Tuesday, November 30, 2010

Financialism and the Disappearing of Labor From Economics

Previously, I noted that classical economics (exemplified by Adam Smith and David Ricardo, for example) analyzed economics in terms of capital, labor and rent.  In response to the criticisms of Henry George and his proposed Single Tax, which would have eliminated rent, the rentiers funded the founding of neoclassical economics which analyzed economics solely in terms of capital and labor.  In response to socialism and Keynesian theory, which would have elimintated rents, if eliminated, the rentiers funded the founding of the neoliberal movement, which included both social instutitions and a new form of economics, which most people still call neoclassical economics but which I believe is more properly called neoliberal economics because of its origins and aims.  In my original post about Henry George, I intuitied that neoliberal economics had disappeared labor, just as neoclassical economics had disappeared rents.

My conclusion that neoliberal financial theory is normative and renders traditional economic theory inoperative confirms this: the only thing that matters in the economic decision-making of firms and governments is capital and yield.  Under financialism, labor is merely a cost that factors into the calculation of yield.  Nothing more, nothing less. 

I suppose that I shouldn't be surprised that financialism was the real end game.  Neoclassical economic theory has its roots in classical liberalism: both microeconomics and macroeconomics were consructed and sold as scientifically proving that laissez-faire economics and free trade benefited society as a whole.  But as I said before, the primary goal of neoliberalism was to excise the "communistic fiction" from Smith's Invisible Hand, to establish that firms had no social responsibility.  Unfortunately, neoliberal macroeconomic theory-- whether from the Chicago or Austrian schools-- cannot satisfy that ultimate goal, as both must be sold as achieving the greatest benefits to society, and they are.  A higher level of abstraction-- finance -- was required to achieve the goal. 

As Michael Hudson has said, what we're seeing is nothing less than the Counter-Enlightenment, which I believe will result in international neo-feudalism.  Hudson has a new piece out here.

Financialism's Flattening of the Economic Hierarchy and What It Means to Macro

As discussed here, my thesis is that the well-understood and widely accepted hiearchy of economic theory (i.e., finance is built on macro which is built on micro) is, in fact an illusion, that finance is normative and drives economic decision-making of firms at the microeconomic level, which is contrary to microeconomics' theory of the firm.  Because the validity of mathematical models of finance depend on the vailidity of mathematical models of macroeconomics which, in turn, depend on the validity of mathematical models of microeconomics, the entire hierarchy of economic theory fails, and the only thing that truly matters is finance.

What I did not discuss in yesterday's post, although I did allude to it here, is that finance is normative at the macroeconomic level, as well.  This is the clear implication of Bill Clinton's famous quote:

You mean to tell me that the success of my program and my re-election hinges on the Federal Reserve and a bunch of fucking bond traders?
Just as corporate executives are rewarded for the ability to maintain the illusion of perpetual exponential growth in their share price at a rate that exceeds inflation, so, too, are the officials of national governments rewarded for their ability to maintain the value of sovereign bonds.
The fact is that money and inflation do not exist in microeconomics, which models a barter system.  The concepts of money and inflation are instead part of macroeconomic theory, which is the level at which monetary policy and fiscal policy operate.  In the U.S., the private Federal Reserve manages monetary policy, while fiscal policy is managed by the federal government. 

While the metrics for measuring governmental success in the secondary bond markets are nominally different, the challenges of a financialized government are the same as those faced by financialized firms.  When, as now, top line growth (measured by GDP for governments, revenues for corporations) appears to be slowing or falling, the only way to show continued, perpetual exponential growth at the bottom line (measured by bond yields for governments, earning for corporations) is to increase margins.  That's the only way to maintain the present value of financial instruments (stocks and bonds) that have already been purchased.  Through this lens, the calls for austerity in the United States are best viewed as calls to increase margins to ensure that Treasury bond holders don't take a haircut. 

But what about the Fed's dual mandate to maintain price stability and ensure maximum employment?  First, the so-called dual mandate needs to be read in its entirety to understand what it really says:
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
Second, it must be understood that the Fed abandoned targeting monetary and credit aggregates in the 1980s, after Paul Volker proved that targeting monetary and credit aggregates did not actually have any effect on employment or inflation.  Milton Friedman and other Chicago School monetarists were proven wrong, and the Fed went back to tweaking the federal funds rate.

At this point, the Fed merely works with federal officials to protect existing Treasury bond holders and keep future Treasury bond yields as low as possible.  If that means a bunch of American fall into poverty, so be it. 

But what about consumers?  Aren't they an important part of economic theory, as well?  Yes, they are, but economic theory is non-operative in a financialist economy.  All that matters to the managers of corporations and governments is maintaining the illusion of perpetual exponential growth.  That's why Obamacare screwed consumers by evergreening biologic patents (Pharma can't lose current profits and maintain the illusion of perpetual exponential growth), and that's why the "Food Tyranny" bill is rumbling its way through Congress right now, a gift to Monsanto and factory farms.

Monday, November 29, 2010

Scale, Innovation and the Role of Intellectual Property (Properly Understood)

I've spent far more time on the blog today than I'd planned, but I might as well embrace that fact and use the blog to develop my theory of the historically imporant role of IP in creating competition, in being the catalyst in all modern cases that led to Schumpeter's "Creative Destruction." 

The paper that I'm working on (I did not win the competition, but I'm still working on it) attempts to counter the pernicious influence of the neoliberal doctrine of "law and economics," which is acting to undermine the long-standing classical liberal foundations of law and equity by replacing "equity" with "economics."  Historically, courts in equity would act when common law courts could not so as to perfect and protect property rights.  The old saying is "equity protects property rights, not personal rights,"  but neoliberal Law and Economics stands equity on its head to protect the "personal" economic rights of corporations over the property rights of individuals.  The Supreme Court has already taken a major step to codify this doctrine in the law, much as they did to make corporations "persons" entitled to civil rights under the Constitution.  It may take a couple of generations to achieve this goal, but it will happen, if unchecked.  We are firmly placed on the road to where only corporations and individuals who exploit property economically will truly have property rights.  When the status of something as property depends on who owns it, that thing is not truly property.

My insight to the financialization of the real economy forms the basis of several policy arguments against this trend, particularly as it relates to intellectual property (by which I mean only patents and copyrights). 

In addition to the history of economics and finance, I've been studying up on the history of IP and the rationales for IP's existence.  The problem is that, of the three or four historical rationales, the one that has the most coin in modern times-- thanks in part to the Law and Economics movement-- is the utility argument, i.e., that IP's primary function is to create an incentive for people to innovate and share their innovations with the commons. 

While this utilitarian rationale makes a lot of sense in theory, it does not hold water in view of practical reality.  Here's why: the theory of intellectual property as currently understood came to maturity in the 18th century, just as the financial markets did.  In the beginning, IP and financialism went hand-in-hand.  As Paul Romer stated better than I ever could (as did Thomas Jefferson), an idea once shared with the public can be replicated at no additional marginal cost.  What this means in financialist terms is that scale would always trump innovation, that an incumbent controller of a particular commercial channel always would be able to "win" in the marketplace because its returns to scale swamped the ability of a small competitor to compete.  The true function of IP as initially instantiated in its modern form was to allow innovators to compete against the scale of incumbent industries in a manner that allowed them, if successful, to achieve their own scale unmolested by anyone other than fellow innovators who provided a non-infringing alteranative.  The alleged rewards to the innovators and the incentives for capitalists to invest in those innovations are both derived from the opportunity to compete against market incumbents in generating cash flow, which is all that financialism really cares about.

The problem is that financialism requires firms to demonstrate perpetual exponential growth, which requires two things: (1) keeping the cash flow you already have and (2) creating additional cash flow that meets the shareholders' expectations of growth.  I've previously explained how the illusion of perpetual growth is achieved through the four basic mechanisms (organic growth, acquisition, cost arbitrage, and rule arbitrage aka "cheating").  The problem is that IP affects the ability of different industries to meet growth demands differently.  For industries where a particulare IP asset and the product are synonymous (e.g., publishing and biotech), the way you keep the cash flow you already have is by making the IP right in question effectively perpetual, which explains why Disney has attempted (and succeeded) in continually extending the term of copyrights and why Big Pharma has accomplished essentially the same thing for its patented lock on biologic drugs through a little talked-about giveaway in the Obamacare law.  On the other hand, for industries that aggregate the innovation of several players (e.g., the semiconductor and software industries), incumbents seek to do away with IP rights (in this case, patents) altogether.  I'm not joking: companies like Intel and Apple would be more than happy if patent rights were abolished because they know that their scale will stamp out any competition that innovators may bring to the table.  I've been in the room.  Their preference, however, would be for the patent laws to work only for them and not against them.
The history of economics and IP bear out this thesis.   "Free trade" is, in fact, an emotional label attached to a policy that is always a bad idea for the nation that is asked to embrace it, as "free trade" is merely propaganda perpetuated to enable firms to continue to scale past the size that domestic markets inherently allow them to achieve.  As part of any strategic planning process, a firm considers its ability to maintain the illusion of perpetual exponential growth in view of its existing markets.  If you go back to the 1850s in the UK, when the cries for "free trade" and against patents first rose to a fevered pitch, you'll find that the firms shouting the loudest were members of innovation aggregator industries that broke free of the feudal land rentiers through the use of IP, but they were finding it progressively more difficult to maintain maintain their margins and growth when they had to pay for using somebody else's innovation.  Google Books has a fantastic collection of historical documents that demonstrate this dynamic.  The anti-patent fervor of the mid-19th century was beaten back due to the long global depression triggered by the collapse of the U.S. railroad bubble: once it became clear that globalism was no longer possible in view of nationalist sentiments brought on by economic hard times, patents became vogue again.   For a time.  They came under attack again in the U.S. shortly before WWI, but the Great Depression ultimately put an end to that effort.  I predict that the current attack will end as th ereality of the current and Greater Depression becomes clear.

Unfortunately, given how broken our government is, I don't know if the damage to U.S. competitiveness can be undone without great pain and greater realization of the fact that IP, properly understood, is critical to enabling competition unders capitalism in the presence of scale.  An "Innovation Economy" is impossible under financialism because true competition is not allowed in deference to scale.  Again, competition is bad for business under financialism.

Ralph Gomory, current NYU professor emeritus and former IBM SVP recognized the problem in this op-ed, although he did not truly understand that financialism is the source of the "Innovation Delusion."  Scale always trumps innovation, which is why large scale companies like Disney, Monsanto, Intel and Apple don't really innovate any longer: they don't have to.  In the case of the IP-qua-Product industries like publishing, biotech, and "seed" companies, the government has agreed to make their IP rights perpetual.  In the case of Product-as-Aggregation-of-IP industries like semiconductors and consumer electronics, the government (this time through the court systm) has agreed to eliminate those IP rights unless they're owned by a direct competitor. 

The role of IP, as properly understsood, is to afford new market entrants a reasonable opportunity to compete in the marketplace against large-scale market incumbents.  This means that IP rights must (1) have a limited term and (2) be treated exactly the same as real property rights during that limited term.  This is, in fact, what U.S. courts determined in the mid-19th century after several decades of a purposefully weak patent law penned by Thomas Jefferson to avoid meeting the Constitutional mandate of "securing" innovators' rights in their inventions and works of authorship.  Jefferson ultimately lost the argument when his position proved to be an abject failure. 

(FYI - I've come to the conclusion that, in spite of his wonderful words about liberty and freedom, Jefferson was just as duplicitous as Hamilton, albeit in his own way.  Any man who can talk so eloquenty about liberty and freedom as a moral imperative and yet keep (and procreate with) slaves has a massive ethical and moral blindspot.  I don't blame the man, who was a product of his times, but I don't have to worship his memory as if he were not deeply flawed by modern standards.)

Update: I have modified the discussion of IP aggregators to reflect that the abolition of patents is viewed by them as an acceptable to alternative to having the patent laws stacked in their favor.

Economic Theory Is a Pathological Lie Carefully Constructed to Normalize Evil

Earlier today I was pushed by a regular correspondent and reader of my blog to explain my position regarding malinvestment more fully.  I always appreciate this person's insights and probing, and this time it is no different.

From the first e-mail:

You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.
I incorporated my initial response as the update to this post from earlier today.  This prompted another email asking for further clarification and providing what I think is fair (and constructive) criticism.  Here are the two most important paragraphs, which have prompted this more open discussion:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .
Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.
I think the title of this post nicely brings my thesis "right down to earth in a language that everybody here can easily understand," as Malcom X once said. 

A Quick Disclaimer

Before I get rolling, I want to make clear that I don't believe that economic theory must always be a pathological lie.  I believe it is possible, in theory, to develop a mathematical model that accurately reflects how the economy really works.  Indeed, some have argued that people like John Maynard Keynes and Hyman Minsky have already done so, and Steve Keen and other Post Keynesians continue to build on their work, the bulk of which has been ignored by the Chicago and Austrian schools, among others.

Unfortunately, as a practical matter, I believe it is impossible to overcome the underlying political nature of economics (which used to be called "political economics") and the interests that economic discipline serves (i.e., the "rentiers" that were disappeared from economic discussion by the creation of neoclassical economics as an answer to Henry George's criticism of classical economics).  What history has shown us is that the fallacious mathematical models of economic theory are never replaced with accurate models.  At best, additional fallacious mathematical models of economic theory are layered onto the old ones, often while claiming that the new models incorporate the theory of a critic while not doing so at all (e.g., the so-called Keynesian-neoclassical synthesis and the later Neo-Keynesians and New Keynesianism).  At worst, criticism of the fallacious mathematical models of economic theory are used elsewhere in the socio-political arena to persuade the masses that the mathematical models are not, in fact, fallacious but sound (e.g., applying Gunnar Myrdall's insights to form neoliberal social institutions that turn citizens into sociopaths). ** Due to the political forces at work, economic theory will always be a set of  clothes tailored for a non-existent emperor

Explaining My Thesis By Breaking It Into Its Constituent Parts

Now, let's break the title of this post into its constituent parts:  economic theory is (1) a pathological lie (2) carefully constructed to normalize "evil."  As to the fallaciousness of mathematical models in economics, people like Steve Keen have done a great job of explaining how the math of orthodox (and related heterodox) economic theory doesn't work.  See here, here and here.  The first link is to a blog post that links to complete set of lectures and video/audio of a course he taught in behavioral finance.  Highly recommended.  The second link is to his book at mobi.com (superior PC-based reader to Kindle's), and the final link is to supplementary material for the book and includes additional lectures. 

Of course, the fact that the mathematical underpinnings of economic theory are provably false does not make economic theory a "pathological lie."  No, what does that is the fact that economists persist in perpetuating the falsehoods while knowing that they are, in fact, a falsehoods.  This one place where I break from Keen, who views his fellow economists' behavior as irrational and "mad", primarily because he incorrectly believes that his profession exists to explain the world as it really is when, in fact, it exists as a propaganda arm of rentier interests to rationalize their behavior as just the magical market doing its work.  In this sense, as I've noted elsewhere (and here, too, I believe), economics codifies-- in very different terms-- a modern version of feudalism's "divine right of kings": the wealthy are wealthy because the market chose them as winners.   The recasting of the divine right of kings in "free market" terms is particularly evident in Hayek's conception of the market, which forms the cornerstone of neoliberal economics and policy in both the Chicago and Austrian schools of economics.

If you can agree that the repetition of a known falsehood as the truth is, in fact, a lie, then I don't need to prove that the lie is, in fact, pathological.  Indeed, my assertion as a whole is that "economic theory is a pathological lie carefully constructed to normalize evil," but the definition of "pathological" implies that the lie is involuntary or compulsory.  The fact is that I chose the term "pathological" to refer to the effect of economic theory on society as a whole rather than to describe the mental state of economists and others who repeat the lie, many of whom do so earnestly and honestly.  As I've stated here and elsewhere, I believe a direct consequence of neoliberal economics and policy is a society of sociopaths, i.e., individuals without a conscience.  This was the entire point of mangling Smith's Invisible Hand.

Turning to the assertion that the pathological lie was carefully constructed to normalize evil, I have several posts that discuss the history of the neoliberal political movement, including who was behind it, how it was initially constructed and how it morphed over time.  Generally, you can find these posts by looking for the "Neoliberalism" label, but good examples can be found here, here and here.  You can also see Robert Vienneaus's thoughts on Milton Friedman, the Austrians, and some of the problems with certain aspects of economic theory.  Robert is a non-economist economist who earnestly and in his own way is marching on the same path as Steve Keen trying answer bad math with good math.  I cannot say that I agree with everything he says, but that's because I have not read everything he has said.  I believe he is a computer scientist by profession, which probably explains why he and I (trained in CS/EE) arrived at many of the same conclusions regarding neoliberal (like everybody else, he calls it neoclassical) economic theory.

I cannot expect anyone to merely accept my conclusion that economic theory is a purposeful lie, but I think a careful reading of history, on the one hand, and the huge known disparity between economic theory and the reality it supposedly describes will convince everyone of good conscience that this didn't happen by accident.  Neoclassical economics was created to avoid the valid criticisms of Henry George, who first identified debt-financed speculation as the true cause of industrial depressions in the late 19th century.  The neoclassical-Keynesian synthesis, New Keynesianism and Neo-Keynesianism all purported to adopt and follow Keynes when, in fact, all of them disappeared the part of Keynes' General Theory that would euthanize the debt-financed speculator (i.e., the "rentier").  Neoliberal Chicago School economics were on hand and at the ready to take over when "Keynesianism failed," as it did when, according to Hyman Minsky, debt-financed speculators created the "stagflation" phenomonen, something that had only been theorized by a Chicago School economist shortly before the theory, which made no sense on its face, became reality.  And then there's the Chicago School's theories of finance, the effect of which was to financialize the real economy in its entirety, allowing the debt-financed speculators to blow bubbles in all asset classes, not just in land, as was the case in Henry George's day.

My conclusions regarding the true nature and purpose of economic theory are based in part on my professional experience in negotiating complex and difficult deals, which often devolved into litigation.  These negotiations had an average duration of 18-24 months, typically involving a lot of travel and many meetings internally and with the other side.  In several cases, hundreds of millions of dollars were at stake.  One of the things the experience taught me was to pay careful attention to what the other side actually did and compare it to what they claimed they were going to do.  Trust but verify.  I discovered that whenever there was a significant difference between the two, the other side was lying.  Plain and simple.

Turning Back to the Correspondence that Prompted This Attempted Response.


You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.
I've highlighted the phrase "competitive dynamic" because that's a term that applies to capitalism, but what we currently practice-- thanks to neoliberal economics and its neoclassical foundations-- is not capitalism but what I've started calling "financialism."  As I stated previously here:

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.
What did I mean by this?  As I explain here, although not in precisely the same terms, finance drives economic decisionmaking by firms because firms are managed to meet the expectations of CAPM financial models that express the stock price of a company in terms of its future cash flow according to its balance sheet.   That is, corporate executives don't manage their businesses to maximize profits, they manage their balance sheets to simulate a financial instrument that, on a quarterly basis, demonstrates an exponential and perpetual increase in value at a rate faster than inflation. Yet another way of putting it is that corporations are managed to maintain the illusion of a bond having infinite duration that perpetually compounds interest at a rate faster than the rate of inflation.  Why?  Because of the incentive structures provided to executives, CAPM is not merely descriptive but is actually normative.

Steve Keen's lectures on behavioral finance explain the economic hierarchy quite well: microeconomic theory supposedly models the behavior of consumers, individual firms and their respective aggregating industries; macroeconomic theory supposedly models how these various industries and consumers interact in the larger economy building, of course, on microeconomic foundations; and finance supposedly models the value of firms by building on macroeconomic foundations.  If microeconomic theory fails, so does the entire edifice of economics fails as the hierarchy is flattened down into finance.

As Keen discusses in the first few lectures of his course, a fundamental assumption of microeconomics is its theory of the firm in which every firm is managed to maximize profits.  As discussed above, this assumption is false.  (FYI -- Keen uses math to debunk the neoclassical theory of the firm, but his math starts from the same basic starting point as what he is debunking without recognizing that finance is normative).  

How did I reach the conclusion that finance drives corporate decision-making?  I used to be an executive at a public company, and there were several instances during my career working in corporations (starting with Intel) where I was struck by economic decisionmaking that was driven primarily by the balance sheet and not by actual cash flow (i.e., profit maximizeing) concerns.  At the time, I really did not understand why this was the case, but as I taught myself finance and valuation theory in order to contribute to discussions regarding M&A etc., I learned about the models that analysts used to estimate the value of our company.  Still, it took another year of studying economics (and the economic history of the United States) outside of the corporpate environment to understand the implications of CAPM on the real economy and on economic theory, as well.  If you understand net present valuation methodology, you'll quickly recognize that the rules of that methodology (e.g., the selection of the discount rate, growth assumptions, terminal value, etc.) ultimately express the value of the firm as bond of infinite duration that exponentially grows in value over time.  If you accept that providing executives incentive stock options and restricted shares aligns their interests with those of the shareholder, which is to have a financial asset that grows in value infinitely and perpetually at a rate greater than that of inflation, then you should have no problem in accepting my conclusion that financial theory is normative, not merely descriptive.  FYI -- I have recently discovered that there is some literature on this topic.

Recapping the follow-up correspondence:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .
Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.
I admit that my explanation of my thesis, which can be summarized into a pithy ad hominem attack on economic theory as a whole, is nevertheless difficult to explain without resorting to an explanation of concepts that are foreign to most people.  Here's the problem, and it's something that I learned a long time ago: the person who determines the starting assumptions of a debate usually wins the debate.  To start by assuming that economic theory is right and trying to explain why it is wrong is a losing proposition because economic theory is based on centuries of layered lies, and attacking all of the lies (as people like Keen tend to do) makes you look weak: if you had a killing blow, you'd deliver it and not seek the death of your foe by a thousand cuts. 

I think my insight about finance as normative can be developed into a killing blow, but it still needs further work to persuade the masses who are stuck with iconic words and useful fictions inflicted on them by neoliberal social institutions that sprang into existence to put the insights of the rival institutional economists and neutral cognitive scientists to work to their advantage (e.g., neoliberal think tanks construct their policy messaging by applying Kahneman's Prospect Theory, even as neoliberal economists construct their policy messaging by applying Benthamite Utility Theory; not surprisingly, both reach the same conclusion, even though Prospect Theory is based on empirical evidence that proves Utility Theory to be wrong).

In the meantime, I'll stand on my outright rejection of economic theory as politics, something that categorically cannot be integrated into people's current understanding of how the world works.  I fully understand how people are most persuaded by things that seem to confirm what they already know, but that's not the route I plan to take because cognitive biases tend to smudge important differences out of existence, much as an eraser smudges graphite off a sheet of paper.  Sometimes you need to challenge first, then engage.

Anyway, thanks go once again to my email buddy for prompting me to attempt to explain my thesis in one place, and apologies for probably failing in my first attempt.

**FYI -- I have a working theory that the Nobel Prize in Economics is awarded based primarily on the extent to which a recipient advances rentier interests in applying economics as a control mechanism over the masses, regardless of whether the recipient purposefully set out to do so.  Gunnar Myrdal (an institutional economist and critic of neoclassical theory) and Daniel Kahneman (a cognitive scientist whose Nobel prize-winning work forms the basis of behavioral economics) are two examples of unwitting participants.

Irony Alert: The "Anchoring and Adjustment" of Behavioral Economics

Another reposted post.

One of the books that I've read recently is Scott Plous' The Psychology of Judgment and Decision Making, available here. This book, although expensive, is a wonderfully concise discussion of the cognitive science, the primary foundation of behavioral economics.

One of the things that struck me was the book's discussion of the cognitive "bug" of anchoring and adjustment, which immediately followed its discussion of another cognitive "bug," the inability to accurately assess probability and risk, which it demonstrated through its discussion of the Monty Hall problem, which the books notes can be solved correctly by applying Bayes' Theorem.

If you look at Bayes' Theorem carefully, though, you can view it as little more than a mathematical expression of anchoring and adjustment. Apparently, when you express a bug mathematically, it becomes a feature.

Behavioral Economics as a whole is a study in anchoring and adjustment in that it persists in the fiction that "rational" behavior requires that humans maximize utility by applying precise mathematical formulas while considering only monetary wealth as utility. Behavioral economists do this because they start from the anchor of neoclassical economics, which they are merely trying to adjust to be more accurate. What they should be doing is scrapping the entire edifice as false.

More on Behavioral Economics

Again, a reposted post from the old blog.  This one refers to the fractal nature of human thinking (another reposted post).

In Democracy in America, Alexis de Tocqueville discusses "self-interest, rightly understood," praising the American people for recognizing that it is in their self-interest to help their neighbors, for example. I recently ran across that phrase again in a brand new book from Prof. Ryan Patrick Hanley of Marquette University, entitled Adam Smith and the Character of Virtue. The book is clearly targeted for the academic as it is very dense and heavily footnoted. Thus, even though it only weighs in at a little over 200 pages, the book demands careful reading.

One of the theories that I have been pursuing since I first read the chapter of The Wealth of Nations in which the "invisible hand" aphorism appears is that Smith, too, was discussing self-interest, rightly understood and not selfishness. Prof. Hanley's book identifies more evidence that supports the theory.

Unfortunately, neoclassical economics assumes selfishness, not self-interest rightly understood. This assumption is embedded in the notion that economic value is the sole measure of utility. Indeed, Milton Friedman and others resurrected the invisible hand aphorism in the mid-20th century as rhetorical support that there is no society, only a collection of individuals each pursuing his own self interest. Apparently, the invisible hand aphorism had been ignored by economists until libertarians and their ideological brethren (e.g., objectivists) recognized its value in supporting their views and started putting it to use.

Because behavioral economics starts with the assumption that neoclassical economics is largely correct and seeks only to explain anomalies between what neoclassical theory predicts and what actually occurs, behavioral economists are predisposed to treat reality as the aberration and tend to use perjorative terms to describe real human behavior (e.g., irrational, herd behavior, etc.). Politically, this makes sense: to the extent that behavioral economists are trying to create meaningful and lasting change in the models that neoclassical economics uses to understand human behavior, they must do so incrementally for fear of being marginalized. Your voice cannot be heard if the herd banishes you. Unfortunately, the politics of the situation frame the conclusions of behavioral economists in a way that obscures much of the value of the research and prevents deeper insights.

Describing the tendency of large groups of people to act the same way at the same time as an "economic anomaly" and perjoratively label it "herd behavior," as behavioral economists do, is a tragedy. The problem lies not with reality but with the assumptions underlying the model.

It was actually "herd behavior" that inspired me to start developing the concept that human decision-making is "fractal" in nature. The bottom line is that human beings have a hard-wired decision-making system, the dopamine system, that is involved in every decision they make. Built on top of that hardware is a software system, cognition, that interpets events based on how the hardware system sorted them (e.g., enjoying events flagged as meeting expectations, worrying about events flagged as possibly not meeting expectations, and ignoring those events not flagged). Each of these human systems is part of a human network, i.e. society. Because of specialization, different people know different things, and no one person can be expected to learn everything. So, people watch what other people do to understand what they should do, particularly in making decisions in areas that they don't understand. Viewed in this way, "herd behavior" is really more a form of delegation than it is an example of herding.

The reason that "herd behavior" can lead to violent business cycles is the dopamine system itself. Again, all human decisions are filtered through the dopamine system and the cognitive function. Some decisions, however, are derived from one's perception of others' decisions. One example is the impact of falling or rising prices in the decision to buy or sell a particular stock. It takes time to develop such perceptions, which is why it takes time for people to "jump on the bandwagon." Because of the dopamine system and confirmation bias in the cognitive function, it also takes time to determine that such perceptions are wrong. The more abstract the problem is to a person, the longer it takes that person to make up or change his mind. (This is what I was trying to get at with the concept of a bias error function.) When reality falls far short of expectations, the dopamine system kicks into overdrive and sends signals of fear and dread that can lead to panic. To the extent that one person's decision is based on his perception of another person's decision, and the perception suddenly changes, those signals of fear and dread propagate by virtue of the observer's dopamine system.

Behavioral Economics and Being Rational (or Not)

Yet another "reposted" post from the old blog.  It basically riffs on how the term "utility" has become iconic, particularly in the political economy profession.

Behavioral economics is a field that has gained a lot of attention recently through the publication of easy reads like Predictably Irrational and Animal Spirits that feature the discipline, as well as by other books that discuss the findings of studies either conducted by behavioral economists or relied upon by behavioral economists to support their conclusions.

A central question of behavioral economics is whether human beings are rational. To answer that question, behavioral economists draw heavily upon experiments conducted by psychologists and cognitive scientists.

Behavioral economists start with the assumption that neoclassical economic theory is fundamentally correct but can be improved through understanding how human beings actually make economic decisions. Staring at the experimental data through this neoclassical lens has led them to conclusions about the rationality of people instead of conclusions about the rationality of neoclassical economic theory. To borrow one of their own observations and apply it to them, framing the problem as "how to improve" neoclassical economics has affected how they approach solving it. Very convenient. And very self-unaware.

The crippling flaw of neoclassical economics that limits the promise of behavioral economics is the belief that human calculations of utility are defined solely by economic (i.e., pecuniary) value. It turns out that this may actually be a "feature" of neoclassical economics instead of a bug because this view actually refutes a fundamental belief of institutional economics, a school of economic thought that was dominant when neoclassical economics first arose. Institutional economists believed that economic decisions are necessarily affected by social and political considerations. That is, individuals calculate utility by considering social value and political value, not just pecuniary value. Adam Smith was of the same mind and said as much in The Wealth of Nations.

This unfortunate feature of neoclassical economics has led to the conclusion that human beings are not rational, at least with respect to economic theory. That conclusion is, in fact, wrong and points out a level of irrationality on the part of behavioral economists that is not present in the underlying experiments.

Let's start with a reasonable definition of "rationality:"

Rationality can be a difficult word to define-it has a long and convoluted intellectual history-but it's generally used to describe a particular style of thinking. Plato associated rationality with the use of logic, which he believed made humans think like the gods. Modern economics has refined this ancient idea into rational-choice theory, which assumes that people make decisions by multiplying the probability of getting what they want by the amount of pleasure (utility) that getting what they want will bring. This reasonable rubric allows us all to maximize our happiness, which is what rational agents are always supposed to do.
How We Decide, Jonah Lehrer

Now, let's take a look at a couple of economists who looked at the seminal work of Kahneman and Tversky, which is part of the foundation of behavioral economics, and concluded that human beings are irrational:

“[S]uppose you offer somebody a choice: They can flip a coin to win $200 for heads and nothing for tails, or they can skip the toss and collect $100 immediately. Most people, researchers have found, will take the sure thing. Now alter the game: They can flip a coin to lose $200 for heads and nothing for tails, or they can skip the toss and pay $100 immediately. Most people will take the gamble. To the imagined rational man, the two games are mirror images; the choice to gamble or not should be the same in both.  But to a real, irrational man, who feels differently about loss than gain, the two games are very different. The outcomes are different, and sublimely irrational.
The (Mis) Behavior of Markets: A Fractal View of Risk, Ruin And Reward, Benoit Mandelbrot and Richard L. Hudson

“Imagine that a rare disease is breaking out in some community and is expected to kill 600 people. Two different programs are available to deal with the threat. If Program A is adopted, 200 people will be saved; if Program B is adopted, there is a 33% probability that everyone will be saved and a 67% probability that no one will be saved.

Which program would you choose? If most of us are risk-averse, rational people will prefer Plan A's certainty of saving 200 lives over Plan B's gamble, which has the same mathematical expectancy but involves taking the risk of a 67% chance that everyone will die. In the experiment, 72% of the subjects chose the risk-averse response represented by Program A.

Now consider the identical problem posed differently. If Program C is adopted, 400 of the 600 people will die, while Program D entails a 33% probability that nobody ill die and a 67% probability that 600 people will die. Note that the first of the two choices is now expressed in terms of 400 deaths rather than 200 survivors, while the second program offers a 33% chance that no one will die. Kahneman and Tversky report that 78% of their subjects were risk-seekers and opted for the gamble: they could not tolerate the prospect of the sure loss of 400 lives.

This behavior, although understandable, is inconsistent with the assumptions of rational behavior. The answer to a question should be the same regardless of the setting in which it is posed.
Against the Gods: The Remarkable Story of Risk, Richard L. Bernstein

There is no way that a rational person can conclude from this experimental data that human beings are irrational. The experimental data show merely that (1) human beings exhibit loss aversion, i.e., a strong bias against losing what they have, and (2) that bias can be manipulated by how a problem is framed. Unfortunately for Mandlebrot and Bernstein, the expected economic values, i.e. the utility, of the risk-taking choice and the risk-avoiding choice that were presented in each question were identical.  Since both choices in each version of the problem resulted in maximum utility, the choice to embrace or avoid risk was of no consequence, at least not from an economic point of view.  Clearly, loss aversion affects the amount of risk that somebody is willing to embrace, but doesn't that tell us that happiness (aka utility) is defined by something more than just economic value?  And, just as clearly, how a problem is framed can affect the choice between embracing and avoiding risk, but doesn't that tell us that context matters, that individual economic decisions are indeed influenced by institutional factors?

Nevertheless, two very smart economists viewed the data and concluded that it proved human beings were irrational. How could that be?  It seems like there was a bit of bait-and-switch going on.  While economic theory describes rational behavior as acting to maximize one's happiness, Mandelbrot and Bernstein seemed to define rational behavior as solving equivalent problems identically.  The logical fallacy here is that problems that are "equivalent" in terms of expected economic value are not necessarily identical in terms of utility, but to recognize that, you must first question the neoclassical assumption that utility is determined solely by economic value.  Unfortunately, it is much easier to accept that human beings are irrational than it is to question the Useful Fictions through wich you understand the world. This is just another aspect of human decision-making, which is characterized by positive feedback, hysteresis and metastability.

NOTE: It is not so much that Mandelbrot and Bernstein are irrational, it is that they point out one form of bias (loss aversion) as establishing that human beings are irrational while ignoring the fact that they could not have arrived at that conclusion without their own bias (confirmation bias). The facts they relied upon simply provide no support for their conclusion.

"Diversification" as an Iconic Word

Below is yet another "deposted" post from the old blog.  Again, I'll explain why I'm bothering with this in a bit.

I had a very interesting conversation with a friend last night about diversification of risk.

The concept of diversification is most broadly understood in the context of investing in the stock market. Warren Buffet explained:

Diversification serves as protection against ignorance. If you want to make sure that nothing bad happens to you relative to the market, you should own everything. There's nothing wrong with that. It's a perfectly sound approach for somebody who doesn't know how to analyze businesses.

Buffet further explainsed that the unsophisticated, ignorant investor should:

. . . both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limititations, it ceases to be dumb.

John Maynard Keynes mocked diversification, viewing it to be "as imprudent for [the ignorant investor] to make his own investments as to be his own doctor or lawyer." He explained his alternative view:

. . . my theory of risk is that it is better to take a substantial holding of what one believes shows evidence of not being risky rather than scatter holdings in fields where one has not the same assurance.
I assume that Keynes really meant to say that the level of risk involved was acceptable. The guy understood there is always risk.

I'm a tweener when it comes to diversification as an investment strategy. I think you have to do it to a certain degree, particuarly at certain times, but I'd prefer to make informed, target bets. Given the extreme uncertainty in the market right now, and the increased difficulty in valuing any business in this economic environment, diversification alone is what I am doing (when I am in the market, which I am not at the moment).

But what about diversification when it comes to running a business? Should the leadership of a company diversify its risk by making multiple bets? I'd say it depends on what you mean by diversification in this context. If you mean making multiple, informed bets that you are passionate about and will relentlessly execute towards accomplishing in parallel (your efforts in one area cannot conflict with your efforts in another), then I'm all for it. But I don't think diversification as that term is understood in the investment context can or should be adopted wholesale into the business context because investing is passive and managing a business is active.

This leads me back to the concept of "iconic" words, words that mean different things to different people without those differences necessarily being recognized. "Diversification" is a word that is used both in the investing context and in the business context. I wonder to what extent people differentiate between their understanding and application of that term in the two contexts, if they do at all. I certainly differentiate, but I cannot assume that anybody else does. Although my experiences leads me to believe that most differentiate as I do, it only takes a few people who don't to obviate apparent agreement on how to proceed.

Let me explain.

In contract law, agreement is not reached unless there is a "meeting of the minds." If two people agree to do something, but each has a different understanding of what that something is (e.g., there are two ships named the Peerless, and one contracting party is referring to the first and the other party is referring to the second), then there is no contract, and there cannot be breach or liability for breach. This was the situation in the case of Raffles v. Wichelhaus.

In organizations, a failure of the meeting of the minds of the employees of the organization to drive the organization towards what they thought was a common goal (but actually isn't) does not free the organization from the consequences. Everybody is stuck with whatever result they get, which is why more time probably should be spent confirming that everybody really has agreed whenever their are multiple decision makers.

I'm sure there's a study of organizational dynamics that addresses this issue. Somewhere. Maybe I will try to find it

When Words Become Icons

The following is another post that I removed when I repurposed the blog.  I didn't realize at the time that I was describing a form of known cognitive bias that arises through the use of heuristics.  I'm reposting it now because it is related to a post that I am composing at the moment.

John Maynard Keynes from his Preface to The General Theory of Employment, Interest and Money, dated December 13, 1935:

The Composition of this book has been for the author a long struggle to escape,and so must the reading of it be for most readers if the author's assault upon them is to be successful,- a struggle of escape from habitual modes of thought and expression. The ideas which are expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been into every corner of our minds.

One aspect of Useful Fictions that I have yet to touch upon is the effect of changes to the usage and meaning of key words and phrases on the application of Useful Fictions. A key aspect of "habitual modes of thought and expression" is the assumption that the meaning of words and phrases are immutable, that they mean what they think we mean. But the fact is that the meaning of words and phrases-- particularly politically charged ones-- morphs over time, particularly in our sound-bite cultural. For example, "socialism" does not mean today what it meant in the times of Marx, Hayek and Arendt. Such politically-charged terms have become what I call "iconic:" they are designed to illicit negative, emotional reactions, not to be descriptive or accurate.

But that's a topic I'll flesh out later.

Is That Really How Capitalism is Supposed to Work?

Charles Hugh Smith has an interesting piece up today entitled "Ireland, Please Do the World a Favor and Default.
I have only skimmed the post, but I'd say on balance that it seems pretty thoughtful, and when CHS thinks things through, he usually nails it.

A couple of things caught my eye. 

First, there is this statement:

It's rather straightforward: as asset bubbles rise, they enable vast leveraging of credit and debt. Once mal-invested assets collapse in value, then the debt remains, unsupported by equity or capital.
I've highlighted the word "mal-invested" because, to me, it highlights CHS's Austrian leanings.  My problem with that term is speculation is not investment, mal- or otherwise.  The fact that the Austrians purposefully pretend that speculation is a form of investment tells me that the Austrians accept financial speculation as normal and acceptable.  I'd rather criminalize it, at least the debt-financed part of it.

Second, there is this statement:

The money is lost, and Capitalism requires those who took on the risk to earn outsized returns must take the loss, come what may.
Really?  Capitalism requires that kind of outcome?  I know that we've all been told something along these lines, but where's the empirical evidence that this has ever truly been the case?  I defiinitely have emprical evidence to the contrary.  For example, while rummaging around in the history of finance and banking, I discovered that in the 1870s the Bank of England bailed out a large number of English banks who were exposed to the fallout of the U.S. railroad bubble bursting. 

Admittedly, in the past we certainly did see financial speculators get their comeuppance, but over the arc of history, it is clear that the system has been continually adjusted to prevent that kind of outcome.  The rise of corporate banks is an example.  When individual bankers or banking partnerships were threatened with ruin, it was kind of hard to bail them out because the owners were the managers.  But when corporate banks are threatened with ruin because of management's missteps/fraud, well, my goodness, we can't allow the innocent shareholders and bondholders take the hit, can we?  It's kind of the flipside of the argument that led to the social safety net as a result of the Great Depression.

It seems to me that what CHS views as a feature of capitalism is actually viewed by capitalism's masters as a bug.

UPDATE: Clarifying:
My problem is that the term "malinvestment" is a euphemism that derealizes the primary economic evil facing capitalist economies and thus normalizes it. To even use the term is to engage in "normalizing evil" as CHS described recently in his "Banality of (Financial) Evil" post. Debt-financed speculation is in no way an "investment." It is always a gamble made with other people's money, and it is the other people that always pay when the bet goes the wrong way.

As CHS said "Not naming evil is the key to normalizing evil. Evil must first and foremost be derealized, detached from our realization and awareness by naming it something innocuous."  Malinvestment is a pretty innocuous term, isn't it?

Tuesday, November 16, 2010

Lessons in Propaganda: Fraudclosure Mess Edition

Yves Smith has a new post up on rumors that the state attorneys generals are nearing a settlement with the banksters.

Yves is highly skeptical, but that's because she still believes that the rule of law matters.  Nevertheless, she is extremely sharp and attuned to the propaganda (aka public relations) techniques pioneered by the likes of Walter Lippmann and Edward Bernays, and she does a good job of parsing the "news" (rumors, really).  She could well be right.

Anyway, one of the things you learn in working with crisis management public relations firms is how to identify your constituents and market your message to all of them.  (I speak from experience; it wasn't fun, but it was educational.)  Perhaps a lot of these rumors about Congress passing a law to sweep the fraudclosure mess under the rug were really aimed at the state AGs: either you play ball and get something; or you don't and get nothing.

Do not underestimate the depth of the game that is being played.  A settlement is the best solution for the banks and the Obama administration, and false rumors of settlement could actually bring settlement about, if the AGs believe that the alternative is worse (and breathless rumors of the revivification of H.R. 3808 don't help).

And, no, this is not a conspiracy theory.  It's the art of manipulation, of manufacturing consent.

Here are links to Bernays' Propaganda, and Lippmann's Public Opinion.  These are the bibles of manipulating the public mind.

Lame Duck Watch: Legitimizing Foreclosure Fraud Edition

I have previously posted about the fraudclosure mess here, herehere and, more recently, here.  To summarize, I never thought that H.R. 3808 was ever a big deal, but I thought the fraudclosure mess was a much bigger deal than it has been portrayed in the mainstream media.

But wait, H.R. 3808 appears to be back.  There's a lot of breathless talk about this, especially from one of my favorite curmudgeons, Karl Denninger.   The claim is that Congress is going to attempt to override Obama's veto of H.R. 3808.  I don't buy it.  Yes, the override procedure has been set in motion, but the same steps lead to laying the bill to rest once and for all.  We'll see.

Regardless, H.R. 3808 alone is not nearly enough to sweep the fraudclosure mess under the rug.

I've done a little digging, though, and there is a straightforward, one-step approach for Congress to pass a law that forgives and perpetuates fraudclosre without ostensibly passing an ex post facto law.  I still think this approach violates Due Process, but there is precedent.

It turns out that there are two federal non-judicial foreclosure statutes (12 U.S.C. Sec. 3701 et seq. and 12 USC Sec. 3751 et seq.).  Currently, these statutes are limited to mortgages owned by HUD.  One way that Congress could avoid the fraudclosure mess, which has been caused by judicial foreclosure states, would be to expand the federal non-judicial foreclosure subject matter jurisdiction to include private rights of action based on securitized mortgages and/or government-guranteed mortgages.  Voila: no Due Process required; fraud authorized!

If you're looking for legislation that may possibly affect the fraudclosure mess, in addition to the keywords that other sites have listed, make sure to add "Title 7," "Title 12," "Title 15," "Title 28," "7 USC," "12 USC," "15 USC," and "28 USC."  In view of the above analysis, I think it is possible for Congress to pass a sweeping change without using many (or any) of the foreclosure-centric keywords.  Also look carefully at anything offered by an outgoing member of the legislature (especially Chris Dodd and perhaps even Russ Feingold; nobody is above suspicion).

A New Social Contract?

Let's face it.  The way things stand now, our government is a farce.  It has been hollowed out by for-profit, multinational corporations who prey upon citizens qua consumers, and our governments at all levels aid and abet this evil because our government officials have come to believe it is good. 

As a result, the social contract between U.S. citizens and their governments has been rescinded, yet, short of violence, we are powerless to take back the personal liberty we gave up under natural law in exchange for protection and promotion of the general welfare.

Or are we powerless?  The fact is that the "free market" is all about scale.  The bigger you are, the more market power you have.  The entire system is geared to prostrate itself before the largest market participants, which explains why giant corporations have accrued so much political power and control our government.

But is there any reason U.S. citizens cannot recreate their "social contract" through an actual contract by creating their own corporation (the new citizen) that negotiates on their behalf to get the benefits of scale?  The citizen's corporation could be run as a non-profit, or as a for profit business within strict guidelines.  Over time, it could take over many state functions and turn back the tide of "privatization," and by so doing, the citizens' corporation would weaken the power of the governments, and, therefore, the power of the giant multinational corporations that rule our lives today.

Imagine re-expressing Jeffersonian ideals of humanity, community and liberty in terms of corporate law instead of natural law. What would you get? We’ve been conditioned to think in terms of for-profit private business on the one hand, and the government on the other. The neoliberal movement has effectively demonized and co-opted the government for the benefit of for-profit private businesses, transforming citizens into consumers and leaving them to the mercy of these corporation. But can for-profit corporations compete against a massive non-profit corporation that dwarfs them in size by several orders of magnitude?

Padding the Bottom Line With Workers' Contributions

This caught my eye:

Des Moines, Iowa (AP) — The Department of Labor says the recession is financially stressing business owners and in a few cases, they're now pilfering employee contributions to 401(k) and health benefits accounts.

On Tuesday, the department filed civil lawsuits against 24 companies and business owners alleged to have kept money withheld from paychecks that was meant for retirement or health accounts.

The companies range in size, from fewer than 10 workers to more than 100. The largest case involves more than $6 million in worker contributions.

In some cases money was not deposited into the retirement account soon enough, but in others it was never deposited.

The Labor Department also has initiated 191 criminal investigations.

Monday, November 15, 2010

One-Two CounterPunch: Michael Hudson and Paul Craig Roberts

Michael Hudson and Paul Craig Roberts have new pieces up today over at CounterPunch.

Hudson goes for the jugular in his piece, which is entitled "Obama's Greatest Betrayal: The Coming Sell-Out to the Super Rich and What it Means for the Rest of Us."  I've only skimmed it, but there are some tasty nuggets in it, like this one:

Baudelaire quipped that the devil wins at the point where he manages convince the world that he doesn’t exist. Today’s financial elites will win the class war at the point where voters believe it doesn’t exist – and believe that Obama is trying to help them rather than shepherd them into debt peonage as the economy settles into debt deflation.
Where Hudson is focused strictly on domestic policy, Paul Craig Roberts turns his attention to the latest news out of Burma to illustrate "The Stench of American Hypocrisy."  The opening paragraph is devastating:

Ten years of rule by the Bush and Obama regimes have seen the collapse of the rule of law in the United States. Is the American media covering this ominous and extraordinary story? No the American media is preoccupied with the rule of law in Burma (Myanmar).
On civil liberties issues, Paul Craig Roberts is like Glenn Greenwald, but with a spine and a clenched fist.

Thursday, November 11, 2010

Will Future Historians Agree That 2010 Was the Death of the United States of America?

If what Neil Garfield is saying is true, then yes:

After years of negative judicial decisions about the use of a straw-man on mortgages, MERS was about to lose its existence as well as its credibility. But now all of that is set to change as Wall Street money is pouring into the coffers of those who are receptive (i.e., almost everyone in Congress). The legislation is already being drafted under the interstate commerce clause to ratify MERS and everything it did retroactively. It appears that the Obama administration is ready to pardon all the securitization deviants by signing this bill into law. This information is corroborated by several people who are in sensitive positions — persons who would be the first to know such proposals. Fortunately, there are some people in Washington who have a conscience and do not want to see this happen.

Besides the obvious seediness of this maneuver, it runs roughshod over state property laws, and the rights of investors, homeowners and borrowers. It amounts to a permanent installation of a Federal system that supersedes the county records for recording property rights. Off-record comments I’ve heard from people in power are outraged at this assault on states’ rights. But these people are not legislators, who are getting promises larger than anything in your imagination, if they will support such a bill. It might be couched as a uniform law to be adopted by the states to get around the states rights issues, but it will permanently remove some of the power over property that lies solely within the jurisdiction of the states and place it preemptively within federal jurisdiction.

All of this is scheduled to happen during the lame duck session of congress between now and the end of the this year, 2010. That means in a manner of days, some bill that may look like it has nothing to do with property, mortgages or foreclosures is going to have attached to it a provision whose effect will go even further than the notarization bill that went through Congress like S–t through a goose and almost got signed by the President. We caught that one AFTER it was passed by Congress unanimously but before Obama signed it.
It is my understanding that Garfield is something of an expert on the fraudclosure mess, as he has been fighting in the trenches against the banksters, and he has been interviewed by national television media on the topic.

I'm going to accept the premise that the lame duck Congress is going to pass a bill, most likely sponsored by an outgoing member (like Chris Dodd or even perennial "good guy" Russ Feingold), that will, as a practical matter, achieve the goals Garfield ascribes to the Obama administration.

I have a hard time accepting that the bill will look anything like the ex post facto law Garfield describes above.  Why?  Because something like that is likely to wake up a lot of economic elites (i.e., people in the top 5% of household wealth and income) to the fact that something has gone horribly wrong, and they can force real change.

For this reason, I think Garfield's sources are purposefully misleading him.  They're creating a false "anchor" from which Garfield and others will adjust incrementally around while the real action will happen elsewhere and may even seem benign.  At this point, Garfield has too much credibility, and the powers that be need him to squander a bit of it by making breathless claims that don't pan out.

So, here's my prediction on how the Washington elite are going to try to pull this off for Wall Street: 
  1. There won't be one piece of legislation but two. 
  2. The first piece of legislation will create federal subject matter jurisdiction over foreclosures involving mortgages that have been securitized (these are the foreclosures that are the real threat to the financial system).  This legislation will definitely be passed during the lame duck session of Congress and will most likely be offered as an amendment to either the Securities Act of 1933, the Securities Exchange Act of 1934, the Federal Trade Commission Act of 1914, or some other existing act that ostensibly passed to protect consumers. 
  3. The form that the second piece of "legislation" takes depends on whether federal subject matter jurisdiction will be assigned to federal district courts or an administrative agency.  Going the administrative agency route is the most attractive to people seeking to avoid transparency and accountability, but the level of scrutiny on the fraudclosure mess and the fact that foreclosures are truly a local problem makes it far more likely that foreclosures for securitized mortgages will land in federal district courts. 
  4. Regardless, the second piece will take the form of either a bill or a regulation that officially touches on "procedure."  This piece does not have to be passed during the lame duck session, and may not be.  My bet is that it will, though, and it may actually precede the first piece.
  5. If federal district courts see their jurisdiction expanded, we will see a second bill, it will be to amend the Rules Enabling Act.  Under the Eerie Doctrine, federal courts dealing with state law claims must follow the "substantive" laws of the states in which they sit, but they must apply the "procedural" laws of the federal courts.  If Congress identifies something as "procedural law" for federal courts, they must accept that designation.  And what do you think Congress will identify as "procedural," if they want to sweep substantive state law claims under the rug without invoking the spectre of an ex post facto law?  Something like the sufficiency of evidence to establish the chain of title, perhaps?
  6. If an adminisatrative agency has its jurisdiction expanded (or a new agency is created), we won't see much of anything.  They'll just issue a regulation at whim (which makes going the administrative route so attractive to those seeking to avoid transparency and accountability).
Anyway, I will be checking for new legislation every day to see if I find something that smells of what I describe above.

That Didn't Take Long . . .

Jane Hamsher wins the prize for the day's best title for a blogpost: "Obama Twists Own Arm, Says 'Uncle' to Extending Bush Tax Cuts."  Here's the piece in it entirety:

Political mastermind David Axelrod says the White House is ready to cave in the wake of imaginary overwhelming pressure to extend all of the Bush tax cuts, exacerbating the “deficit” problem they’ve been completely obsessed with:
President Barack Obama’s top adviser suggested to The Huffington Post late Wednesday that the administration was ready to accept an across-the-board continuation of steep Bush-era tax cuts, including those for the wealthiest taxpayers.
That appears to be the only way, said David Axelrod, that middle-class taxpayers can keep their tax cuts, given the legislative and political realities facing Obama in the aftermath of last week’s electoral defeat.
“We have to deal with the world as we find it,” Axelrod said during an unusually candid and reflective 90-minute interview in his office, steps away from the Oval Office. “The world of what it takes to get this done.”
Me or David Axelrod — one of us does not understand how congress works.
Lame duck.  Democrats still have the majority in the House. So they pass extensions for the middle class, excluding the ones for the wealthy.
All funding bills have to start in the House.  And since a rather large number of Democrats aren’t worried about reelection at the moment, there’s not much downside for them.
Then the bill goes to the Senate.  And at that point, Axelrod is worried the Republicans are going to filibuster the tax cuts?
I mean, THAT’S what he’s afraid of?
If Axelrod is the “political genius” guiding the Democrats these days, they should consider themselves lucky it wasn’t 100 seats.
Of course, this is what I predicted back in September:
But my answer doesn't end there: I firmly believe that Obama and the Democratic leadership are completely aligned with the Republicans in seeking an extension of all the 2001 Bush income tax cuts, including those that go to the wealthiest households.  The problem is that the Democrats cannot achieve this goal when they are in control of the presidency and both houses of Congress.  The Democratic base would not stand for it.  The good news for Obama and the Democratic leadership is that, in all likelihood, the Republicans will recapture the House this year and "force" Obama and the Democratic Senate to extend all of the Bush tax cuts.  That will be the narrative, anyway, you can count on it, if the Democrats don't hold both houses of Congress.

Tuesday, November 9, 2010

Evil Is The New Good

Charles Hugh Smith posted one of his excellent "deeper game" (my label, not his) essays today entitled "The Banality of (Financial) Evil."  The entire piece is well worth reading, but I want to focus on a few selections from it because they deftly describe the dynamics behind two other recent stories :
Hannah Arendt coined the phrase the banality of evil to capture the essence of the Nazi regime in Germany: doing evil wasn't abnormal, it was normal. Doing evil wasn't an outlier of sociopaths, it was the everyday "job" of millions of people, Nazi Party members or not.
Not naming evil is the key to normalizing evil. Evil must first and foremost be derealized (a key concept in the Survival+ critique), detached from our realization and awareness by naming it something innocuous.
. . .
Can any of the tens of thousands of people working on Wall Street or in the bowels of the Federal Reserve, Treasury, Pentagon, etc. truthfully claim they "didn't know it was wrong" to mislead the citizenry, the soldiers, the investors and the buyers of their fraud? On the contrary, every one of those tens of thousands of worker bees and managers knows full well the institution they toil for is doing evil simply by hiding the truth of its operations.
Now, let's turn to Bill Black's latest piece, "Lenders Put the Lies in Liar's Loans," which lays bare the cognitive dissonance of Andrew Kahr, who Black describes as "one of the architects of subprime lending."  Essentially, Kahr details the "liar's loan" industry (without realizing he is describing a criminal enterprise built on on accounting control fraud) and then blames the borrowers for the fraud.

At the end, Black summarizes precisely how Kahr has "normalized evil" to the point of identifying the victims of his criminal industry as the criminals and the criminal industry itself as the victim:
To sum up situation to this point:
  • Mr. Kahr says that "the banks" created liar's loans, knowing they would produce endemic mortgage fraud. They even redrafted their loan documents to encourage fraud.
  • The nonprime lenders did not create liar's loans due to competitive pressures because such loans cause severe losses.
  • The banks identified widespread fraud - and deliberately violated the law by failing to file criminal referrals.
  • The nonprime lenders and brokers encouraged the mortgage fraud because they profited from it. The fraud produced more loans that they could sell at a profit to Fannie and Freddie. The officers controlling the nonprime lenders and brokers knew that a strategy of endemic fraud would make them wealthy and transfer the losses to the taxpayers.
  • The strategy that Mr. Kahr describes is fraudulent. Indeed, it is a classic accounting control fraud.
  • The controlling officers of the fraudulent nonprime lenders and their brokers created the "echo" epidemic of appraisal fraud in order to maximize the firms' accounting income and their personal compensation.
  • Yet, Mr. Kahr, assumes that the nonprime lenders are the victims of an epidemic of fraud committed primarily by financially less sophisticated working class borrowers. He offers no proof -- it is self-evident to him. He has no idea that the strategy he ascribes to the nonprime lenders is fraudulent. He has no apparent sympathy for the working class borrowers induced by fraudulent lenders and brokers to borrow money to buy homes (at the peak of the bubble) that they could never afford to repay -- and the inevitable destruction of working class wealth.
Meanwhile, we have Duncan Smith, a government official in the UK, threatening long-term jobless with "compulsory manual labor" (i.e., slavery), if they don't "play ball," even as his government props up the criminal financial system that caused these people to lose their jobs.

Apparently, Evil is the new Good.

Monday, November 8, 2010

The Deeper Game: Managed Deflation

On the heels of the Fed's announcement of QE2, the Fed today announced the results of it "Senior Loan Officer Opinion Survey on Bank Lending Practices," which Calculated Risk summarizes, stating "in general banks have stopped tightening standards (they are alredy very tight) and demand has stopped falling (there is little demand for loans)."

A couple of things to note.  First, this report only discusses lending to households and non-financial businesses.  I don't know whether there is a similar report for lending to financial institutions, but the banks are very secretive (and the Fed protects that secrecy), so I doubt it.  Second, the FOMC must have known the results of this report, but they went ahead and announced QE2 anyway. 

Got that?  The Fed knew last week that adding more liquidity to the system would have no direct effect on households and non-financial businesses, but they went ahead and announced QE2 anyway.

What does this mean?  It confirms that the Fed is not even pretending to follow its dual mandate of price stability and maximum employment.  Yes, Bernanke says he's trying to combat disinflation/deflation by creating inflation (you know, an increase in the money supply), but he knew last week that none of the QE2 "money" can or would find its way into the real economy through lending, increased employment, or higher wages.  In other words, he knew that QE2 would have no impact on M0 or M1 (and perhaps M2).

He also knew last week that a lot of the QE2 money had already found its way into speculation in the commodity markets, as he acknowledged that the prices of staple commodities were rising.  All this will do is shift spending away from discretionary goods into necessities, to the detriment of non-financial businesses and to the benefit of financial speculators (aka the banks). 

The screwflation will continue until the next round of layoffs, which will cause a tumble in the commodity markets, which the banks will have shorted by then as many from the "lower rungs of the rich" will have piled into the trade, just in time to get fleeced.

Paul Craig Roberts, Bitter and Seething

Paul Craig Roberts' latest post on Phantom Jobs mostly regurgitates what anybody who frequents shadowstats.com already knows: government employment data are a bunch of smoke and mirrors.

The final few paragraphs are worthwhile, however:

The American working class has been destroyed. The American middle class is in its final stages of destruction. Soon the bottom rungs of the rich themselves will be destroyed.

The entire way through this process the government will lie and the media will lie.

The United States of America has become the country of the Big Lie. Those who facilitate government and corporate lies are well rewarded, but anyone who tells any truth or expresses an impermissible opinion is excoriated and driven away.

But we “have freedom and democracy.” We are the virtuous, indispensable nation, the salt of the earth, the light unto the world.
I've emphasized the statement about the "bottom rungs of the rich" because (1) they don't see it coming, and (2) the "rungs of the rich" next up the ladder don't realize that they're the next to be consumed by the cannabilistic system they think they know and control.  That system must maintain the illusion of perpetual growth, or it will collapse.  Unfortunately, that system is awash in bad debt and cannot expand by extending new debt, as it normally does.  To maintain the illusion of growth, the system must increase the pace at which it consumes itself, and that's precisely what it's doing, as Russ describes here.

It's Like Musical Chairs, But There's No Chairs

In his latest post "Dependency, the Fed and the Market," Charles Hugh Smith argues that the "the U.S. stock market is increasingly dependent on the the Federal Reserve's constant interventions to maintain the illusion of an organic demand for equities," and this "growing dependence on the Federal Reserve will end like all dependencies--badly."

Actually, the U.S. stock market is dependent entirely on high frequency trading (HFT) to maintain the illusion of an organic demand for equities.  Unfortunately, as my investment advisor tells me, withouth HFT right now, there would be no liquidity, and the market would crash.  Or, as my wife summarized in plain English, the stock market "is like musical chairs, but there's no chairs," and HFT is the music, not the Fed. 

To be clear, the Fed is playing a very important role: it is distracting usually insightful people like Smith from fully understanding the deeper game.  Smith routinely shows that he sees the outlines of the deeper game, which must play out over a longer timescale, yet he also routinely allows his vision to be obscured by daily events that, when put in their proper context, are not worthy of attention.  For example, see his post of November 1 (which I critiqued here), and then compare it to CHS's post of November 2.  In the first post, he argues that the Fed is foolishly blowing an asset bubble that must collapse.  In the second post, he argues that the size of QE2 is nowhere near enough to blow an asset bubble.  He got it wrong in the first place, but upon further reflection, he got it right.

I'm still trying to figure out what I can learn from this phenomenon because everybody is susceptible to falling victim to it.  If I were to summarize my current thinking it would be that each of us has blindspots created by biases, and the key to eliminating the blindspots is detecting the biases.

Sunday, November 7, 2010

Karl Denninger Doesn't Get It (and Neither Does Sarah Palin)

As I've said before, there's a lot of things I like about Karl Denninger.  Unfortunately, he can get sloppy in his thinking, even as he makes some pretty keen observations.

Karl has been doing a great job in identifying price inflation caused by speculation in commodities that are consumer staples.  Really, nobody has been more vocal than Karl in pointing out this phenomenon, which will undoubtedly cause a lot of pain to the least fortunate Americans, who are already struggling.

The problem is that Karl equates increasing prices with inflation (to the point that he equates price reductions due to improved productivity as "deflation"):
Now watch very carefully... remember, my thesis is this: Depressions are a function of margin collapse, not deflation.  You seek deflation intentionally every time you go to the store.  Technology creates massive deflation in many things (e.g. calculators, computers, music players, televisions, etc)   This is not bad, it is good.  It allows your earnings to go further and enhances your standard of living.
Because Karl thinks of inflation and deflation in terms of the price of consumer goods, he fundamentally misunderstands what is going on, even while he seems to see the self-reinforcing feedback loop that is being set up by QE2.  Unfortunately, he mistakenly believes that QE2 squeezing operating margins (which will implicitly lead to more layoffs or other forms of cost arbitration that will negatively affect the U.S. economy) is the problem, when the real problem is that QE2 will reallocate aggregate demand away from discretionary spending, causing  a reduction in unit sales.  Management at companies that sell consumer discretionary goods have a fair amount of control over their costs (and, therefore, their margins).  They have no control over whether or not customers will have any money to spend on consumer discretionary goods.  He also isn't taking into account the currency wars that are currently underway.  The international flavor of our global economy will ameliorate some of the margin impact in the U.S. because of the devalued dollar (which really isn't devalued directly because of QE2 because that money has no velocity and is not finding its way into the U.S. in any event).

Anyway, he shouldn't be surprised that Sarah Palin shares his confusion.

Joseph Stiglitz Understands the Problem, Too

In the video embedded in the last post, Amy Goodman asks Michael Hudson to comment on statements made by Joseph Stiglitz in the following interview:

The full transcript can be found here.

At around 16:45, Stiglitz makes an important point, and he uses the 2005 revisions to the bankruptcy laws to make it. 

AMY GOODMAN: Would you support a foreclosure moratorium?
JOSEPH STIGLITZ: Well, I think probably the answer is yes. The fact is that they’ve generated so many bad mortgages, so many fraudulent mortgages. And by the way, this problem of fraud has been known for a long time. The FBI started reporting on this years ago. I talk about that problem in my book. It’s not just risky lending. It was fraudulent, predatory, all these—and so, we have a backlog now. And we shouldn’t be surprised that our legal system is not capable of processing the numbers of foreclosures that have to be processed. We’re talking about probably something in the order of magnitude of three million, three-and-a-half million foreclosures actions this year. Last year, the estimate was about two million lost their home; the year before, two million. Our system isn’t geared to do that.
But there’s a more—there’s a deeper point that I’d like to raise, which is the following. You know, in a democracy like ours, people have to have confidence in the fairness of our legal system. And if they feel that the legal system is stacked against them, then voluntary compliance—our whole social fabric starts fraying. And I think a lot of Americans have come to the view that the system is stacked against them. It began, in a way, with the bankruptcy law that was passed back in 2005 that, in effect, reintroduced bondage in America. I mean, people haven’t realized how bad that law was. If you owe a hundred percent—you know, amount of money that’s equal to a hundred percent of your income—you have a $40,000 income, you wound up with a credit card debt and other debt of $40,000—for the rest of your life you may be working 25 percent of your time for the banks. The way it works is very simple. They can take 25 percent of your income—you know, it used to be easy that you could go bankruptcy and you get discharged of the debt. They made it very difficult. So, you can pay 25 percent of your income every year to the bank, but then the bank can charge you 30 percent interest. So, the end of the year, you owe more money than you did at the beginning of the year, even though you gave 25 percent of your income to the bank. Now, this is an example of something that is clearly socially unjust.
AMY GOODMAN: This was passed when the Republicans were in control.
JOSEPH STIGLITZ: That’s right.
AMY GOODMAN: And this was 2005.
JOSEPH STIGLITZ: That’s right.