deregulation

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Oh, Those Crazy Mega-Banks

Oh dear. I managed to avoid talking about banks for quite a while. It seems time to revisit our favorite villains. They’re up to no good again.

The problem with banking, as someone far wiser than I once said, is that banks are more dangerous than standing armies. I guess he must have said that back before the contemporary American infatuation with all things military. But the point remains the same.

Banks are dangerous. Really and truly dangerous. And the bigger they get the more dangerous they get. Comparing a mega-bank like Citibank with our local three branch small bank is ludicrous. They may look and sound similar, but they are in different universes. It’s like comparing a bee-bee gun to a nuclear bomb. They both can go pop. But one can do an awful lot more harm.

So much so that our regulators are scared stiff of regulating them.

You probably missed it, but one of our regulators recently admitted that his agency was afraid of enforcing the law against a big bank because of the mess it could make of the economy were it even rumored to fail, let alone actually fail. This attitude effectively moves the mega-banks outside the law. They used to be too big to fail. Now they are too big to prosecute. Don’t you wish you could be outside the law? You could trash entire economies and then bitch about being inconvenienced by those bad economies. Heck you could even get yourself bailed out whilst you foreclose on the poor people you sold rotten loans to. You would become truly blameless. For everything. You could even brag publicly, as Jamie Dimon CEO of JP Morgan Chase did, that your bank does really well in recessions.

No wonder banks cause so many recessions. They profit from them.

Not that Dimon is very good. He managed to lose a pot load of money for his shareholders in a great scam scheme risk avoidance strategy known affectionately as the ‘London Whale’. The ‘Whale’ bit being a reference to the extent of the losses the brilliant yahoos involved managed to accumulate. Not that, mind you, any of the senior executives knew about those losses. Heavens forfend! Not once were the people who earn gazillion dollar bonuses for being the epicenter of all things good involved in such plans. Oh dear heaven no. The poor dears were just as surprised as you or I when the losses started oozing from every pore of the beast they purportedly manage. Never mind. Their bonuses and stellar reputations remain intact. Safe too are the yahoos.

No. The only idiots in the episode of the ‘Whale’ are you and I who steadfastly underwrite JP Morgan Chase and its peers, tolerate it excesses, allow it to roll over its regulators, and generally muck around with our economy.

And: Yes we do underwrite the mega-banks.

They benefit from being too big to fail, prosecute, and stop. Because of this their creditors, who are the devil incarnate when they deal with your or me, become cream puffs and hand over money at ever cheaper rates to the mega-banks. You see, because bank stupidity goes unpunished – we bail them out and set them on their way every time – their creditors could care less about silly schemes like the ‘Whale’. Those losses just don’t matter. The taxpayers will step in and pay up.

Why?

Because if a mega-bank goes down, the economy goes down with it. In another context it would be called hostage taking. In banking it’s called being regulated. With the definition of regulated being that you can get away with anything.

It was not always thus. And for small banks it still isn’t thus. Small banks get closed down all the time. When they fail, the regulators think nothing of stepping in, taking over, and selling off the profit making bits to other, usually larger, banks. It goes on all the time. I know. I helped buy a few. So small bank creditors are a lot more careful and charge a lot more for their money.

So the big banks – the really dangerous ones – get all the breaks. The little ones get none.

And the bigger you get, the more breaks you get. Eventually you can even rise to lawless status. The only thing you have to fear – apart from not having enough space to accommodate your bonus – is those pesky anti-trust laws. But in post-Reagan America we don’t use those laws. Indeed we encourage bigness.

So it is both refreshing and curious to see a small, but determined, band in Congress beginning to beat the ‘break up the banks drum’.

Yes. Please. Break up the banks.

And if you think this is academic think, if you will, for a moment about poor Cyprus.

Cyprus is one of those unfortunate small places that allowed its banks to outgrow its economy. Cypriot bank assets are about 800% of the island’s GDP. Its banks had become a favorite offshore location for Russian ‘hot’ money. The Cypriot economy has been destabilized in recent years, it is shrinking and needs Euro Zone help.

This is another one of those paradoxes. Euro Zone help is the same as applying the leeches. If the first leech doesn’t work – it never does – then they apply more. In this case the leech takes the form of a one time tax on savings accounts. Your savings account, were you a Cypriot bank customer, is about to get zapped by as much as 10%. So whereas your retirement nest egg was $10,000, it could now be as little as $9,000. All because of hot money and unregulated international capital flows.

So Cyprus is going the way of Iceland and Ireland before it. All because its banks swam in the shark infested waters of global capital flows. I am sure it won’t be long before we read stern messages about how the sudden rise in poverty and unemployment within the island’s citizenry is a small and necessary price to pay for stabilizing the banking system.  Oh. And you may hear homilies from sundry German bankers about then need for fiscal discipline as if Cyprus had lax budgets. It didn’t. It was a model of fiscal rectitude.

Nope. It was just bad at regulating its banks.

Like us.

The danger of us following in Greek or Spanish footsteps comes not from our debt or our deficit. It comes from our unwillingness to confront the mega-banks.

Our biggest banks are a clear and present danger. They represent a threat to national security.

That ought to get everyone’s attention.

Let’s stomp on the mega-banks. Let’s break them up.

 

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Break Up The Banks. Please.

How do I say this delicately?

The banking system, and in particular the biggest banks, were central players in the development of the crisis; they then played a major role in spreading contagion around the world; they then collapsed due to mismanagement, poor regulation, and endemic greed; this required that they be propped up beyond their normal subsidy by the taxpayer; the cost of propping them up transformed a private debt catastrophe into a sovereign debt catastrophe; this undermined national budget across the globe; which, in turn, induced a wave of austerity-driven debt reduction by governments; which has now ensured that the crisis has become a depression.

Well done banks.

Break up the banks.

So what began as an orgy of private debt growth has ended up becoming a national and governmental debt crisis. The human cost is scarcely calculable. As governments desperately try to carve back their debt levels – rightly or wrongly – they slash at programs that generally benefit the poor, the elderly, or the sick. So those that most need protection get less. Whereas the banks, sitting at the supposed center of our primal capitalist system, get coddled, protected, propped up, and generally avoid any consequence of the competitive struggle that is supposed to be that system’s hallmark feature and source of strength.

The self described paragons of capitalist virtue, those big bad bullies of cut throat trading and macho creative destruction, turn out to be mommy’s boys who cry at the slightest scratch, slink off pathetically to whimper in corners when criticized even slightly, and require a gossamer weight touch rather than a heavy hand so as to avoid their tender egos being undermined.

What wimps.

Meanwhile, it turns out, they’ve been cheating, conniving, and variously being rotten throughout. Indeed they represent the very apotheosis of the capitalism they espouse. Were it not for rigging, creating cabals, hiding in dark corners of murky pools, drawing a veil over their shady dealings, and corrupting public officials with floods of money, they would not have survived this long.

Our banking system is rotten to the core. It is toxic. It fails in its social purpose at every turn. It misallocates capital. Worse: it syphons off capital for its own use and thus starves the real economy. It imposes huge costs on the rest of us by way of absurd fees, poor service, and constant error in risk management. It needs perpetual attention and subsidy. In short it is a great big expensive spoiled brat.

And by big, I mean big. As in massively over-sized, flabby, gorged, and mortiferously obese.

And that’s the good news.

Phew.

Please recall that, at the onset of crisis, I was one of those who argued for nationalization rather than bail out. I also called for enforced downsizing so that the banking system could be rendered into something vaguely resembling a competitive capitalist style system freed of constant public subsidy. I didn’t get very far. Such things were all too radical.

Yet here we are after years of discussion, so-called reform, and botched regulation and we are still uncovering evidence of just how deviant our banks are. To say they behave in anti-social ways is to do massive injustice to that concept. They are the very poster children of anti-social behavior.

It was inevitable.

When the American banking system was deregulated few of us predicted the current outcome. Some of that early deregulation made sense. Getting rid of the McFadden Act was sensible. Allowing banks to set up branches across state lines eliminated a very artificial and unnecessary barrier to banking business. After all the bank’s customers are not thus limited.

But getting rid of Glass-Steagall turns out to have been a big mistake.

At the time some of us were concerned about mixing trading, investment, and commercial banking under one roof. That’s a volatile mix. The prevailing theory was that the brew would be positive not negative and that the income flowing in from investment banking and trading would augment the commercial banks to keep them afloat. Recall that the big concern back then was that straightforward commercial banking was becoming increasingly unprofitable as chunk after chunk of its usual business, and thus sources of profit, were being allowed to drop outside the usual boundaries of banking. I can remember management discussions as we fretted over the damage that the boom in commercial paper issuance by AAA rated companies was doing. As more and more companies were able to raise cash outside of the then ‘normal’ channels of commercial lending the commercial banks found themselves being squeezed. They were being forced to rely on small business and individual lending, both of which were fragmented, higher risk, and lower profit.

How innocent those concerns now appear in light of the subsequent tsunami of error and failure that engulfed banking.

So the commercial banks, we were one of them, lobbied hard to be allowed to diversify. They saw trading and investment banking as alternative profit sources.

What none of us foresaw was the enormous cultural impact that the shift would have. It was assumed, as much by the regulators as by the commercial banks themselves, that the consolidation of banking would benefit the commercial banks. By size they dominated the overall industry. They would, it was thought, remain predominantly commercial, but that they would add other activities.

It didn’t work out that way. Not at all.

Because trading and investment banking produces gaudy returns on capital and because banks are rated on their ability to produce a return on capital, boards of directors, shareholders, rating agencies, analysts, and pretty much anyone involved in the development of the industry suddenly shifted their attitudes. Investment bankers producing huge profits emerged as front runners to manage the merged business. Commercial bankers, whose businesses tended to produce lower returns, fell by the wayside. Anyone with ambition went into the investment or trading side of the newly merged banks. Power went with them. The center of gravity shifted. From the late 1980’s through to today old time commercial bankers struggled to rise to the top of the industry. The top jobs invariably went to their investment banker competitors. The industry was changed beyond recognition. The older values went out the window. They were replaced by the values we are so appalled by today.

In retrospect it makes sense. In an industry obsessed by ROC, those who can claim to produce higher ROC’s win the big jobs.

Further, deregulation set off a merger mania.

When I first entered banking the bank I worked for had $2.3 billion in assets and was ranked in the top twenty-five banks in the country. JP Morgan Chase has just lost that much in one quarter on one set of trades. Those smaller banks were losing ground to non-bank competition. This meant that the regulatory system, designed to protect old time banking and thus the flow of capital into business, was becoming anachronistic. The investment banks and their ‘innovation’ were destroying the status quo. In the face of an out-of-date regulatory system the banks needed to fight back. One way – before the elimination of Glass-Steagall – was simply to create bigger commercial banks. Customers were supposed to benefit. Indeed, had this been the only trend, they probably would have. The last great innovation in banking is generally argued to have been the ATM, but I think we ought give that nod to the general ‘digitization’ of the payment system which has made electronic funds transfer, payment, and access to money more convenient and, despite those fees, cost effective.

The problem with banking is that it is incredibly difficult to assess the true cost of a specific service. Banks are great big bundles of cross subsidized activities, so disentangling the exact cost of service makes charging sensible prices very difficult. I have always characterized banks as mammoth bookkeeping services attached to great big lending machines. As those bookkeeping services were shifted to electronics and away from paper, the industry plunged into IT. Banks we’re amongst the first big customers for mainframe computers. They were among the first to use new database technologies. And they embraced the internet earlier than others. Banking is transactional – think withdrawing cash from an ATM of paying a bill by check. And computers lower the cost of transactions.

The problem is that in order to keep up with the ROC produced by trading, the people managing the bookkeeping functions like the branches and the payment system, and those running the lower return services like credit cards and small business lending were forced to ratchet up their fees. So the benefits of lower costs were eclipsed by rising fees. Instead of passing on the benefits to customers in the form of loser fees, the banks perversely raise fees in order to match the higher ROC targets now imposed on the industry.

The industry was thus slowly transformed, not so much in its activities, but in the perception of its ‘natural’ or sustainable return. What was once an acceptable return was no longer considered acceptable. So activities that failed to meet the newer and rising levels of desired return were de-emphasized, under invested in, or simply ignored. Capital was increasingly allocated to those activities capable of meeting the higher returns that analysts, shareholders, and even regulators were calling for as measures of competent performance. This meant trading and investment banking eclipsed old-time banking. The capture of the banking system by traders was underway.

I lived through this. Indeed I can recall conversations with our then chief financial officer as we planned to upcoming year. He was always calling for higher returns, his external advisors and our shareholder were pressing for them. I, along with others, argued that this meant taking greater and unacceptable risk. It implied getting into areas of banking that were both riskier than we were used to, and which were beyond our recent experience. We went for return. We blew the bank up.

So I have observed toxic banking firsthand, and I can recall how much of the toxicity stems from a commitment to meet unsustainable and unrealistic profit goals. Commercial and investment banking are different endeavors that need to be measured, managed, and regulated in different ways.

But that’s not the industry we have.

We have a commercial banking system with a cancerous investment banking system grafted on top. Worse, the commercial system is now subject to an investment banking style management. The cancer feeds off of and subjugates the rest. The industry is run, not for its customers, but for its executive management. And they are traders not bankers. The cultural incompatibility is stark. The banks have destabilized what was once stable. They have done this, first in response to outside nonbank competition, and then as a result of ill-advised merging of two incompatible businesses.

First they grew to offset the loss of traditional business. Then, when that failed to stem the loss, they grew by merging with investment banks. The result is manifestly a failure. An anti-social failure.

Their growth has not produced a more stable industry. Nor has it stemmed the growth of non-bank competition. All it has done is to produce organizations that sprawl across finance; are a morass of poorly fitting activities; are too big to manage; too big to fail; and too big to be useful. They simply exist in their own universe to feed themselves and to extract profit from the economy in order to justify their continued growth and existence.

We don’t need them.

They need us.

But we don’t need them.

Their size produces no value. On the contrary it destroys value. Especially in view of the cheating, market rigging, and other abuses of social propriety that they indulge in to feed the maw of their bonus cultures. They have grown to excess. They are excessive. We cannot afford them any longer.

They should go.

We need to revert back both to smaller banks and to an industry divided. So breaking up the banks ought address the misguided imposition of investment banking culture in commercial banking; and it ought to make the new banks small enough that management actually knows what it is managing, and if it doesn’t then the new banks need to be small enough to blow up without taking the economy down with them.

One last thing.

Possibly the greatest advantage of breaking up the banks will be to reduce their ability to corrupt politics. The age of deregulation has been the age of corruption. Our politics is poisoned by the cash that flows not just from the banks but from the oligarchs beyond. The Supreme Court conflated, to its eternal shame, cash with freedom of speech. This was not the beginning of corruption, but simply the affirmation of it. It was a final cynical act in the steady erosion of the balance between wealthy oligarchs and democracy. It brought clarity to the subversion of the pre-existing order by wealth, and to the clear and present danger represented by the oligarchic class to our basic freedoms. Bankers played a key and early role in this subversion. The takeover of banking by traders and their desire to prop up their ability to reap excess rewards, now, in retrospect, seems best explained as the capture of an entire industry for the personal gain of a few. A few, who once ensconced in charge, then used the profits of that industry to entrench their privilege.

So liberating banking from the traders who now run it will reduce the corruption of our politics.

Break up the banks. Break them before they break us … again.

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Business Taxes, Or the Lack Thereof

There is an alternative universe somewhere in which America’s biggest businesses actually pay taxes. I know, I know, I am being idealistic. Well some of them do, even here on earth – blessed be Monsanto! Last year anyway. But many don’t. Indeed many seem to be able to collect refunds of grotesque proportions.

Ask most anyone in Washington policy circles and you will be told that American companies face a major global disadvantage: our corporate tax rate is one of the highest around. This, supposedly, is a huge burden on the poor dears, and is just one more reason why these put-upon patriots are groaning rather than beaming. Listen to their apologists and you begin to wonder how they survive at all in this intense anti-business, hostile, and undeserving nation of big business haters. That no company worth its salt actually pays anything close to the tax rate is never mentioned in polite circles.

It is uncouth to mention reality when big business wants to make its case.

And I am realistic: this is an imperfect world, soany tax paid by big corporations is simply passed along to consumers ultimately, just as any cost of business is.

Nonetheless, if we have a corporate tax we ought to try to collect some corporate taxes. Our current effort is embarrassing in its ineffectiveness.

The Citizens for Tax Justice and the Institute on Taxation and Economic Policy have just issued a joint report documenting just how far we are from even that minimal goal. According to their report, corporate taxes covered over 25% of federal expenditure during the first two post-war decades. Then big business started to attack through their lobbying efforts. They managed to buy off enough of our legislature that by the 1990’s that percentage had fallen to around 11%. Not content, they pressed on. So by 2010 corporate taxes covered a mere 6% of federal outlays.

That is an epic lobbying success story. Or corruption on a grand scale.

This is, of course, a byline in the long pro-business deregulatory narrative of the last three decades. At each step along the way big business bleated away complaining of its unfair burden. It coupled this with threats of imminent collapse, outsourcing, offshoring, and all sorts of dire threats. As true patriots these companies wanted – they told us – to continue to employ people here, but these taxes were breaking their backs. Our tax rate of 35% is simply the last straw. No wonder we are not competitive anymore. It was able to purchase protection and subsidy. It showed its gratitude by pouring cash into politicians pockets. By way of free speech naturally. Companies are people too, as Mitt Romney blurted out last month.

That none of this conforms with the facts should surprise no one who listens to either modern politics or economics. Most all of economic theory has nothing to do with actual economies and the facts found within them. And no element of reality stands between our policy makers and their craven efforts to pander to those who pay for their election.

A few facts from the report:

  • Verizon: reported a profit of about $12 billion in 2010. It didn’t pay any taxes. No. It received a refund of $703 million.
  • General Electric – whose CEO is playing a role for Obama as jobs czar – earned $10.4 billion in profit in 2010. It managed to scam a refund of $4.7 billion. If I were the Verizon CEO I would be firing my army of lawyers and accountants and hiring GE’s.
  • Pepco, a power company in DC, hit the jackpot. It scammed a refund of $508 million on profits of $882 million.
  • 37 of America’s largest companies pay no taxes at all. None. That is to say that you or I pay more than DuPont, Wells Fargo, Boeing, and the aforesaid Verizon and GE added together. I bet that makes you feel good. Patriots all.
  • The 56% of all tax subsidies and tax breaks went to four industries: finance, utilities, telecom, and oil/gas/pipelines.
  • The list of companies getting the biggest subsidies includes the poverty stricken: Wells Fargo, AT&T, Goldman Sachs, Exxon, IBM, Boeing, Verizon, GE, Proctor and Gamble, and PNC Financial.

Clearly it pays to hire that army of lawyers and accountants: Federal Express scammed sufficiently to get its tax rate down to 0.9% averaged over the last three years. UPS, in the same business and a direct competitor, paid 24.1% If you are a UPS shareholder its time to join the line complaining.

The report is worth your while reading. It is an endless indictment of our tax code. It will make you annoyed, angry or outright murderous.

And it will have no impact.

This is because, as the report writers point out, the prevailing wisdom in Washington is that our top companies need help. If there was ever a more direct example of how corrupt American politics has become it is this. These companies are on the public dole, and yet they want more. Those corporate jets are getting a tad old after all. And those CEO’s all need shiny new cufflinks – and I include the new female CEO of IBM in that category after having checked out what she was wearing in her PR campaign after her recent promotion.

As I said: the realist in me knows that fixing the loopholes that create this mess will merely pass the higher taxes along to customers. None of these companies are known to swallow such costs in the name of competition. And most, as you will have noticed, are in heavily subsidized and protected industries. They are not typically under entrepreneurial cost or competitive pressure. They are used to twisting Washington around, and fleecing customers at the same time.

Ultimately knowing all this will simply annoy us rather than lead to change. For all the storm being kicked up about tax reform, we all know that big business will be able to buy enough votes to protect its turf. Reform will go nowhere other than to continue to shift the tax burden onto the little people who have no representation in Congress. Taxation without representation – now that’s a rallying cry worth using. I wish somebody had thought of that.

Perhaps we should save ourselves the trouble and just surrender to the plutocrats. Let’s abolish corporate taxes altogether. That way they can fire all those tax lawyers and accountants and make even more profit. After all they need more profits. It’s not like corporate profits are at a seventy year high or anything.

Oh. Wait. Yes they are.

Now that makes me even more upset.

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Ideology, The Fed, and The Blame Game

Here we go.

The next couple of years promise to bring us lots of fun as the newly elected Republicans bring their libertarian notions into the public gaze and out from the shadows where they have lurked hitherto. Today we got off to a good start as Ben Bernanke was quizzed in one committee, while in another we heard from a professor who call Abe Lincoln a tyrant. According to him secession is the only way to bring back the liberties stolen from us by the big bank, counterfeit money socialists who now infest Washington DC.

Fun times indeed.

This is not a time to be Chairman of the Fed. The Republicans have long had a visceral dislike for anything that smacks of a central bank intent on using monetary policy to solve our unemployment problem. There are rumblings that we will see an initiative to strip the Fed of its dual mandate – on both inflation and employment – and instead restrict it to just inflation. This is in reaction to all the unconventional efforts the Fed has made to help lift the economy over the last two years. In particular opposition to QE2 has crystallized around the dual drum beats of inflation fears and Fed over reach.

So in his appearance before a Congressional committee today poor old Bernanke was grilled relentlessly about the way in which Fed policy was threatening to undermine the economy by stoking uncontrollable inflation.

‰ÛÏMy concern is that the costs of the Fed‰Ûªs current monetary policy ‰ÛÓ the money creation and massive balance sheet expansion ‰ÛÓ will come to outweigh the perceived short-term benefits,‰Û?

This was how Representative Paul Ryan, the lead GOP spokesman, put it. Those costs being a burst of inflation. Not that Ryan backed up his argument with much data about that burst. He simply pointed to rising commodity and raw material prices, and higher bond yields. Since there isn’t any sign of a surge in inflation just yet, he had to limit himself to dark warnings that if, and when, such a surge crops up it would be hard to contain.

I agree. It would be hard to contain. Inflationary expectations, once baked into prices, wages, and contracts, are hard to reverse without vigorous counter measures, usually the inducement of huge slack in the economy sufficient to eliminate both pricing power and expectations simultaneously. Those of us who lived through the Volcker recession back in the early 1980’s can recall the amount of pain needed. We all want to avoid a repeat.

So, is inflation a threat? No. This is a problem for those ideologically inclined to look for it.

Prices are rising in some economies, especially in emerging nations, where demand has increased rapidly. In other places supply constraints caused by crop failures are putting pressure on food prices. These are both real issues and we need to follow them closely. But neither have anything to do with recent Fed policy. And the US economy is not showing much, if any, sign of those problems occurring here. So Ryan’s fears are entirely hypothetical at the moment. Which, unfortunately, doesn’t prevent him from encouraging the Fed to cease its support for the recovery.

We all need to take a deep breath and be sensible here. Core inflation was 0.7% in 2010, and trending down still. In the last year before the recent calamity it was 2.7%. Since 0.7% is both negligible and below the Fed’s target range, there is no current need to react by raising interest rates. At least if you are driven by data. To raise rates now would blunt and possibly reverse the recovery. We should wait a while longer, at least until unemployment has started to trend down consistently.

If you are driven by ideology the story is very different. Hence the Wall Street Journal’s almost daily headlines about inflation fears spreading [From where to where? Perhaps from the editorial page to the front page?] The point being that there is a large group of politicians and others who are motivated not by any facts they can gather, but by an opinion they hold. That opinion being the Fed has no business helping prop up the economy. We should, they say, let the market do its work. We have heard this story before. These folks overlook the inconvenient, but noticeable, fact that it was the market that sent us tumbling into the abyss. It was a private sector failure, not a government policy failure that launched us into crisis.

Or was it?

That is, of course, just my opinion. It would be nice if we could get some objective agreement about what started the crisis boiling up.

Then again, if you read the Financial Crisis Inquiry Report published last week, the ideological divide is so wide there is no agreement about the true causes of the crisis. One side – the Democrats – gave us a dull recitation of events, and ended up blaming banks, deregulation, and the rating agencies; while the other side blamed the government. Actually the Republicans were divided into two factions. One blamed the government. And the other blamed the government even more. Overall the most reasonable comment in the entire 500+ pages of the report came from a lone right wing dissenter who wondered out aloud why American banks and personalities like Greenspan could be blamed, when a real estate bubble blew up in so many other countries too.

No one, apparently, wants to admit that economic policy in the US has been off track for decades and that the entire world was awash with cash needing a home. That cash ended up fueling ridiculous home price increases wherever delinquent bankers could get their hands on it, and wherever lax oversight, a collapse of credit standards, and mass hysteria on the part of home buyers combined to destabilize things enough. Which is to say in plenty of places. Not just in the US.

Given that the FCIC was ideologically split from the beginning it was always a long shot that it would produce anything useful. Besides it published its findings long after politicians had embarked on whatever ideologically predetermined course they chose.

Personally I go a little deeper and argue that the crisis was the logical outcome of three decades of illusion during which we undertook a sustained experiment in market based solutions to problems; reduced the government’s ability to act as a bulwark; and engaged in social engineering to induce more home ownership than is either sensible or sustainable over the long haul. In the US both political parties are culpable. And along the way no one paid attention to the huge inequality in incomes that inevitably distorted both the shape and source of demand. Of course a whole lot of people did stupid things like overpay and under save with respect to real estate. We were encouraging them to. We gave them incentives to. And getting deeply into debt was the only possible way to keep the “dream” alive: wages were stagnant.

It was this rotten wage performance that drove so many people over the edge, and made them very vulnerable to the siren song sung by the banks and other mortgage lenders who were trying to find uses for the enormous flood of credit slopping about the globe. When regular people felt their living standards under pressure, and when bankers saw an opening for enormous profit, it became a perfect storm. Desperation met lack of scruples. In other words it was government – both inaction in the form of deregulation, and action in the form of housing policy -that did it. And the private sector too. There was fraud, a remarkable collapse in ethics, greed, shiftiness, and plain stupidity. The system went haywire. We collectively lost our minds and created conditions in which predators could stalk the streets uncaring and untouched.

In such circumstances, establishing blame is simply an attempt to meet the ideological need to avoid taking responsibility.

Stagnant wages; excess credit creation; and inequality. Excessive deregulation; unfettered capitalism; and lost ethics. Imbalances all.

We need policies that re-establish balance. Not ideological bun fights over Fed activity.

How the heck calling Lincoln a tyrant fits into anything remotely useful I have no idea. But these are the things we will be hearing about for a while now.

As I said: fun days indeed.

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Smith’s Curse

I am not easily swayed by talk of curses. They make for good gossip and a laugh, but have no explanatory legitimacy. All except Smith’s Curse. Adam Smith that is. Here’s why:

Ever since Adam Smith wrote, just once, about the mysteries of the “hidden hand”, economics has had its brains addled by the allure of those magical powers Smith postulated as the reason he saw order rather than chaos around him. His was possibly the first insight into what is now called the self-organizing properties of a complex system.

The problem with this is the absurd lengths to which economists have gone in order to give credence to Smith’s insight. Instead of embracing the muckiness, and infuriatingly indirect nature of complex systems, they have gone the other way entirely. They have been driven to simplify at inordinate and quite ridiculous length in order that they come up with the answer Smith first thought of. Their tools and methods are wrong. Their desire runs deep. That combination makes for some pretty ugly reasoning. This doesn’t mean that complex systems are not comprised of very simple components. It’s just that they are not deterministically thus constructed. Therein lies the big error of orthodox economics. It is still rooted in a mechanical vision where the economy is a vast machine playing out in an orderly fashion from a set of basic assumptions.

When we observe apparent order, such as we see in the confines of a well behaving market, we must be careful not to interpret that observation as implying that the underlying system is, itself, well ordered. Disorderly systems are far more common. In fact they are the norm. Yet sometimes they give rise to patterns that belie their true nature.

This was Smith’s error. And by making such an error he bequeathed economists a long lasting curse.

They imagined that markets are orderly structures. They are not. They have people in them, which means they are can be whimsical, subject to fashion, or tightly ordered and efficient all at the same time. They are human, not magical.

We could simply end at this point by saying that the rest is history. Economics, or at least its orthodox versions, has labored long and hard to detect and theorize about the mystical forces necessary to ensure, not just orderly outcomes, but orderly workings. In a deterministic system the outcome is orderly because the systems itself is precise. It plays out along known and predictable lines. Hence the theories of people like Walras who conceived of the economy as giant machine capable of arriving at a single best solution to the problem of allocating resources. Only his machine needed help. He wasn’t able to solve his equations without the assistance of an external “auctioneer” who directed the traffic to make sure everything resolved itself neatly. Some of us think of this as cheating, but to the orthodox it was simply a challenge to try harder.

As Walrasian thinking became to pervade orthodoxy all sorts of bells an whistles were added to try to get around the fictional auctioneer. The humans within the system were invested with superhuman powers of calculation and information. Gathering information was made costless. What people wanted or needed was crushed into something called utility so it could be fitted within a mathematical structure. Time was reduced to a single point by using the trick of futures markets. And so on. Smith’s curse drove a great many intelligent people to extraordinary and, frankly, almost psychotic, lengths to discover and articulate the magic he imagined lying beneath the surface.

In the end orthodox economics was reduced to getting rid of humans in order to make things work well at all. And even then the prime movers of the final edifice, Arrow and Debreu, were not sure of the relevance or use of the monster they created.

This is because there isn’t any use. It was always a wild goose chase. The order Smith saw was a chimera. A mirage beckoning economists and no one else.

Now here’s the really big problem with Smith’s Curse:

It can make clever people do bad things.

Ever since the 1930’s classical economics has taken on a morally superior tone. It has been preached rather than taught. Free markets are, according to the orthodox, superior because they produce “the right answer” without any intervention by governments. Thus they are untainted by the wants, requirements, and biases of mere mortals. Markets march, so they say, to the beat of immutable forces that are impervious to human intervention. So they are ideals we should strive to achieve. As if Smith was channeling Plato when he devised his curse.

If this sounds vaguely religious, you are not the first to notice the resemblance.

In the hands of folks like Hayek and Friedman classical economics was used as an ideal bulwark against the intrusion of the dark side of human calculation. Hayek meant it when he talked about “The Road To Serfdom”. Friedman meant it when he wrote about being “Free To Choose”. Both imagined that a free society whose economic relations were determined by the forces that drive unfettered markets cannot end up in a bad spot. It just works out that way. It just is. Perhaps a mystery. But it just is. Worse: whenever silly and limited humans get involved things will alwatys go awry. Those of us who a tad more skeptical are told to keep our tawdry questions to ourselves and not to sully the beauty of the free market vision. We should allow the faithful to go on believing. Their faith unquestioned because it is unquestionable.

Such was their fervor, and such was the hold Smith’s Curse held over them, that no amount of foolishness was allowed to sway their thinking. Thus Friedman could write, presumably in earnest, that no matter now ridiculous, absurd, or other worldly the assumptions needed to make a free market systems superior in theory – let alone practice – those assumptions were justified if they drove the theory to the “correct answer”. By which he meant the answer he, like Smith, first thought of. Where there is science in this is questionable. But you have to admire the zealotry.

Now comes the damage I mentioned.

So smitten by Smith’s Curse are orthodox economists that they engage in social engineering. By their own logic people like Hayek and Friedman should aver all attempts at imposing a system upon society. After all that way lies the road to serfdom. And surely we – the rest of us – are free to choose. Yet Friedman in particular, and his army of righteous followers, think nothing of advocating all sorts of changes to society in order to get things ordered the way most conforming to their theoretical views. This is why Friedman was a major, if not the major, force behind establishing a free wheeling derivatives market. You know like the one that just blew up the world economy. This explains the ardor with which orthodox economists advocate deregulation, the dismantling of social safety nets, and other community oriented devices. Their faith drives them to preach and alter anything they deem inappropriate. Like society, or any construct with word word “social” in it.

So in the end Smith’s curse has produced a prodigious paradox: the theorists most stricken by his vision are both the most ardent advocates of freedom, and the most determined social interventionists at the same time. They think nothing of forcing the rest of us to conform to their utopian visions. More to the point: the past few decades have been a prolonged social experiment in free market economics. In any number of places orthodox economists have influenced society in an effort to make reality reflect their theories. Society, as it had evolved by the 1970’s, needed to be saved. It needed to be shunted back into its rightful place. If that meant imposing order and restricting the choices of others, so be it. Nothing should get in the way of the neoclassical crusade.

This is, of course, back to front. In respectable science theory reflects or explains reality.

But then it might not come up with the right answer. And Smith’s Curse would lose its grip.

And it’s such a warm and fuzzy feeling when slip into the dreamworld described by that curse.

It can’t just be a myth can it?

I don’t know. Maybe we should ask the unemployed.

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