More about credit cards, debt, pyramids, and eschatology

My recent post “Why I’m canceling my Bank of America credit card” brought a comment pointing out that cancelling credit cards can adversely affect one’s credit score, perhaps making it difficult to borrow for cars and houses. That may well be true, but it seems to spring from a view of credit and debt quite different from mine. Rather than dump this on the hapless commenter as a reply, I’ll say it here.

First, the companies have no incentive to restrict credit, and I expect they’ll soon be back to sending out credit apps to dogs and kindergartners. When the banks lose money through extending credit unwisely, they raise rates on the rest of us to recoup. Worst case, as now, the taxpayers bail them out, they buy each other up, write off debt, get tax breaks for losses. So I think people can safely cancel all but one or two cards, and still be able to use credit to make major purchases.

Second, I’m hoping that ordinary people, who DO have an incentive to learn from the present debacle, may start restricting their debt to large necessary items. Cars and houses usually do require going into debt. But I’m old enough to remember life without credit cards; my mom had a metal “charge-a-plate” for Macy’s, and there was layaway at some stores, but no credit cards. If you wanted something you saved up for it. If you couldn’t afford to go out to dinner, you didn’t go. To those accustomed to incurring chronic credit-card debt for indulgences, such a life may seem a bleak prospect. But actually I recall very few people growing despondent for want of cruises, concert tickets, and designer handbags.

Back in the 1980’s when I saw items at an Oregon department-type store bearing tags that said “Want me? Buy me!” and a credit card logo, I viewed it as a dangerous & selfish attitude to cultivate. Along with it came the re-definition of human beings as “consumers”.

The present economic system is a pyramid scheme because it is predicated on continual growth. We do not live in a world of infinite resources and space, therefore neither population nor consumption/production can continue to increase forever. Business interests, and even the administration, expect increased consumption to get us out of this depression. If it does, it can be only a temporary fix.

I know there are a lot of optimists out there who say not to worry about dismal stuff like the economy, climate change, and all that, because the world is going to end in 2012 (Mayan Calendar theory) or “soon” (some Christian fundamentalist theories). But I just can’t be that optimistic. Call me crazy, but what if we’ve got those Mayan numbers just a little bit wrong? Or some translator introduced an inaccuracy into the Book of Revelations? What if God has changed His mind, and now thinks it might be amusing to see how His little creatures manage with these challenges? We just can’t know. Better to keep our eyes on the ball, as it were (in this case the planet & its inhabitants) and not count on the Umpire calling the game on account of End of Time.

Desperate retailers: come get free stuff!

JC Penney, one of America’s big traditional retailers, sent out “savings certificates” in early December offering $10 off a single in-store purchase of $10 or more. There were exclusions, including cosmetics, electronics, cookware, and small appliances, but even so there must be plenty of small items like gloves and sox, that would be less than $20, for a discount of >50%.

JC Penney has slipped in the Fortune 500 ratings of America’s largest corporations, from number 74 in 2005, to 126 in 2008.

The Top Ten for 2008?

1. Wal-Mart Stores

2. Exxon Mobil

3. Chevron

4. General Motors

5. ConocoPhillips

6. General Electric

7. Ford Motor

8. Citigroup

9. Bank of America

10. AT&T

AT&T has been buoyed by merging with Cingular and others, and by the success of the Apple iPhone. The oil companies are doing very well, but all the others on this list are reeling from the end of the finance bubble, except for the only retailer: Wal-Mart. It’s our giant conduit between the US and China—jobs go out, Chinese landfill fodder comes in. What do we fill those ships with for their return voyages? Oh yes, dollars and T-bills.

Developed nations circling the drain

In a related note, io9 summarizes a news item in the journal Foreign Policy:

Remember back when you knew you were in the so-called developed world because the economy was doing better than the so-called developing world? Well times are changing. Today the International Monetary Fund announced that, for the first time since World War II, the world’s developed economies would be shrinking by 0.3 percent in 2009 and America will decline by 0.7 per cent. American unemployment is at a 25-year high. When the globe emerges from this economic shakedown, membership in the “developed” club may have changed dramatically. [via Foreign Policy]

A few more cheery predictions:

Japan’s estimate [of growth, by the International Monetary Fund] was trimmed to 0.5% growth this year and a 0.2% contraction next, compared with the previous estimate for growth of 0.7% in 2008 and 0.5% in 2009.

Forecasts for emerging and developing economies were adjusted even more sharply, with the 2008 growth estimate falling to 6.6% from 6.9% and the 2009 forecast dropping to 5.1% from 6.1%.

“Among the most affected are commodity exporters, given that commodity price projections have been marked down sharply, and countries with acute external financing and liquidity problems,” the report said, while noting that China and other countries in East Asia are generally in better financial and economic shape.

China’s 2008 forecast was left unchanged at growth of 9.7%, while the 2009 estimate was cut to 8.5% from 9.3%. [Wall Street Journal blog, Nov. 6, 2008]

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

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.

What should happen at the International meeting on the economic crisis?

On Nov. 14 and 15, leaders from around the world (the “Group of 20”) will meet in Washington DC to negotiate a response to the continuing economic crisis. An article from the Washington Post on Nov. 2nd gave some good background to this meeting, for those of us who are not versed in international finance. An article yesterday at bloomberg.com gives more detail.

Discord on Economies In a World Of Trouble––
Conflicts Emerge as Nations Seek Solutions

By Steven Mufson, Mary Jordan and Edward Cody

Washington Post Staff Writers

Presidents and prime ministers from major countries around the world will gather in Washington in two weeks to begin heated negotiations over the shape of global financial regulation as they scramble to avoid a deep worldwide recession and restore confidence in markets.

Key European allies are pushing for broad new roles for international organizations, empowering them to monitor everything from the global derivatives trade to the way major banks are regulated across borders. But the Bush administration has signaled reluctance to go that far. In the past, it has resisted similar proposals as potentially co-opting the independence of the U.S. financial system or compromising free markets.

Some economists and policymakers say the summit could launch important reforms. But others predict it could turn into an economic tower of Babel, with weak political leaders promoting solutions fundamentally at odds with one another. And if leaders cannot bridge their differences, they could risk another bout of financial disarray.

There are also differences of opinion on the issue of timing. French President Nicolas Sarkozy, who pressed for the 20-nation summit, says it must produce concrete and immediate results. But the host, President Bush, is a lame duck who says the meeting will be “the first in a series” and should focus on principles even though “the specific solutions pursued by every country may not be the same.” Emerging proposals to sharpen existing regulatory tools appear to conflict with plans to create entirely new ones.

What is clear is that expectations for the summit among many observers are high.

“At the moment, I don’t think it would be acceptable for the major leaders to come back from this conference and to go to their respective parliaments or whatever and say, ‘Yes, we rearranged the deck chairs a little bit.’ Because this is genuinely a Titanic crash,” said Howard Davies, director of the London School of Economics and former head of Britain’s financial regulator, the Financial Services Authority.

But no matter what parliaments and people may think about the need for prompt and effective action, it seems to me unlikely that the meeting will succeed in doing much more than talking; the establishment of a new global economic monitoring agency with “teeth” faces too many obstacles: lack of preparation, lack of a precedent or foundation for such a global regulatory institution, too many parties who must agree, Chinese insistence on unfettered national sovereignty.

The summit does have a precedent, one reaching back more than six decades. At the 1944 Bretton Woods conference, world leaders gathered to design the current international financial architecture, laying the groundwork for the International Monetary Fund and the World Bank. The Nov. 15 summit has been popularly referred to as Bretton Woods II.

But this time is different. Two years of preparation went into the 1944 summit. And whereas the United States and Britain largely shaped the postwar financial system, financial regulation and coordination will now require the participation of a broader and more unwieldy group, including emerging economies, many of them loaded with foreign exchange reserves, foreign debts and influence over global financial markets.

Those emerging economies, far from being “decoupled” from traditional industrial powers as many analysts believed just a few months ago, have found that they and more developed nations need one another.…

Bush, meanwhile, has been reserved. “We need to proceed with caution and care but also with all due speed,” White House press secretary Dana Perino said recently. “The president is concerned about moving too far too fast and wanting to avoid unintended consequences.”

Locking In Allies

World leaders are already maneuvering for position. Sarkozy, in particular, has methodically sought allies.

He won a key, although carefully worded, endorsement for action from China on Oct. 25 in Beijing, where a Europe-Asia economic cooperation summit called for more regulation of global financial markets.

“Each of us perfectly understood that it was not possible to meet [Nov. 15] just to talk,” Sarkozy told reporters at a closing news conference.

“This is about no less and no more than the creation of a new financial constitution,” German Chancellor Angela Merkel said.

Sarkozy has also called a Nov. 7 summit of the European Union’s 27 heads of state and government in hopes of winning a Europe-wide mandate to demand swift action in Washington. Recognizing Britain’s special contacts with the United States, Sarkozy invited Prime Minister Gordon Brown to a strategy session Tuesday at a presidential retreat in Versailles.

Still, despite all the posturing, there are different views on what concrete action would mean.

Sarkozy and Brown have voiced support for a new international regulatory body to supervise large transnational banks. Brown has called for strengthening the Financial Stability Forum, created after the Asian financial crisis of the late 1990s. The group of central bankers, finance ministry officials and international financial institution representatives produces important recommendations, Brown said in a speech this week, but, he added, “It never had enough teeth.”

Merkel, who has been more conservative in dealing with the crisis than the hard-charging Sarkozy, favors a stronger International Monetary Fund, giving it a supervisory role in international finance and making it a “guard” of financial stability. Brown, too, has proposed making the IMF “an early-warning system” for financial problems, singling out low bank capital ratios or wildly mispriced securities.

IMF officials have embraced the idea that the fund could take on a larger role, perhaps as part of a secretariat involving other multilateral institutions.

Sarkozy has also sought support for proposals to curtail tax havens with new international investigative powers; require increased transparency on high-risk hedge fund investments; and regulate financial traders’ compensation packages in a way that would reduce the incentive to make risky investments. But a French analyst said Sarkozy may scale back some of those ambitions given U.S. opposition. “He may have overreached a bit,” said the analyst, who spoke on condition of anonymity so that he could speak candidly.

Japanese Prime Minister Taro Aso, in power just five weeks, spelled out in a nationally televised speech Thursday night what he wants from the summit: international regulation of financial institutions and of credit rating agencies as well as standardized accounting for international business and markets.…

China may prove more cautious than any other nation. Wu Xiaoqiu, director of the Institute of Finance and Securities, said he thinks Chinese officials, while joining their European counterparts in calling for an overhaul of current regulatory systems, would stop short of supporting a proposal for a worldwide organization with significant power.

“It is important to have an agency which can coordinate the global market and policies of different countries,” Wu said. “But China doesn’t like the idea of having a global SEC since no organization should affect the sovereignty of countries.”

Prospects for Politicians

For some leaders, the financial crisis offers a political opportunity at a time when electorates are deeply concerned about the future. Brown, Merkel and Sarkozy are all facing low approval ratings.

“I think all of the governments are uncomfortably aware that they have got very, very nervous electorates. Point one is just to show that somehow there is an agenda which can allow people to feel that something’s under control,” said Davies, the director of the London School of Economics. “People like Sarkozy, in particularly, and Brown know that their future depends on it appearing that they are responding adequately to this crisis.”

There are dangers, though. The pressure to be seen as taking vigorous action could lead to overregulation, say many business leaders, especially in London, where the financial services sector plays a key role in the economy.

Willem Buiter, a professor at the London School of Economics and a former Bank of England policymaker, said he feared “we will . . . end up regulating so tightly that a lot of financial institutions will be untenable and unprofitable and we will spend the next decade slowly chipping away at over-regulation.”

Disunity is another risk. If world leaders fail to coordinate, the consequences could be severe. Their staggered responses to the financial crisis in September contributed to bank runs and currency fluctuations, as money fled to whatever country was promising the most generous guarantees.

“If we forbid alcohol in two pubs only, everyone would just go to the other pubs,” said Dimitrios Tsomocos, professor of financial economics at Oxford University and a consultant to the Bank of England, who added that one nation’s regulatory scheme must not be more attractive to business than another’s.…

Robert Hormats, a vice chairman at Goldman Sachs and former National Security Council staffer, said that the November summit would be valuable if it became the first in a series of G-20 meetings, widening economic coordination.

“We’re at a point of time where the role of emerging economies has become very apparent and where the G-7 does not have the capacity in the eyes of many people in the world to solve this problem alone,” Hormats said.

“We’ve learned from this crisis that you can’t conceivably in the future try to pretend that the global financial system can be run by the occasional phone call between the Fed, the Bank of England, the SEC and the FSA,” Davies agreed. “That’s not going to work anymore.”

Brown, in a speech to business leaders in London this week, said, “We have got to . . . involve China, India and all the emerging market economies because the world economy is changing before our eyes, and the system that is just built on Europe and America will not survive the test of time.”
.

credit app offer

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.

amexad.jpg

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”

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.

A short comment on the economic bailout

So many bloggers and talking heads comment on big political issues that I have steered clear of them; believe me, I rant a-plenty in our living room! But in my lifetime only two other distinct events have stood out, at the time of occurrence, as of such great importance for the future. The first was the assassination of John F. Kennedy; the second was 9-11 (though most of the disaster that has followed it has been chosen and created by the Bush administration). And this is the third.

I’ll keep my comment short. Here’s the email I just sent to Nancy Pelosi.

Dear Madam Speaker,

My husband and I, lifelong Democrats, commend you for your courage and good judgment in standing against the bailout bill. I also heard your interview last Thursday on NPR and was well impressed with your arguments and articulate presentation. I wish we could vote for you.

But be assured that many out here agree with your position. I do not know if you share my belief, that our economic structure is not just tilted drastically in favor of big interests–everyone knows that–but is unsound at its core, based on speculation and unending growth that cannot continue. Hence a series of bubbles that burst. The citizen always gets hurt whether by mortgage foreclosures that can devastate a family for decades, or by inflation, paying for bailouts, increasing the national debt, and so on. The war may be a distraction, as one of its purposes, from all this.

There is no “free market” when the biggest players set the rules and then are bailed out when they break them. At this point in history a free market is neither desirable nor possible. Let’s start changing it to a market that benefits the majority of people (not just by providing low-wage jobs) and benefits the planet and our succeeding generations.

Respectfully,

[me]

rural southern Oregon