I have been watching the Occupy Wall Street (OWS) movement with a mix of resignation and admiration. It is nice to see that people are finally starting to get ticked off with the government and corporations that caused a lot of unneeded pain, while I sit on the sidelines with my surly slacktivism. On the other hand, many of the participants seem hopelessly naive and misinformed about what actually happened, and what might be done to fix our society. And really guys, the finger wiggling stuff, it's ridockulous: just stop it. Since this blog is my personal soap-box, I figure it is well past the point to document what I saw happening back in 2008, and where I think the problem lies. Politics ain't my forte, but sometimes a man has to vent.
OWS on the left blames the corporations; the Tea Party on the right blames the government, but neither have accuracy pinpointed the problem. The real problem is the incestuous relationship between corporations and government, and how they've bypassed a lot of the mechanisms (checks and balances) that are supposed to make representative democracy fair. So the protesters, in my opinion, are off-base in protesting the banks. They should be addressing the base of the problem, and occupying K-street in Washington, DC, where many lobbyists are based.
I am reminded of the character Nick Nailor in the movie, "Thank You for Smoking." Nailor is the top-dog of the smoking lobby, and his job is to obscure, confuse, and otherwise muddy the waters so that the tobacco companies can continue to do business as usual, without any pesky facts to confuse consumers (or citizens as some of us old-school folks call people). If you haven't seen it, it's a very smart and clever comedy, and one of my favourite films. At the end of the day, I think the point of the film is the glamourize a scumbag. I.e. the film is lobbying you to admire Nick Nailor, and it is a test to see if you loathe him or not at the end of the movie.
http://www.youtube.com/watch?v=iBELC_vxqhI
However, before I get into the troubles lobbying is wrecking on democracy, let's go back and take a look at what caused the housing crisis. In the most simplistic sense, people were greedy.
The Housing Bubble
The recent real-estate financial crisis was essentially caused by a failure in risk management, which eventually led to the downfall of many financial corporations, but principally Lehman Brothers and AIG. A whole bunch of home loans were made by many actors to people who didn't have the ability to pay down the principle on the properties they were purchasing. This ran the gamete from 'Sub-prime', to the less risky but actually larger magnitude problem hunk of 'Alt-A' loans, and of course craziness like the NINJA (no-income,no-job,no-assets) loans.
The reason all these questionable loans were made was because the companies making the loans were not holding them in order to make money from the interest. Rather, they were packaging them into securities, called
collateralized debt obligations (CDOs), to be sold like bonds to
suckers interested customers. Now, no one wants to buy a package of NINJA loans, so each securities was divided into pieces called tranches. The bottom tranche took losses, first, then the next level, and so on, until you got to the best tranche, which only lost value if the entire equity was lost. Those top tranches often had AAA and AA ratings, but as it happens, if the housing market declines by 30 %, you in fact do lose every cent of the equity in a mortgage security and even the supposedly AAA tranches got hosed. The housing bubble was not sustainable in the long-term, to the surprise of only people who were not paying attention.
The key problem with traching things this way is how much equity is leveraged up. Unlike you or me, banks are allowed to lend out typically more than 10 x the amount of reserves they hold. In the high of the housing bubble, this reached 30:1 in many cases, which implies if the overall investment declines by only 3.3 %, the whole starting equity is wiped out. In this case, it's easy to see why the AAA tranches were worthless: the housing market declined by an order of magnitude more than the equity could cover.
That wasn't the worst part, however. The worst part was how risk management for those low-hanging tranches that no one wanted was handled. Risk management is generally composed of five different aspects:
- Retention
- Reduction
- Avoidance
- Transference through Insurance
- Transference through Participant Assumption
Retention is simply acceptance of risk; this is actually how we deal with the majority of risk. Reduction and avoidance are obvious, although in this case reduction (by not loaning money to people who are unlikely to pay it back) and avoidance ("too big to fail") were not really respected. Assumption of risk is things like waivers, it assumes that the participants are informed of what's happening and the people in charge aren't committing fraud (::cough:: ::cough::).
For the housing bubble and mortgage securities,insurance was the risk management tool of choice. In this particular case, they used instruments known as
Credit Default Swaps (CDSs). Basically, they're contracts that say if someone defaults on our debt, you pay for it. One can argue back and forth as to whether securitizing mortgages is a problem or not, since if the originator of the mortgage doesn't hold onto it, they lack incentive to ensure the lendee pays it back. However, the financial fobbles came mostly from the idiocy of the tranching at super-high leverage ratios and the cargo cult of finance that insurance through CDSs constitutes sufficient risk management.
The reality is that, for the most part, insurance and assumption of risk don't actually prevent bad things from happening. However, everyone in the financial industry was assuming that their insurance would protect them, not realizing that they were all insuring each other. Insurance only works when the many repay the few that suffer loss. When everyone's a loser, everyone's still a loser even if they're insured. Or in this case, AIG was the bag-holder for too many of the default contracts, and couldn't pay them, so the taxpayers had to do it instead.
Corporations as Artificial Persons
In economics, an externality (or transaction spillover) is a cost or benefit, not transmitted through prices,[1] incurred by a party who did not agree to the action causing the cost or benefit. A benefit in this case is called a positive externality or external benefit, while a cost is called a negative externality or external cost.
In these cases in a competitive market, prices do not reflect the full costs or benefits of producing or consuming a product or service. Producers and consumers may either not bear all of the costs or not reap all of the benefits of the economic activity, and too much or too little of the good will be produced or consumed in terms of overall costs and benefits to society. [...] (http://en.wikipedia.org/wiki/Externalities).
Corporations have many legal rights, in many cases equivalent to a citizen (see
legal personality for some background). This is essentially a requirement for corporations to operate within the legal system. However, there's an accountability problem with how corporations currently legally operate. If a corporation is responsible for negligent manslaughter, does the corporation go to jail?
I think the problem isn't with government or corporations or other large groups of people per sae, but more so a conflict between ethics and morals. We are pretty cooperative, altruistic, and egalitarian animals so a lot of our morals as individuals are hard-wired. A lot of enforcement of this behaviour from the tribe comes from shaming and guilt, but our society has become so huge than individuals have a lot of anonymity. So when a government or corporation does something we would find objectionable from an individual stand-point, the bad behaviour can be rationalized by the participants as, "it's the company doing it."
This comes back to the idea of externalities, and in particular negative externalities and
moral hazard. The banking industry took on a bunch of risk, risk they thought they fire-walled themselves away from by purchasing credit default swaps. When the housing bubble burst, their risk management policies failed, and the government had to step in because they were, "too big to fail." As a current, egregious example, consider this: last week, Bank of America was busted for moving derivatives (in the trillions) from an uninsured investment subsidary into a taxpayer insured, deposit subsidy (
Bloomberg News). Derivatives aren't real money per sae, but this does show exactly how risk is being off-loaded from financial corporations onto the rest of the world.
Where were the consequences to the individuals working in the FIRE industry burning down the remainder of the (productive) economy? Anyone? So here is where the anger of both the Tea Party and OWS comes from: the financiers have received a multitude of benefits for screwing up, and there was no reciprocation when the collapse occurred. Yes, many middle/upper-class real estate agents and mortgage originators lost their jobs, but most of Wall Street got their bailout money and were left untouched.
The problem, in my opinion, comes from the fact that corporations, as artificial persons, do not vote but have an inordinately large influence onto government because of their ability to hire paid lobbyists. Lobbying is essentially an ethically acceptable form of corruption. I might say that it's analogous to how paraphrasing is an ethically acceptable form plagiarism: we find it vaguely disquieting, but we can't really find enough dirt to call you out on it either. In the end though, lobbying is influence peddling, contains a ton of moral hazard and that makes it wrong.
It's fair and reasonable for other governments (whether they be foreign or domestic) to lobby government officials, and individuals. The problem comes when corporations do it, and in a corrupt fashion. Many lobbyists are former public servants who are then hired to help game the bureaucracy by the corporations they were previously regulating. This is a form of quid pro quo, "do what we want and we'll hire you after you retire," that I think would be considered amoral by most people, but yet it is pretty much the norm, especially in the defence and financial sectors. It is a major disruption of the checks and balances that were originally built into democracies: we need a large bureaucracy to administer our governments, and elected officials are very dependant on the technocrats to execute legislation. So when an international corporation gets its fingers into the pie, we end up with democracy pie with a distinctive oligarchy-filling.
The Race to the Bottom
The last decade has been punctuated by two significant recessions, the dot-com crash and then the housing bubble. Aside from those events, growth has been quite impressive. However, it has also been quite uneven, with a lot of people being left behind.
What is perhaps less obvious is that social dislocation may also follow periods of rapid growth, since the benefits of growth are very seldom evenly distributed. Indeed, it may be precisely the minority of winners in an upswing who are targeted for retribution in a subsequent downswing. (Niall Ferguson, The War of the World, p.lxii)
In the above quote, Ferguson is talking about how Jews benefited from the increasing urbanization of Europe following the great depressions of the 1870s and 1890s, and how this made them a target on the basis of tribalization, following the great depression of the 1930s. It is pretty apropos for our current mess too.
The growth starting after the dot-com crash up to the housing market crash of 2008 was largely a mirage. In a lot of ways, it was a jobless recovery. Productivity increased, wealth increased, but in general many people were left behind. The employment index gives a much fairer impression of the scale of the problem than any unemployment rate ever could.
 |
| The proportion of employed persons in the USA (from Calculated Risk). Note the y-axis does not originate at zero. |
Roughly 5 % of the jobs in the USA have simply disappeared over the past ten years and is at the same level seen in the 1970s. That means that 1 in 20 people have permanently left the workforce. At that level, everyone will know someone who's no longer working, and badly effected demographics will know many people. I cannot believe that conservative pundits are are not screaming bloody murder about having so many people out of the workforce since all of them have to be supported by the working population.
This brings me to the notion of the
race to the bottom. That is, he idea that you need to attract businesses by making regulations that protect the environment, workers, and offering tax breaks and subsidies. This to me sort of says, we think our local industry is incompetent, and we need to bring in a multinational to provide jobs rather than build our own economy. I.e. it's lazy governing. The main winners in the deregulation sweepstakes of the finance industry were the USA, Ireland, and Iceland.
How well did that work out for you guys? I think the dichotomy that we have to allow bad actor corporations to operate in our boarders to keep people employed is a false one: why cannot the elimination of a naughty corporation allow space for a nice corporation to win market share?
Bad actor corporations are just that, and they tend to be a net-negative on the economy. Just as an example, look at high-frequency trading. What is the economic benefit to high-frequency trading? To my eye, it seems the more
sophisticated complicated financial instruments become, the less benefit they provide to the rest of society as legitimate instruments of providing credit to the rest of the economy. The Keep It Simple, Stupid (KISS) should rule our laws surrounding finance.
Try to think of capitalism as a sandbox experiment in evolution. The initial conditions and rules that govern our little experiment will determine what sort of corporate mileau that pops out the other end. If we have rules that allows negative externalities to be produced without any negative consequences, of course the end result will favour the corporate animals that produce a lot of them. If we want to get more altruistic companies in our countries, we need to make sure the sandbox favours them. If you want more Enrons, deregulate and race to the bottom.
First, the USA has to figure out what direction it wants to take its economy in because too many people have been left without a livelihood. Exporting imperialism, sustainability, high-tech manufacturing, whatever... Right now 20 - 25 % of the US economy is in the FIRE (financial, insurance, and real estate) sector and sorry but that's silly. You cannot produce wealth by shuffling around pieces of paper (or more likely, bits in computer memory). The FIRE sector is essential, but also essentially parasitic on the rest of the economy. It's the only sector that has become more bloated and less efficient with the massive gains in information technology over the past half-century, and that indicates to me that something is wrong with the laws and regulations that govern it.
We need to recognize that there's a need for a balanced economy, because honestly you cannot have everyone doing research and development, developing new ideas and products. I'm barely smart enough to do research myself, in my own tiny little highly specialized field. Germany does it; Japan does it.
Second, occupy K-street. Wall Street seems to be doing too good of a job of populating the US Treasury Department and Financial Reserve with their own people. Laws and regulations are not a bad thing, but there is a tendency due to excessive political partisanship for these to not be flexible, living rules. I think it is fair to say that in the USA, the blame for excessive partisanship should largely lie on the GOP and their righteous, doctrinaire approach to governance. Regardless, the rules surrounding political lobbying and the various forms of, well, bribery that are allowed to go on need to be tightened up immensely.
Third, the Euro needs to go. I haven't talked about the Eurozone at all, but I think it's fair to say, sovereign governments not being in charge of their own currency has caused 'issues.' It was a technocratic solution imposed from the top without a plurality of support.
I wouldn't want to come across as histrionic, the system actually works pretty well, but it does need to be reformed to deal with the reality of international corporations being artificial persons with little to no accountability to anyone. Most people in the West are fabulously wealthy by any historical standard, and technology continues to march on, but clearly things could be better as change has outstripped some of the rules our culture lives by. Corruption is never a positive thing and we should always try to stamp it out whenever we can.So no violent revolution please, just real reforms, and end the race to the bottom, because we don't want to
be at the bottom.