William Black’s five fatal flaws of finance

William Black is a white-collar criminologist who has written a compelling account of how the bloated parasitic financial sector is ruining America in his recent post at Huffpo. These are Black's five "fatal flaws" of finance:

1. The financial sector harms the real economy. Even when not in crisis, the financial sector harms the real economy. First, it is vastly too large.

2. The financial sector produces recurrent, intensifying economic crises here and abroad.

3. The financial sector's predation is so extraordinary that it now drives the upper one percent of our nation's income distribution and has driven much of the increase in our grotesque income inequality.

4. The financial sector's predation and its leading role in committing and aiding and abetting accounting control fraud combine to: A) Corrupt financial elites and professionals, and B) Spur a rise in Social Darwinism in an attempt to justify the elites' power and wealth.

5. The CEOs of the largest financial firms are so powerful that they pose a critical risk to the financial sector, the real economy, and our democracy.

The Solution: Fix the real economy, if you can find it. "The real economy came off the rails at least three decades ago for the great majority of Americans." I was highly impressed with William Black after seeing him interviewed by Bill Moyers. And now, after reading this detailed by accessible analysis, I'm even more impressed. We can't begin to fix the economy unless we begin to implement basic principles we can actually understand. Fixing the real economy and making sure that finance is merely the servant of the real economy are clearly steps one and two, for each of the reasons listed by Black.

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Conservative Rewrites the Bible

We've featured Andy, son of Phyllis Schafly and his anti-reason heavily monitored blog site, Conservapedia before. His latest project is to create an edited version of the Bible better suited to American Reactionary philosophy. Yes, he is removing all those Liberal parts where the inerrant Word of God must be wrong. Mark C. Chu-Carroll (Good Math blog) wrote The Conservative Rewrite of the Bible where he gives specific examples of what is being edited and why. Like removing any mention of "government", and merging all the names of God to avoid confusion. Even God, in his 10 Commandments, says to forsake all those other Gods over which he has no control and only worship him. Schlafly represents this as a new, better translation. But he is using the KJV as his primary source. The English translation with the most known inconsistencies from original source material is his best version from which to start. Well, might as well. After all, he will be "fixing" God's Word. Even conservative Christians that I know think that this is a crazy project.

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Regulation as a prerequisite to meaningful cooperation

While I was reading up on free market fundamentalism, and I happened across an intriguing article by biologist David Sloan Wilson. As I started reading this article, I was wondering this: Even assuming that a “free market” works wonders in small societies, can societies be scaled up in size guided only by the free market, without formal regulations? D.S. Wilson argues that this is the wrong question. All societies are regulated. The only question is how they are regulated. D.S. Wilson notes that humans are incredibly cooperative, especially in “small face-to-face groups.” In fact, we regulate each other’s conduct so easily in small groups that “we don't even notice it.” This gives us the illusion that there is no regulation keeping things in check. All well-functioning groups, large and small, human and non-human, are highly regulated, however. Small groups often seem to work well without formal regulation, but free market fundamentalists (and others) confuse this lack of formal regulation for the total lack of regulation.

This self-organizing ability to function as cooperative groups is "so perfectly natural" because it evolved by a long process of natural selection, in humans no less than bees. By the same token, functioning as large cooperative groups is not natural. Large human groups scarcely existed until the advent of agriculture a mere 10 thousand years ago. This means that new cultural constructions are required that interface with our genetically evolved psychology for human society to function adaptively at a large scale.

Wilson’s approach makes intuitive sense. Throughout the Pleistocene (from about 2 MYA until 10,000 years ago), people lived in small groups. They lacked written language and written laws. They used unwritten techniques (presumably customs, habits, ostracism and various other informal methods of social control and punishment) to coordinate community efforts and punish cheaters. These informal methods worked well enough and long enough that we can now sit here and ponder how well they worked. But just because those ancient forms of regulations weren’t written down doesn’t mean they didn’t exist. And it doesn't mean that ancient societies weren't tightly regulated. Just as human households are highly regulated without formal rules, so are small societies. So are non-human societies:

These social preferences go beyond our own species. Cooperation and cheating are behavioral options for all social species, even bacteria, and cooperation survives only to the extent that it is protected against cheating. The eternal conflict between cooperation and cheating even takes place within our own bodies, in the form of genes and cell lineages that manage to game the system at the expense of the organism upon which they depend. We call them diseases, but they are really the failure of a vast system of regulations that enable us to function as organisms as well as we do . . .

What about the eusocial insects, such as ants, wasps and bees? Wilson would argue that a well-functioning hive doesn’t simply happen, and it certainly isn’t driven by something as simplistic as the “self-interest” of individual bees:

[B]ee behavior cannot be reduced to a single principle of self-interest, any more than human behavior. There are solid citizens and cheaters even among the bees, and the cheaters are held at bay only by a regulatory system called "policing" by the biologists who study them.

According to D.S. Wilson, you’ll find regulation (informal or formal) everywhere you find a well-functioning society of living organisms. Further, a human society based merely on individual selfishness can’t self-regulate because we can no longer depend on selfishness to be well-tuned or consistent thanks to Daniel Kahneman’s brilliant destruction of rational choice theory. Regulation runs a continuum from informal to formal. It is not like regulation itself just showed up for the first time in modern human societies. D.S. Wilson argues that in all large-scale societies, “regulation is required or cooperation will disappear, like water draining from a bathtub.” Without some form of regulation, all societies become rudderless and unproductive. Therefore, there must always be some form of regulation. The question to decide is “What kind of regulation?”

Let there be no more talk of unfettered competition as a moral virtue. Cooperative social life requires regulation. Regulation comes naturally for small human groups but must be engineered for large human groups. Some forms of regulation will work well and others will work poorly. We can argue at length about smart vs. dumb regulation but the concept of no regulation should be forever laid to rest . . . We also need to change the metaphors that guide behavior in everyday life to avoid the disastrous consequences of our current metaphor-guided behaviors. That is why the metaphor of the invisible hand should be declared dead.

I would agree that the “invisible hand” is shorthand for the informal regulations that have been since prehistoric times to facilitate social coordination of small primitive societies. Rather than declaring the “invisible hand” to be dead, though, it might be more accurate to suggest that the “invisible hand” lives on in modern societies, quietly and substantially supplementing our formal regulations. Seen in this way, the “invisible hand,” used in the complete absence of consciously planned social regulations and laws, is not a method for creating or maintaining a complex functioning modern society. Rather, it is the path back to the Pleistocene.

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Matt Taibbi on economic death by short-selling

In this month's Rolling Stone, Matt Taibbi once again takes on Wall Street with an article entitled "Wall Street's Naked Swindle." This article is not yet available online. Taibbi's focus this time is naked short selling. Taibbi has proven to be an excellent teacher of abstruse financial concepts, including the concept of short selling, and also including the insidious practice of naked short selling. With this technique (and others) Wall Street has turned the economy into "a giant asset-stripping scheme, one whose purpose is to suck up the last bits of meat from the carcass of the middle class." Taibbi's article is an excellent read, which is not at all surprising given Taibbi's track record. The bottom line is that naked short selling is a "flat-out counterfeiting scheme." How bad is the widespread use of this technique?

That this particular scam played such a prominent role in the demise of [Bear and Lehman] was supremely ironic. After all, the boom that had ballooned both companies to fantastic heights was basically a counterfeit economy, a mountain of paste that Wall Street had built to replace the legitimate business it no longer had. By the middle of the Bush years, the great investment banks like Bear and Lehman no longer made their money financing real businesses and creating jobs.

As Taibbi then reminds us, there is more than one way to counterfeit. Consider credit default swaps:

If you squint hard enough, you can see that the derivative-driven economy of the past decade has always, in a way, been about counterfeiting. At their most basic level, innovations like the ones that triggered the global collapse-credit default swaps and the collateralized debt obligations-were employed for the primary purpose of synthesizing out of thin air those revenue flows that are dying industrial economy was no longer pumping into the financial bloodstream. The basic concept in almost every case with the same: replacing hard assets with complex formulas that, once unwound, would prove to be backed by promises and IOUs instead of real stuff.

In this related piece, Taibbi further discusses "naked short selling":

Again, a lot of this stuff is complicated and not only hard for people outside the finance world to follow, but kind of, well, boring as well. But it’s through these tiny regulatory loopholes, these little nooks and crannies, that the economy gets manipulated. The effect of all of these regulatory gaps has been to transform Wall Street from a means of connecting capital to good business ideas into a giant casino, where the object of the game is shaving little slices off the great flows of money as you push them back and forth using a great big toolbox of manipulative techniques. This is one of the tools.

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How foreclosed homes affect the rest of us

Arianna Huffington referred to the Brennan Center's recent study in reminding us that 300,000 homes are foreclosed every month in the U.S. This is terrible news for the people who used to make those houses their homes. But the problem is bad for the rest of us too:

[A]n estimated 40 million homes are located next door to a foreclosed property. The value of these homes drops an average of $8,667 following a foreclosure. This translates into a total property value loss of $352 billion. And vacant properties take a heavy toll on already strapped local governments: an estimated $20,000 per foreclosure (California is estimated to have lost approximately $4 billion in tax revenue in 2008). And the negative impact of a foreclosed home can affect the entire community: a one percent increase in foreclosures translates into a 2.3 percent rise in violent crimes.

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