a day and follow their links to source material. Calculated Risk is one of my favorites because of the wealth of data and charts.

I take a daily look at liberal political blogs like Firedog Lake, Hullabaloo and Talking Points Memo, which tend to provide the raw data and not just the opinions they've arrived at. Because it tends to be much more ideological and inflexible, I only occassionally look at DailyKos, which had this screed today, entitled "America's Lost Decade":

The problem that I have with the rant is that it ignores the larger picture and focuses instead on laying blame on the bankers and Wall Street. That's not only not helpful, it could be harmful.

The Banks Didn't Bring Us Here On Their Own; They Were Effecting U.S. Policy.

If you take a look at the U.S. economic data that has been summarized in books such as Shiller's Irrational Exuberance, Baker's Plunder and Blunder, and Reich's Supercapitalism, you will be forced to conclude that the ascendancy of the Financial sector of our economy to its acme in 2006 could not have come about but for the economic policy of the U.S. government as introduced by Reagan and carried through to this day by Obama. This economic policy, advocated by the neoclassical economists like Milton Friedman, focused on "free markets" and "globalization." U.S. investors-- individuals and corporations alike-- were encouraged by tax incentives, accounting rules and sometimes by monetary incentives (i.e., cash) to invest their capital outside of the United States. [Note: although it was published in 2005, I find the data and analysis of Irrational Exuberance the most compelling.]

The result of this economic policy was the ascendancy of the Finance sector : in 1980, the Finance sector accounted for only 15% of corporate profits, in 2004 it was 30% of the corporate profits and remained about 25% of the GDP in 2007. (See, e.g., Figure 1.1 of Plunder and Blunder) . This makes a lot of sense. As U.S. capital was invested in manufacturing infrastructure overseas, we saw domestic production of goods drop, and we had to look to something else to be the engine of growth for the U.S. economy that our manufacturing industries once served as. And that something had to grow fast enough not only to make up for the drop-off in production by the manufacturing sectors but also to provide the expected increase in overall growth that is needed to have a healthy economy generating wealth. So our economy was retooled to be driven by the service sectors of the economy, and the biggest winner of all was the Finance sector, which was deregulated and told to get out there and be fruitful. [Note: I eventually will update this post with some data that illustrate the point.] And the Finance sector, was very, very fruitful.

Unfortunately, most of the apparent fruitfulness has proven to be illusory, and the stock market today stands where it was ten years ago. Hence, we have somebody over at the DailyKos referring to the last ten years as a "lost decade" for America.

That being said, although the excesses of the Finance industry are absolutely the cause of our current economic situation, getting angry at the bankers won't help us get out of the current situation, nor will it help us to restructure the U.S. economy to grow sustainably into the future while avoiding this kind of problem again, if at all possible.

Indeed, I'd argue that focusing too much attention on the bankers will only increase the chances that are going to repeat the mistakes that led up to the current crisis. Why? Because the problem starts with neoclassical economics and the willful blind spots (e.g., inanities such as the Efficient Market Hypothesis) that its adherents have created to match the "facts" to the policy. "Oh, the data don't fit the model? No problem, just assume the data away," seems to be a touchstone of neoclassical economics, particularly Friedman and the Chicago School. For a taste of what I am talking about, check out this post by Prof. Steve Keen:

If past is prologue-- and I'm focusing on what happened in the wake of the Great Depression-- there is going to be a strong push to dramatically increase regulation of the Finance sector of the U.S. economy. People are already starting to howl for it.

While more regulation is necessary, we better be careful about how and when we implement it. Why? Because we don't have anything just yet that can replace the Finance sector as the growth engine for the U.S. economy. And we won't be able to figure out what the new growth engine (or, preferably, growth engines) are unless and until we sit down and rethink our economic policy.

This is the challenge that Obama, Bernanke and Geithner really face: neoclassical economic theory, or at least our implementation of it, has failed so spectacularly and so quickly that we don't have any other sector of the economy to turn to as the next engine of growth. As much as I hate the term, I have to call this event a Black Swan, albeit a Black Swan that arose from hubris more than anything else.

The U.S. Needs to Rethink Its Economic Policy Before We Get Too Far Down the Path of Increasing Regualtion to Punish An Industry That Was Just Doing What Was Expected of It from a Policy Perspective.

Am I saying that we have to scrap globalization and "free" markets? Nope. I think that those policies implemented wisely will win in the end. I just don't think that they can be implemented wisely if we continue to rely upon the flawed models of neoclassical economics as our guide.

Here is the current outline of my prescription for fixing this mess:

  1. Scrap neoclassical economic theory and start over by accepting that markets are inherently unstable (i.e., adopt an approach that is Post Keynesian in nature)
  2. Retool U.S. economic policy to be more balanced, both in terms of encouraging more domestic investment of capital for the production of goods and in terms of encouraging a distribution of domestic investment across multiple sectors of the domestic economy so that we can reduce the risk of the epic failure of one sector dragging the whole economy down as the Finance sector has. This is going to require a massive restructuring of corporate tax policy. Just closing corporate tax "loopholes" is not going to cut it; we're also going to have to reduce the marginal tax rates and get every corporation paying U.S. corporate taxes. We should do for corporate income taxation what Reagan allegedly did for personal income taxation. (I say "allegedly" because I don't accept the assertion but I haven't investigated it myself to say one way or the other whether it's true; I've seen arguments on both sides, though.)
  3. Completely overhaul corporate accounting rules and disclosure rules for public companies to help investors and regulators to understand what is really going on. I will detail my thinking in a later post. My bottom line here is that current rules have led to significantly overstating the rewards generated by public companies while substantially understating the risks they've undertaken, thus ultimately causing our Minsky Moment.
  4. Finally, we need to reconsider how we report economic indicators such as the GDP. My greatest concern here is that we were fooled by the combination of (1) the dominance of the Finance sector and (2) the part played by Mortgage Equity Withdrawal (MEW) in propping up the GDP starting in 2001. As a result, we overestimated the true health of the economy. People like Nouriel Roubini saw the explosion of private debt and rightly intuited that we were in for a big fall, but it sure would be nice if somebody were to point out in economic data such as the GDP how different sectors of the economy depend on one another and can falsely inflate the data. To illustrate this concern-- as I fear I am not explaining it well-- I will ask the following question: If we were to attribute spending arising from MEW to the Finance Sector instead of the sectors that received that money as income, what would we see? I think we'd see that our economy depends much more on the Finance sector than we realize, i.e., that it is responsible for more than 50% of the real GDP. Being so dependent on one sector of the economy simply isn't healthy.
Once we've taken these steps we'll be in a position to determine what additional regulations may be necessary. I suspect, however, that we'll find little additional regulation will be necessary.

Early Thoughts On Neoliberal Economics

When I started out to develop my new business model, I wanted to develop universal, cross-cultural themes, which led me to study up on philosophy, religion, and mythology.  Somehow, this led me to start digging into economics (it was probably Marx that led me there).  As a result, my wife claims that I've achieved the equivalent of a graduate degree in the philosophy of economics.

As you'll see from the below post, I started off thinking that neoliberal economics (what I called neoclassical economics at the time) were the result of a mistake, the compounding of intergenerational translation errors.  While I think the politics that have grown up around neoliberal policy certainly displays the tendency of "temporal telephone" described below, I've come to the conclusion that neoliberal economics were the result not of a mistake but of a carefully calculated fraud.

J.S. Kim seems to have reached similar conclusion here.  There are a lot of things that I've heard from J.S. that I don't agree with, and I actually think that the depth of his skepticism may have taken him to the point of paralysis, but he makes a lot of valid points about economics and the reality of our financial system.

Temporal Telephone and Neoclassical Economics
One thesis that I am continue to flesh out is that neoclassical economics (including the Chicago School and Friedman) as well as its close relatives (e.g., the Austrian school of economics and Ayn Rand's Objectivism) all arose in response to the threat to capitalism posed by socialism and communism in the early twentieth century. Now that the threat of socialism no longer exists, we should really take a hard look at neoclassical economics and ask ourselves whether it remains a Useful Fiction or whether it has outlived its usefulness (i.e., whether it has become a Debilitating Fiction that leads to Unknown Knowns).
Now, some will argue that socialism is still a threat, and didn't Newsweek just tell us that "We're All Socialists Now?"

To paraphrase the brave and wise Inigo Montoya, "You keep using the word 'socialism.' I do not think it means what you think it means. "

The term "socialism" is used very haphazardly these days to refer to any action whereby the government gets directly involved in helping people (as opposed to corporations). For example, some libertarians refer to public education as a form of socialism.

This incorrect understanding of socialism was not promulgated by the founders of neoclassical economics, who understood what socialism was and were very careful to define it (see, e.g. , Hayek's The Road to Serfdom, Friedman's Capitalism and Freedom, and Von Mises' Socialism). I'll update this post to provide pin-point cites and perhaps even quotes.

Rather, this incorrect understanding of socialism arises from a compounding of "translation errors" that happens whenever you unwhittingly play "temporal telephone." Everybody has heard of the game of telephone, in which one person is given a message to pass on to one other person in the room, and the process continues until everybody in the room has received "the" message. What typically happens, given a large enough number of people, is that the final message differs substantially from the original message. I coined the term "temporal telephone" in recognition of the fact that even if the words of the message are passed on accurately from person to person, if enough time passes, the context of the original message is lost and the meaning of those words often changes (e.g., the words can become iconic, as I discussed in a prior post). Thus, due to the passage of time, even a message that has been dutifully passed on precisely as it was originally dictated will have a substantially different meaning.

What were the errors that led us to this point?

First, the founders of neoclassical economics embraced the non-interventionist aspect of Adam Smith's laissez-faire economics but studiously ignored Smith's recognition that the government has a larger role than just being policeman (indeed, Smith recognized the need for welfare and public education, for example). In view of the existential threat that radical socialism and communism posed to capitalism, it is to be expected that some capitalists would respond by being radical themselves, and how could die-hard capitalists embrace a broader role for the state when that would appear to legitimize the aims of socialism. [NOTE: the first sentence is factual and can be substantiated with citations, which I will provide in an update; the second sentence is a theory based on a brief review of a number of articles and books and my own experience, which I will explain further in an update.]

Second, the founders of neoclassical economics did not understand that Smith's laissez-faire economics arose from a very different time and context than what existed at the beginning of the twentieth century. In particular, Smith assumed that the individual was the engine for progress and that the ethics of that individual in pursuing his own self interest acted as an invisible hand that promoted the greater good of society. [cites will be forthcoming] Corporations in Smith's time were somewhat rare and very different than what they had become by the late nineteenth century, and Smith actually heaped as much (if not more) scorn on corporations as he did on the state. [cites will be forthcoming] Today, corporations are the rule, not the exception, and they have replaced the individual as the engine for progress.

Third, this failure to distinguish between the individual-driven economy of Smith's time and the corporate-driven economy of the early twentieth century led to an overestimation of the efficiency of the markets. The most significant difference between corporations and individuals is the legal consequences for their actions. If an individual engages directly in an activity that goes wrong, the individual can lose everything. If an individual engages indirectly in the same activity undertaken by a corporation, he can at most lose his investment, the rest of his fortune remains safe. Because the individual's risk is reduced, the guidance of the invisible hand lessens. Because the managers of corporations are not putting their own money at risk and may have interests that conflict with the individual shareholders, it is an open question whether the inivisble hand disappears completely. [this section will most likely be removed and form part of a separate post]

Finally and somewhat predictably, the political rhetoric that has flowed from neoclassical economics has become categorical: government action is always bad. Again, however, Smith never said that; in fact, he took the opposite position. Yet, the neoclassical school's version of laissez-faire economics does not allow for any positive role for government.

Where we find ourselves today is that socialism and communism are no longer threats to capitalism, the clear winner of the "-ism" wars. Given this fact and the horrible economic situation that we find ourselves in-- which is the result of the wholesale adoption of neoclassical economics, including monetarism-- doesn't it make sense to go back and test the assumptions of neoclassical economics to see they remain viable and, more importantly, operative? If we do put neoclassical economics under a "stress test," I am pretty certain we will agree that this byproduct of the Cold War is no longer operative and that it vastly overestimates the efficiency of the markets in view of the corporation's impact on the risk-reward analysis. While I am not advocating a move away from corporate capitalism, I do believe more government regulation is required to ensure that corporations have the same invisible hand guiding them as does the individual.

How My Current Journey Began

Below I repost my very first blog post from over a year ago, which I pulled down when I repurposed and relaunched the blog to focus primarily on economic issues.

When I started out back in late 2008/early 2009, the economy was not even on my mind.  I was looking to escape the corporate world, and to accomplish this I was developing a new business model more consistent with what I want to accomplish in life.  (In one of his videos, Damon Vrabel talks about how corporate execs are trained to think of sabbatticals as the time you spend thinking about what you're going to do next to make money; that's where I was at the time, on sabbatical thinking about my next gig.)  I have not given up on this idea, but I view the approach as an adjunct to more important things to do.

Useful Fictions: On the Models That We Use to Interpret Our World
One of the primary goals of my side project (hereafter, simply “the Project”) is to use entertainment to encourage critical thinking and meaningful discourse by the audience. I say “encourage” because (1) not all human beings are predisposed and/or interested in engaging such thinking and (2) if you are too aggressive, it will stop looking like entertainment and starts looking like a sermon. Since my focus is to promote a process and not any particular outcome of that process, seeming “preachy” would entirely defeat my purpose.

As I will detail in future posts, there are multiple obstacles to achieving this particular goal, but the most imposing is what I have come to call “Useful Fictions,” which are the models of the world that we have developed and/or adopted to help us make sense of the world. All of us rely on such models, although the vast majority of us are not conscious of that fact. Many have recently commented on this phenomenon (although not using the “Useful Fiction” label), including Nassim Nicholas Taleb in The Black Swan (2007), Michael Philips in The Undercover Philosopher (2008), Jonah Lehrer in How We Decide (2009) and George Cooper in The Origins of Financial Crises (2008). Most of the commentary is phrased in psychological terms as most of the research into the phenomenon has been conducted by psychologists and cognitive scientists. I prefer my construct because it is free of any judgment of the rationality of human beings. Besides, I came up with it before discovering the work in the area, and it is more consistent with the goals of the Project.

What makes Useful Fictions such a thorny problem is that our widespread and unrecognized reliance on them prevents critical thinking from the get-go. Most of us are far more interested in confirming what we think we already know—our models of life, if you will—than we are interested in questioning it. And with the explosion in the availability of information (both processed and unprocessed), much of it seemingly contradictory, Useful Fictions become even more important for many of us to help us make it through the day. Indeed, I blame the amazing advances in information technology as the primary driver behind the rise of religious fundamentalism around the world and the “conservative” movement in the U.S., two examples of people running towards unswerving certainty in the face of uncertain times.

Like any model, every Useful Fiction is subject to boundary conditions beyond which the assumptions of the model break down. Unfortunately, because we are (1) largely unaware that we rely on Useful Fictions and (2) we intuitively seek to confirm our Useful Fictions, we are completely oblivious to when our Useful Fictions become non-functional, which at best makes our Useful Fictions useless and at worst makes them harmful. Taleb’s “Black Swans” often arise because commonly-held Useful Fictions break down.

So, if your goal is to encourage critical thinking, how do you successfully get past Useful Fictions when they exist precisely to avoid the need to engage in critical thinking? Frankly, I don’t have a complete answer just yet. I do believe that fiction has to be the avenue for accomplishing this goal because people process fiction differently than facts, they’re more likely to take it at face value than spin it to match their expectations.

It is ironic that human beings tend to be more accepting of fiction than we are of facts, but that’s the case. For proof, you need look no further than the impact of The Da Vinci Code on Christianity generally and Catholicism specifically. That work of fiction (which I thought was pretty horribly written), had more impact on some people's faith than the rise of Dawkins et al.'s neo-atheist movement ever will. Why? Because fiction invites the willing suspension of disbelief but does not challenge the beliefs you already hold, so no defenses are raised in response. Ayn Rand's Atlas Shrugged is an example of how fiction can be purposefully used to advance an ideology. I think that both Dan Brown and Ayn Rand were dishonest in their approach-- Brown because he presented fiction as if it were fact; Rand because she disguised her philosophy as fiction. I don't want people to change their minds but rather open them.

Tuesday, October 19, 2010

Further Blog Roll Updates

All of the people that I admire these days are people who are able to challenge their cognitive biases in order to understand the true nature of their reality.  To emphasize this preference, I've trimmed my blog roll down to focus on the voices of these pioneers of independent thought, the people who challenge conventional wisdom.

Eliminated from the roll are Paul Krugman, Mark Thoma, Calculated Risk (nice guy), and Mish (another nice guy, although you couldn't tell from a lot of what he posts).  I've also added Damon Vrabel's blog.

Please feel free to provide suggestions regarding blogs from other independent thinkers. 

Adding to the Blog Roll

I've now added Charles Hugh Smith's "Of Two Minds" and Mike Konczal's "Rortybomb" to the roll.

I've previously mentioned "Of Two Minds," which truly is worth checking out on a daily basis.

"Rortybomb" is now my goto source for the fraudclosure mess because of how he breaks things down really well.


Monday, October 18, 2010

Okay, Just the Once (Today)

If you haven't already done so, check out what Charles Hugh Smith has posted over the last week or so.  It's really brilliant stuff.  He posts one essay a day, and the title of today's post is "The Loss of Trust and the Great Unravelling to Come."  I agree with his assessment that:
Anyone who believes the foreclosure crisis can be contained is deluded, because the real issue in play is the citizens' trust in their government's ability to govern the nation's Financial Elites according to the rule of law. Clearly, our government has failed its citizens--utterly, completely, totally, at every level of governance (Federal, State, local) and at every level of oversight and regulation.
 Friday's post, "The Normalization of Sociopathology in America" was also particularly good and is consistent with some of the things Russ has been writing about over at Volatility about how true believer fans of Obama are exhibiting the same exact behavior they mocked when true believer fans of Bush exhibited it.  The following sentence from Smith sums it all up nicely:
The depth of our own pathology can be measured by our resistance to admitting the systemic fraud, lying, entitlement and narcissistic pathologies in whatever slice of American society we value

Sunday, October 17, 2010

Slow Posting for Another Few Days

I won't be posting here or commenting on other blogs for the next few days because I need to commit all of my creative energies to writing an article that I've been drafting, off and on, for almost eighteen months.  I'd probably put the article off for another six months, but there's a chance to win $10,000 and get an invite to speak on a panel at Stanford Unversity, which would be a good way to kick off my next thing (which is still taking shape).

Tuesday, October 12, 2010

Hoisted From My Own Comment at Naked Capitalism

I had decided that there are enough top-notch bloggers (e.g., Yves, Karl, Barry and Rortybomb) out there covering the fraudclosure mess that there was no reason for me to post more about it here, but the latest info coming out of Wall Street is very interesting.  Since I shared it over at Naked Capitalism, there's no reason not to do so here:
From Karl Denninger, a link to a Citi analyst report regarding their meeting with a law professor about the possible outcomes of foreclosuregate.

From the paper Karl links to:
“Levitin articulated three possible outcomes to the aforementioned issues and assigned an equal likelihood to each. In his best case scenario, these issues are deemed merely technical in nature and are successfully resolved but it takes at least year to do so and all foreclosures are delayed by at least a year. Levitin disputed the claim by banks that these issues can be resolved in a month or so and attributed the banks’ claims to “legal posturing.” In the medium case scenario, litigation ensues and it takes years to sort out these matters. In the worst case scenario, the aforementioned issues become a “systemic problem” which causes the mortgage market to grind to a halt as title insurers refuse to insure mortgages involving existing homes.”
Even the best case scenario all but assures Chris Whalen’s prediction from last week of of a new banking crisis within 3-6 months.

I was betting on the under, but I now think it will come before Nov. 2nd to ensure that the expected QE2 is as big as possible . . .

And now I guess we know that QE2 is really intended as just another bank bailout, but this time we’re not even pretending that the government has a say in it.
Addendum:  I speak to my investment advisors almost every day, and when I told them of the depth and legs of the foreclosure mess today, it was news to them.  Since they were at Lehman when it collapsed, they were very, very concerned.  I'll get their take on the Citi report tomorrow.

Sunday, October 10, 2010

Obama Administration Falsely Frames Foreclosure Fraud As a "Paperwork" Problem

We knew this was coming:
The Obama administration opposes a moratorium on home foreclosures, but wants problems involving improper paperwork resolved as quickly as possible, senior adviser David Axelrod said Sunday.
"I'm not sure about a national moratorium," Axelrod said on the CBS program "Face the Nation." He said valid foreclosures with proper paperwork should go forward, and that questionable foreclosures need to be addressed right away.

"Our hope is that this moves rapidly and that this gets unwound very, very quickly," Axelrod said.
The Wall Street Journal simultaneously channels the same meme:
Talk about a financial scandal. A consumer borrows money to buy a house, doesn't make the mortgage payments, and then loses the house in foreclosure—only to learn that the wrong guy at the bank signed the foreclosure paperwork. Can you imagine? The affidavit was supposed to be signed by the nameless, faceless employee in the back office who reviewed the file, not the other nameless, faceless employee who sits in the front.

The result is the same, but politicians understand the pain that results when the anonymous paper pusher who kicks you out of your home is not the anonymous paper pusher who is supposed to kick you out of your home. Welcome to Washington's financial crisis of the week.

In the 23 states that require judicial foreclosures, lenders seeking to seize property from a delinquent borrower must file a summary judgment motion in court. Typically, this document must be signed in the presence of a notary by a "witness" who has reviewed the relevant documents and confirmed that the borrower is in default and the lender owns the mortgage.
Recently GMAC Mortgage, whose parent Ally Financial is majority-owned by the U.S. government, suspended foreclosures in those 23 states after acknowledging that in some cases notaries may not have been present and the signers may have relied upon others to review the documents instead of doing it themselves. Bank of America and J.P. Morgan Chase then halted their own foreclosures in those 23 states to ensure they are following the letter of the law, and yesterday BofA announced its moratorium is now nationwide.
Notice how this piece focuses on notarization of affidavits in support of summary judgment motions instead of forged documents being used to fraudulently establish a chain of title? 

Steve Pearlstein at the Washington Post puts his own spin on the "paperwork" meme:
Listening to the fiery rhetoric about the mortgage mess emanating from politicians this week, you'd think that big bad banks were trying to foreclose on hundreds of thousands of homeowners who were current on their payments but had become victims of sloppy business practices. If that were the case, declaring a national moratorium on foreclosures would be the just and reasonable thing to do.

But if, as appears to be the case, the overwhelming majority of homeowners facing foreclosure have fallen far behind on their payments, then it is a good deal harder to summon up the same moral outrage over reports that the banks and loan service companies cut corners, failed to keep the right documents and engaged in shoddy and even fraudulent practices. Just because the banks and servicers have screwed up doesn't mean they and their investors are no longer entitled to get their money back.

Certainly banks and servicers should, at their own expense, be sent back to do things right. Those who engaged in fraud should be punished. And if there are legitimate questions about who owns a loan, those will need to be resolved before the proceeds of any foreclosure are distributed.

But none of that changes the basic reality that there are millions of Americans who took out mortgages they could not support on houses they could not afford. It may be necessary to postpone their day of reckoning for a few months to get the paperwork in order and ensure that all the proper procedures are followed, but the reckoning is inevitable.

. . .

The breakdown in the foreclosure system has also exposed serious weaknesses in the way mortgages are written, packaged and serviced that should force the industry to adopt instruments and structures that are simpler and easier to change when things go wrong. Based on the recent revelations, the consumer protection agency should require that mortgage servicers meet minimal standards of customer service and offer clear procedures for loan modification and third-party adjudication before the foreclosure process can be initiated. If this adds to the price of a loan, so be it.

That said, those who are cheerleading for a moratorium should realize they can only push things so far. It would not help the recovery of the economy, or the real estate market, if the foreclosure process became so hopelessly tangled that banks and investors effectively lose the ability to recoup the remaining value of their collateral. That would provide some immediate financial relief to households facing foreclosure, but it would encourage many more homeowners to begin shirking their mortgage payments in the belief that they would also be able to avoid the consequences. The long term consequences of that would be that mortgage rates would be higher and mortgage loans would be smaller and harder to get.

Perhaps it is only natural for Americans to take some guilty pleasure in watching as the big banks and Wall Street wizards who created this flawed and complex mortgage machine are hoisted on their own petards. But be careful what you wish for. The financial system is still fragile enough that we may not be able to afford a full helping of revenge.
It's just a "flawed and complex mortgage machine."  Nothing to see here.  Move along.

Expect to see this meme being pushed as a major talking point from all of the major media outlets and professional pundits of all stripes over the next week or so.  When everybody bursts into singing the same tune at the same time, you should be suspicious.

Saturday, October 9, 2010

Karl Denninger Asks and Answers the Most Important Question: "Why?"

Karl has a new post up this afternoon with some observations about foreclosuregate.  While his claim that nobody but he has been asking the "why" question is incorrect (Yves Smith has been asking the same question for at least a week), I think he is the first one to provide a comprehensive answer.  You can find the post here

While it is well worth it to read the whole thing, here is the punchline:

So what we have here are two answers to "Why?"
  1. The deals were un-economic unless someone cheated.  That is, there's only so much risk-adjusted "spread" in a particular lending transaction.  The common law of business balance says that nobody ever works for free, and as a consequence the more hands that touch a deal the more that profit is dissipated among those hands.  In a competitive market where multiple entities compete for business this means that the true yield available to at least some of the investors would always have to understate the risk of default, and therefore someone was always going to get screwed.  On balance there's nothing unlawful about that, so long as you properly and fairly disclose everything about the deal - there's nothing that stops you from buying a thing that is disadvantageous to you.  We take this risk every day when we, for example, buy a pack of cigarettes.  The "pleasure" (such as it were) from smoking may come with a horrific cost (lung cancer); it was only when the Tobacco Companies tried to conceal this risk that they were held responsible.
  2. As the pyramid grew higher, the number of good borrowers was exhausted.  To keep the charade going it was necessary to fund loans to "patsies" - the infamous "fog-a-mirror" lending.  That would have been ok too, except that the lenders actively concealed the fact that the loans they were stuffing into the securities did not meet the standards under which they sold those resulting MBS to investors
So between #1 and #2, we have two things that would not be illegal if they were properly and fully disclosed, but if they were fairly and fully disclosed there would have been no money in securitizing these loans, as nobody would have bought them.
To sell them, they had to cheat.  And when the "caught" part of the cheating became apparent as housing prices started to collapse, they attempted to cheat again to cover up the earlier cheating, which is what you're seeing now.
The next question is why cheat?  As I said in a previous post, public companies like the TBTF banks all must show perpetual growth or see their share price plummet.  There are only so many ways to keep the illusion of perpetual growth alive, and the last resort is always cheating, which can be as trivial as timing sales and as brazenly criminal and systemic as the predatory lending, the fraudulent conveyance of mortgage-backed securities that were not, in fact, backed by mortgages, and the subsequent foreclosure fraud to cover up their prior misdeeds. 

Friday, October 8, 2010

"Complexity" and What It Means to What We Think We Know

This post is a placeholder/teaser for a more complete post that I plan to write up later.

We're taught to think of monetary policy, fiscal policy, industrial policy and tax policy as four completely different things.  In fact, they are each part of a complex political topography that manipulates the human nature of individuals to produce a collective result in the broader political economy.

The focus of this "checkpoint" post is tax policy, which many claim redistributes wealth.  This is incorrect.  Tax policy, against the broader background established by monetary, fiscal and industrial policies, does not so much affect one's wealth as how one's wealth is distributed among wages, entrepeneurship and rent-seeking. 

The current policy of relatively low tax rates for the highest wage earners and favorable capital gains treatment for financial speculation exaltts non-productive rent-seeking over true investment in the productive economy.  If the goal is to encourage investment in the real economy (domestic entrepeneurship), one way to do that is to discourage rent-seeking by providing relative incentives for investing in domestic businesses that create jobs in the United States, which would funnel unneeded earned income into productive businesses as opposed to non-productive financial speculation.  Both productive businesses and non-productive financial speculation throw off wealth, if managed properly (and losses, if not), so no wealth or opportunity is lost by choosing to invest in productive businesses over non-productive speculation.  Indeed, as we're learning with the continuing collapse of our debt-financed speculative economy, speculation is actually destructive in the long term.

The point is that we need to think of these various policies together and not in isolation.  I'd go further to say that we need to reconstruct these policies in parallel to provide the appropriate incentives for creating a self-sustaining political economy that is not subject to the boom-bust cycles caused by debt-financed speculation.

Could "Foreclosuregate" Spell the End of the Debtrix?

Karl Denninger calls the current foreclosure fraud mess "Foreclosuregate." 

Personally, I think labeling the foreclosure fraud mess with the obligatory "-gate" suffix makes Watergate appear to be a far bigger deal than it was.  Watergate just involved some petty crimes by lackeys of the POTUS to secure fodder for political dirty tricks.  By contrast, the foreclosure scandal is systemic and appears to include, at some level, the complicity of pretty much everybody in the elite power appartus (POTUS, Congress, courts, banks, lawyers, other corporations), all to the detriment of average American citizens. 

The foreclosure fraud scandal is several orders of magnitude worse than Watergate and could well result in an existential political crisis on the order of the Revolutionary and Civil Wars.  Because the foreclosure scandal does not lend itself to the typical "A versus B" frame of conventional politics, it cannot devolve into the factionalism or regionalism that marked prior existential crises.  Indeed, because the foreclosure fraud scandal strikes at the heart of our conception of America as being a country premised on the "rule of law" and the sanctity of property, even many economic elites will feel compelled to join the cause of reigning in the predatory FIRE sector, just as they did in response to the Great Depression. 

I view Obama's veto of HR 3808 as confirmation that the White House understands just how volatile this situation could become.  Why?  Because HR 3808 is really no big deal.  Contrary to a lot of the breathless headlines out there, HR 3808 would have had no real effect on foreclosure fraud because nothing in the bill requires judges to accept fraudulent documents as either evidence or true.  The authentication of documents, which is all that notarization provides, is but the first step in getting a document in front of the finder of fact (in judicial foreclosures, this is the judge), and the mere fact that a document is authenticated as genuine does not mean that its contents are true.  It is up to the finder of fact to weigh all of the evidence presented and determine what the truth is.  Obama knows this.  His choice to veto the bill in view of the completely unfounded concerns of lay people** was a purely political one meant to mollify the masses and get them back to being angry at each other instead of the banks.  The bill will ultimately become law.

I don't think the political whirlwind caused by the foreclosure fraud scandal can be so easily contained.  The number of states imposing moratoria on foreclosures is growing, as is the number of major banks being subject to them.  This makes Chris Whalen's prediction of a new banking crisis within the next 3-6 months that much more likely, and I'm betting on the under.

The timing could not be worse for the major political parties, who are only a month away from the mid-term elections.  Expect a major shift in campaign rhetoric as candidates realize that the foreclosure fraud scandal transcends politics-as-usual.  Another bank bailout is politically impossible after the banks paid themselves billions of dollars in taxpayer money for being so "successful" after the last bank bailout just 18 months ago. 

We'll see how this all plays out.  We're definitely living in interesting times.

** I practiced law for fifteen years, most of them as a litigator and trial lawyer.  While I no longer practice law, I remain interested in the discipline.

UPDATE 1:  Via Mish, 40 state attorney generals are now investigating mortgage/foreclosure fraud. 

FYI -- In the linked post, Mish links to a previous post in which he blames the SEC's lack of regulation for the fraud we're seeing.  While there's no doubt that things might not have turned out so poorly if the SEC had been doing its job, the reason why the NEC was not doing its job is because neoliberal ideologues like Mish were in charge of the SEC and Federal Reserve.  The only people who can properly be blamed for the fraud are the banksters who engaged in it.  If you want to blame captured regulators as accomplices of the banksters, fine, but to blame only the regulators is to absolve the real criminals, i.e., the banksters.  Austrian neoliberals like Mish cannot have it both ways.

UPDATE 2: Here's an interview with the Ohio Secretary of State regarding foreclosuregate and HR3808 (h/t Karl Denninger).  My take on what she had to say is that HR 3808 would have made it cheaper and easier for the banks to engage in forging missing mortgage documents by setting up shop in states with loose notary laws.  This concern does not translate directly into the assertion that the law would have made it easier for the banks to obtain judicial foreclosure, although arguably being able to pump out forged documents more quickly could sharply increase the number of foreclosure cases in the system and encourage other states to create a Florida-like "rocket docket" for handling foreclosures. 

The Postcatastrophe Economy: A Summary

I recently finished reading Eric Janszen's The Postcatastrophy Economy: Rebuilding America and Avoiding the Next Bubble.

While I continue to believe that Janszen's book is the best I've read regarding the ongoing economic crisis, I find myself strangely disappointed.  The reason?  The book starts out amazingly strong, but it fails to carry the same levels of energy and clarity into the second half.  In fact, I'd argue that towards the end, Janszen undermines some the clarity of the first half of the book.  Nevertheless, as a whole, the book represents quite an achievement for an entrepeneur turned investment advisor. 

The book is divided into three sections.  First, he describes the FIRE (finance, insurance, real estate) economy that caused the current crisis.  Second, he describes his solution and alternative to the FIRE economy, which he calls the TECI (transportation, energy, communication, infrastructure).  Finally, he provides his "midterm macro forecast."

The first section, which spans a little over half the book, details the FIRE economy, how it operates, and how it led to the crisis that began in 2007 and continues today.  Janszen is clearly familiar with the economics of Michael Hudson, which form the foundation of Janszen's analysis of the FIRE economy, but Janszen extends Hudson's economic theories and synthesizes them into something that is far more accessible to the lay person than Hudson's original works.  He also introduces the interesting metric of "dollar-of-debt" per "dollar-of-GDP."

Things start to break down in the second section, which presents Janszen's vision of a solution to the FIRE economy, which I find compelling but not fully baked.  Janszen is clearly speaking from a position of legitimacy as a technology entrepeneur, and it is clear that his experience shades his judgment of what needs to be done.  This is when some of his blindspots become apparent.  First, his vision is one that caters to people like him, which is a common failing whenever somebody tries to plot a course for the future.  The good news is that his vision is complete enough that it can easily be extended to be more inclusive.  Second, while he understands the economics of the FIRE sector, it is not clear that he grasps how many of our laws, regulations and "rules of thumb" would have to fundamentally change in order to fully break free of the FIRE economy and the embrace the TECI economy.  This is not fatal to implementing his vision, it just means that this is a much larger undertaking than he realizes.  That's why I call his solution merely a vision of a solution.

Things almost fall apart in the final section, primarily because he puts on his investment advisor hat.  I'm not saying that his predictions about things like "peak cheap oil" or gold will prove wrong.  What I'm saying is that, in spite of his understanding of the FIRE sector, he does not seem to truly he understand that he is actually a "speculation advisor" not an investment advisor, and in that role he actually perpetuates the financialization of the real economy by the FIRE sector.  When he cannot see his role in perpetuating the FIRE economy, how can he be correct that the FIRE economy is already over?  Answer: he can't be.

At the end of the day, I do not believe these relatively minor flaws detract from the genius of the book, which is found in the first two sections.  Janszen probably felt it necessary to tack on the third section to treat the preparation of the book as a business expense (advertising), and some people will find the third section alone justifies buying the book.

Tuesday, October 5, 2010

Shorter Milton Friedman: "Never Mind the Man Behind the Curtain"

Milton Friedman often said: "inflation is always and everywhere a monetary phenomenon."

Except when it isn't, which is never.

Speculation in commodities can and does cause inflation without an increase in money supply (i.e., a monetary phenomenon).  It did so in the 1870s, the 1900s, the 1920s, the 1970s, and it does so now.

If you compare the change in commodity prices year to date versus the change in the dollar's value compared to the Euro, you'll find something remarkable.  Using copper as an example, both the value of copper (in dollar terms) and the value of the dollar (in Euro terms) are up since the beginning of the year, but the value of copper is up by A LOT more.  According to Uncle Miltie, this isn't supposed to happen.  Commodity prices and the value of money are supposed to move inversely to one another, not together, and not in a manner that commodity prices move in the same direction as the value of a dollar but as a multiple of it.

I've seen some data from Karl Denninger that suggests the same thing is true in agricultural commodities, and if it isn't it soon will be.  The FIRE sector is a parasite on the productive sector, and their rent-seeking in consumer staples is going to cause a lot of pain and probably a few deaths.

'Nuff said.

Neoclassical Economics Are to Henry George What Neoliberal Economics are to John Maynard Keynes

I recently learnd about Henry George, a 19th century thinker who figured out in the 1870s that the boom-bust cycle is caused by debt-financed speculation and rent seeking.  At the time, he limited his conclusion to debt-financed land speculation, but that's because the secondary equity and bond markets weren't nearly as established in the 1870s as they were in 1907 and later in 1929.  (Note: there are a number of 19th century investing texts available at Google Books, and they show that the stock exchanges even in the 1890s were nowhere near what they became by the 1920s.  Take a look around there, you'll find it fascinating.)

As Keynes would later do, George proposed his own solution for euthanizing the rentier, which he called the "Single Tax."  (My understanding of George's proposal are admittedly cursory, so I'm not going to try to explain them in any kind of detail.)

The response by the rentiers was to fund political economists to develop a new doctrine of political economy, and neoclassical economics was born (at least, this is what Mr. George believed motivated the establishment of this new doctrine).

The key feature of neoclassical economics was that it treated land as capital.  According to the classical economics of Smith, Ricardo, Say et al., there were three players in (or drivers of) the economy: labor, land and capital.  Essentially, George's Single Tax sought to tax land rents out of existence to leave only labor and capital standing.  The neoclassical economists obliged George by "disappearing" land from their lexicon and treating it merely as another form of capital.

Neoclassical economics came to dominate the scene, and George's Single Tax proposal ultimately went nowhere.

Then we had the Great Depression, and John Maynard Keynes offered his own solution to the rentier problem (although he was politic enough to not explicitly assign blame for the Great Depression to the financial speculators). 

The first step in undermining Keynes was the so-called "neoclassical synthesis," that grafted some of Keynes' ideas onto neoclassical doctrine.

The second step in undermining Keynes was to repeat what had been done to Henry George: the rentiers funded the founding of the neoliberal movement and its economics in the Chicago and Austrian schools. 

Today's "neoclassical" orthodoxy is, in fact, the Chicago School, which is distinctly neoliberal.  Thus, as much as Steve Keen still labels the orthodoxy neoclassical, it is more appropriate to label it neoliberal.

Where neoclassical economics whittled the economic drivers from three (labor, land and capital) to two (labor and capital), neoliberal economics left us with only capital.  There is no labor any longer.  There are only consumers.  And the rentier segment of capital is the only part of it that continues to grow.

I'll Take Stagflation for $100, er $150, er $200, er . . .

With the Federal Reserve maintaining its zero interest rate policy (ZIRP) and promising more quantitative easing (QE), I'm beginning to fear that we will see stagflation in the United States over the next several years.  Here's why.

The Fed has proven that the combination of ZIRP and QE can't spur borrowing by an already overleveraged consumer.  The housing market is dead, and the foreclosure mess is likely keep it dead for awhile longer.  And it's not like there are any jobs out there, and there's a downward pressure on wages, so we won't be seeing price inflation due to wage inflation.

This puts the Fed into quite a pinch.  It can't rely on the consumer increasing demand for either goods or debt, so there's no inflation to be found there.  Non-financial businesses aren't borrowing, either, certainly not at their traditional levels (yes, there was an increase in borrowing by the non-financial business sector in the last two quarters, but the increase was paltry and nowhere near normal).  So, no inflation there, either.  And financial businesses have been leading the way in deleveraging.

The banks are in their own pickle.  They need to rollover debt by getting new borrowing ASAP.  In spite of the continuous backdoor bailouts (e.g., getting paid 3% to hole onto reserves) and "record" profits, some of them have already frozen hiring and are signalling that there may be layoffs.

If only there were a way for the banks to help themselves and the Fed.  But wait, there is! Debt-financed speculation in the commodity markets would be a perfect solution!  The banks get to extend new debt to financial speculators, who use the leverage to drive up the prices of consumer staples like sugar, wheat and corn, and industrial metals like copper, gold and aluminum.  Voila!  You have rolled over debt, created inflation for consumers and industry, and you get to make a tidy profit, all in one fell swoop.

Increased speculation in commodities has already driven their prices up by a multiple of 1.5-2x compared to the drop in the value of the dollar, while stock prices have pretty much gone up by as much as the dollar has gone down.

The only question is whether this is a temporary aberration or the new normal.  Given the greed of the FIRE sector, I'm betting that this is the new normal, that the financial speculators are going to ravage our economy just as they did in the 1970s.  Things will play out differently, however, in part because we no longer have a vibrant manufacturing sector, and in part because various laws and regulations shape the decisionmaking in a different way than it was done in the 70s.  I need to put some more thought into how things play out.

Monday, October 4, 2010

Michael Hudson and Steve Keen, Together!

I was over at Steve Keen's place.  His latest post includes links to audio and video of a conference that he spoke at recently. 

A couple of the links are to the audio/video for a panel discussion where Hudson and Keen two of the panel members. Here is the audio for the discussion, which I find fascinating.  Check out the whole post, though.

That Other Friedman: Tommy Boy Recognizes the Problem, Fails to Blame Himself

To me, Thomas Friedman defines the term "useful idiot."  A tireless cheerleader for neolib/neocon policies, you can always count on Tommy Boy to butcher the English language to almost make a point.

Over the weekend,  Tommy Boy had an opinion piece calling for a third political party to "rip open [our] two-party duopoly."  While I have no real issue with the concept of the third party, I think the problems we face do not spring from the two-party system but from the common neolib/neocon ideology that underlies both parties' policies, a primary feature of which is Tommy Boy's own Chicago School neoliberal economics.

Here's how TOF ("That Other Friedman") sets up his argument:
There is a revolution brewing in the country, and it is not just on the right wing but in the radical center. I know of at least two serious groups, one on the East Coast and one on the West Coast, developing “third parties” to challenge our stagnating two-party duopoly that has been presiding over our nation’s steady incremental decline.
Sorry, there is no "revolution" brewing, and there's no "radical center."  The "center" is defined by the neoliberal Washington Consensus and its financialized economy.  Maybe some of Tommy Boy's neoliberal elite buddies are tired of the polarizing rhetoric of the two parties, but it is doubtful that anybody he knows would actually govern differently.
“We basically have two bankrupt parties bankrupting the country,” said the Stanford University political scientist Larry Diamond. Indeed, our two-party system is ossified; it lacks integrity and creativity and any sense of courage or high-aspiration in confronting our problems. We simply will not be able to do the things we need to do as a country to move forward “with all the vested interests that have accrued around these two parties,” added Diamond. “They cannot think about the overall public good and the longer term anymore because both parties are trapped in short-term, zero-sum calculations,” where each one’s gains are seen as the other’s losses.
No, we don't have "two bankrupt parties bankrupting the country," we have a morally bankrupt ideology-- neoliberalism-- bankrupting the country, and the fundamentals of that ideology are shared by both parties as well as by Tommy Boy.  The reason why neoliberals "cannot think about the overall public good and the longer term" is because neoliberalism deleted the very concept of  "the overall public good" (i.e., "there is no society"), and the financialized neoliberal economy forces politicians to focus on the short term.  That's how neoliberalism works: citizens are reduced to narcissistic consumers and political and business leaders have to focus on their respective "business cycles" to ensure they stay on top.
We have to rip open this two-party duopoly and have it challenged by a serious third party that will talk about education reform, without worrying about offending unions; financial reform, without worrying about losing donations from Wall Street; corporate tax reductions to stimulate jobs, without worrying about offending the far left; energy and climate reform, without worrying about offending the far right and coal-state Democrats; and proper health care reform, without worrying about offending insurers and drug companies.
Spoken like a true neoliberal technocrat. 
“If competition is good for our economy,” asks Diamond, “why isn’t it good for our politics?”
If competition were good for the economy, we'd have it.  We don't.  The reality is that competition is BAD for a financialized economy because real competition disrupts the illusion of perpetual growth that makes the FIRE sector a lot of money.  J.P. Morgan realized in the late 19th century that competition is bad for business, if you're an investment banker.   Monopoly is a feature of neoliberal policy.
We need a third party on the stage of the next presidential debate to look Americans in the eye and say: “These two parties are lying to you. They can’t tell you the truth because they are each trapped in decades of special interests. I am not going to tell you what you want to hear. I am going to tell you what you need to hear if we want to be the world’s leaders, not the new Romans.”
That's a good idea in theory, but in practice all we're likely to see from a third party is somebody like Tommy Boy pimping the same neoliberal policies that got us into this mess.  The problem is not the polticial system but the rules that define how that system operates, and those rules are embodied in the neoliberal Washington Consensus.  All the political theater is just a show meant to distract the masses from what's really happening, and Tommy Boy is playing his own role by keeping people focused on the spectacle of politics instead of the reality that neoliberal policies like "free" trade and globalization (both championed by TOF) are the real cause of the economic disaster that we're living through.

Sunday, October 3, 2010

The Postcatastrophe Economy

I'm now halfway through Eric Janszen's excellent The Postcatastrophe Economy: Rebuilding America and Avoiding the Next Bubble.

The first half of the book is devoted to providing his analysis of where the economy is right now and how it got there.  His views are quite consistent with my own, but it is clear that he has been thinking about the issues longer and has a more complete view of the field.

I'll provide a full review of the book when I'm finished.  I can say just from reading the first half that the book is a must read.

Calls For Ending ZIRP Now Coming From the Financial Sector

Charles Schwab has a WSJ op-ed calling for the end of the Fed's zero interest rate policy.

While Schwab's piece is behind a pay wall, Henry Blodget of Business Insider weighs in to second the motion:

It's Time For The Fed To Stop Screwing Savers And Bailing Out Banks And Borrowers With 0% Rates
The Fed's zero-interest-rate policy, now going into its fourth year, is hosing people who are responsible and live within their means to bail out people and companies who don't (or didn't).  Anyone who has saved money is being screwed by this policy. Anyone who borrows money is being rewarded.
The Fed's zero-interest-rate policy is also still giving a gigantic subsidy to banks by allowing them to borrow money from the government for nothing and then lend it back to the government at a ~3% interest rate.  The spread on this trade continues to produce massive Wall Street profits, and, with them, enormous bonuses--without any of the risk that is normally supposed to accompany such profitability. Once again, this policy rewards those who helped cause the crisis in the first place, at the expense of those who didn't. (If you don't understand how great it is to be a banker right now, read "How To Make The World's Easiest $1 Billion").
Go read the whole thing