Saturday, December 26, 2009

How working on Wall Street made me an Anarchist

Today, the lucid wonder that is Interfluidity linked to a Milton Friedman essay, which I found interesting.

... there is one and only one social responsibility of business -- to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

Milton, if I may call him that, is always a joy to read because he is a sort of reductio ad absurdum of the libertarian position that once held me in its near total sway.  The essay succinctly summarizes the basic insight that third party managers (eg. corporate executives employed by a businesses owners) who declaim the "social responsibility of business" are really just spending other people's money, and without even the semblance of pseudo-democracy that serves as the prelude to this same expropriation by our government. 

I still like this perspective, and I think it has something to offer anyone willing to take it on for a moment, even though, as I say, I have moved away from it.  The reason for my change of stance in not, however, because I've gone all soft and bleeding heart.  On the contrary, I feel like I've departed from Milton only by taking the best part of his philosophy -- the reliance on freedom as a principle that can unify your view of politics -- to its logical conclusion.  This turns out to look a lot different than his stopping point, and suddenly lets his ideas communicate with anarchists like Chomsky, and even, strictly for illustrative purposes you understand, allows you to conceive of what it would mean to be a "free-market Marxist".  But for all that it has evolved, I still trace my thinking back to the moment when I saw how the question of freedom cuts right through the political spectrum and for the first time organizes your views into something that can properly be called a political philosophy.  Of course, it was actually Nozick, not Milt, that first made me see this, but whatever.  In either case, politics is transformed from a scattering of unrelated opinions/superstitions pertaining to various issues, into the application of a single principle under varied conditions -- how can we free ourselves?

What has changed since then?  Basically, I've just felt the need to expand the definition of freedom; passing from rebellious youth to creaking maturity has made me aware that being able to do what you want goes beyond simply not being told what to do.  From freedom from to freedom to.  I'll certainly not disagree with anyone who considers this extension obvious, but that doesn't make it any less profound.  It is not simply a matter of adding more freedom, as if freedom from were a proper subset of freedom to; while there is always a danger that utopian ideology wields the hammer of oppression, it's also evident that our age suffers from an overly narrow version of freedom from that can end up cutting us off from our ability to do more things, and in fact can even come back to erode the very walls we use to hold at bay all those things we are free from.

All of which brings us to the razor-sharp quote with which we began.  People should be free from the exploitation that occurs when someone else spends their resources without their consent.  Hence business as such has no social responsibility and should be uniquely concerned with profit.  So long as they stay within the rules and compete without deception or fraud, these joint ventures, as it were, are nothing but the voluntary and temporary pooling of individual resources, and it is as morally unconscionable for them to arbitrarily confiscate the resources of individuals by failing to maximize profits, as it would be for any of these individual members to expropriate the goods of another.  Freedom from coercion.

The political principle that underlies the market mechanism is unanimity. In an ideal free market resting on private property, no individual can coerce any other, all cooperation is voluntary, all parties to such cooperation benefit or they need not participate. There are not values, no "social" responsibilities in any sense other than the shared values and responsibilities of individuals. Society is a collection of individuals and of the various groups they voluntarily form.

Loyal readers will be absolutely groaning with the obviousness of where I'm going with all this, so I'll drop the coy shit now.

Who writes the rules that the businesses play within?  We admit the necessity of having rules.  The rules have to be uniform and standardized for the competition to be free and open.  Somebody has to write the rules. Somebody has to define the game we're playing.  So, how do the rules get written?  With just that one question, the entire libertarian apparatus unravels.  Because it's evident that businesses seeking to maximize their profit will find themselves morally obligated to extend their competition in an effort to write the rules in their favor.  And this feedback loop is entirely within the rules of the game, involves free and open competition in a political market and no more than customary quantities of deception and fraud.  In other words this problem is an inevitable and predictable outcome of a libertarian philosophy, and not a question of particular petty corruption  and dishonesty.  Eventually, strictly profit seeking enterprise will always seek it by capturing the government.  The logical conclusion of this freedom from coercion is its own self-destruction. 

The self-destruction of the libertarian position does not mean we should give up on the principle of freedom.  On the contrary, broadening this principle to include the concept of positive freedom and to safeguard our ability to engage in these games of voluntary cooperation to begin with can serve to reinforce the basic libertarian conclusion that the best way to stay free is to keep the government small.  It's true that you could argue in the opposite direction.  Consider the way people have painted the alternatives since our latest financial crisis -- government vs. business, profit and innovation vs stability and control.  The thinking is that big government will put a leash on the profit aspirations of big business by adding more rules to the game and insisting that all that panting and straining drag us in the right direction. 

But this doesn't turn out to be a very coherent response if you agree with my diagnosis of the problem.  How can adding more rules make this system more stable?  The instability arises from precisely the way the players are able to write new rules.  How can compounding this effect ultimately lead to a better outcome?  Even if, today, in a fit of reformist zeal, you manage to add rules that restrain business and channel its energies in the desired direction, you will still have tomorrow and the next day to worry about.  In fact, you can't even be sure that the new rules you write now are not precisely those that certain businesses wanted written to begin with.  Making the problem bigger in order to solve it might work, but does it seem like the most sensible direction to pursue?  Why give this feedback loop more material to consume?  Why imagine that it will somehow stop itself?

Nevertheless, I think most people instinctively go in the direction of bigger government and more rules because it is something they understand.  Control.  Domination of the future.  Planning and centralization and subsequent re-delegation to those trusted organs charged with maintaining the forward momentum that the great technocratic brain has calculated for our social organism.  Everybody is pretty comfortable with the wizard, and nobody really wants to know exactly what's behind the curtain.

And anyhow, the other direction is marked hic sunt draconesLess government?  More freedom?  How are we going to solve our problems?  How are we going to get what we want?  How are we even going to know what will happen?  Do you know who's in charge here?  It's just Anarchy.  The mind recoils.

So I became an anarchist.  And I've been becoming one ever since.

Tuesday, December 22, 2009

Jânio Quadros -- Strangest Populist Ever

The English wikipedia entry simply doesn't do this guy justice, so here's the spanish version.  Lord knows what they say in portugese.

La carrera meteórica de Quadros puede ser atribuida a su retorica populista y su comportamiento extravagante. Es electo Alcalde de la ciudad de São Paulo en 1953 y gobernador del mismo estado en 1955. Resulta electo ganador por mayoría absoluta de la presidencia de Brasil en las elecciones de 1960, tomando posesión el 31 de enero de 1961.

Quadros recibió la presidencia de su antecesor, Juscelino Kubitschek, en la recién inaugurada ciudad de Brasilia el 31 de enero de 1961. Luego comenzó a tener actitudes extrañas: se comunicaba con sus ministros por medio de esquelas; prohibió el uso de bikinis en los concursos de belleza; prohibió la riña de gallos; intentó poner reglamentos a los juegos de baraja. Intentando una aproximación con los países comunistas, Janio recibió y condecoró a Ernesto Che Guevara con la Orden de la Cruz del Sur (Cruzeiro do Sul), la más alta distinción honorífica del gobierno brasileño.

Carlos Lacerda, gobernador del extinto estado de Guanabara (formado por la ciudad de Río de Janeiro, después que esta dejó de ser la capital federal de Brasil) que hubiera apoyado a Janio, empezó a oponerse a él. En una proclama del 24 de agosto de 1961, Lacerda denunció lo que llamó un plan de Janio para "intentar un golpe de estado" y convertirse en dictador. El día siguiente, 25 de agosto, Jânio anunció su renuncia, lo que prontamente fue aceptado por el Congreso Nacional Brasileño. Se cree que Jânio deseaba que el Congreso no aceptase su renuncia, y le diese poderes especiales para gobernar el país, lo que constituiría un "autogolpe".

There are some basic rules in modern politics -- never start a land war in Asia, never argue with your dentist, and never, ever, overthrow yourself, especially not in Latin America, and especially not after prohibiting the use of bikinis.

Wednesday, December 16, 2009

The Best of the Most

So, I made the mistake of looking at some of the most popular videos of the year on Youtube.  I mean, I felt like I should know what the rest of the world, including even the parts beyond my extremely well-examined and handsomely groomed navel, might be interested in.  This, I hypothesized, would make me more understanding, more forgiving, more ... human.  Instead, it just makes me wonder why I'm not on a boat, motherfucker!  And it also made me wonder whether this Schirrmacher fellow was onto something.

"What if the price of machines that think is people who don't?"

Friday, December 11, 2009

The Year in Punchlines

Liberal black women from New York City drive like maniacs:

Victor Harris was rendered quadriplegic after the police rammed his car, ending a nine-mile high-speed chase outside Atlanta. The issue was whether a suit by Harris against the officer who rammed him should be allowed to proceed to a jury trial. Lower courts were inclined to give Harris his day in court, because he had committed no crime except speeding before he fled, and while he topped 85 miles per hour during the chase, he was in theory in control of his car.

The Supreme Court disagreed and defended its position in an unprecedented way: by posting a video of the chase, taken by the police, on its Web site. "No reasonable jury," Antonin Scalia wrote for the majority, could watch the video without agreeing that the chase had to be stopped, even if it meant killing Harris.  "We are happy to allow the videotape to speak for itself," Scalia wrote.

Did it? Kahan, Hoffman and Braman showed it to a diverse group of 1,350 Americans. Most of the test subjects saw things as the Supreme Court did: 75 percent concurred that deadly force was justified. The dissenters, however, were not randomly distributed: they reflected distinct subcategories of Americans, like liberal African-American women from cities in the Northeast.

Don't shaft drunk people:

Morewedge and Krishnamurti took a "data truck" to a strip of bars on the South Side of Pittsburgh (where participants were "often at a level of intoxication that is greater than is ethical to induce")

Reduce, Recycle, Reuse your loved ones:

... powering a crematorium requires an enormous amount of gas and also sends carbon dioxide and other pollutants skyward. Enter resomation, an alternative to cremation for the eco-conscious cadaver.  Unlike cremation, resomation doesn't vaporize the toxic mercury of dental fillings and doesn't char joint implants, leaving them clean, shiny and potentially recyclable.

In a way, Austen's novels are already zombie novels

Wednesday, December 9, 2009

Just in case

... you thought you were anything but an algorithm

Posted via email from The Capitalist Axiomatic

Tuesday, December 8, 2009

My biggest fear

One of the things that I've been trying to understand is to what extent the boyz down at the Fed get it.  No doubt, these are smart folks, they have great data, and they know 6000 times more about economics than I do.  But, is that knowledge counter-productive?  Some days it seems like they've grasped the fundamental problem that would require a major re-think of neo-classical economics -- namely that money is real, and that how you count stuff matters to the real economy -- and some days it seems like they are trapped in a "money is just a very efficient form of barter" mindset. 

Which is what makes reading stuff like this new paper from the Dallas Fed so scary.

If the nominal exchange rate regime matters for the determination of relative prices such as the real exchange rate or the terms of trade, it must matter because there is some kind of nominal price stickiness. For example, if the U.S. dollar/euro exchange rate is to affect any real prices, it must be because there are some nominal prices that are sticky in dollar terms and others that are sticky in euros. From the standpoint of modern macroeconomics, the question should be posed: What policy best deals with the distortions—from sticky prices and other sources? Is it a fully flexible exchange rate, or some sort of exchange rate targeting?

Now, this sounds like an interesting paper.  The basic question being why you need the nominal exchange rate to adjust when you could just have prices and wages adjust to produce the same effect in real terms.   In other words, if China keeps the Renminbi pegged too low, why isn't there more inflation in China or more deflation in the US?  Good question.  Maybe I'll read the paper. 

But note how the question is phrased (the bold emphasis is mine).  A behavioral fact as simple as the reluctance of people to take a pay cut is being called a "distortion".  Yeah, okay, it's a distortion of some economist's imaginary model of a perfectly frictionless economy, but that is not a very useful definition of "distortion".  Until these sorts of "distortions" are simply considered "facts", I'm not sure we're going to make any fundamental progress in managing or meta-managing the economy, and I will remain worried that the brave men in charge of the liquidity hose are all wet.

Friday, December 4, 2009

Hey, wasn't that equilibrium we just passed?

Unsurprisingly, very smart Harvard profs suggest that we need nothing more than a technical fix for financial regulation to get us moving on towards the next bubble.

The harder question is how to limit inordinate risk-taking by the protected financial firms, especially given the difficulties in evaluating the risk in their portfolios. Ideally, bigger firms that enjoy some sort of public guarantee should pay a "public insurance premium,'' which would be a function of capital levels and risk. 
But the daunting problem in either charging such a premium, or enforcing plain old capital requirements, is measuring risk-weighted assets.

So don't risk weight the fucking assets.  This was always a practice that lent itself to regulatory arbitrage, and the definition of risk as recent volatility leaves, ahem, something to be desired.  People always tell you that, "yes, we're highly leveraged, technically, but you have to differentiate between leverage and risk". Bullshit.  Leverage IS risk.  Volatility comes and goes, but bankruptcy is forever.

One way for regulators to better evaluate financial risk is to borrow a trick from the income tax system. Our incomes are reported more or less correctly because employers have a strong incentive to state our earnings. Since stating our full income reduces their tax liability, firms rarely help hide their workers' incomes. Employers and employees that report different numbers are raising a giant red flag.

Banking regulation can use the same rat-on-your-partner structure. Every credit default swap involves two parties - one taking on more risk and one shedding risk. The regulatory system should treat this as a transfer of risk where the insurer is taking on exactly as much danger as the insured party is shedding. If each firm's public insurance payments or capital requirements depend on their risk, then the insured entity has an incentive to accurately report the risk the insurer is taking on. With the right system, every firm has an incentive to report on each other and to make sure their numbers match.

Having the banks rat on each other sounds great until you realize that:
  1. there are only a few big ones now, and they could collude pretty easily
  2. your measure of risk is useless to begin with.  The banks could each run to the Fed screaming about how little Cathy stuck her hand in the cookie jar, while they meanwhile ignore and even encourage Testosterone fueled Tommy in the basement with his shiny new nuclear weapons playtime kit.
All this brings up another question.  Lots of clever people have come up with lots of clever ideas about how to improve the rules the financial system is forced to play by.  These solutions are typically designed to involve the smallest of regulatory tweaks to our existing structure.  The claim is that this approach is more "pro-market" and preserves the incentives for "financial innovation".  The obvious flaw is the reasoning is that these people begin with the mistaken assumption that we have a market, and that we have financial innovation worth preserving.  We clearly have neither.  Markets allow firms to fail when they flounder.  Innovation provides for new services (such as banking for the 25% of Americans who don't regularly use a bank) which tends to be disruptive and causes some firms to fail and others to succeed. 

Real pro-market (rather than pro-business) solutions don't try to dot an imaginary i in an effort to preserve a non-existent market.  Real pro-market reforms start with the realization that the market for rules -- financially, politically, and ideologically -- has already been cornered.

Thursday, December 3, 2009

Deriving Derivatives

Tommy Gun Tim, The Man of A Thousand Silver Bailout Bullets, recently testified in Congress about the next act in the financial regulatory charade.

Mr. Geithner said that pending bills in the House which would carve out fairly broad regulatory exemptions for companies that use customized products to hedge risks should be reviewed and possibly tightened.

Mr. Geithner testified about administration's plan to bring new regulations to the over-the-counter market. A key part of the plan would require many routine products to be traded on platforms and processed through clearinghouses, which guarantee trades.

But businesses have warned such a move could have a dramatic cost impact because it would force them to post cash margin to a clearinghouse. In response to those concerns, two key House panels carved out exemptions for commercial firms in their derivatives bills.

Mr. Geithner on Wednesday reiterated his support for preserving a customized swap market in which products are still traded off-exchange. But he warned that any clearing exemptions should be narrowly defined so firms can't skirt the rules.

Just two thoughts. 
  1. The things that are going to get proposed exemptions are actually the only derivatives that should exist to begin with.  These derivatives are useful for real economy hedging and should clearly not be traded in a custom, opaque and high margin OTC fashion, because the companies that are using them to hedge will never know whether their counterparty is actually good for it or not.  Your not hedged unless you know you're hedged.  This, you will recall, is why we're having the "gee, maybe we should regulate derivatives," discussion to begin with.  So I can't tell whether the ploy here is to create a loophole so large that nothing important happens at all, or whether he's trying to force all the useless and speculative derivatives (like CDS) onto an exchange as a way to effectively kill them by raising the collateral requirements to the point where they're uneconomic.  And it could be both at the same time -- take away the shiny bauble the child keeps choking on, but give him a less dangerous and still highly profitable gift in its stead so as he keeps his yap shut.
  2. The idea that having to post cash margin will kill the useful commercial derivatives is nonsense.  I mean, what do we have banks for to begin with if not to assess the credit worthiness of a borrower and extend ... um ... credit ... aka ... cash ... which could then be used to post collateral.  Right now we've got all this opaque bullshit like increasing ownership of a utility's turbines serving as Goldman Sachs' collateral on some funky structure they've got with an aluminum smelter in China.  Please, guys, this is what we invented money for.  It makes things a hell of a lot clearer than bartering derivative exposure, which as we have seen, also has a cost that only comes out when everything goes bad, and in the meantime sweeps it under the accounting rug.  If the derivative is worth it to begin with, GS can loan the utility and the aluminum smelter some money to post as collateral to an exchange traded product which hedges both of their electric prices.  All this does is makes the cost clear and upfront and explicitly accounts for the implicit leverage involved.  Oh, and cuts into the vampire squid's margins -- money is, lest we forget, a commodity.

Wednesday, December 2, 2009

Capital and Imagination

I really enjoyed the opening lines of something Yves pointed to this morning, an introduction to the work of Marxist Historian Robert Brenner.

For even the most ardent critics of today's distributions of power and wealth tend to accept reflexively the pervasive reality of prices, markets, and money. We cannot really see these institutions that govern our lives as anything other than givens, and thus our grasp of the role of place, of history, of culture and power in shaping these institutions has indeed almost entirely loosened.

In this sense, despite the ease with which one can poke fun now at theorems such as Modigliani-Miller and Black-Scholes that underpin orthodox modern finance theory, [1] the hegemony of capitalism is complete, to paraphrase Gramsci. We can no longer conceive in any visceral concrete manner of different arrangements ordering our lives. We may be aware that our financial system has failed us; that our ways of doing things threaten to despoil irrevocably the water we drink and the air we breathe; that hundreds of millions of people live in unnecessary misery – unnecessary because we have the technologies at our disposal to feed, clothe, and shelter everyone alive in reasonable comfort and dignity. And yet our proposed "solutions" amount to tinkering – a little more regulation here, a bit more welfare spending there, turning over governments and supra-national organizations to the high-minded who will see to good educations for all, strict environmental standards, and a gradual reduction in armaments.

The rest of the piece is also worth reading, and contains some interesting reflections on Japan's and China's paths to economic development.  I don't agree with all of it -- either in theory or in terms of the facts.  There's been no systematic decline in profitability as he suggests, and as Paul Krugman points out very well in Pop Internationalism, nations don't really compete the way companies do, so you have to be very careful in making that analogy.  I also completely fail to understand why Marxist thinkers can't get it together to differentiate between capitalism and markets, so as to make their best point much more clearly and without an inevitable stream of soothsayingly apocalyptic rhetoric one might expect out of the local fishmonger.  But at least we have here some of the imagination we so sorely lack.

If you want another example, you can also go watch George Soros, the only multibillionare Marxist I know of (depending on how you define Marxism).  Those who have no patience for how atrocious a speaker he is might prefer the short version, or even the really short version.

Tuesday, December 1, 2009


Interfluidity is truly one of the wonders of modern communications technology.  Consider his latest post on a real version of the famed "democratization of finance":

If someone devised an equity instrument that would offer stronger, easier-to-value promises than common equity, that would effectively disperse entrepreneurs' risks while offering investors an upside, that could be efficiently offered in modest chunks small investors could incorporate into diverse portfolios, I think that would be a fantastic financial innovation.

Suppose businesses sold numbered dollars. Dollar number 420,167 has just been rung in. How much would you pay for dollar number 600,000? If you pay 91¢ for that dollar and it takes a year for the business to bring the next ~$180K, you've earned a 10% return. If business is great, and it only takes 6 months reach that sales level, then you earn a 20% annualized return. ROI is dependent only on the briskness of sales, something that is tangible and observable, something that customer/investors can understand and estimate. These claims would confer no control rights upon their holders (except potentially when they are in arrears), so entrepreneurs, the residual claimants, would price their goods and services to maximize profits, not revenue. Holders of fixed income / variable term claims would be along for the ride. Assuming a non-wimpy business owner, investors' best strategy for maximizing the value of their claims is to drum up business, which is a win/win for the entrepreneur and the investor. Investor repayments would naturally correlate with business success: when business is slow, few payments to investors would come due. When business is brisk, lots of claims would mature.

This is quite a bit bit smarter than anything I had to say when I was reflecting on why we have debt to begin with, though it goes in the same direction.  It's funny to think of this as innovative, when it turns out that truly democratic finance would look a lot like the investment companies of yesteryear, minus the fraud of the South Sea Company (we hope).  Everything goes to reinforce the idea that democratic finance shouldn't be trying to "restore the flow of credit" or "allow homeowners to tap their equity" or any of the nonsense that was flogged off as terribly innovative during our latest round of Ponzi finance.  Instead, we should be trying to imagine a system that puts people who save together with people who need the money to build something new, plain and simple. 

Real financial innovation would put a lot of banks out of business, just as real technological innovation made the mainframe obsolete.  And local equity investing would not only be a financial revolution, but you can easily see how it would be the first step in a revolutionary political decentralization as well.  Which of course brings me to my dead horse of recent months, namely that after 500 years of rapid technological development, our species really only has one social technology, applied intermittently at best, to show for its efforts -- I wish my markets improved as rapidly as my motherboard.