Saturday, January 9, 2010

A Conspiracy of Dunces

I'm most of the way through Andrew Ross Sorkin's Too Big to Fail.  It's blow-by-blow account of the financial melt-down, and Sorkin had amazing access to all the main players -- Geithner, Paulson, Dimon, Blankfein, etc ...  It makes for a very readable story, and immediately impresses on you how little the events of 2008 were about finance or economics, per se, and how much they were about personalities and dealmaking; the crisis was an inevitable symptom of the underlying credit bubble disease, but the exact shape it took had much more to do with which monkeys were golf buddies than anything substantive.

Reviewing the course of collapse has made me reflect yet again on the poverty of conspiracy theories.  These theories always mushroom in the wake of any dramatic event -- 9/11, Kennedy, AIG, MJ, me stubbing my toe, etc ... They are always so true as to be useless.  The problem is that the drama of events is nothing in itself.  Events are just singularities.  They are the crystallization of a set of circumstances.  So to say that one event causes another just obscures the real mechanism.  To blame a crisis on a conspiracy begs the question of how the purported nefarious agent would have been able to exercise such power, and on why the critical event provoked such dramatic response.  Hitler can't take over the world without the Germans.  There is always mechanism.  There is never anything but mechanism.

But I digress.  The current conspiracy theory revolves around Goldman Sachs, in particular, and the behavior of bank CEOs in general.  We are to imagine that these people calculated the private profit they could derive from driving the financial system to the brink of collapse.  We are to imagine that they knew the government would bail them out, and that they consciously availed themselves of the Armageddon Put.  We are even to imagine that the government played along.

We have no trouble imagining this of course.  And that's precisely the problem.  Because our analysis of the situation always stops there.  We know what went wrong -- greedy and unethical bankers ruthlessly drove the economy to collapse while they paid themselves billions.  So we think we know how to fix it.  We'll fire those bastards.  We'll get some new regulators that cut their paychecks and we'll sick the BIS bloodhounds on their bullshit balance sheets. 

And we won't have solved our problem, because we will have completely mis-diagnosed it.  It's always the same with these things.  We imagine that the world is filled with people rather than causes.  We imagine the uniquely weird genealogy of human morals applying to a situation it was not bred for.  We fail to understand, as one Morgan Stanley executive said of the short sellers feeding the panic in their stock, that "They are cold-blooded reptiles.  They eat what's in front of them".

Reading the book, this becomes abundantly clear.  I had already understood pretty well how this logic applied to the boom times.  Capitalism has never needed moral hazard to get a bubble going.  When things are inflating all you need are normal amounts of greed, competition, and near-sightedness to touch off a race to the bottom.  In the immortal words of Chuck Prince, former Citibank CEO, if the music's still playing, you have to keep dancing. 

But what I hadn't totally seen is how this same logic applies throughout the crisis.  Of course we understand how, in a panic, you have a coordination problem, as everyone is covering their ass.  Everyone must protect their personal interest, and no one is in a position to act for the greater systemic good, even if this would be better for all the participants individually.  The logic goes deeper than that though, because there's no clear moment when the very competition that fueled the bubble stops.

The weekend before Lehman Brothers' collapse, all the players are sitting around the table brokered by the Fed and Treasury, still jockeying for position, still trying to drive the hardest possible bargain, still trying to force a competitor to overpay or to be the firm that scoops up a deal on the cheap at the last second.  Not only is there no moment where these guys band together for their protection, there isn't even a moment where they stop trying to stab each other in the back.  They never switch from offense to defense.  They have no defense. 

For me this was an important insight.  When we talk about moral hazard we always imagine that there is a decision involved somewhere.  We think of some unethical, unsavory act that no warm-blooded mammal would engage in.  A man sets fire to his house for the insurance money; even the flames are not enough to melt his heart. 

But here is a mechanism that doesn't involve any human decisions at all.  Everyone simply follows the rules of rationality.  They don't think or feel, they strategize and execute.  They maximize profit.  Nothing immoral is required.  Nothing is required but the same competition that we normally take such pride in.  Too Big To Fail is just another innovative financial product.  Such are the wonders of a free market.  None of these guys count on being bailed out.  They know they're risking everything.  They've seen what happens.  But as the end nears the stakes just get higher.  There is that much more incentive to double down.  Someone will be left standing, even if it is just the government.

The sinking ship is filled with the same rats that built it, still clawing at one another.  Chaos needn't conspire to produce order.  Reality is beyond good and evil.

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