If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.
-- John Maynard Keynes, 1931
In this week's Sift:
- The Sift Bookshelf: ECONned by Yves Smith. The writer of the blog Naked Capitalism has a new book explaining the financial collapse. It's comprehensive, readable, and not at all pretty or reassuring. She believes the lessons of the crisis were not learned, and won't be learned until something even worse happens.
- It's Important, But It's Not News. Some of the most significant stories play out too slowly to get the news media's attention. Here are two: A gene conferring antibiotic resistance on bacteria can jump from one strain to another, so many different diseases might soon be untreatable again. And global warming was supposed to increase plant growth, which would trap carbon and slow the process down. But it's not working out that way.
- Short Notes. Disbelief in global warming is becoming a standard Republican position. Palin still doesn't understand the First Amendment. The surface slick is gone, but the underwater oil plume is still there. The Ground Zero Church. And more.
I'm still trying to figure out what happened in the financial collapse of 2008. In April I reviewed The Big Short by Michael Lewis, which gave a trader's perspective and boiled the whole thing down to one problem: The Wall Street investment banks figured out how to trick the ratings agencies into giving AAA ratings to crap investments, and once that hole-in-the-system existed, they did the logical predatory thing and ran as much money through it as they could. Something-for-nothing deals have to collapse eventually, and the collapse of this one ate up trillions.
I still think that's a true story, but it begs some larger questions: Such a story can only happen in a certain kind of world. How did we come to be living in that world? And why can't we seem to get out of it?
Yves Smith's ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism provides a larger context for the collapse and explains why it is likely to happen again.
Economics. Rather than a single point of failure, Smith describes problems on many levels. She starts with economics -- both the way it has developed and the way it has been popularized for political discussion.
Since World War II, economics research has become increasingly mathematical. An economist makes his/her name by expressing something economical in an equation, and then proving that equation from more abstract assumptions.
The problem is that economics is not really that kind of science; inherently it's more like sociology than like physics. So turning an economy into a mathematical model involves making very unrealistic assumptions. (For a detailed criticism of those assumptions, see Eric Beinhocker's The Origin of Wealth, which I reviewed last year.)
Several of those bad assumptions play a role in the 2008 collapse:
- Random distributions are normal distributions. Normal distributions are the easiest to deal with mathematically, but it's well known that actual economic variables have much fatter tails than a normal distribution. In laymen's terms: Extreme events that the model says happen every million years might in fact happen every ten or twenty years.
- Markets tend toward equilibrium. Engineers who design complex systems understand that there's a trade-off between efficiency and stability: Things that work really well (when they work) have a disturbing tendency to blow up (when they don't). But if you assume from the outset that markets are stable -- that's what this assumption boils down to -- then you can ignore those nasty explosions and focus all your attention on efficiency.
- Perfect information. The easiest markets to model are the ones where everybody knows everything. But if some participants have inside knowledge and use it to exploit the others -- that's more like sociology than physics. It's hard to put into an equation.
- Uncorrelated markets stay uncorrelated. In normal times, gold trading in Zurich has nothing to do with wheat trading in Chicago which has nothing to do with the price of houses in Las Vegas. But in a crisis all markets are correlated -- because people who need to raise cash in a hurry sell everything they can.
If all these bad assumptions led economists to conclude that we should confiscate wealth and distribute it to the poor, the powers that be would see through them instantly. But conveniently, they lead to a result that is attractive to the kind of corporations and plutocrats who hire economists and support business schools: Business should be free to do what it wants, and the invisible hand of the market will make it all come out right.
So procedural bias has aligned with patron bias -- the technique you want to use gives you the answer that your sponsor wants to hear. Why question it?
This creates economic "common sense" that is actually nonsensical. And that's why regulators like Alan Greenspan decided that they didn't need to intervene in the housing bubble or the debt explosion, and why the Clinton administration went along with leaving credit default swaps unregulated. Their common sense told them to trust the market.
The same economic common sense told people that greed is good; the market would sort it out and impose whatever moral discipline was necessary. And so everyone discounted the problem that Nobel Prize winner Amartya Sen illustrates with this little story:
"Where is the railway station?" he asks me. "There," I say, pointing to the post office, "and would you please post this letter for me on the way?" "Yes," he says, determined to open the envelope and check whether it contains something valuable.
In other words, if everyone looks for selfish advantage in every interaction, nothing works. Every-man-for-himself competition only makes sense as a small component carefully constrained inside a system of honesty and cooperation.
Wall Street corporate culture. Wall Street investment banks increasingly have adopted the total-selfishness model Sen was criticizing. Traditionally, the goal of an investment bank was to have long-term relationships with large, profitable corporations -- and to help them become larger and more profitable. (You can see this same attitude in the ad agency of Mad Men. Don Draper is no saint, but he sees his interests as aligned with his clients' interests.)
Over the last few decades, investment banks have shifted from a long-term relationship model to a short-term trading model, where the goal is to make as much money as possible on every transaction. That means taking advantage of the client whenever possible -- buyer beware -- even if it destroys the relationship and even if it destroys the client altogether.
The result was predictable to anyone who understood Sen's point: A banker who sees his clients as prey will soon start seeing his stockholders as prey too. The trader who cares nothing for his long-term relationship with the client will also not care about his long-term relationship with his firm. And so trades that create short-term profits (and bonuses) but put the firm in long-term danger -- those are good trades from the perspective of a short-term predator.
The final stages of the financial collapse -- the ones that made even masters-of-the-universe like Goldman Sachs insolvent without a government bailout -- involved complex transactions that tricked internal accounting systems into booking future profits as current profits (and paying bonuses on them), even though those future profits would ultimately turn into losses. The pirates pillaged their own firms.
Smith is one of the few authors to call this what it is: looting.
Bailout and reform. By the time things unraveled in 2008, the government had to do something and it was going to cost the taxpayers money. The economy would have collapsed otherwise.
But what the government did -- under both Bush and Obama -- was to replace the looted money and otherwise leave the system untouched. They treated the collapse as a glitch, not as a structural problem that needed a structural solution. (And not as incompetence that required a wholesale housecleaning of every bailed-out firm.)
What's more, the same policy-makers who watched it all happen and made excuses for Wall Street as the looting unfolded -- Tim Geithner, Ben Bernanke and others -- are overseeing the reform process, such as it is.
Smith concludes:
We have not built enough checks into the process to assure that the banking class will not go out and create the same train wrecks again on a grander scale. In fact, as things stand now, they are almost guaranteed to do precisely that.
If this were just corruption, it would be bad enough. But Smith points to a deeper problem she calls "cognitive regulatory capture": The Geithners and Bernankes share the economic common sense that created the disaster, and they don't know how to look at the world differently.
To a lesser extent, the public shares this economic common sense as well, so (in spite of a widespread belief that Wall Street robbed us) there is little political support for an alternative system.
And finally, there is a truth no one wants to face up to: Economic growth used to be based on increased employment and increased wages -- which led to increased consumer spending and increased production in a virtuous cycle. Recent booms have been based on asset bubbles that created collateral for increased debt. Consequently,
no one seems prepared to accept that healthier practices will result in much more costly and less readily available debt.
At the moment, no one has painted a convincing picture of how we get the economy moving again without another debt-based asset bubble. Until the public has such a picture firmly in mind, it will look at a future without cheap debt the way that an addict looks at a future without drugs.
Rolling Stone's Matt Taibbi shares Smith's skepticism about the post-crisis reforms in his article Wall Street's Big Win:
During the yearlong legislative battle that forged [the Dodd-Frank] bill, Congress took a long, hard look at the shape of the modern American economy – and then decided that it didn't have the stones to wipe out our country's one dependably thriving profit center: theft.
He also sees regulatory capture:
Throughout the negotiations over the bill, in fact, Geithner acted almost like a liaison to the financial industry, pushing for Wall Street-friendly changes on everything from bailouts (his initial proposal allowed the White House to unilaterally fork over taxpayer money to banks in unlimited amounts) to high-risk investments (he fought to let megabanks hold on to their derivatives desks).
And the underlying problem:
In a sense, the failure of Congress to treat the disease is a tacit admission that it has no strategy for our economy going forward that doesn't involve continually inflating and reinflating speculative bubbles. Which sucks, because what happened to our economy over the past three years, and is still happening to it now, was not an accident or an oversight, but a sweeping crime wave unleashed by a financial industry gone completely over to the dark side.
Both ECONned and The Big Short make a point that bears repeating: The financial sector makes so much money because it is so inefficient.
In the standard Econ 101 capitalist fantasy, that statement makes no sense. The whole justification for profit is that entrepreneurs add value to the system either by enabling people to do new things or do the same things more cheaply. On the surface profit looks like money taken out of the system, but in fact it's just a small slice of the value entrepreneurs put into the system.
Take Henry Ford, for example. His combination of assembly line production and mass marketing made it possible for middle-class people to afford cars. He made $100 million in a single year in the 1920s, but so what? Even after subtracting his profit, he added value to the American economy.
If the bankers were doing something similar, if they were just siphoning off a portion of the value they add to the financial system, who could grudge it to them? They'd be matching up lenders and borrowers more efficiently; creating a payments system that got money from buyers to retailers with less overhead; writing more transparent, more accessible insurance policies that helped people insure exactly what they needed to for less money. We'd all benefit from their actions.
But they're not doing any of that. None of the new financial products concocted during the bubble years created value for ordinary people. Instead, they invented confusing products precisely so that they could sell people things they didn't need, get them to take risks they didn't understand and couldn't afford, and trick them into paying large fees that weren't obvious when the contracts were signed.
This is not the everybody-wins capitalism of Econ 101. The huge salaries and bonuses of the bankers are simply a drain on the economy. We get nothing back from them.
News is whatever has happened since the last time we talked. So CNN thinks of news in minute-to-minute terms, newspapers day-to-day, and Time week-to-week. Only at high school reunions are multi-year processes considered news.
But important things do happen on a five-year or twenty-year or hundred-year timescale. When should CNN tell you about them? To its credit, CNN and other news sources do sneak them in once in a while (if they can be tied to something that happened since the last time you tuned in). But if you blink, you miss them.
Here are two that crossed my radar screen recently:
New antibiotic-resistant bacteria. Somewhere in the back of your mind you probably already know about drug-resistant bacteria like MRSA (staph) or XDR-TB (tuberculosis) or C-DIFF. Well, those pesky bugs are just the overture. It's going to get a lot worse over the next 10 years or so.
The underlying problem is that overuse of antibiotics creates an environment where drug-resistance can evolve. Every time we rain antibiotic hell down on some population of bacteria, the germs that are less susceptible to that antibiotic get an advantage over their competition. Over time, the bugs pick up one resistance after another.
We used to think about resistance in terms of individual strains of bacteria, but now researchers have discovered the NDM-1 gene
which passes easily between types of bacteria called enterobacteriaceae such as E. coli and Klebsiella pneumoniae and makes them resistant to almost all of the powerful, last-line group of antibiotics called carbapenems.
So NDM-1 is not just a small step for a germ, it's a giant leap for germ-kind. It works like this:
The gene is carried on a plasmid, a small section of DNA that can move from one bug to another, passing on drug-resistance as it goes. These have, according to the paper [in the current issue of Lancet], "an alarming potential to spread and diversify among bacterial populations."
The gene's discoverer, Professor Tim Walsh of Cardiff University, comments:
Even if scientists started work immediately on discovering new antibiotics against the threat, there will be nothing available soon. We have a bleak window of maybe 10 years, where we are going to have to use the antibiotics we have very wisely, but also grapple with the reality that we have nothing to treat these infections with.
NDM-1 bacteria apparently are already widespread in India. Medical tourism -- Brits saving money by getting their surgeries done in India -- is bringing it back to the United Kingdom. From there, who knows?
The potential problem isn't just plague-like infections that so far haven't surfaced. Antibiotics provide the foundation on which the rest of modern medicine has been built. Without effective antibiotics, organ transplants are impossible and every abdominal surgery is life-threatening.
Plants aren't keeping pace with global warming. A few years ago scientists thought that as the Earth got warmer, the total planetary plant mass would increase too. It seemed to make sense: warmer weather, longer growing seasons, more and bigger plants.
Plants capture carbon out of the air and hold it in their bodies, so plant growth would be a stabilizing factor: People putting more carbon into the atmosphere would lead to more plants taking it out.
Global plant growth is now overall declining and this is because, while some areas are still benefiting from an increased growing season, other areas are starting to be retarded by drought and water deficits
If a longer growing season would help anywhere, it would be someplace with cold winters and good soil. Someplace like, say, Russia. See the problem?
So it turns out that plants (like shrinking polar icecaps) are a de-stablizing factor in global warming: The more carbon in the atmosphere, the hotter it gets, and the more the deserts expand, leading to plants taking less carbon out of the atmosphere.
At a debate among New Hampshire Republican Senate candidates, all six agreed that man-made global warming is unproven. When the Milwaukee Journal Sentinel asked Wisconsin Republican Senate candidate Ron Johnson about global warming, he said "I think it's far more likely that it's just sunspot activity." Asked what he thinks CO2 does in the atmosphere, Johnson said, "I think it's sucked down by trees and helps trees grow."
Sarah Palin continues to have no idea what the First Amendment says. She thinks it means that she herself and people who agree with her shouldn't be criticized for saying crazy things -- and she's been remarkably consistent about that interpretation for the last two years.
The BP oil slick may be gone from the surface, but there's a mile-wide, 20-mile long plume about 3600 feet down. A Florida State oceanographer told Congress:
I expect the hydrocarbon imprint of the BP discharge will be detectable in the marine environment for the rest of my life. The oil is not gone and is not going away anytime soon.
A lot has been made of the poll showing that increasing numbers of Americans (18% now) think President Obama is a Muslim, but I think they're missing the real point: How would you know -- not just suspect, but objectively know -- if the media were biased and that one side or the other had a propaganda advantage?
Well, it's obvious, isn't it? If people were getting biased information, they'd believe false things that slanted in one direction. Like "Obama's a Muslim" or "Obama wasn't born in this country". Crazy crap like that.
Jon Stewart demonstrates how the same techniques Fox uses to connect the imam behind the Ground Zero Mosque to terrorism can also connect Rupert Murdoch..
And what's up with that church near Ground Zero that Fox cares so much about? Is it getting worse treatment than the mosque? No. The hold-up is about whether it will get a public subsidy to rebuild, an issue that doesn't apply to the mosque.
Each story I hear about the Christianization of our armed forces is a little more outrageous than the last one. Here, Chris Rodda reports about a company being marched out to attend a Christian rock concert, with those who opt out being put on maintenance duty instead.
The Weekly Sift appears every Monday afternoon. If you would like to receive it by email, write to WeeklySift at gmail.com.
