Property rights

Interfluidity has hit the nail on the head once again -- contracts are not bilateral agreements.

Commenting on Nassim Taleb's provocative agenda for fixing the world, Felix Salmon notes that

Looking at the rest of the list, how on earth do you stop the financial sector from... creating complex products? Derivatives are, at heart, bilateral contracts: how can you ban two consenting adults from entering in to such a contract?

The only bilateral contract is a gentleman's agreement. Binding contracts involve an implicit third party, the state which (through its courts system) stands ready to enforce the terms of private arrangements. The state is not, and cannot be totally neutral in its role as contract enforcer: Communication between contracting parties is always imperfect; the universe presents an infinite array of unforeseeable possibilities; even very clear contractual terms can be illegal, repugnant, or contrary to the public interest. The state makes affirmative decisions about how it will (or will not) enforce the terms of contracts.

 

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This has something to do with derivatives, but even more to do with one of Taleb's broader concerns: debt. At present, the state enforces debt contracts by permitting lenders to force nonperforming borrowers into bankruptcy. That is not a natural or obvious arrangement. Bankruptcy evolved as an improvement over automatic liquidations or men with big necks and brass knuckles.

In fact, there are no natural or obvious arrangements.  There is a social choice about what types of property rights we are going to have.  Up until now, the way this choice has been made has dramatically favored debt rather than equity financing, and has led to the instability we are experiencing.  This is by "design" in the sense that a tree which only germinates during a forest fire would by "design" tend to become more flammable. 

We should consider coining the term Big State to go along with Big Oil, Big Pharma, and Big etc ...  Big State's business model is called emergency; it finds itself strengthened every time there is a crisis a shock or a war.  This is the logic of Big State, and is no more of an accident than the corruption which makes it possible.