Monday, April 13, 2009

The Critical Mass

A critical mass is near. It seems that even the neoclassical economists and pundits now agree that the bailout model of economic recovery has failed and a wholesale change will be necessary. Public opinion is gradually swaying in favour of letting the bankrupt companies go bankrupt. And the truth about how we got into this mess is taking precedent over politicians and their subservient media lapdogs are trying to tell us.

"The problem" has reached a consensus viewpoint. Score one for the side of common sense. "The solution" is being debated and deliberated ad infinitum.

An interesting interview of William Black by Bill Moyers crossed my radar last week. Interested readers may wish to view below:

Neither of these guys would be considered favourites of mine. But I like this interview because it highlights some of the absurdities that went on during the boom years. It was exactly what Black describes it as. Fraud. It was done with impunity. They knew they were doing it and they knew that it would blow up at some point. But they did it anyway. And they lied about the risk all the way. "You're saying our entire financial system became a ponzi scheme?" "Yes."

Unfortunately, Black seems to contradict himself quite a bit in this interview. He states over and over that we have fraud laws that were supposed to prevent "false representation" yet those laws were rarely, if ever, enforced. But he then goes on to say that "more regulation" is the solution. And states some politically partisan populist stuff like "Bush essentially eliminated regulation." Of course, we know that it was not the absence of regulation, rather the corruption of government regulators that led to all the shenanigans. This is something that history has proven correct time and time again. Government regulators are held hostage to those that pay their salaries. Those that pay their salaries are easily influenced by lobbying and campaign contributions that urge turning a blind eye in order to achieve a certain short-term goal (accounting standards prior to earnings season, for example).

The solution obviously isn't to have more of this. It is to actually charge those responsible for fraud to the most punitive extent allowed by the law (life in prison) via judge and jury. Consumer choices will handle the rest of the regulating. If they don't think their savings are safe at a certain bank, they'll pull their money out and put it in another one. The irresponsible bank goes under and the responsible ones gain customers. It works the same way with auto manufacturers or food processors. If people are getting sick from eating a certain food product, they'll stop buying it and the company will go out of business after being sued by those that were made ill. There are very few exceptions (some would argue none) where government regulation can achieve what already written laws cannot.

Another interview I found interesting was Paul Krugman on CNBC last week. I obviously don't agree with much Krugman says. He's what best could be described as a "radical Keynesian." But even he realizes that none of what is being done by the Geithner/Summers/Rubin team are going to solve anything.

I highly recommend my readers have a listen to a 55 minute interview given by Austrian Economist and author Tom Woods on Financial Sense. He discusses with Jim Puplava his new book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. An Mp3 of the interview can be downloaded by right-clicking here. Or you can click here to listen online.

I also found myself in broad agreement with Nassim Taleb's Financial Times article, "Ten Principles of a Black Swan Proof World."

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

Well put, Mr. Taleb. However, I'd like to know whether it is humanly possible for such common sense to last for more than the lifespan of one person? Are we capable of sacrificing short-term gain for long-term pain if nobody has felt what that pain is like and only understands it via the history books? I suppose the answer doesn't matter. Whether our ancestors destroy the checks and balances we set up for them is up to them. For our sake, in this lifetime, we should be heeding your advice.

A cartoon from the Chicago Tribune all the way back in 1934 teaches us one very important lesson: "The more things change, the more they stay the same."

The media would have you believe that those who are outraged enough about all of this to take their anger to the streets are nothing but jobless, lazy, anti-government nihilists. A group of about 200 of these rabble rousers gathered in front of the San Francisco Federal Reserve last weekend to express their misplaced discontent. Don't these anarchists have anything better to do? It's a good thing there were approximately 50 riot police on the scene to quell any disturbances.

Hmm. Upon second look, it appears this band of riffraff is nothing but a cross section of the American middle-class. Fully aware that they are being robbed blind by those who claim to be helping them. But pay no heed to this most natural expression, readers. Don't question authority. Capitalism is to blame for all of your problems and the government is here to help you...

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mike.montchalin said...

I really enjoyed Matt's critique of Black.

Black does bring up the important point of fraud.

What dismays me is the lack of attention given to congressional fraud. I mean, every congressman who voted for the AIG bail out was committing a fraud and should be prosecuted.

Anonymous said...

Matt- take a look at this blog before Goldman shuts it down with law suits (already started)

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