Sunday, February 08, 2009

On parallel histories... and depression

Do you remember this?
...there is one section of the community that has benefitted from that wealth. It is not the mum and dad investors, the ordinary people. It is the community that has earned multi-million dollar bonuses and stock options; the hangers-on who pimp worthless product to an unsuspecting and ignorant market.

In other words, we are seeing what happens when the economy is run by snake-oil medicine men and itinerant side-show freaks.

Thanks to the old confirmation bias and the good folks at ALDaily I have come across The American featuring an article titled “Our Epistemological Depression”. Now, I had to look “epistemology” up in the COD to make sure I got it right. “The theory of the methods or grounds of knowledge.”. The opening paragraph
The history of socialism is the history of failure—and so is the history of capitalism, but in a different sense. For the history of socialism is one of fundamental failure, a failure to provide incentives and an inability to coordinate information about supply and effective demand. The history of capitalism, by contrast, is the history of dialectical failure: it is a history of the creation of new institutions and practices that may be successful, even transformative for a while, but which eventually prove dysfunctional, either because their intrinsic weaknesses become more evident over time or because of a change in external circumstances. Historically, these institutional failures have led to two reactions. They lead to governmental attempts to reform corporate and financial institutions, through changes in law and regulation (such as limited liability laws, creation of the FDIC, the SEC, etc.). They also lead market institutions to reform themselves, as investors and managers learn what forms of organization and which practices are dysfunctional. The history of capitalism, then, is the history of success through dialectical failure.

I am not going to dispute the difference. Socialism (true socialism, not the kind Americans dream of in their nightmares) stifles experimentation, expels individuality. Capitalism on the other hand (in its dreams at least) sees the individual as prime, sees wealth as the incentive for innovation and greed. That Muller sees the success of Capitalism (yes, the capitals are important to me...  ) as derivative from “dialectical failure” (the failure of logical debate?).
But [the various known causes of the current crisis] are not the whole story, and certainly not the most original part of the predicament. What seems most novel is the role of opacity and pseudo-objectivity. This may be our first epistemologically-driven depression. (Epistemology is the branch of philosophy that deals with the nature and limits of knowledge, with how we know what we think we know.) That is, a large role was played by the failure of the private and corporate actors to understand what they were doing. Most heads of ailing or deceased financial institutions did not comprehend the degree of risk and exposure entailed by the dealings of their underlings—and many investors, including municipalities and pension funds, bought financial instruments without understanding the risks involved. We should keep this in mind when we chastise government agencies such as the SEC for failing to monitor what was going on. If the leading executives of financial firms failed to understand what was taking place, how could we expect government regulators to do so? The financial system created a fog so thick that even its captains could not navigate it.

In other words, “they knew not what they were doing”.

Arguable, there were some who knew very well what they were doing. The lessons lie at the next level down with the people who "accepted" what they were told or even not told but believed. (Does that sound familiar? It should!!)

Has that changed? Is it likely to change? Reading both the lines and between the lines of the new Administration it seems likely not. Well not yet anyway. Muller again...
The cult of “accountability” was linked to key innovations that turned out to have unanticipated undersides. One was the shibboleth of linking pay to performance, which put a premium on schemes that purported to measure performance. This tended to produce “hard” numbers that seemed reliable but were not. It created tremendous incentives for CEOs, executives, and traders to devote their creative energies to gaming the metrics, i.e. into coming up with schemes that purported to demonstrate productivity or profit by massaging the data, or by underinvesting in maintenance and human capital formation to boost quarterly earnings or their equivalents.
Two milestones in the process of creating the fog of finance were the transformation of Wall Street investment banks from private partnerships to publicly traded corporations (beginning with Salomon Brothers in 1986), and the repeal of the Glass-Steagall Act of 1933 through the Gramm-Leach-Bliley Act of 1999. The former created tremendous incentives for risk-taking, since the firms no longer invested using the money of their top executives, who instead were remunerated based in large part on the amount of business the firm conducted, creating incentives to increase business by producing ever more complex and opaque financial instruments, such as collateralized debt obligations, swaps, etc. Then along came Gramm-Leach-Bliley, which opened the door to unlimited contagion, so that when one financial sector turned downward, it took the rest with it.

Looking ahead, the sort of government regulation and private re-organization that will be most beneficial will focus on these epistemological problems. Some of this goes under the rubric of transparency: making the asset holdings of financial institutions more publicly visible in order to reduce the problem of counterparty risk. Equally desirable would be transparency through the reduction of complexity, which includes avoiding intra-institutional contagion through greater limits on the ability of financial institutions to engage in an open-ended variety of financial activities. It means, in short, the reformulation of something like the Glass-Steagall Act, which would separate savings banks, investment banks, insurance and brokerage from one another.

Would that help? Well it might in the short term. The difficulty is the requirement for “new” controls – the anathema of Capitalism. The very greatest difficulty is really stated elsewhere. Remember Enron? That particular shibboleth is one which Capitalism would like very much to sweep under the carpet of history. Yet, in truth it is exactly the same process as has been the current “financial crisis”. A group of high level managers, accounting and financial practices used to increase their personal wealth and at the same time to conceal the truth, self promoted as “the brightest men in the room” beyond question or even doubt.

And, while one or two individuals have thus far been brought to account (to justice and not money) the lunatics are still in charge of the asylum.


T. F. Stern said...

"the lunatics are still in charge of the asylum."

On this point we are in agreement.

The probligo said...

Which lunatics and which asylum for you TF? The banks and bankers, or the politicians and government?

T. F. Stern said...

The banks and bankers have always run the world; this you should know, being a historian. Every politician is beholding to those who hold the money. So, it boils down to capitalism or socialism; I chose the individual and capitalism.

Dave Justus said...

I don't know of any system that has managed to get rid of all the cheats and frauds. If there is one, I would love to hear about it. Given that, I don't know that saying capitalism is a failure because some people are able to cheat and fraud in a capitalist system is a very fair criticism of capitalism.

The probligo said...

TF, I don't know that you actually had the "choice". You were born into the system, and that is perhaps a matter of good fortune as much as anything else.

Dave, as I understand it Christ himself had a pretty hard crack at that job and I don't know that he succeeded. Perhaps TF can take that thought a bit further (the money changers in the Temple).

The failure of Capitalism will not be (as I follow Muller's line of thought) the consequence of the actions of cheats and frauds.

Far more important in its failure will be the likes of the "brightest men in the room". Yes, I know that there might likely be a direct correlation between them and "cheats and frauds". That certainly was the case in Enron.

What is far more important is the ability of those responsible for monitoring and controlling to bow to the brightest men in the room. That class of people would include the likes of investors, auditors, Directors, shareholders, right on through to the statutory and governmental controls such as SEC and the other bureaucracies.

Every single one of those groups failed to flag Enron.

Every single one of those groups failed to flag the actions of individual traders as far back as 1995. Remember Nick Leeson? Tef sure does. What has been happening over the past 5 years is exactly identical to the methods used by Leeson. The only difference is that Leeson siphoned the proceeds to his own account rather than to his employer.

If capitalism is to survive, it must give both the knowledge (Muller's point on the epistemology of investment) and the controlling powers back where they belong.

How often do we hear the cry that "bureaucrats employed by the government are the employees of the taxpayer"? Perhaps there has to be a similar responsibility and catchcry for company directors and administrators. It certainly is in the law...

Eugene Tan said...

Hear hear! I always know where to go if I need to find a good fight. I know I am a lunatic but I think Probligo runs the asylum. But is he a lunatic?

You are right, Probligo. The problem is commonsense is obscured when people face the prospects of profiting from others' common cents. But when the common cents are taken away, commonsense returns. Human beings are innately greedy. This has never changed. We hoard, we rob, we steal, we cheat...

You have also rightly pointed out that the very whistle blowers whom we employ to blow the whistle have derelicted their duties. Why? Because their wheels are greased by the oil they let pass them.

Capitalism, socialism, communism... all these fail because of human greed. Once we can eliminate the greed, we can get rid of most of the problems. Why wouldn't everyone just pass their valuables to my keeping so there isn't anything left to tempt the others?

Dave Justus said...


I think what you are criticizing is what I call 'corporatism' not capitalism itself. Corporatism is when power private interests seize control of government organs to advance their own interests. It is a common danger of any government and particularly Democratic ones. This isn't capitalism, although it certainly occurs in ostensibly capitalist systems and is anathema to the philosophical ideal of capitalism.

It is certainly something to be guarded against, and we probably won't ever be able to completely stop it. One comfort though is that the damage done by corporations taking over aspects of government for their own ends is typically much less then when governments take over corporations.

As an example, contrast the environmental records of western 'capitalist' nations with that of the Soviet bloc nations. The difference is pretty clear.

The probligo said...

Dave, the nub of this whole article, that of the "epistemology of depression" has nothing, absolutely nothing to do with ...
when power private interests seize control of government organs to advance their own interests. It is a common danger of any government and particularly Democratic ones. This isn't capitalism, although it certainly occurs in ostensibly capitalist systems and is anathema to the philosophical ideal of capitalism..

Your response (and TF thinking along the lines that I am criticising Capitalism) is an illustration of the problem - of lack of understanding; of lack of knowledge; the very point that Muller was making.

Now do not get me wrong, I do not think I am among the "brightest men in the room". Far from it. If I were I might be more able to come up with cogent argument and constructive solutions.

What is wrong in this debate is trying to lay the blame at the feet of the wrong people.

Those who are much closer to the action - the various guardians I mentioned in my previous comment - are far more culpable than any individual politician or group of politicians.

When I studied for my professional qualification the accounting profession internationally was in a blind paranoid panic about the probable consequences of a serious of English and American Court cases. These cases opened the door for auditors to be sued where investors (in the very widest possible sense) lost as a direct result of the negligence of the auditor.

The fact that the audit industry (just one of those I would blame) has not learnt from Leeson and the techniques he used, has not learnt from the experience of Enron, or Global-dot-com and the others is clear illustration of Muller's point.

They do not understand.

The probligo said...

At long last it looks like someone is catching up with the play.

I must read tonight - be back with commentary...