The Driver of Social Change (1 of 2)

In developing the characteristics of speculative capital, I wrote in Vol. 1:

Speculative capital is, by definition, opportunistic. It is constantly on the lookout for “inefficiencies” across markets which it can arbitrage. The opportunities arise suddenly, so the capital that hopes to exploit them must always be available; it cannot afford to be locked into long-term commitments. The requirement to be opportunistic translates into the need to be mobile, to be nomadic and interested in short-term ventures. Such are the inherent attributes of speculative capital.

Then added:

Because these attributes define speculative capital, the manager of speculative capital must employ it in activities that are consistent with these attributes. This rigidly defined role turns him from being a manager of speculative capital into its agent, someone who nominally “runs” the speculative capital but must in fact follow its “agenda.” Speculative capital becomes the grammatical subject of the sentence as if it were alive.

In addition to traders who act on its behalf, capital also has agents who speak on its behalf. These agents are a curious mix of dissembling advocates and ventriloquist dummies. Their advocacy is unconditional but indirect, as if to throw off the scent. Yet, they are unaware of the role and influence of their ever-present “client” and speak of their “free will” in earnest. That is how they are dissembling advocates and ventriloquist dummies; knaves and fools in equal parts.

Observe, if you will, Prof. Gary Becker of University of Chicago. He is commenting on the U.S. economy in The Wall Street Journal of Dec. 21:

Productivity has gone very well actually throughout the decade, even during recession. That’s an excellent sign for the economy, if that can continue … The thing that concerns me is whether we are getting too much regulation and social engineering in the next few years. I would be concerned about that as a possible factor that is putting brakes on the growth of the economy.

Now, return and read these comments again, this time substituting “capital” for “I”, “me” and “economy”.

The substitution clarifies the professor's comments and eliminates the seeming contradiction implied by “even during recession”. This is how it appears to me, with my thoughts automatically appending themselves to the text in brackets:

The productivity [that is, workers producing more with the same or lower wages and salaries,] has gone very well actually throughout the decade. [It is not surprising that this has taken place] even during recession. [In fact, it is precisely during a recession that workers can be made to produce more with less.] That’s an excellent sign for [the further accumulation of] capital, if that can continue. The thing that concerns capital is whether we [i.e., the sum total of capitals] are getting too much regulation and social engineering in the next few years. Capital would be concerned about that as a possible factor that is putting brakes on the growth of the capital.

There is no reference to people, either explicitly or implicitly; productivity and recession are mentioned in the same vein one might describe good air quality or bad weather – or the sighting of a black swan. And Prof. Becker is the winner of the 1992 Nobel Prize in economics “for having extended the domain of microeconomics analysis to a wide range of human behavior and interaction”.

I am not writing to criticize the good professor's language. His is the standard language of economics and finance professors everywhere. What I want to focus on here is social engineering. Prof. Becker does not like social engineering because it puts “brakes on the growth of the economy”. By the same token, he does not like regulation because it is the agent of social engineering. His ideal society, we can surmise, is one where the “economy” grows “naturally”, without any regulatory burden or interference.

Prof. Becker is correct in associating regulation with social engineering. Social engineering is consciously influencing and altering the course of the development of the society. It is the attempt by men to direct the social and economic forces towards a definite end. To the extent that regulation is aligned with that goal, it can be the agent of social engineering.

But Prof. Becker is fundamentally wrong in believing that the absence of regulation is synonymous with the “natural” economy or society. There is no such thing as natural economy, no matter how primitive the society. And there is no such thing as the absence of the regulation, only that law and regulation favoring the dominant force in the society are enacted at such tectonic scale and fine level of technicality that they are all but invisible to the general populace – and economics professors. What is the deregulation on whose behalf Prof. Becker and his colleagues have been the most tireless cheerleaders for the past 35 years if not the most brazen attempt in social engineering undertaken on behalf of speculative capital?

I devoted a full chapter in Vol. 1 to the way speculative capital – the latest and most advanced form of capital in circulation – affects the law and regulation. I wrote:

Speculative capital abhors regulation. Regulations interfere with the cross-market arbitrage that is its lifeline. If speculative capital cannot freely operate, it cannot generate profits and must cease to exist. The opposition of speculative capital to regulation is thus not a matter of some technical or tactical disagreement but a question of life and death.

The attack of speculative capital on regulation is not indiscriminate. Speculative capital singles out only those regulations which directly or indirectly hinder its free flow across the markets. Meanwhile, it supports and pushes for the passage of sweeping laws that favor its expansion. In so opposing the regulation and supporting the law, speculative capital distinguishes between the two in ways few philosophers of law could.

And the beat goes on. Listen to Bill Gross, the chief investment officer of PIMCO, the largest fixed income fund in the world. He is talking to the New York Times about the impact of near zero interest rates which has forced the traditional savers, always risk-averse, to financing a “second bailout of financial institutions”:

“What the average citizen doesn’t explicitly understand is that a significant part of the government’s plan to repair the financial system and the economy is to pay savers nothing and allow damaged financial institutions to earn a nice, guaranteed spread,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco. “It’s capitalism, I guess, but it’s not to be applauded.”

The good man is exactly wrong – or expediently pretends not to know – in saying that “it’s capitalism”. It is precisely not capitalism, in the sense of the market forces determining the prices and the rates. If it were, the interest rates would skyrocket in the face of massive debt financing, as they did in the case of the auction-rate securities.

The near-zero interest rate, rather, is the result of sustained interference in the markets by the Federal Reserve in accordance with a deliberate policy set by the Federal Reserve. Prof. Becker does not see that as social engineering, but regardless of his sensitivity to what takes place around him, the effects are there. Look at this reverse mortgage “product” from the same Times article:

Eileen Lurie, 75, is taking out a reverse mortgage to help offset the decline in returns on her investments tied to interest rates ... Such mortgages allow people who are 62 and older to convert equity in their homes into cash tax-free and without any impact on social security or Medicare payments. The loans are repaid after death.

The name itself is interesting. Mortgage and reverse mortgage. Just like repo and reverse repo.

But there is a difference. Repo and reverse repo are transactions in capital markets. Both refer to temporary financing. In repo, you borrow money and post security as collateral. At the end of the term, typically overnight or a week, you pay back what you borrowed (with interest) and receive your collateral. Reverse repo is the reverse. You lend money and get security as collateral.

In reverse mortgage, there is no reversing in the sense of having a second transaction. You receive monthly payments on your house. When you die, the lender gets your house.

Note the reference to tax and Medicare. In the U.S., income is taxable (except for the Maddoff “investors”). Also, in the U.S., income beyond a certain level would disqualify an individual from receiving Medicare, the government run health insurance. Someone has gone through the trouble of introducing legislation to specifically exclude the reverse mortgage payments from the calculation of income. One could always claim that the deed benefits senior citizens. But the law has also made reverse-mortgages enticing to cash strapped senior citizens. It has made the product “salable”. If I were a betting man, I would bet that lobbying for the measure did not come from isolated senior citizens.

A reverse mortgage transforms capital to money. A house is capital by virtue of its capacity to generate rent. That is why its price increases over time. The money received as part of the value of the house and spent on say, food and medicine, is wealth (capital) converted to money. So whilst previously a working man could dream the American dream of owning a house and perhaps leaving it to his children, now he must hand it over in return for sustenance. That is a curious twist on New Hampshire’s state motto, Live free or die. It is now live and die free – of worldly possessions.

That is social engineering par excellence.

It is social engineering in excelcis.

But Prof. Becker would have nary a word on it because a social condition that enables predators to get the better of the old and the vulnerable is a part of the natural order of things for him.

Still, these are small matters. I will return with a discussion of the European Union, the counter move to deregulation; one of the most brazen social engineering projects in history being countered by one of the most colossal social engineering projects in history.

And Prof. Becker has had nary of word on them.

An Economist of Our Time

Few people stand up to a close scrutiny. Paul Samuelson, who died on Sunday at the age of 94, fell apart at first glance. The man was a mountebank, a particularly offensive mix of knave and fool whose crowning as “Titan of Economics”, as the Wall Street Journal put it, said volumes about the society which did the crowning.

He neither understood nor followed the age-old advice that Clint Eastwood’s Inspector Callahan disdainfully summarized: “A man’s got to know his limitations”. In that, he was a fool. He knowingly and methodically downplayed, dismissed and covered up the contradictions that came into his ken, especially the ones which sprang from his “theories”. For that, he was a knave.

He was a “popularizer”; he stripped the “complexities” from the ideas to make them more palatable to the masses. He explained, according to the New York Times obituary, “what Marx could have meant by a labor theory of value”. (Marx meant what he said!)

He dabbled in everything and left behind “voluminous” writings. To the Times, they are the evidence of his “astonishing array of scientific theorems and conclusions”. What they are is a circular canon of superficiality; they show how one may write million of words on a subject and not advance it one iota forward. His Economics is a case in point. It sold millions of copies. It was a veritable cash cow for the Titan over a half a century. And it reads like a Danielle Steel novel, only with more inconsistencies. It is a hillbilly tune to the grand symphonies of the classical economics.

Here is a sample of the Times’ description of Samuelson’s contribution to economics, beginning with his much touted Neoclassical Synthesis.

Mr. Samuelson wedded Keynesian thought to conventional economics. He developed what he called Neoclassical Synthesis. The neoclassical economists in the late 19th century showed how forces of supply and demand generate equilibrium in the market for apples, shoes and all other consumer goods and services. The standard analysis had held that market economies, left to their own devices, gravitated naturally towards full employment.

Economists clung to this theory even in the wake of the Depression of the 1930s. But the need to explain the market collapse, as well as unemployment rates that soared to 25 percent, gave rise to a contrary strain of thought associated with Keynes.

Mr. Samuelson’s resulting “synthesis” amounted to the notion that economist could use the neoclassical apparatus to analyze economies operating near full employment, but switch over to Keynesian analysis when the economy turned sour.

To summarize: Theory A worked under Condition A, but not Condition B. Theory B worked under Condition B and not Condition A. Paul Samuelson came along and “wedded” the two together to create Theory AB. He suggested using part A under condition A and part B under condition B. This, he called “Neoclassical synthesis” – or “Can’t We Just Get Along?” (He probably got the idea from quantum mechanics, where the light is shown to be both wave and particle at the same time).

His speeches and his voluminous writing had a lucidity and bite not usually found in academic technicians. He tried to give his economic pronouncements a “snap at the end”, he said, “like Mark Twain”. When women began complaining about career and salary inequalities, he said in their defense, “Women are men without money.”

So the “Titan of Economics” wanted his comments to have bite, just like Mark Twain! How could have one explained to him that Mark Twain’s comments had a bite because he was conscious of the larger social inequalities. On this topic, he would have probably said: Women are black men.

Mr. Samuelson also formulated the theory of public goods – that is, goods that can be provided effectively only through collective, or government, action. National defense is one such public good. It is nonexclusive; the Navy, for example, exists to protect every citizen. It also eliminates rivalry among its many consumers; that is, the amount of security that any one citizen derives from the Navy subtracts nothing from the amount of security that any other citizen derives.

The features of public goods, Mr. Samuelson taught, stand in direct contrast to those ordinary goods, like apples. An apple eaten by one consumer is not available to any other. Public goods, he concluded, cannot be sold in private markets because individuals have no incentive to pay for them voluntarily. Instead they hope to get a free ride from the decisions of others to make the public goods available.

Here, Samuelson compares the U.S. Navy with an apple and “concludes” that no one would voluntarily buy a nuclear attack submarine, no matter how bad the crime situation got in the neighborhood. From this, he draws the further conclusion that the government has to force everyone to pay for the navy. (Notice how he chooses the safely remote Navy and ignores police, a more logical and intuitive example of the “public good”. Some might have questioned the “nonexclusivity” of the police force from their experience.)

Mr. Saber, now, really. You must be exaggerating; having fun at the expense of the dearly departed. There had to be some value to Samuelson’s work. More than half a century of prizes, awards, citations, recognitions; his book being translated to more than twenty languages and now all these posthumous praises. Surely you are not suggesting that all that is due to chicanery and the man fooled most of the people all his life. You, yourself call him an economist of our time. Even with the hint of disapproval that it is there, he had to do something to deserve the designation. No?

Samuelson influenced our world in two ways. Both were destructive. Both set back the cause of science and gave a black eye to civilization.

One is his “introduction” of mathematics to economics and, later, finance. A single sentence in the Times obituary – in code, as usual – captured this sinister deed:

Mr. Samuelson was credited with transforming his discipline from one that ruminates about economic issues to one that solves problems, answering questions about cause and effect with mathematical rigor and clarity.

Here, “mathematical rigor and clarity” means calculation. It is referring to Paul Samuelson taking economics, which was a social and philosophical discipline concerned with discovering the laws of the dynamics of social change, and bringing it down to the service of the businessmen, putting it to use for the calculation of profit and loss. It was the opportunistic seizing of an opportunity by an opportunist. And it was a serious blow. If the war of ideas were fought like wars, Samuelson would be shot for treason. I wrote about this in Vol. 1:

Pursuing mathematical finance along the lines of Portfolio Selection was advantageous in other ways too. It provided a respite from the contentious ideological disputes in economics between the Left and Right that in the era of McCarthyism were beginning to assume an ever sharper, and potentially career-ruining, tone. Research in mathematical finance had no downside risk. It was socially safe, it provided a perfectly respectable line of research and, with luck, it could lead to new discoveries and from there, to fame and fortune.

But, taking the Times’ descriptions, how does one solve problems and answer questions about cause and effect without ruminating about the issues? This question did not concern Samuelson. He was not interested in the larger social issues that resulted from the business decisions. His work on linear programming is the Exhibit A in this regard. From Vol. 1:

Linear programming epitomized the “objective” science. It seemed to be the embodiment of Friedman’s assertion that “positive economics is in principle independent of any particular ethical position.” The solutions it offered were arrived at mathematically and were indisputable. There was only one best way of scheduling oil tankers between a given number of ports if the profits were to be maximized or costs minimized. Democrats and Republicans, capitalists and communists, oil producers and tanker owners, all had to agree on it.

But while mathematics is abstract, it is always applied in the context of given social conditions. And precisely because mathematics is abstract, upon application it assumes the characteristics of the context to which it is applied. If the context is the Battle of Britain, the mathematics of linear programming shows the best way of organizing fighter planes. If the context is the profitability of commercial airlines, it still shows the best arrangement, which is establishing “hubs” and cutting service to low traffic destinations. Both solutions are mathematically correct. In the latter case, because the purpose behind the application of the method has changed–and that purpose is determine by social conditions–the solution leads to a different kind of consequences: medium-sized and small communities become further isolated.

It mattered little that Samuelson’s knowledge of mathematics was, like his knowledge of economics and finance, shallow. In Vol. 2 of Speculative Capital, you may recall, I examined a densely mathematical passage he wrote on warrants pricing. I was taken aback by flagrant flaws in calculation and reasoning and, especially the way Samuelson handled a contradiction that his own formulation had created; he simply dismissed it as “prosaic”. I wrote: “The passage, after it ceases to be funny, remains difficult to believe”.

What mattered is that Samuelson “delivered” the goods, the goods being the nations’ best and brightest to the service of finance. “When today’s associate professor of security analysis is asked, ’Young man, if you’re so smart, why ain’t you rich?’, he replies by laughing all the way to the bank or to his appointment as a high paid consultant to Wall Street”, he wrote in the introduction to Merton’s Continuous-Time Finance. That was the new goal of economics: training highly paid consultant to Wall Street. Looking back at what took place in the business schools and economics departments in the past 30 years, we must, in fairness, acknowledge Samuelson’s service.

When economists “sit down with a piece of paper to calculate or analyze something, you would have to say that no one was more important in providing the tools they use and the ideas that they employ than Paul Samuelson,” said Robert M. Solow, a fellow Nobel laureate and colleague of Mr. Samuelson’s at M.I.T.

Exactly. That is the secret of Samuelson’s fame and success: genuflection in the direction of the businessman. What a falling off was there.

Still, this retrogression pales next to the effects of Samuelson’s other deed, whose impact went further and deeper in the society. I do not suppose the man who emptied economics of social elements noticed or appreciated the irony.

Prior to Samuelson – and Friedman – writing and speaking about economics had been in the form of discourse, which is “proceeding from one judgment to another in logical sequence”, according to its dictionary definition. All classical economists were schooled in logic and philosophy. They could disagree with each other – and they often and vehemently did – but each side could answer and refute the opposing arguments point by point. Because there was a logical relation between the points of a case, in this way one could, if he had the logic on his side, refute the core thought of his opponent.

Samuelson, and his partner in crime, Milton Friedman, changed that. The change was violent and disorienting. It had a similar effect on the intellectual terrain that the introduction of the machine gun had brought to the battlefields of WWI. Whilst previously cavalry had charged the enemy lines, now two men behind a machine gun could hold the line against a thousand charging cavalrymen.

Samuelson and Friedman had no core theory, no central point, no logical anchor, only an “astonishing array of scientific theorems and conclusions”, which meant that they could not be nailed down to any particular position; they switched the subject and sides at will. And they were “formidable debaters”, according to the New York Times, precisely because the substitution of the spoken word for the written word created the ideal environment for their style of polemics. They uttered rapid-fire sequence of nonsensical assertions, peppered with false statistics that they knew no one could check.

With the rat-a-tat of their drivel, they killed discourse. They made discussion, and even conversation, impossible. What do you do with a man who goes on and on about the contrast between the U.S. Navy and an apple and cannot be thrown into a madhouse because of his Nobel Prize and M.I.T. tenure?

In this way, the Tweedle Dee and Tweedle Dum of economic scene invented the aggressive in-yourfaceness of unreason that we see today in talk radio hosts, Rush Limbaughs and the public figures. That is the main legacy of Samuelson with which we will have to live for years to come.

The Times obituary mentioned that Samuelson had trained and mentored many “brilliant” economists who went on to occupy important positions in academia, government and the private industry. Looking around at the social and economic landscape, I must say that I could have surmised that on my own.

The Trojan War
is over now; I don’t recall who won it.
The Greeks, no doubt, for only they would leave
so many dead so far from their own homeland.

The U.S. Treasury Reaps Big Profits

The news that the U.S. Treasury had “reaped” $936 million from the sale of JPMorgan warrants was everywhere over the weekend. Google “treasury + $936 million” and see for yourself.

Credit the U.S. Treasury with the P.R. job. Its announcement said that JPMorgan’s warrants provided “an additional return to the American taxpayer from Treasury’s investment in the company”.

Additional return. Investment. American Taxpayer. Only Apple Pie and Motherhood were missing from the formal communiqué.

If the “return to U.S. taxpayer” had any meaning, or if the sum involved even matched what Maddoff “investors” are going to get back from the IRS, I would go through the trouble of showing in numbers what this “return” entailed; I know a thing or two about warrants and options.

Still, you can form an informed opinion about the matter from the concluding sentence of the FT article that reported the happy news on its front page:

The Treasury said the price was well above what JPMorgan had offered to buy back the warrants, adding that the auction had been oversubscribed.

The price was well above what JPMorgan had offered. That is called lowballing.

The auction had been oversubscribed. There was nary a word about the buyers, but you could bet your top dollar that they were all professional traders and fund managers. And they were falling over one another to buy the warrants, which is why the auction was oversubscribed.

Bravo, Secretary Geithner – playing one scene of excellent dissembling and letting it look like perfect honor.

A Brief Commentary On a Picture

According to the New York Times, this is how Prof. Sidney Plotkin of Vassar “dramatizes the pressure a president faces in a falling economy”. Click here to see how.

The paper said that Prof. Plotkin shines “a Marxist light” on the economic crisis, though Marx is an “uninvited guest,” the professor was quick to add.

What does he know about his uninvited guest?

Marx wrote: “In the analysis of economic forms … neither microscopes nor chemical reagents are of use. The force of abstraction must replace both”.

Prof. Plotkin has substituted dramatization for abstraction. He no doubt thinks that this shows his enthusiasm. And he may well be enthusiastic. But there is a deeper rationale behind his theatrics which makes them appeal to his students and administrators.

Here is an excerpt from the manuscript of Vol. 4 of Speculative Capital. We pick up where the product is produced and must now be sold, i.e. converted into money. Without this conversion, the production process will come to a halt:

Given this centrality of sales and its practically limitless sub-specialties in a Capitalist society– in the U.S., one would find hiring ads for “nuclear waste salesman” – it is natural that the subject is deeply embedded – intertwined, really – with the culture. Often, it is the driver and creator of the culture, especially in the “Anglo-Saxon” U.S. and U.K., where the businessman’s influence goes further than it would in other nations. The culture in these countries could be said to be the culture of a salesman, as it is shaped by the habits, sensibilities, tastes and priorities of a salesman. This point can best be seen by a look at Dale Carnegie’s How to Win Friends and Influence People.

The book’s title is precise. It telegraphs the content, so attention must be paid. Carnegie wants to win friends. Why? Because he wants to influence them. But the purpose of this influence is not bringing new friends to the righteous path. Carnegie is not an Islamic zealot practicing the Prevention of Vice and the Propagation of Virtues. He wants to influence people in order to sell to them. Friendship is a strategy, a mere means, towards that end. Note the word “win” – not finding friends or making friends but winning friends. The purpose is exploitation, after which “friends” become what they always were: people. It is a singularly cold-blooded and cynical title.

A straight line connects Dale Carnegie to the modern financier, Michael Milken who, responding to a minion’s comment that the rate they were charging a friend was too much answered: “Who are we going to make money off of if not our friends?”

I am not overstating the role of this depression-era salesman. Dale Carnegie did not invent the ways of salesmanship. He merely categorized them – arranged them around a central theme and in doing so, gave them cohesion and focus. His is the authentic voice of a salesman the way braying is the voice of a donkey.

Look at his chapter titles: Three Ways of Handling People; Six Ways to Make People Like You; Twelve Ways of Winning People to Your Way of Thinking; How to Change People Without Giving Offense or Arousing Resentment (in 9 steps, ending with “Making People Glad to Do What You Want”). Little wonder, then, that his book became the manifesto for a country whose “chief business” President Coolidge had declared was “business”.

What Carnegie began has grown into a multi-billion a year “self-improvement” and “interpersonal skills” business. Millions of people have taken courses on dressing, speaking, walking, even sitting – that would be “your silent presence” – to hone in their selling skills.

The graduates have then gone on to quietly instill the culture with the values that they learned and internalized in the classrooms. In this way, the modus operandi of the salesmen has turned into the cultural trait of the society. When the modus operandi changes, the culture changes.

One main change in the past 40 years has been the intensified competition due to the falling rates of profit. That has made selling a far more stressful occupation than it was in the heydays of the U.S. industrial power. The salesman is under constant pressure to be more “productive”, meaning that he has to sell more in less time.

The ensuing stress has darkened his mood. The passive Willy Loman has given way to the obscenities-spewing, conniving and downright criminal salesmen of Mamet’s Glengarry Glen Ross.

In practical terms, efficiency squeeze has necessitated harsher sales tactics. One is that the prospective buyer has to be evaluated quickly: is he/she going to buy or not? There is no time to be wasted on those “just looking”. This could only be done visually, checking the prospective buyer’s car, clothes, shoes – in short, any outward signs of material wealth. Hence, the elevation of the visual and “first impression” above all else. Rorschach test is the “psychological” test of this culture in which the salesman constantly and quickly “sizes up” his prey ...

In this way, the reliance on the visual becomes the norm. The “visual art” rises.

Prof. Plotkin’s understanding of economics is shaped by the salesmen, in the same way that Black, Scholes and Merton’s understanding of options was shaped by the traders. Those who have read Vol. 3 know the price one pays for blindly following these agents of circulating capital.

A Daisy Chain of Crises

What should you conclude upon hearing of the financial crisis in Dubai?

Perhaps the question is too vague. So let me give a hint:

• after the collapse of the financial system in the U.S.;
• after the collapse of the financial system in the U.K.;
• after the collapse of the financial system in much of the Western Europe;
• after the collapse of the financial system in the Eastern Europe;
• after the collapse of the financial system in the emerging countries;
• after the collapse of the Russian economy in 1998;
• after the collapse of the Mexican economy in 1994;
• after the collapse of the financial system in Argentina in 2001;
• after the collapse of the “Asian” economies in 1998 – that would be Hong Kong, Indonesia, Malaysia, Singapore, Thailand, The Philippines, South Korea, Taiwan;
• after the economic and financial crisis in 1998 in Latin America – that would be Brazil, Argentina, Chile, Bolivia, Ecuador, Columbia, Uruguay;
• after the collapse of the Japanese economy that has been going on for almost two decades;
• after the protracted economic and financial crisis in Turkey in 1980s and 1990s and the 2000s that saw Turkish lira lose its value 1,000,000 times;

After all these crises, what should you conclude when you hear of the crisis in Dubai?

You must conclude that theses economic and financial crises cannot, by definition, be aberrations or exceptions. They are more like a natural phase of the system, the inevitable and necessary aspect of its operation.

That is the subject of the Vols. 4 and 5 of of Speculative Capital: the crisis as the “property” of the financial system currently in place in much of the world, with all the social, economic and financial implications that follow.

Stay tuned.

A Question of Perspective

Last Friday, William Dudley, the president of the Federal Reserve Bank of New York delivered a long speech on “Lessons From the Crisis” in the Center of Economic Policy Studies Symposium at Princeton University. I don’t suppose you could get any more serious than that in terms of authority and setting, even though the speaker felt compelled to issue a disclaimer: “As always, my remarks reflect my own views and opinions and not necessarily those of the Federal Reserve System.” It is astounding how no one dares to speak freely, even when the subject is a non-political, technical one and the speaker is the president of the New York Fed.

My aim is not to offer a blow-by-blow critique of the speech. What I want to focus on, rather, is Dudley’s perspective, the way he sees things. I wrote about this seeing-things-through-the-eye-of-finance-capital in here and here. So the focus is not on Dudley. He is merely a Rumian part that adequately reflects the whole.

The technical description of markets and processes in the speech are generally accurate. But look at the circumlocution and the child-like narrative when the speaker explains the tri-party repo market.

In the case of the tri-party repo market, the stress on repo borrowers was exacerbated by the design of the underlying market infrastructure. In this market, investors provide cash each afternoon to dealers in the form of an overnight loan backed by securities collateral.

Each morning, under normal circumstances, the two clearing banks that operate tri-party repo systems permit dealers to return the cash to their investors and to retake possession of their securities portfolios by overdrawing their accounts at the clearing banks. During the day, the clearing banks finance the dealers’ securities inventories.

Usually, this arrangement works well. However, when a securities dealer becomes troubled or is perceived to be troubled, the tri-party repo market can become unstable. In particular, if there is a material risk that a dealer could default during the day, the clearing bank may not want to return the cash to the tri-party investors in the morning because the bank does not want to risk being stuck with a very large collateralized exposure that could run into the hundreds of billions of dollars. Overnight investors, in turn, don’t want to be stuck with the collateral. So to avoid such an outcome, they may decide not to invest in the first place. These self-protective reactions on the part of the clearing banks and the investors can cause the tri-party funding mechanism to rapidly unravel. This dynamic explains the speed with which Bear Stearns lost funding as tri-party repo investors pulled away quickly.

The result was a widespread loss of confidence throughout the money market and interbank funding market. Investors became unwilling to lend even to institutions that they perceived to be solvent because of worries that others might not share the same opinion. Rollover risk—the risk that an investor’s funds might not be repaid in a timely way—became extremely high.

These words are simultaneously convoluted and simplistic. When the speaker says that in the tri-party market “investors provide cash each afternoon to dealers in the form of an overnight loan backed by securities collateral”, it is as if a 5th-grader is explaining the market. And he has the order wrong. The drivers of the tri-party repo market are not investors who provide cash but the broker dealers who seek money to buy an asset that they themselves could not otherwise afford. If you miss this point, you will not understand the tri-party repo market.

Dudley’s language reflects his thought process, the ways he see things. But the language is not only a passive reflector. It has an active, pernicious side as well: It hinders thinking by creating the impression that something new was told and learned while in fact nothing of the sort happened. So the real cause remains unexplored. Look at this explanation of the crisis:

At its most fundamental level, this crisis was caused by the rapid growth of the so-called shadow banking system over the past few decades and its remarkable collapse over the past two years.

But why was there a remarkable growth of shadow banking? Why did it collapse? Mr. Dudley is giving as the explanation of the crisis the very things that he is called upon to explain.

With such muddled thinking, his “framework” to fix the problem naturally degenerates into a discussion of the “psychology” of lender and borrowers, as in this gem:

This second cause of liquidity runs—the risk of untimely repayment—is significant because it means that expectations about the behavior of others, or their “psychology”, can be important. This is a classic coordination problem. Even if a particular lender judges a firm to be solvent, it might decide not to lend to that firm for fear that others might not share the same assessment.

This is the nonsense that he must have heard from some CEO or one his minions as the cause of the crisis.

I wrote about the role of the tri-party repo market in fermenting the crisis here and here. Read them to see why I emphasize, and mean by, the perspective, the “angle of vision on reality”; it liberates the language and allows for imparting knowledge.

On the larger question of the cause of crisis, I have already pointed out that only two issues matter: the structure of the financial system which develops naturally and could be said to be imposed onto the system, and the fall in the value of the securities due to the transformation of values to prices. Most of this blog has been about the first issue. The question of transformation I will take up in Vols. 4 and 5 of Speculative Capital.

On “Industrial Policy”

What type of stories would I cover if I were a financial journalist?

A couple of weeks ago, The New York Times had an interview with William Clay Ford Jr., “perhaps the most seasoned auto executive in Detroit.” He has more than 30 years on the job at Ford Motor Company which was founded by his great grandfather. He is presently the executive chairman of the board. A Q&A and the follow-up went as follows:

Q: Is the financial support given by taxpayers to G.M. and Chrysler a positive development for the American economy?

A: The biggest concern that we had all through this was the collapse of the supply base. I believe that if G.M. and Chrysler had gone into free-fall bankruptcies, it could have devastated the entire industrial base of this country.

Q: Does the average American value the domestic auto industry?

A: They should. One cannot find a healthy economy anywhere in the world that does not have a strong industrial base, period. We seem to be the only country in the world that doesn't strongly value that. Everywhere else Ford does business in the world the government and people understand it, and do everything they can to enhance it. The notion that we can just simply become an information-age data provider as a nation is ludicrous.

The interview was published in a special section about cars and not in the business section.

If I were conducting the interview, I would note that Ford Jr. was lamenting the lack of an industrial policy, although he did not dare/care/want to mention that phrase. I would also note that he was lamenting the lack of an industrial policy the way one would lament the lack of, say, good beaches in the country.

I would gently push him on the subject, encouraging him to continue with his thoughts.

“Mr. Ford”, I would ask, “as a high ranking executive of Ford Motor Company and a powerful business executive, your views carry tremendous weight on the subject of manufacturing. You have the ear of every Fortune 500 executive and every policymaker in this country, including the president of the U.S. Since you maintain that without an industrial policy a nation is doomed, “period”, why is it that you have not pushed for the creation and adoption of just such a policy? More importantly, given the critical role of such policy, one would expect it to be the playbook of the business and the government activities. But it is not. Who and what stand in the way? Please take your time.”

I would then go to Larry Summers, the wunderkind working from the While House, and ask him the flip side of the question.

“Dr. Summers”, I’d ask. “The Wall Street Journal of February 13, 1998 carried an incredible news story on page A2 pertaining to your testimony in front of a congressional committee in the context of the Asian financial crisis that was then raging. Here is what you said:

There has been more progress in scaling back the industrial policy programs in these countries in the last several months than there has been in a decade or more of negotiations.

“In your testimony, you expressed satisfaction at the scaling back, or even the destruction of, the industrial policies in Asian countries. Is it now or has it ever been the policy of the U.S. to dismantle the industrial policies anywhere it finds them, including within the U.S.? If so, how and where is this policy set? If there is no coordinated opposition, why do you think that there has not been any such policy despite the conviction of manufacturing executives that it is absolutely needed?”

These are the questions I would ask if I were a financial journalist.