The Recession, Human Greed and Economic Models

My own, amateur, view of the current recession is that human greed was all important as a primary cause, but greed was much aided by a lack of regulatory oversight and accounting rules were missing, or finessed (ignored), for reporting the actions of hedge funds. There was also an unwise and unquestioning knee-bending to the ideological ideal (vastly unworkable) of the free-market. It was inevitable these factors would bring everything crashing down.

Consequently, I find it remarkable how remarkable and shocking many observers, not all amateur like me, find this recession to be. Why the surprise, I ask, when it seems so clear that the free market capitalism model (aka "the big dream") neglects, or better, can't handle greed and other mysteries of the human psyche. These human "qualities" are so controlling of economic models because of their uncontrollable and unquantifiable nature, so it should seem to any one with common sense.

But there were historical warnings about greed. During the Big Depression of the '30's, John Keynes' wrote about the "dark animal spirits" that served to spoil the nice, clean economic (capitalist) model of Adam Smith (Wealth of Nations, 1776). Keynes posited "animal spirits" as the model-blitzing human factors that put the kibosh on Adam Smith and kin, (Keynes, The General Theory of Employment, Interest and Money, 1936). Keynes' notions about economies falling prey to human weakness/spirits are most recently expanded in another book, Animal Spirits (Akerlof and Okun, 2009). Prof. Okun gives a current overview of the Keynes-Okun-Akerlof evolution in the new Financial Times series on the future of capitalism.

Although Professors Akerlof and Okun are owed gratitude for their new book, it is curious that from 1936 (Keynes) through 2009 (Okun and Akerlof) there haven't been more of major investigations into the human-contributed weaknesses of free-market modeling. Maybe there have been, but there has certainly not been major insights that could have prevented idealist, free-market capitalism from becoming the destructive false-god leading to the binge and bust market cycles (junk bonds, savings and loan, dot-com, hedge funds through subprimes) over the past decade and more.

Prof. Okun aptly summarizes about the current recession:

"The idea that unfettered, unregulated capitalism would invariably produce the good outcomes was a wrong economic theory regarding how capitalist societies behave and what causes their crises. That wrong economic theory fails to take account of how the animal spirits affect economic behaviour. It fails to take into account the roles of confidence, stories and snake oil in economic fluctuation".

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Personally, I would add: "Good luck, Drs. Okun and Akerlof, because luck is the only chance you will have trying to model human nature. And no matter how hard you try, I betcha the human psyche has many more twists, tweaks, and tricks that will rise from the dark and outwit you. Ahh, the genius of the mind." (Attributed to me!)

Solution? Obvious - hard regulatory boundaries then let the bulls run.

Medicine for a Sick Stock Market

The Pill: ban short selling --- until the Dow hits 8500?

Bail out money is being sucked down a bottomless pit created by stock market manipulators (short sellers).

HuffingtonPost reports on the short sell manipulations of one hedge fund manager who amazingly says:

"What's important when you are in that hedge fund mode is to not be doing anything that is remotely truthful, because the truth is so against your view - it is important to create a new truth to develop a fiction,.."

Obama and team should take care of this problem soon.

Limbaugh: the Dem Quandry

I first came aross Russ Limbaugh some years ago. My still fresh mind was struck by the distortions, twists of facts and outright lies coming from this person. It seemed impossible to me that someone could say these things over the public airways without control, or not be sued for libel, incitement to public sedition or simply tossed off the air.

But over a couple of months of RL, my astonishment changed to mild amusement. The distortions and twisting of reality carried a kind of iconoclastic thrill. But it never left me that RL's message was a kind of radio circus - empty vocalizations with no purpose or meaning except for their shock.

I felt RL was not called to account because actually he fits into the role of medieval fool, an often physically handicapped, or mentally challenged person historically tolerated because his only reason to exist was to make people laugh.

In time, though, the utterances of RL returned to their original impact on me but they were sounding even more distasteful than at first. As his audience increased in size, and became regionalized I began to see how destructive RL's vocalizations were becoming. I saw no difference bewteen his "exaggerated distortions" and the urgings and shouting of historical demagogues who spawned really bad consequences.

It did not surpise me that Russ Limbaugh was eventually revealed to have a pharmaceutical addiction. Something had to have been afflicting him.

I still find it fascinating that RL can vent such lies and distortions without check or serious blowback. I think one big reason is that very few Dems can stand even to mention his name. There are reasoned counters to RL: Keith Olbermann, Rachel Maddow , but maybe the most willing, and exceptionally able, to go down into Limbaugh's snake hole and smoke him out is Randi Rhodes (imho). Randi takes no prisoners when it comes to RL.

Behind the Recession: MBA Follies #3

Many fingers are pointed at the collapse of the subprime market as the reason for the world global recession. Question: why was so much faith put on the subprime mortgage market when by very definition the word "subprime" denotes shaky, high risk. The answer is that subprimes were combined with other investment assets in hopes to lessen the risk, Hedges. So were created a new type of esoteric investment that no one really understood or could predict about where they would lead.

A smart mathematician, not necessarily a businessman, developed an equation that at first seemed to make it possible to simplify the economics of packaging and selling subprimes. Of course it turns out that the initial enthusiasm for the equation was unfortunately premature, i.e. empty.

The reason why the equation does not work is a very human weakness for letting the promise of great riches overshadow common sense. In the case of subprimes, the very esoteric mathematics assumed that housing prices would increase FOREVER!. Hmmmm.

Worse, it did not occur to anyone at first that just for the giggles, why not see what the mathematics would predict if housing prices did not increase forever. The answer would have been easily obtained and quite clear - everything would collapse along with the housing prices, ergo the recession. ["Recipe for Disaster: The Formula That Killed Wall Street", Wired online, 17:03].

One of the interesting new business science concepts is a whole new study field, "financial engineering" (aka computational finance), which is an attempt to package for our comprehension the new world of exotic (read incomprehensible to ordinary folk) financial devices such as derivatives, e.g. hedge funds. These new wrinkles in high finance are almost impossible to understand even for professional auditors. However, it should be noted that the most famous (or infamous) example of this new field is the subprime equation mentioned above. Will all this lead nowhere? Depends on whether really smart people can hold on to their common sense...which could be diificult when one is functioning in the rarified air of higher learning.

"Trickle Down": The Trauma, Oh The Trauma

No, Dorothy, there is, was, no "trickle down" economic effect. More, it was the "stash away" - offshore, mega bonuses,...smoke and mirrors.

Cooperation Needed: Harmonizing the Global Financial System

Since early 2008, many of the leaders of the major industrial nations, even China, have urged out loud that the world needs a universal and multinational (cross border) set of financial rules for our increasingly interrelated global economies. The term used is "Global Harmonization", which can be pictured as an orchestra, with no conductor and with each instrument playing its own tune, deciding to hire a conductor to guide the separate instruments (national economies) to play together from one sheet of music (the harmonized accounting rules). Today"s international electronic money system is like a conductorless, discordant orchestra. The new president should shore up Basel II accord and champion a working multinational financial regulatory system (e.g., Organisation for Economic Co-operation and Development).

A globally harmonized set of financial rules would help prevent future global recessions and prevent total world financial collapse mainly by making it possible to determine where and how much risk there is in the global financial markets. These rules would coordinate the various financial centers (exchanges) and the entire global financial network. The rules would apply uniform financial controls focusing on more rigorous accounting standards that put a leash on the new financial investment devices such as derivatives and hedge funds, and do not allow cover ups, disguises, lies. Harmonized financial rules are now critical because the new financial world is exotic, hard to understand and practically impossible to audit.

Setting up a solid information base capturing global financial exposures is imperative. There is a long list of exposures that are not transparent today, for example the cross-border links between large, complex financial institutions (LCFIs) and the whereabouts of credit default swaps, collateralised debt obligations and other asset-backed securities. Putting together a global “risk map” displaying financial links among LCFIs as well as the most important risk drivers, such as asset price changes and yield spread dynamics, would enable authorities to carry out financial system stress tests.

The new financial exotism with derivatives on top of derivatives and cresit swaps of increasing distance from sinmple real assets, along with the lack of matching controls, was a major factor in causing the current recession. As noted by the Harvard MBA holder, Philip Broughton:

“What we have witnessed is a stunning and sobering failure of financial safeguards,......”

We should note: global harmonization is not new; it's just that first, accounting controls are such a sacred cow it has been difficult to create a universal set of rules, i.e an international standard. Second it is hard to get the economic trading nations to adopt a unifom accounting rule.

There are many instances of international standards. One is the International Standards Organization (ISO). ISO has developed over 17500 International Standards on a variety of subjects and some 1100 new ISO standards are published every year. Harmonization of one important segmant of this body of standards, medical devices, is well along the path to completion. The United States, Europe, China, Japan, South america, and many other countries and regions now have the same set of rules for approval of medical devices, and pharmaeuticals. Some problems (non-participating countries)still exist but the near future looks positive.

Some have reacted to global harmonization with fear of the new. Harmonization does not mean global New Deal! But harmnonization is necessary.

The idea of a global, multinational set of financial standards and systems has been growing, but might meet strong opposition from some political ideologists. For instance, some history-preservation conservatives will no doubt view a global system as a threat to the 18th century, self-suficiency spirit that led the Founding Fathers declare independence and to split off the United States from England - a move that was critically aided by the convenient separation of 2000 miles of ocean during the sailing ship days.

But, this is not the 18th century, we are into the 21st century. Modern life and its required systems grow more complex by exponential progression. The coastal villages of 18th century America are no more. National isolation is not a reality even for someone in rural Tennessee -there is no longer a pure, food self-sufficient, self-defense capable, rurality left in America.

The founding fathers did not fly to constitutional conventions in private jets - horse back or carriage travel covered 40 miles a day.They did not communicate by cell phone and private video links. Did not speak internationally in an instant (it took weeks to communicate by ship-born pouch to Europe and China). There were no airplanes. No mass markets. No international electronic banking exchanges. No automobiles. No need for oil beyond some lamp light and most could get by with candles.

It's time. Global coordination and harmonization of financial systems is a critical urgency.

GOP Morphing: The Child Krohn - More to Come?

Today, for first time, I saw and listened to the GOP child-political-"expert", Jonathan Krohn (JK), via HuffingtonPost. 13 years old?!??! JK spoke at last week's Conservative Political Action (CPAC) meeting. One does not like to disrespect children who should evoke nurturing and similar positive responses, but JK comes off like a Bible Belt child preacher at a revival. Lingering weirdness after the vid. Regret peeking through that fence hole. But since I didn't put up Jonathan for adult examination, and considering the seriousness of the subject he speaks on, the economic crisis and conservatism, I have to desribe his effect as wonderment akin to listening to a trained parrot. Others write the same with better phrasing.

More the issue: is this how "unusual" (bad, strange,...) things are in the GOP? Are we to listen to and equate a sharp witted child to a George Will? Hardly. Are we to equate this child to a Russ (Limbaugh)?...Hmmm, well...maybe this works, indeed,..reversal of this logic leads to 'Limbaugh is just a witty child', am apt label, imho. But to be serious, are we to believe the depths of conservative political philosophy pondered over historical spans by learned adults have emerged in a child's voice at a revival tent venue, the CPAC conference? (Hmmm..Limbaugh the child again.)

(Miles of symbolic blank space here to transmit a loss for words, but here's a try.)

I think my unsettledness comes from suspecting the new GOP base takes this child seriously? It seems they do. I believe in and enjoy child prodigies in music, but life is not a set of instructional or compositional rules. Life is complex and subtle, at least to me, don't really know about you or others but I suspect you're all with me. Never heard of a child philosopher but i am not a student of philosophy. Name one child prodigy in oil painting...maybe there is one which raises the issue of what is art vs technique..on the other hand even elephants paint nowadays...let this go.

A clue to the JK appearance is as I posited in an earlier blog (Feb 26, this blog): to the GOP the child represents not a child but a label, in this case a label announcing the rural GOP tradition of the a religious spirit channel through the biblical voice of a child.

What further demonstrations: of spirit speaking, channeling, calling out, ....might come from GOP morphing contortions? Probably some prize winners will emerge, but to guess what's coming ....the cost to travel to that land of the imagination is too high(hangovers, etc).

As I posited in an earlier blog, the GOP is likely to take on unusual shapes as it morphs along to where ever it will end up (Feb 26, '09).

A third ring to the GOP circus is bound to come...maybe more...it's only March 1, '09.