Like Candide, go and tend your garden (but share the produce)

Posted on Saturday, November 22, 2008 by nosleepingdog

The popular press is seizing upon greed and stupidity as causes of the ongoing economic ripoff, and that’s true as far as it goes, but there’s a larger context. Here’s part of a European take on it:

The malady of infinite aspiration
In the first of two issues of Esprit devoted to the economic crisis, editor Olivier Mongin argues that market crashes are less the fault of ignorant or irrational traders and more the result of a broader historical trend in politics, philosophy, and aesthetics. Since the nineteenth century, value is no longer a property of each object or idea, but determined by the price it will fetch on the market.

Enter the herd mentality: traders who expect the market to move in a certain direction buy and sell accordingly, and so cause the change they have predicted. Politics and the media are plagued by the same self-destructive introspection. Without stable values, politicians and journalists try to anticipate what the public wants, and attempt to buy into a rising trend. As public discussion converges on these predicted beliefs, it propagates them through society – prophecies that self-fulfil.

One current consensus, notes André Orléan, is that the financial sector needs more regulation. Look deeper, though, and ideological differences remain. The dominant perspective sees markets as sound in principle, merely distorted by concealed risks. Regulate to increase transparency, and markets will get back on track. This view is opposed by those who note that bubbles and crashes appear in the most transparent markets. Markets are too volatile, this group holds, and would best be helped by keeping them connected to the economy of the real world. These fundamentally different approaches deserve to be publicly considered, argues Orléan, and not relegated to technical discussions between economists.

This is from the Eurozine Review, which presents summaries in English from European publications.

The analysis in the third paragraph echoes that of Nassim Nicholas Taleb in a book I’m reading, Fooled by Randomness: the hidden role of chance in the markets and in life. Taleb is a mathematically trained and philosophically inclined trader in the US markets; it seems as though his early life, as a Lebanese Christian whose family lost everything suddenly during the decades-long civil war there, helped him realize the power of chance events and the fragility of human fortunes. He emphasizes not only the role of chance but also the need to consider not just the odds of an investment, but its potential downside. Such consideration precludes participation in bubbles such as the sale of mortgages and credit debt, packaged and presented as safe investments.

Our American attitude has always been one of denying chance; we exalt the individual’s ability to prevail and the concepts of unlimited positive progress. We now find ourselves in a situation where many negative trends/possibilities are beginning to affect us–ones which we have denied, ignored, deferred action and study upon, for more decades than the Lebanese civil war lasted.

If the popular reports from neuroscience and behavioral studies are to be believed, humans have built-in tendencies that make us unfit for facing the complexities we now live with. We embrace short-term gains and ignore long-term risks, we do not judge the magnitude of risks accurately (e.g. we worry about dying on an airliner but drive with blithe blindness to the odds of injury or death on the road), we have short attention spans, and when something conflicts with our established ideas we ignore it or make up reasons why it doesn’t apply (cognitive dissonance behavior). And so on, the list is long.

At this point the rhythm of writing demands that I suggest some positive courses of action in mitigation of what I’ve described, but if you’ve read this far you probably know as well as I do the sort of changes, individual and systemic, that need to be made. When things get bad enough, perhaps some of them will happen in sufficient frequency to help. Until then, we must be frugal, provident, and compassionate in our own lives, and work at extending those principles more widely whenever there’s an opportunity.

credit app offer

Posted on Saturday, November 8, 2008 by nosleepingdog

So here I am just now, reading on the Washington Post site about the credit card companies all reducing their unsolicited offers of credit:

The fourth-largest U.S. credit card lender [American Express]has already announced this week it would cut about 7,000 jobs, or 10 percent of its worldwide work force, in order to save $1.8 billion in 2009.

The article also says that American Express in particular is being investigated by the Justice Department for potential illegalities in merchant surcharges.

And right then, guess what happens? I get a popup window from American Express inviting me to take advantage of 0% interest for up to 12 months.

This is crazy but not surprising. I have to say that I’ve been waiting for the economic crash we are having since sometime before 1996, after I saw two things:

First, a tv ad for a bank showing a car being driven through one of those straight-line courses where you have to weave around cones–but the car drove right over the cones, scattering them. The bank’s pitch was, and I quote from memory, “We break the rules for you.” My immediate reaction was “No! Who wants a bank that breaks rules, that is out of control careening down the road? We want our banks to be serious believers in and observers of financial rules & laws. We want our money to be safe!”

Second, merchandise at a local chain marked with tags that said, “Want me? Buy me!” and the picture of a credit card. Great, go in debt with impulse buying, over and over.

I remember seeing both of these things before we moved from Portland in 1996, years before President Clinton signed the Gramm-Leach-Bliley Act in 1999 which is so often referred to as the start of the deregulation which permitted banks to act like carnival hucksters and drunken sailors, throwing our money around. The irresponsible financial behavior of institutions really did begin before 1999, as a December 1992 NY Times opinion piece shows when it quotes a bank promotion:

Apply for a loan now, and you’ll automatically be entered in our FREE LOAN GIVEAWAY. You could win a FREE LOAN — borrow up to $15,000 and NEVER pay it back!

The NY Times piece was occasioned by banks pressing Clinton for deregulation at an economic conference earlier in December 1992. According to the author,

Bankers promised to pump billions of dollars of new loans into the economy if only you [Clinton] would ease the amount of reserves banks are required to hold and waive other costly regulations. The new loans, they argued, would jump-start the sluggish economy — and not cost Congress a dime.

Does this sound familiar? Now it is the taxpayer and future generations of taxpayers who are “pump[ing] billions of dollars” into the banks emptied by lending out the money they had, to people who can never pay it back. And again the motivator, the political justification, is that it will “jump-start the sluggish economy” (although now “sluggish” has been replaced by even scarier words).

Economics and complexity theory: “It’s like a swamp”

Posted on Thursday, November 6, 2008 by nosleepingdog

An article in New Scientist (issue 2679, 22 October 2008, page 8-9) provides what I think is very useful perspective on the current global economic crisis. At the New Scientist site, the full text is only available to subscribers, but I think it raises issues we all need to know about, so I’m going to quote it in full here with my humble apologies to the New Scientist and the author, who do hold the copyright. My own comments and additions are interjected.

[I urge those interested in the scientific issues of our time to subscribe to this magazine, or read it at the library; it presents current scientific research and problems across the board of scientific disciplines, with a strong bias toward social implications. While you may not agree with the sometimes rosy expectations for application of science and technology to problem-solving, the magazine is the best single source of new insights into problem analysis that I know of.

The article is entitled “Why the financial system is like an ecosystem”, by Debora Mackenzie.

AS GOVERNMENTS struggle to prevent the global financial crisis turning into a deep worldwide recession, attention is also turning to the longer-term problem: how to avoid a similar crisis happening again. When politicians meet in Washington DC in December they are likely to agree that the “loose touch” approach to financial regulation of the past two decades will have to give way to tighter controls. But the global financial system now operates at a level of complexity no one has ever tried to tame. How do we re-engineer it so breakdowns don’t happen again?

One place to start is the science of complexity itself. We now know that large interconnected systems, such as the weather, can behave in unexpected ways: for example, small changes can trigger fundamental shifts. New understanding of the principles governing such complex systems offers hope that the global financial system can be got under control. The snag is that politicians will have to accept that costs are likely to be involved.

Existing economic policies are based on the theory that the economic world is made up of a series of simple, largely separate transaction-based markets. This misses the fact that all these transactions affect each other, complexity researchers say. Instead, they see the global financial system as a network of complex interrelationships, like an electrical power grid or an ecosystem such as a pond or swamp. In a swamp, certain chemicals that normally keep pond life ticking over can, under the wrong circumstances, trigger an explosion in the numbers of one species – an alga, say – which then goes on to strangle all other life in the swamp.

Similarly, they say, apparently unimportant changes that have crept into the global financial system may have triggered the current crisis. “Slow changes have been accumulating for years, such as levels of indebtedness. None on their own seemed big enough to trigger a response,” says Johan Rockström of the Stockholm Environment Institute. “But then you get a trigger – one investment bank falls – and the whole system can then flip into an alternative stable state, with different rules, such as mistrust.” To prevent events like this, governments need somehow to restructure global finance to limit these kinds of instabilities.

So how exactly has the financial system come to be so vulnerable? One key factor is that money can now flow more easily from country to country. This has stimulated trade and prosperity throughout the world, but it also means that an upset in one place can have severe and unpredictable consequences elsewhere.

Days before winning the 2008 Nobel prize in economics last week, Paul Krugman of Princeton University published an analysis which concluded that the rapid increase in cross-border investments since 1995 is what allowed a local shock – the collapse in inflated US real estate values – to propagate globally, especially through highly indebted investment firms that can respond to a loss of money in one place by pulling back credit anywhere in the world. Krugman noted that “these channels are not yet part of the standard analysis”. This is exactly the kind of linkage that the complexity theorists say economists have been missing. “The source of the current problems is ignoring interdependence,” says Yaneer Bar-Yam, head of the New England Complex Systems Institute in Cambridge, Massachusetts.

I would add that, at least in the US system, deregulation allowed a blurring and overlap of functions between banks, insurance companies, savings and loans, and other financial businesses. The packaging and selling of home mortgages is an example: instead of loans being made and held by local institutions, they were made by various sorts of institutions and then resold to other sorts of institutions as investments.

It appears as though the same bundles of loans were being sold and resold repeatedly in some cases. This creates a fragile dependency: the soundness of the investment depends on actions by the original lender, and subsequent buyers have no reliable way to know whether those actions were wise or even legal. The bundled mortgages were supposed to minimize risk because each investment contained multiple mortgages––like diversifying a portfolio of stocks––but in this case each bundle represented not stock from a single company, but mortgages from various sources, too many to evaluate given the scale of the transactions. And many bundles must have contained mortgages from the same few big irresponsible lenders (like Countrywide), thus undermining the diversification of risk. (I’m no economist; I’m just reasoning from what I have read over the past weeks.)

For example, he [Paul Krugman] says, financial firms calculate the risk involved in taking on a debt for each transaction separately, and then simply add them up to arrive at the total risk. This made the whole system look more secure than it actually was, because failure in some transactions can in fact multiply the risks of others. “They totally failed to account for couplings between them, which can change things dramatically,” Bar-Yam told New Scientist.

Warnings go unheeded

The banking industry itself was not entirely oblivious to this. In 2007 the Federal Reserve Bank of New York published a study, based in part on testimony from ecologists and engineers specialising in complex systems, which concluded that while vast sums were spent assessing the risks of individual investments, almost nothing was being spent on systemic risk – which could be much more grave. “It is really frustrating to me and others that the warnings were not heeded,” says ecologist Simon Levin of Princeton University, who was one of those who testified – all the more, he points out, because increased connectivity doesn’t just propagate trouble, it makes the whole system less diverse and more vulnerable to dramatic shifts.

According to Rockström, one of the key ways in which diversity was lost arose from the uniformity of criteria that have been used to judge economic success. One example of this is value-at-risk (VaR), the measure used by banks to report their potential losses from trading financial instruments. Since the late 1990s, it has been standard practice for banks to publicly report VaR measurements. When use of this measure was proposed, critics argued that this would encourage herd behaviour, with banks rushing en masse to sell off assets that were depressing their VaR numbers, but their concerns were ignored.

To prevent this sort of thing, complexity experts say that “firebreaks” that cut back connectivity should be built into the financial system, and that it must become less uniform. “The heterogeneity of the system must be restored,” says Levin. In other words, don’t let everybody become part of the same pond, all following the same rules.

This is unlikely to be popular with the banking industry: it lost diversity and gained connectivity in the first place because this cut costs and boosted profits. But such diversity is what allows ecosystems to remain resilient as conditions change; the same principle should apply to financial systems.

Achieving this is likely to be difficult, not least because in a complex network like the financial system, no one is in charge. And if international coordination were to happen, it could end up imposing even greater rigidity and uniformity. “Governments will have to be very careful, and set rules and limits for the system without actually telling people what to do,” says Bar-Yam. It can be done, he says, citing Wikipedia as a good model for such coordination.

Among the factors not mentioned here is one that seems fundamental to me: the ideal of never-ending growth that underlies our economic system. Economic diversity is maintained not just by restoring the legal differences between types of institutions––differences removed by deregulation––but also by taking steps to preserve larger numbers of institutions in each category. Here in the US we have already heard that some banks want to use bailout money to acquire other banks, thus continuing the very trend toward mega-institutions which has intensified the crisis. If the banking industry, for example, functions in some ways like an ecosystem, say a swamp, then we want lots of swamps of various sizes, not three huge swamps. (I must admit that the swamp analogy is especially appealing, given the slimy behavior of so many of these financial companies and executives.) But all the structure and ideology of this country’s economic system is in favor of growth: a larger company is a better company, the big fish eat up little fish and get even bigger so they can eat up bigger little fish.

Another way that this growth madness contributes to a crash is when companies “diversify” their activities solely based on profit margins, without considering their core strengths. Last week, for example, I saw a television ad for the aggressive refinancing company Ditech, and noticed that Ditech is part of GMAC, the General Motors financing division originally set up to finance car purchases. It may seem that it is easier to make money by collecting interest on loans, than by building cars (which has so many more complications such as labor unions, cost of materials, cost of energy for manufacturing, changing desires of consumers, etc.). Maybe it is easier, but it means entering a whole new world of risks too.

General Electric is another company most of us think of as an industrial giant, which has “diversified” into the financial business in a big way: “over half of GE’s revenue is derived from financial services” according to Wikipedia. Before the September/October crisis, GE was even working on selling off its industrial divisions (rail cars, appliances, even the “entire GE Consumer & Industrial group”. Why? “This is really a reflection of the fact that these are not growth engines for the company,’’ said William Batcheller, who helps manage $85 million including GE shares with Butler Wick & Co. from Youngstown, Ohio. “This has been [GE Chief Executive Officer Jeffrey R.] Immelt’s mantra: “We’re a growth company and we’re going to invest in the businesses that are growing and we’re going to trim the businesses that aren’t.” Then came the crisis (the part of it that we’ve seen up to now, it hasn’t bottomed out yet), and Oops!––

US conglomerate General Electric (GE) experienced a massive fall in third-quarter earnings as a result of the ongoing financial crisis.

With the weak financial sector, which normally contributes to a large portion of consolidated earnings, GE’s net income fell by 22 percent to $4.31 billion.

Earnings per share fell by 10 percent to $0.45, GE said in Fairfield, Connecticut, on Friday.

Its financial services division earned $2 billion, 33 percent less than the third quarter last year. Earnings from other GE divisions such as energy, infrastructure or business media with the broadcaster NBC Universal, however, grew. (source)

The bloated delusionary financial services sector that led to this economic disaster has crashed, which leads to reduced purchasing by consumers and businesses, which will mean less demand for the products of GE’s manufacturing and research divisions. Another proud giant of American industry bites the dust, perhaps, as General Motors seems likely to do.

Bar-Yam says, however, that he sees little evidence of such thinking in government responses to the crisis so far. For example, early in the crisis, US regulators put limits on the “short sellers” who speculate that a company’s stock value will stop rising. Short sellers were supposed to weed out weak firms, but a loosening of rules last year meant that they also brought down healthy ones. Bar-Yam says the result was like a predator-prey system run amok. Yet when regulators acted, they only stopped them attacking certain types of company, leaving them free to pounce on others. “It shows they still aren’t thinking about this as a connected system,” he says.
Bar-Yam thinks models of complex relationships such as those between predators and prey can help prevent such systemic problems, and show regulators how they can modulate market behaviour in a more sophisticated way. “We haven’t had the scientific tools to do this for very long. But we can now model the global system and capture the key collective behaviour that causes collapse.”

“At its core the science of complex systems is about collective behaviour,” Bar-Yam points out. “The invisible hand of the market is collective behaviour.” The problem till now, he says, has been that economic policy has failed to take into account the complexity and consequent unpredictability of such behaviour. In the absence of testable models, people “try to believe what they know really isn’t true”, he says – for instance, that real estate values always increase.
The remedy Bar-Yam proposes is to subject economic policies to verification with the same sort of rigour that is normal in science. That has never been done. “But with recent scientific advances, I believe we can now truly inform policy.”

I am not convinced that the science of complexity theory is ready for the powers proposed to it here, but it does offer a new way of examining and evaluating economic issues. At the very least it would be another tool to use. The ones used by those (like Alan Greenspan) charged with overseeing our system, seem to have failed us quite badly. The complexity model challenges some of the assumptions that Greenspan admits to having made; that alone makes it valuable.

Post-election rumor and divisiveness

Posted on Thursday, November 6, 2008 by nosleepingdog

Springfield Fire Department Photo by Dennis Leger

The Southern Poverty Law Center’s Hatewatch site carries news of a black church being set ablaze yesterday, the day after the election. Not in Mississippi or Georgia, but in Massachusetts.

[MA] Post-Election Church Arson Investigated As Hate Crime
The Republican / November 5, 2008
The torching of a black church a few hours after Barack Obama was elected president is considered a probable hate crime by federal investigators. [Read full article]

The second comment on this article (on the Hatewatch site) was notable:

ManchurianC said,

ON NOVEMBER 6TH, 2008 AT 12:04 PM

Gee, what a surprise. Way too many Obama supporters were threathing [sic] riots in the streets if their god lost the election so to me this is tame even if it is an anti-Obama burn.

I don’t recall there being Republicans hanging at voting places in this country with clubs threatening voters on the 4th as occurred in Philly by Black Panters [sic] dudes.

Payback can be quite rough, folks. Welcome to America. I am sure it will get much worse before it gets better. And that’s an optimistic view of things.

When I investigated this person’s claims I found much mention on partisan websites, but the factual basis was small or nonexistent. No one else had yet replied to ManchurianC, so I did, and reproduce it here in an effort to help defuse this sort of counterproductive discourse.

@ManchurianC,

These are dramatic charges. Can you provide some links to news coverage of these threats? Such comments can provide a basis for susceptible people to engage in counter-violence of their own, pre-emptive violence, or just harden their demonization of the other party. Without substantiation, these are just dangerous rumors.

In searching for the Black Panther news I found an account: 2 guys threatened voters, cops came, end of story. Bad, criminal, but not some kind of major movement. And, based on our observation of the Obama campaign all through this long time, the candidate and his staff would have condemned such actions (and may have done so, if asked, I don’t know). If 2 skinheads showed up at a polling place and tried to intimidate some group of voters, would we assume it was planned or condoned by McCain or the Republican Party? I hope not.

When I googled the threats of riots I found one article
http://newsbusters.org/blogs/p-j-gladnick/2008/10/08/james-carville-hints-riots-if-obama-loses
where a blogger used a comment by James Carville and led it off with a “riot” headline that did not represent what Carville said. Carville said he thought the election was going to go to Obama, based on polls, then added:
“But you stop and contemplate this country if Obama goes in and he has a consistent five point lead and loses the election, it would be very, very, very dramatic out there.” No mention of riot. Had the lead belonged to McCain, and a Republican talking head had said the same thing, would we be accusing McCain and his party of encouraging riots?

Another blogger cites an AP article with the headline “Obama warns of ‘quiet riot’ among blacks” but goes on to give Obama’s actual words, which were as follows:

Many of the folks in this room know just where they were when the riot in Los Angeles started and tragedy struck the corner of Florence and Normandy. And most of the ministers here know that those riots didn’t erupt over night; there had been a “quiet riot” building up in Los Angeles and across this country for years.
If you had gone to any street corner in Chicago or Baton Rouge or Hampton — you would have found the same young men and women without hope, without miracles, and without a sense of destiny other than life on the edge — the edge of the law, the edge of the economy, the edge of family structures and communities.

Those “quiet riots” that take place every day are born from the same place as the fires and the destruction and the police decked out in riot gear and the deaths. They happen when a sense of disconnect settles in and hope dissipates. Despair takes hold and young people all across this country look at the way the world is and believe that things are never going to get any better. You tell yourself, my school will always be second rate. You tell yourself, there will never be a good job waiting for me to excel at. You tell yourself, I will never be able to afford a place that I can be proud of and call my home. That despair quietly simmers and makes it impossible to build strong communities and neighborhoods. And then one afternoon a jury says, “Not guilty” — or a hurricane hits New Orleans — and that despair is revealed for the world to see. [end quote from Obama]

The blogger who quoted Obama’s speech goes on to say,

Obama is actually making a subtle and interesting point. He’s not saying that “quiet riots” are actual riots or that the quiet riots inevitably produce the actual ones. By contrast, he’s saying that “quiet riots” aren’t riots — they are things that devastate communities, such as crime, joblessness, localized violence, and inner-city despair. He’s saying that we shouldn’t need high-profile events like Katrina or the Los Angeles riots to alert us to the “quiet riots” that have been going on in the background for years and years.

Nor is Obama saying, as the AP claims, that the quiet riot currently “threatens to erupt” into new riots comparable to the ones in Los Angeles. That idea simply isn’t in the speech. The AP just dreamed it up. As a result, Obama suddenly sounds like he’s trafficking in the sort of rhetoric that conservatives love to get outraged about: That we’d best minister to inner city problems lest we have another big riot on our hands. Obama just didn’t say this at all.

Shameful, profoundly incompetent garbage. Just awful.

Please, everyone, our country has more than enough problems without putting a vicious meaning onto innocuous words. And it is highly irresponsible to write words that seem to accept arson of a church as not so bad, because the other side had (allegedly) threatened or done worse things. It’s easy to hold yourself aloof and be condemnatory, with or without facts to back you up, but at this point the election is over and the best American tradition is to come together and work together for the mutual good, not try to stir up anger and thereby undercut positive action that benefits us all as a nation.

President Bush’s approval ratings, and the results of “Do you think the country is on the right track?” polls, indicate that most Americans think our country is not doing well and not on the right track. We had an election, it was nowhere near as close as the last two, and now it’s time for positive action. Help shape the actions that are taken by making your thoughts known but don’t try to paralyze us with rumors and divisiveness. Don’t be Nero, fiddling while Rome burns: you’ll have to live in the charred ruins just like the rest of us.