Deficit deceit and the rentier class (10 June 2011)

It drives me a little crazy when I read any kind of reporting or polling on the U.S. deficit and all the phony concern people feel obliged to exhibit about it. It's a bit like when people complain about how many thousands of dollars a baseball player gets paid per at bat or something -- that fact that we know about it to complain is testimony to why the player deserves it. Fears about the deficit size has nothing to do with any impact it will have on most ordinary people and everything to do with media coverage of big numbers and the admonitory tone that is reflexively adopted. Matt Yglesias linked to an image that gets at the problem; it depicts a van covered in anti-abortion and anti-debt-limit-raising slogans. Yglesias writes, "It’s a problem for the country when strong emotional and ideological views about abortion get intimately linked in people’s ideas with views about much more technical questions about the merits of raising the debt ceiling or whether we have too much inflation or too little." When these things are lumped together, it means that both have become subject to demagoguery and tribalism, about winning at the expense of enemies, who in the case of the deficit are wholly imagined.

The losers in the deficit-reduction scenarios being worked out in Washington are basically everyone who is not a rentier, as this recent Krugman column argues: "Consciously or not, policy makers are catering almost exclusively to the interests of rentiers — those who derive lots of income from assets, who lent large sums of money in the past, often unwisely, but are now being protected from loss at everyone else’s expense." Who, exactly, are the rentiers? Krugman has some data here. He concludes that "it’s very much about benefits to the wealthy versus benefits to the middle class."

Krugman is elucidating a case made by Robert Kuttner in this essay (pdf) for the American Prospect, which inspired Mike Konczal to do some good analysis here and assemble a bunch of useful links here. Kuttner's basic point is that debt politics is about protecting previous creditors from accepting any losses (full repayment, despite the risk premium they had already been earning as interest) and protecting them from inflation, which reduces the value of their claims. (An argument for why inflation -- most obviously wage inflation -- would help most of us here.) Here's how Konczal puts it, in the context of the financial sector's recent recovery in profits (while the rest of the economy sputters):

Whatever you think of the financial sector being that profitable, it is important to remember what those post-crisis profits represent. Those profits aren’t the reward for effectively allocating capital to a recovering economy. The financial sector actually did a terrible job of that in the past decade. And capital isn’t being allocated anyway. Much of the capital in the economy is sitting on the balance sheets of banks and large corporations.

These profits are based off milking the bad debts of the housing and credit bubbles while Americans struggling under a crushing debt load. Instead of sharing the losses, the financial sector has locked itself into the profit stream and left the real economy to deal with the mess. These profits reflect, in Kuttner’s excellent phrasing, the claims of the past, not the potential of the future.

At Interfluidty, Steve Randy Waldman points out that big banks become rentiers because of implicit government guarantees that they won't be allowed to fail. Those guarantees in turn are perpetuated by bankers' outsize influence in politics:

when we modified accounting standards to eliminate the risk that bad loans on the books would translate to failures, when we funded their recapitalization on the sly, we changed banks. We transformed them from nervous debtors into pure rentiers, who see a lot more upside in squeezing borrowers than in eliminating a crippling debt overhang. And since banks are, shall we say, not entirely disenfranchised among policymakers, we increased the difficulty of making policy that includes accommodations between creditors and debtors, accommodations that permit the economy to move forward rather than stare back over its shoulder, nervously and greedily, at a gigantic pile of old debt.

As a result, politicians serve banks' interests and unemployment starts to be regarded as a permanent feature of the economic landscape, unfortunate but "structural" and not at all related to the suffocating claims of the rentier class.

Rentiers always argue from their interests that austerity is necessary and whip up support for their position with a bunch of misleading rhetoric about how reduced debt generates economic confidence that encourages business owners to expand and hire. There's not much evidence to support this idea; the recent experiment with austerity in the UK suggests that ruthless budget cutting removes demand from the economy by impoverishing everyone but the rentiers, and this stifles growth across the board. Everyone loses, not just the people who were once supposedly "winning" by benefiting from spendthrift government bureaucrats and their allegedly indefensible spending programs. But that doesn't prevent the idea from taking hold among regular voters, who are presumably seduced by the fallacious logic of budget cutting as inherently virtuous, as though government debt and personal debt were analogous (they aren't) and as if debt is a moral failing (it's not, especially in an economy that explicitly relies on entrepreneurialism).

No one who is not living entirely on bondholdings -- no one who has to work -- should be rooting for austerity or bothering at all with deficit worries. Such worries are not really their worries; they are the transferred worries of elites who need to manipulate voters to protect their financial interests and their privilege in a democracy.

Konczal linked to this 1943 article by Michael Kalecki, "Political Aspects of Full Employment," which serves as a useful reminder about what is at stake in austerity debates -- not fiscal responsibility or the insecure future of welfare spending but labor discipline:

One might expect business leaders and their experts to be more in favour of subsidising mass consumption (by means of family allowances, subsidies to keep down the prices of necessities, etc.) than of public investment; for by subsidizing consumption the government would not be embarking on any sort of enterprise. In practice, however, this is not the case. Indeed, subsidizing mass consumption is much more violently opposed by these experts than public investment. For here a moral principle of the highest importance is at stake. The fundamentals of capitalist ethics require that 'you shall earn your bread in sweat' -- unless you happen to have private means.... The maintenance of full employment would cause social and political changes which would give a new impetus to the opposition of the business leaders. Indeed, under a regime of permanent full employment, the 'sack' would cease to play its role as a 'disciplinary measure. The social position of the boss would be undermined, and the self-assurance and class-consciousness of the working class would grow. Strikes for wage increases and improvements in conditions of work would create political tension. It is true that profits would be higher under a regime of full employment than they are on the average under laissez-faire, and even the rise in wage rates resulting from the stronger bargaining power of the workers is less likely to reduce profits than to increase prices, and thus adversely affects only the rentier interests. But 'discipline in the factories' and 'political stability' are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the 'normal' capitalist system.

This seems more true than ever with "factory discipline" dissolved for many workers into post-Fordist arrangements of self-exploitation. Independent "free agents" and flexible workers have even less bargaining power and less of a basis for solidarity, less grounds to demand their share of profits earned from the increased productivity that has come from workers' devoting ever more time to work -- from all aspects of everyday life, in effect, becoming work, as consumption becomes a mode of immaterial production.

But capitalists are always fighting a two-front war in democracies, against workers and against their representatives in the government, who might begin to change the social framework to give workers more bargaining power. Capitalism is predicated on the asymmetries of power, on capital's ability to compel workers to sell their labor power. Capitalists must fight anything that threatens that imbalance, regardless of whether it leads to an aggregate increase of social wealth or even improves their individual profits.

UPDATE: In this post Yglesias links to a paper called “Financialization, Rentier Interests, and Central Bank Policy” (pdf) which describes central bank policy as serving the interests of keeping asset prices stable rather than raising employment levels. As Yglesias puts it: "For all the rising salience of goldbug cranks whining about fiat money, the Fed has hardly been indifferent to the potential for monetary expansion. It’s just that the goal of monetary expansion has been to do just enough to stabilize financial asset prices without going far enough to produce catch-up growth in the labor market.
What’s more, from the point of view of capital maybe it’s better not to catch up. As long as growth is positive and unemployment isn’t rising then maintaining a large 8-9% of the labor force out of work could be a useful tool of wage restraint."
Not to be too functionalist about it, but it often seems like a good idea to work backward from the need for labor discipline to understand certain vagaries of economic policy; at the level of policy and not individual firms, class struggle and getting leverage over workers matters more than efficiency or profit or even growth.

Plutonomy (4 Jan 2011)

I didn't see Michael Moore's Capitalism: A Love Story but apparently in the documentary he references this memo, written by some global-equities analysts at Citigroup, in which they describe the U.S., U.K. and Canada as "plutonomies" -- economies in which income inequality is so vast, the spending propensity of nonrich people is statistically insignificant. The memo has cropped up again in this Atlantic article by Chrystia Freeland about the "new global elite." Guess what: there are actual people behind those statistics about the top 1% earners, and reading about their lives will probably make you sick. Freeland notes (as the Citi memos also point out in graphs) that these wealthy people didn't inherit their wealth and grow it from rents and asset appreciation; thus she suggests they are "economic meritocrats, preoccupied not merely with consuming wealth but with creating it." How much merit has to do with it is debatable, but i does seem inarguable that the recentness of their rise has made them more actively concerned with adjusting the playing field to protect their wealth -- keeping finance deregulated, securing tax cuts, etc. They had to earn their money by aggressively leveraging inequities and asymmetries in the economy, and thus learned how to create new opportunities along the same lines. This is what makes them the "working rich" -- they work to make capitalism more unfair and generally less efficient and productive so that inequality can become even more obscene. Since they are internationally oriented and are loyal only to profit, not any country or people, they thrive on regulatory arbitrage schemes and other global shell games and are heedless of the damage their activities cause to the little people in local economies. (It helps, as Freeland notes, that the plutocrats' sense of having to work to rise to the top makes them have no sympathy for those little people.) Of course, this doesn't prevent governments from bailing their companies out or protecting the value of their bond holdings. The lesson, Freeland suggests, is that helping out Big Business and finance is basically helping them gut U.S. middle-class prosperity.

The U.S.-based CEO of one of the world’s largest hedge funds told me that his firm’s investment committee often discusses the question of who wins and who loses in today’s economy. In a recent internal debate, he said, one of his senior colleagues had argued that the hollowing-out of the American middle class didn’t really matter. “His point was that if the transformation of the world economy lifts four people in China and India out of poverty and into the middle class, and meanwhile means one American drops out of the middle class, that’s not such a bad trade,” the CEO recalled.

That sounds almost egalitarian and certainly utilitarian, but hedge funds don't particularly care about the greatest happiness for the greatest number. That you can make poor people in developing economies slightly less poor for far less than it costs to keep middle-class Americans at the standard of living they're used to is just an excuse to distract from the greater proportion they are raking out from economies everywhere.

In short, the new global elite sound a lot like the old "power elite" described by Wright Mills in the 1950s, only more horrible and with less a sense of responsibility for the damage they do from their position at the commanding heights. I am with Felix Salmon: "If the angry bankers went off to destabilize some other financial system, they wouldn’t actually be missed."

Anyway, the Citi memo is definitely worth reading. It lays out the conditions of neoliberalism with no-nonsense aplomb:

we postulated a number of key tenets for the creation of plutonomy. As a reminder, these were: 1) an ongoing technology/biotechnology revolution, 2) capitalist-friendly governments and tax regimes, 3) globalization that re-arranges global supply chains with mobile well-capitalized elites and immigrants, 4) greater financial complexity and innovation, 5) the rule of law, and 6) patent protection.... The wave of globalization that the world is currently surfing, is clearly to the benefit of global capitalists, as we have highlighted. But it is also to the disadvantage of developed market labor, especially at the lower end of the food-chain... In general, on-going globalization is making it easier for companies to either outsource manufacturing (source from cheap emerging markets like China and India) or “offshore” manufacturing (move production to lower cost countries).

They assess the risk of a backlash against plutonomy but decide it is unlikely in the short term: "So long as economies continue to grow, and enough of the electorates feel that they are benefiting and getting rich in absolute terms, even if they are less well off in relative terms, there is little threat to Plutonomy in the U.S., UK, etc." The memo dates from before the 2007 crash, but nothing that has happened since seems to have threatened it either. The U.S. has elected a rabidly pro-business Congress, and the financial regulation bill that passed did little to change the playing field, and in fact fits the analysts' contention that "the cleaning up of business practice, by high-profile champions of fair play, might actually prolong plutonomy" by creating a broader-based illusion of systemic fairness.

I don't know if the arch tone of the Citi document is or isn't typical of analyst memos, but it's not any kind of smoking gun. If you want to see evidence that the economy is skewed toward the wealthy and the plutocrats are pleased with that arrangement, just watch CNBC or read any day's edition of the Wall Street Journal, where the ideology that capital matters and laborers don't underwrites just about everything there. Controlling labor costs and increasing companies' share of profits is always good and almost always described as if no people are affected adversely by those developments. And then there are the abhorrent lifestyle sections (like the FT's How to Spend It), which detail the glories of luxury spending and facilitate the sort of heedless consumption that supports the investment strategy the Citi memo details -- namely, buy stocks of luxury-goods companies, because given the political climate in the U.S., the rich will continue to get richer and this makes them comfortable with wasting money on yachts and things.

The Citi analysts gleefully track a Forbes "Cost of Living Rich" index, which shows how the cost of a basket of ridiculous luxury goods are rising faster than a basket of staples for ordinary people. Apologists for income inequality like to cite this sort of data as proof that inequality is overreported because it costs more to be rich, as though the lifestyle of outrageous wealth was an inescapable burden to be upheld. The Citi analysts at least have the intellectual honesty to present the data for more straightforward purposes, not to argue that inequality isn't as bad as it might seem, but to suggest that inequality is a plain fact, a boon for the wealthy that expresses itself in their positional goods' jumping in price. (The analysts go so far as to label luxury items "Giffen goods," the demand for which increase as the cost of them rises). The wealthy spend more because they are making more; this doesn't diminish the reality of income inequality; it's a consequence of it.

The analysts also have an interesting explanation for the negative savings rate of the pre-recession mid-decade period. Many commentators (me included) would read into that the idea that too many ordinary Americans were spending beyond their means. The Citi memo argues that in a plutonomy, the flush and confident rich cut their savings and spend more on the increasingly expensive luxury goods, and their lack of savings skews the averages.

when the top, say 1% of households in a country see their share of income rise sharply, i.e., a plutonomy emerges, this is often in times of frenetic technology/financial innovation driven wealth waves, accompanied by asset booms, equity and/or property. Feeling wealthier, the rich decide to consume a part of their capital gains right away. In other words, they save less from their income, the well-known wealth effect. The key point though is that this new lower savings rate is applied to their newer massive income. Remember they got a much bigger chunk of the economy, that’s how it became a plutonomy. The consequent decline in absolute savings for them (and the country) is huge when this happens. They just account for too large a part of the national economy; even a small fall in their savings rate overwhelms the decisions of all the rest.

But of course if ordinary consumers are regarded as the problem, as being spendthrift and spoiled, then that's all the better. Economic hard times can be made to seem like its their fault, a result of their alleged irresponsibility, and not the result of malfeasance by the superwealthy.

n+1's Diary of a Very Bad Year (5 Oct 2010)

I had read some of the interviews that n+1 had conducted with an anonymous hedge fund manager when they first appeared online, as the financial crisis was unfolding, but they have a much different impact when collected as a book -- the recently published Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Manager. Just about everything in that title is off. The hedge-fund manager isn't really confessing to anything, and the interviews that make up the book took place over several years, 2007 to 2009. It's not a diary at all; it's not the ruminative voice of someone talking to themselves but a series of informal talks where someone who knows a lot about something deliberately explains it to someone who is relatively ignorant. Also, the way the book has been marketed as a financial-crisis postmortem is somewhat misleading. The hedge fund manager (HFM) discusses possible causes of the crisis, as well as its impact and some of its consequences, but it's less an analysis of the 2008 meltdown than it is an elucidation of how the financial world operates in general -- how capital flows work, what different kinds of debt are, what risk means, how financial players' minds calculate odds and find their edge on others, how they habituate to a zero-sum environment and try to tame irrational animal spirits and waves of panic, how they administer their nonrenewable and ever-depleting stock of "emotional resiliency" as HFM calls it. The book gives a concrete sense of what investment banks and hedge funds do, what trading at that level consists of and how it struggles to get financed.

Keith Gessen, the n+1 interviewer, admits in his introduction to having been "shockingly and embarrassingly ill-informed" about how capitalism works, despite having a political investment in critiquing it. I completely empathize with that; after quitting grad school, I put myself through a kind of baptism by fire several years ago, reading every section of the Wall Street Journal every day (before it was a Murdoch-run waste product) to try to get a grip on the business world, which suddenly came in to focus as being far more relevant to "the struggle" than the use of metaphoric language by late 18th-century novelists (even if they are arguably intertwined in the grand scheme of things, as I once wanted to argue in a dissertation). It dawned on me that my gripes with consumerism didn't reckon with the structural forces that generated it, or with the good faith efforts of the many people making their living to make consumerism so. It seemed willfully blinkered to analyze culture -- pop culture, material culture, consumer culture -- without taking into account the business context that produced and distributed it and in certain, inarguable ways determined it. Only then can one make pertinent suggestions about how to change things, about where vulnerabilities exist, where processes can be subverted or resisted.

The n+1 book speaks to the same intuition. If you really want to criticize capitalism, it is incumbent to learn how it works, to understand the sort of people it rewards and why. And that means admitting ignorance and listening to those people. It means wrestling with their logic, respecting their mastery of the system as it is, accepting that their ideological precepts have real, practical consequences that hardens them into a kind of wisdom about how things "really" work and people "really" act.

You can't read the n+1 book without coming away impressed by HFM's lucidity and eminent reasonability. He is the personification in some ways of the poor ghoul Marx evokes in Chapter 24 of Capital -- the capitalist compelled beyond his individual will or pleasure to accumulate. Marx describes the fate of those who become "capital personified":

But, so far as he is personified capital, it is not values in use and the enjoyment of them but exchange-value and its augmentation that spur him into action. Fanatically bent on making value expand itself, he ruthlessly forces the human race to produce for production’s sake; he thus forces the development of the productive powers of society, and creates those material conditions, which alone can form the real basis of a higher form of society, a society in which the full and free development of every individual forms the ruling principle. Only as personified capital is the capitalist respectable. As such, he shares with the miser the passion for wealth as wealth. But that which in the miser is a mere idiosyncrasy, is, in the capitalist, the effect of the social mechanism, of which he is but one of the wheels. Moreover, the development of capitalist production makes it constantly necessary to keep increasing the amount of the capital laid out in a given industrial undertaking, and competition makes the immanent laws of capitalist production to be felt by each individual capitalist, as external coercive laws. It compels him to keep constantly extending his capital, in order to preserve it, but extend it he cannot, except by means of progressive accumulation.

HFM often comes across this way, as someone who has become divorced from the ideological incentives of capitalism but continues to exercise its calculating logic because it has become a weapon he can brandish so adroitly. Toward the end, he seems to recognize this, in the form of "stress" and discomfort at constantly having to deal with other ruthless capitalists, and he plans to retire.

Gessen notes that HFM exemplifies how the financial world has become "a place where the best of human reason, science and intuition are applied to the question of whether credit spreads will widen or tighten in the next 24 hours." And that's certainly the impression the book gives, though it reveals how that question is not as narrow as it may seem but can be unfolded to encompass all sorts of broader issues -- how credit spreads are so intensely overdetermined that their movements could credibly seem to intimate the movements of the spheres. You can see hints of how capitalistic thinking is so labile and accommodating in practice despite its bottom-line fixation. In some ways, the bottom line is never really drawn but instead represents a horizon, an ideal, something akin to Gatsby's green light across the bay.

The bottom line is always being redrawn. In other words, capital is a process, it must be in motion -- there must be a constant concern with liquidity, with what is convertible. Capital is never a pile of money one can take hold of. As HFM notes, it's not as though the money cycling through the financial world is ever "like the pool that Scrooge McDuck has, with gold coins, and he swims around in that, and when the money is needed he takes the gold coins out of the pool and uses them to pay for things." Money, as HFM explains, is "consuming power moved intertemporally." He almost sounds like he espouses the labor theory of value when he argues that when someone has money, it means "they've produced more than they've consumed in the past, so they have a right to consume more than they are producing in the future." This means that money is always a credit -- an implied debt somewhere in time counterbalances it. "My money, through an extended chain of financial relationships, is someone else's debt, it's a credit to somebody else." The financial world is basically all about playing with that chain, with manipulating the idea of value in the time dimension -- that is, with pricing risk. HFM points out that "what you do when you're trading is apportioning risk. It's about moving consumption from today to tomorrow, or vice versa, and about the risk associated with that, about transferring the risk associated with that. If nobody wants to take the risk, then nothing happens."

That's a pretty stark explanation of capitalist political economy. All activity essentially takes the form of risk -- or animal spirits, as Keynes called it. Risk is akin to effective demand and the propensity to consume -- it's all understood as risk. Consumption as well as production carries risks. All human endeavor is thrown into the calculus of risk, and capitalism convinces us that it could not be otherwise, that is the realistic way to view collective action and personal decisionmaking. Capitalism is a foundationally insecure society, it knows itself only in terms of insecurity and deliberately produces insecure subjects.

The Treasury Officials and the Bloggers (24 Aug 2010)

I know I would feel much better informed about what is going on in government if all press conferences were like the one the Treasury Department held with a group of econobloggers last week and all corrospondents were as frank, thorough and perceptive as Steve Waldman is in this recounting. There's not much reason for optimism in what he reports, but the very fact of his report seems itself a reason to be somewhat optimistic at least about some of the changes in the public sphere and the media. Conversations about policy that once never circulated beyond the upper crust of the power elite are now accessible to the likes of us, if we bother to seek them out.

But as Waldman suggests, this may be a subtle way to placate those most likely to articulate criticism of various policies without those policies being altered. He begins by emphasizing that the Treasury officials are by and large friendly and intelligent:

I am very, very angry at Treasury, and the administration it serves. But put me at a table with smart, articulate people who are willing to argue but who are otherwise pleasant towards me, and I will like them. One or two of the “senior Treasury officials” had the grace to be a bit creepy in their demeanor. But, cruelly, the rest were lively, thoughtful, and willing to engage as though we were equals. Occasionally, under attack, they expressed hints of frustration in their body language — the indignation of hardworking people unjustly accused. But they kept on in good spirits until their time was up. I like these people, and that renders me untrustworthy. Abstractly, I think some of them should be replaced and perhaps disgraced. But having chatted so cordially, I’m far less likely to take up pitchforks against them.

This strikes me as a basic and important point of how power functions. There are not really evil geniuses in government or elsewhere plotting to be cruel and relishing the misery of the little people -- such people are rare sociopathic anomalies, even if capitalism as a system fosters incentives to developing a sociopathic subjectivity. Because they are situated within a bureaucracy, people in positions of power lose sight of the big picture and reconfigure their typically good intentions in terms of the limited scope of their job responsibilities and, most important, make a ethical priority of being warm and human in their personal exchanges with the people their work brings them into contact with.

Anyway, that is what the technostructure is all about, I think -- bureaucratizing away unpleasant realities about the overall effects of what we are doing while bringing us into enough "team" situations and interpersonal exchanges to allow us to feel good and cooperative and successful at caring about people and not greed or profit.

So it does little good to attack the good intentions of the people in government if you want to have a grown-up discussion about politics or the economy; unfortunately the commercial media does virtually nothing but discuss politics and policy in terms of personality and character. (Richard Sennett's The Fall of Public Man assesses some of the reasons for this; maybe if I wasn't on vacation and had the book with me I'd cite some of them.) But it also means that we have to go against our own grain and put aside the collegiality and self-regard that is our general reward for participating in society in order to sustain a critical view. Waldman explains how this process fans out, defining the hierarchy behind the bureaucracy:

Drawn to the Secretary’s conference room by curiosity, vanity, ambition, and conceit, I’ve been neutered a bit. There’s an irony to that, because some of the people I met with may have been neutered, in precisely the same way and to disastrous effect, by their own meetings and mentorings with the Robert Rubins and Jamie Dimons of the world.

His own reservations notwithstanding, Waldman offers a good critique of the state of financial reform and economic policy. Here are some points that jumped out at me.

1. "Like a gas under pressure, the financial sector pushes and prods for places where high returns can be earned at someone else’s risk." This is the financial sector's reason for being in capitalism; the sector collectively overrides any ethical reasons people might have for not testing the regulatory boundaries and forces every actor to play at the margin of legality. It generates the capitalist ethos over and against our personal inclinations to be considerate and reciprocal in our dealings. It generates systemic greed that exposes all possible modes of exploitation. Waldman notes "how well aligned the incentives of equityholders, bank managers, and traders are at highly levered institutions. All three groups benefit by putting creditors’ resources at risk and earning outsize profit against limited costs (loss of equity value or loss of a job)." They don't check and balance each other; the balance must come from outside regulation.

The systemic nature of the pressure to test limits to find the most extreme profits points to why Waldman and others are always arguing for "structural rather than supervisory regulation" -- hard-and-fast rules that are easy to assess and comparatively transparent. The point is to erect an obstacle that changes the banks' incentives from profiting by gaming regulations (and shifting risk to the taxpayers by being too big to fail) to finding socially productive uses for capital. Waldman has a long footnote that elaborates his reasoning on this that is impossible to excerpt but is crucial reading.

2. About HAMP, a Treasury program meant to deal with the mass of underwater mortgages:

I believe these policymakers conflate, in full sincerity, incumbent financial institutions with “the system”, “the economy”, and “ordinary Americans”. Treasury officials are not cruel people. I’m sure they would have preferred if the program had worked out better for homeowners as well. But they have larger concerns, and from their perspective, HAMP has helped to address those.

The degree to which the officials are not "cruel people" is the degree to which they can convince themselves that helping the "system" helps ordinary people. But to have any kind of critical perspective on society, you have to be able to recognize the status quo -- the people who are already profiting from existing relations -- as something that is not inherently worth defending in order to explore possible relations that might be more equitable, more just. The problem is that power invests us in the status quo and at the same time makes us feel moral only by preserving that status quo. To put that a different way, power is contingent on the ability to sell the status quo as necessary -- to qualify for power within bureaucracy one must convincingly demonstrate that one has made that association of incumbent interests with the "good".

The alternative is a form of power that takes an explicitly revolutionary and "dangerous" form that typically threatens personal identity. One is no longer a collaborative and cooperative part of society but its enemy.

To return to the case of big banks, their interests are fundamentally opposed to those of ordinary Americans, who bear the risks for their speculations under the existing economic arrangements. Treasury officials have talked themselves out of that recognition as a condition of their job. Waldman writes:

Perhaps Treasury officials really can’t see how limiting “size” might help. But I don’t think that’s right. These are very, very smart people. I think they understand the merits of the structural approach to financial regulation, but view the transition costs as simply too large to bear. But that begs the question of costs to whom, and whether (per the HAMP conversation above) it is wise to conflate the health of status quo financial institutions with the welfare of the economy as a whole.

How can that conflation be prevented? How can transition "costs" be reconceived as social progress?

3. "I view the current macro-sluggishness as a function of insufficient demand, yet stand with the hypothetical public in being hesitant to support 'stimulus' and 'jobs' programs that strike me as haphazardly targeted and sometimes wasteful or corrupt." This highlights the conflict between the goals of the bureaucracy, the goals of the individuals who populate it and the personal goals we have as citizens in a democracy. What specifically should be "demanded" in order to increase demand? What are the appropriate channels for stimulating it, and should it even be stimulated if it can only be done in a way we would regard as socially corrupt? We want to put our collective productive capacity to use, but we have evolved a system that has undermined our capability to believe in the signals indicating what we might need as a society. Profit has come unmoored from social necessity, or the ideological overlay that associates the two has unraveled. People can find "productive" ways to spend their time but the economy is not set up to reward their efforts, and stakeholders seem to have exposed as looting the system rather than facilitating the appropriate investment of our productive capacities. That is to say the government and the banks, from the view of "ordinary people", seem to have their interests aligned in protecting their ability to loot the system. And there is no clear alternative politics for shifting those interests, or bringing in new people with different interests -- people who might make a difference rather than assume the mantle of the bureaucracy as it already exists.

Reward Cards, Interchange Fees, Class Warfare (22 June 2010)

I have never really understood the popular zeal for enrolling in airline-loyalty programs and collecting miles toward discounted flights or whatever else one uses that company scrip for. Part of my skepticism stems from a belief that companies don't particularly deserve any loyalty -- why blunt the beneficial effects of corporate competition? -- and if they did, it wouldn't be because they bought it with an intentionally confusing price-discrimination scheme that charges different prices according to how many arbitrary, bureaucratic hoops one is willing to jump through in hopes of bargains. (It's especially weird when airline-mile-collecting chumps are depicted as corporate-class swashbucklers. The film Up in the Air had an ambivalent take on this -- it seemed to admire its characters for the loyalty-program mastery that seemed to be part of the attempt to satirize them as tools.) Loyalty programs seem to present the promise of a deal down the road as a beguiling substitute for an actual deal in the here and now. It's an ongoing implementation of the rebate strategy, in which retailers get consumers to pay full price and hope they screw up or forget to apply for the money that they understood at the point of sale as a discount. it is confusion as a business strategy, and creates even more of an incentive for businesses to flood the zone with disinformation and fine print.

These programs are a manifestation of what Michael Betancourt, in this article, calls "agnotologic capitalism: a capitalism systemically based on the production and maintenance of ignorance." In such an economy, profits are secured by duping or trapping people, distracting them at the key moment in which they enter into contracts not in their best interest. Or to put this another way, firms sell consumers the pleasures of distraction, paid for by entering into unfavorable contracts regarding the goods the consumers are ostensibly interested in instead of the pleasures. Airline customers are buying the pleasures (such as they are) of playing the miles game as much as the flights themselves.

Lately, in an effort try to take the world as it is rather than stubbornly refuse to acknowledge it, I have signed up for rewards programs for several airlines, but all that I've accomplished by doing that is a tremendous spike in the amount of junk mail I receive -- mainly offers to sign up for miles-based credit cards through which I earn miles for using the card instead of cash. Such rewards cards are the basis of the credit-card-company racket of collecting more interchange fees -- the processing costs merchants must pay when their customers use plastic. This leads to a roundabout series of cross-subsidies, as Kevin Drum argues here, in which the poor subsidize the rich:

Banks charge merchants far more in interchange fees than it costs to actually run their payment networks, and merchants pay because they have no choice. Visa and Mastercard are functional monopolies, so if you want to do business with them — and what merchant can afford not to? — you have to pay whatever they tell you to pay. This cost gets passed on to consumers, of course, and the poor and working class pay it. The middle class and the rich, however, don't: they basically get the fees rebated in the form of reward cards.

The most diabolical aspect of this is that I become the agent of destruction: reward cards give me an incentive to use credit, which makes retailers increase the cost of goods for all customers, regardless of whether they use credit or not. It enlists me in the effort to exploit the poor, investing me in the structure of society that makes my advantage seem contingent on the continued disadvantage of those below me. Rewards programs are basically disguised class warfare. Middle class people like me get "rewarded" -- that is, we don't get punished by having to pay the passed-through interchange costs -- for being middle class.

Mike Konczal has much more about interchange fees here. Two highlights:

1. "The system is set-up to encourage you to use credit as much as possible, and then pay that credit off later. This is not an accident. The common phrase among credit card company people is that people are “sloppy payers”, and these sloppy payments function as a major profit center for businesses. This system also transfer money upwards in a regressive, tax-free manner and distorts prices so that shareholders of financial companies can get a cut." This is more agnotology at work. We basically pay for privilege of being care free about money, not simply the stuff we get with a credit card. Companies hope we will slip up and be careless, and thus promote such carelessness in most of their marketing materials. Credit card companies have put themselves in the business of encouraging us to be "sloppy."

2. "this is the payment system. If it was a random consumer good, I would care much less about cross-subsidies and squeezing. If people who drink their coffee black subsidize cream and sugar coffee drinkers, whatever. But this is the very mechanism of which our economy runs – the way in which we trade goods and services. If distortions goes to the core of the economy, it doesn’t surprise me that we have a lot of bad scenarios much further downstream." The payment system is not some God-given thing, as Konczal points out, it's "not a state of nature event" but the complex product of institutions, regulation, convention, social trust, and so on. All payment systems have clearing risks, and it seems to me that one of the justifications for federal states is to minimize that risk so that commerce can flourish; banks, on the other hand want it to be a profit center.

Happily, it seems that interchange will indeed be facing new regulation soon. Felix Salmon notes that this may have some effects that middle-class credit-card users won't like: "if credit-card interchange fees stay high while debit-card fees fall, then merchants will simply start offering broad discounts to anybody using cash or debit, essentially forcing customers to pay extra for all those frequent-flier miles and cash rebates." I hope that eventually means the end of credit-card reward programs in general.

UPDATE: Salmon has more on payment systems in this post. The essential point: "Being able to easily pay for things without worrying about the mechanism is a great public good." We don't want to have to decide between modes of payment anymore than we want to have to second-guess our doctors about what they prescribe for us, as advocates of competition in health care demand we do. Competition among payment systems seems like a libertarian idea that can be logically defended but is wildly impractical and would b counterproductive in reality. As Salmon writes, "The fact is that payments are a utility; they’re regulated like utilities; and utilities tend not to see much in the way of innovative new entrants."

And as my friend's old landlord, who refused to take checks, liked to say, "Cash is king."

The Austerity Debate (18 June 2010)

Steve Randy Waldman delivers, as usual, a clarifying post on the ongoing "austerity debate" -- the discussion among economists and pundits and politicians about whether the government should engage in more stimulus spending to support an economic recovery that may or may not be starting and help create jobs to reduce the unemployment rate (still hovering near 10%), or whether it should impose austerity measures to control the deficit and ostensibly protect the currency and prod the jobless into looking harder for work by cutting off their unemployment benefits. Waldman links to several posts that set the stage.

This debate has come to head recently with the Senate voting to block an extension of unemployment benefits, among other fiscal measures. This infuriates a lot of people (me included) because it seems to privilege political demagoguery about deficits and the interests of the leisure class over economic growth and the rest of us. It plays upon the idea that the unemployed are merely too lazy or fussy about taking jobs, not that they lack relevant skills or that employers aren't willing to hire. It also depicts downward mobility as something the unemployed should simply accept, as if moving down the wage-chain in jobs doesn't have a permanent effect on one's earning potential and prospects.

Also, austerity preaching from government sends the signal to businesses that the climate will be unfavorable, and prompts them to buy back shares rather than seek out other investment opportunities or expand. And everyone around the world can't be austere at the same time; that just amounts to worldwide depression.

Waldman's entire post is well worth reading, but a few things jumped out at me:

1. This is relevant to the notion of free labor, of the sort the networked economy has made more prominent. Waldman is question the idea of austerity at the expense of putting unemployed people to work: "Doing paid work has social meaning beyond the fact of the activity, and doing what is ordinarily paid work for free has a very different social meaning. It is perfectly possible, and perfectly common, that a person’s gains from doing work are greater than their total pay, so that in theory you could confiscate their wages or pay them nothing and they would still do the job. But in practice, you can’t do that, because if you don’t actually pay them, it is no longer paid work. The nonmonetary benefits of work are inconveniently bundled with a paycheck." I'm perhaps under the influence of all sorts of quasi-utopian "end of work" literature, but I wonder if the pleasures of work are inseparable from the paycheck. Perhaps under capitalism, the "in practice" Waldman is talking about, it is. The point I take away from this is that as our society is configured, free work is irreparably stigmatized and thus demoralizing. You have to be working for wages first in order to secure what capitalism makes into the second-order benefits -- job satisfaction, meaning, participation in the "general intellect" or what have you.

2. Waldman is worried that increased fiscal intervention could promote an aura of corruption: "Transfers of relative purchasing power from other citizens to the beneficiaries of government spending may call into question the legitimacy of the distribution of opportunity, wealth, and influence and of the government itself. Perceptions of make-work or corrupt contracting are deeply corrosive." This is what Tea Party types tend to harp on -- freeloaders soaking up their hard-earned tax dollars, etc. Demagoguery certainly helps encourage this attitude; it is easy to put across in sensationalist terms and highly divisive and useful politically. Strangely, no one seems to have much incentive to sell the idea of stimulus; the establishment media is apparently more interested in maintaining an appearance of political balance than in encouraging the economic growth that might in turn help their businesses. But some corruption is probably inevitable with government handouts, particularly since the alibi of "market forces" cannot be invoked to explain unfair distributions. And there is the Hayekian fear of the central planner, unconditioned by meaningful price signals, using resources inefficiently. Waldman suggests such effects are not merely a danger in the short-term; rather, they acquire momentum: "Since economic activity is habit forming and temporary interventions become permanent, the cost of poor government choices can be high. It matters very much what work the government is paying for. Work must be well-tailored to the talents, interests, and future prospects of individuals. Employing people badly is much worse than just giving them money." One might point to the farm-subsidies situation in that regard.

3. This is just well-put, clarifying what is ultimately at stake in these often abstract discussions: "Savers really could flee the euro, dollar, yen or yuan. Interest rates here or there could suddenly spike. A sudden dash to gold is possible. None of these financial market events would directly affect the real resources at our disposal, but any of them could devastate our ability to organize economic behavior, and would call into question the legitimacy of economic outcomes and the stability of governments." The "real resources" of an economy can't put themselves to work for our benefit automatically -- we can't put ourselves to work in a socially beneficial way through sheer force of will. There needs to be a communicative system that relays what society actually needs, revealing what uses of resources are desirable and useful and which are corrupt and which are wasteful and so on. Markets, for better or worse, are the main way this information is revealed, but the markets themselves need to be regulated so that they serve this purpose (and not the purpose of further enriching the fat-cat class and their running dogs). Production must be socially organized in such a way that the outcomes are recognized as legitimate -- are markets the only way to secure social legitimacy when capitalism has become hegemonic? -- and this legitimacy redounds to the ruling order, legitimizing the government as serving the people and not itself.

4. Waldman says we should expect, perhaps even hope for more "austerity theater" -- political noise about austerity while stimulus continues in the shadows. "We should expect policymakers to justify their actions with a lot of intuitive but awful theory. As the Modern Monetary Theorists remind us, the analogy between a fiat-currency-issuing government and a budget-constrained household is poor. It is, nevertheless, the framework under which most citizens and savers understand government accounts, and forms the basis of conventional discourse." Basically, governments are not like households (I can't just go and print more money for myself to pay my rent, for instance), but voters can seemingly only understand discussions about the federal budgets in terms of what they themselves have to do to make ends meet. And politicians feel obliged to cater to this ignorance, helping reproduce it by endorsing the "common-sense" view that you can't go on running deficits for ever and that the piper must be eventually be paid.

5. His conclusion: "We have intellectual work to do that goes beyond choosing a deficit level. The austerity/stimulus debate is make-work for the chattering classes." In other words, the austerity debate is a stalling tactic to prevent the consideration of specific interventions that might allow policymakers to assert some control over the economic cycle. Engaging in the debate is tantamount to conceding there's nothing we can do.

Michael Lewis's 'The Big Short' (5 May 2010)

I borrowed The Big Short by Michael Lewis from a friend the other day and am rapidly reading my way through. I'm glad I waited until now to read it, because it makes for a smoother ride having already tried to digested the mechanics of Goldman Sachs's Abacus deal and the Magnetar trade. Some of it was familiar from my Portfolio days as well. The book masquerades as an aw-shucks account of some of the people who figured out that all the subprime lending made for a titanic house of cards and how they managed to get rich from their insight, but beyond that it's a pretty far-reaching critique of financial capitalism.

The way ideologues defend the inherent instability of the capitalist system ("creative destruction," etc.) is that competitive innovation may destroy individual firms but overall society reaps benefits from their espousing better ways of doing things. A firm that makes, say, steel cheaper buts the inefficient steelmakers out of business but lets society do more with steel.

But when capitalism is dominated by finance (and finance by 2007 was responsible for over 40% of all business profit in the U.S. by the mid-00s), competition and innovation become a matter of merely betting against fools rather than fixing the system that produced them. Financial innovation didn't allocate capital for the betterment of society; it allocated capital for the enrichment of Wall Street douches.

The people Lewis writes about don't seem especially douchy, and Lewis tends to try hard to make them sympathetic Cassandra figures who were on a quixotic quest to expose a financial system that had become systemically irrational. And they were merely acting on the basis of the prevailing ideology when they recognized that the whole financial system could meltdown but did nothing to prevent it and everything they could to profit from it -- their profiting from it, according to capitalist ideology, was supposed to be an expression of the system fixing itself. In reality, their wisdom that could have prevented financial calamity instead helped enable and intensify it. The glorification of markets presumes that everything of social worth and everything about human behavior is a matter of incentives, and anything worth doing will ultimately be incentivized. But there was no way to incentivize the prevention of financial disaster.

So Lewis's protagonists could have been heroes, might have mitigated a catastrophe, but instead fomented a profitable disaster because capitalism suggests that heroism is measured in profit and that profit can't be wrong. And many people probably still think that (what could be wrong with making money?), despite all the collateral damage to those who had nothing to do with subprime lending but ended up out of a job anyway, or the people who are still paying off an oversize mortgage on a house that got to be way, way, way overpriced thanks to the investment bankers' heedless rapaciousness inflating housing bubbles with insanely easy credit.

Market fundamentalists still probably think it's better to let a "self-regulating" system crash completely -- making a few winners and a society of losers -- then to have regulation (of derivatives, of rating agencies, etc.) designed to prevent such things from happening. That's the essence of Goldman's eagerness to hide behind the "sophistication" excuse that Thomas Frank points out in this WSJ op-ed. Nothing could be wrong with the gambling proclivities of sophisticated, consenting bankers, regardless of the collateral damage of their actions, which they seem simply to ignore as irrelevant. Lewis's book reveals that no matter how smart investors were, nothing they could do would prevent economic disaster. Frank's op-ed (a recapitulation of some of the arguments he made in One Market Under God) points out how the supposed sophistication of players in financial markets is used as an excuse to eschew regulation.

If the public is "smart," then who needs the nanny state? Meanwhile, as the familiar expression goes, those who support regulation "think you're stupid." So: Goldman Sachs builds up the "sophistication" of its counterparties because that, apparently, is what will get Goldman itself off the hook. And the boosters for the broader market build up the "sophistication" of small investors because that will get the market generally off the hook, by summoning up an "investor class" that will carry on Wall Street's war against the regulators.

(A variant on this is the idea that regulators are inevitably the people too stupid to hack it at the banks they are hired to regulate, so it all is a big waste of time.) Regulation, the banks allege, prohibits smart people from acting on their intelligence in the markets, thus wasting it. But what really happened in the past decade was that all the sophistication deployed in markets led only to making a bigger and bigger meltdown. The sophistication on various sides of trades doesn't balance out and produce optimal outcomes; it swirls and eddies and produces economic death spirals. Everyone tries to find the bigger fool, and everyone ends up getting made a fool of.

Paul Krugman argues here how regulation could have prevented what Lewis describes -- what Krugman calls "white-collar looting." And in this statement to a congressional subcommittee, Jamie Galbraith explains how the assumptions of market fundamentalism provided ideological cover for fraud.

Latter-day financial economics ... necessarily treats stocks, bonds, options, derivatives and so forth as securities whose properties can be accepted largely at face value, and quantified in terms of return and risk. That quantification permits the calculation of price, using standard formulae. But everything in the formulae depends on the instruments being as they are represented to be. For if they are not, then what formula could possibly apply?

Further discussion from James Kwak of the pros and cons of the financial regulation debate taking place now in Congress can be found here.

Bookies on Wall Street (28 April 2010)

One of the most famous passages from Keynes is this one (bold added):

If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase. In one of the greatest investment markets in the world, namely, New York, the influence of speculation (in the above sense) is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market. It is rare, one is told, for an American to invest, as many Englishmen still do, “for income”; and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that, when he purchases an investment, the American is attaching his hopes, not so much to its prospective yield, as to a favourable change in the conventional basis of valuation, i.e. that he is, in the above sense, a speculator. Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism — which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.

It's hard to follow the Goldman Sachs hearings without thinking of this. The standard ideological defense for the finance industry is that it matches savings with investment opportunities and leads to a more productive use of capital for the benefit of society as a whole. But the financial crisis and its string of revelations about what Wall Street was actually up to makes that notion seem ludicrous and naive.

What the financial innovators were doing seems a lot like bookmaking. Ryan Avent points approvingly to this passage from The New Yorker's James Surowiecki:

No one on any side of this debate appreciates the casino analogy, but I think it’s still the most useful way to think about this question: when you place a bet on the Super Bowl, the casino is taking the other side of that bet. In many cases, it’ll balance the bets it makes on both sides of the trade, so that it’s exposed to no risk and it collects the certain profit from the spread. Regardless, though, any individual bettor knows that if he wins, the casino loses, and vice versa. That is, he knows the casino is on the other side of the trade. Levin seems to be saying that this means there’s a conflict of interest between the casino and the bettor, and that it’s illegitimate for the casino to take the bet. But there’s no conflict, because everyone knows what the deal is. And as long as the bet’s honest, and as long as the price is fair, the casino is doing right by the customer, because the customer is getting exactly what he wants: a chance to speculate.

That Wall Street was running a casino for speculators seems exactly right, and who cares whether it bothers bankers? Call it what it is. When you make synthetic CDOs, you are basically facilitating gambling -- these instruments didn't contribute much to encouraging socially beneficial investing. (At Interfluidity, Steve Waldman sheds some light on what function synthetic CDOs originally served for banks -- basically it allowed for regulatory capital arbitrage.) (UPDATE: This NYT discussion looks at the social worth of CDOs. All the contributions are worth reading.)

The point Surowiecki wants to make here is apt, but the analogy he uses is wrong. His explanation doesn't read like an accurate description of how sports books work. As I understand it, Vegas bookmakers always try to balance bets on both sides of a game by adjusting the odds or the point spread to even out the action. Your bet for a team is matched with that of someone who has the other side. No one bets against the casino at all, unless the bookmakers have badly botched their job. (I think the Scorsese film Casino actually details some of this; De Niro's character, if I am remembering right, is an expert line setter.) The casino is trying assiduously to avoid having action. It doesn't make bets at all. (Unlike Goldman.) The casino collects the vig -- the percent it gets for matching the action (similar to the rake in a casino poker game) regardless of the outcome -- and orchestrates the orderly payouts to winners. But it doesn't care who wins the game, only that it gets played. Like Jay-Z, the casino will not lose ever and all but the most ignorant sports gamblers understand that. They are trying not to beat the casino (by definition impossible), but to beat collective wisdom that has misjudged a likely outcome, or they are trying to get action at a favorable spread before lines move or odds change.

So if Goldman was really like a bookie, its behavior would be sort of excusable -- it was providing a way for gamblers to find one another and gamble and taking its established cut. But if I understand correctly, it was making others responsible for basically bearing the risks of paying off the outcomes of the wagers, and shirking the responsibility of running a fair game that it is supposed to assume to earn its money. As Waldman explains: "When Goldman is shifting risk that it did not wish to bear or hedge to an underwriting client, it is not acting as a market maker. Rather it is acting as an agent for a client wishing to take a position, while imposing the burden of liquidity provision on uncompensated and uninformed underwriting clients. When a bank arranges and underwrites deals to meet its own hedging needs, or especially to take an opposing speculative position, that is also ethically questionable if not plainly disclosed." (That quote probably makes no sense out of context, but I hope it will prompt you to read Waldman's post, which is dense and complex but will reward careful attention if you are curious about what investment banks are actually supposed do when they are not operating like hedge funds.)

And as Surowiecki points out, the legal issue with what Goldman stems not from their bookmaking (though that is arguably the larger moral problem with all of Wall Street in recent years), but from their fraud. Perhaps the appropriate analogy for the allegations regarding the Abacus deal is this: Goldman knew Paulson had fixed the Super Bowl, yet worked hard to make sure enough people were betting on the losing team to fund the payoff on Paulson's inevitably winning bet. The question is whether Goldman should have taken this game off the board.

UPDATE: Subsequent posts by Waldman and Ezra Klein have made me reconsider my analogy. Klein argues that Goldman, like a casino or a bookie, has no obligation to tell bettors its opinion of their bets, even when it knows they are bad bets. It just takes the action. Waldman explains that the Abacus deal did not put Goldman in the position of bookie, and why the bookie metaphor may be altogether inapt:

Goldman wasn’t structuring a trade between two clients, as far as IKB and ACA were concerned. It was working to form a business entity called ABACUS 2007-AC1, LTD and underwriting an issue of securities by that entity. The only clients formally involved were IKB and ACA, and they were on the same side of the deal.
If this had been an adversarial deal, Goldman would have had no obligation to inform the side that wasn’t paying it whether they were making a good trade. But if this had been an adversarial deal, Goldman would have been advising one party or the other. Both parties could not have been its customers.
Imagine you are trying to buy a house. It is contentious. Disputes arise over price, warranties, settlement terms, etc. You would hire an agent, and the other party would hire an agent. Those agents would be different people. The hazards of relying on the same advisor in a difficult negotiation are obvious.

Then he adds what seems to me the key point to remember with regard to "market making": "Goldman was unwilling to make a market for Paulson at a price he would have accepted, so it manufactured an entity willing to do so. Investors in that entity were not informed that they were dealing with an active, involved adversary. And Goldman has the nerve to call both sides of the arrangement 'customers.' "

Goldman Sachs Sued by SEC (16 April 2010)

A few days ago I wrote about the expose of the hedge fund Magnetar, and its shady practice of buying equity in and default swaps on the same CDOs and then working to make those CDOs fail by getting them stuffed with toxic garbage. It turns out that the SEC has charged Goldman Sachs with something similar and is suing the great vampire squid. This seems like the kind of news that should be trumpeted throughout the nation, that finally at least some consequences are being imposed on bankers after they wrecked the economy -- though we shouldn't take away from this the idea that we already have enough regulation in place covering the financial industry and we simply need the SEC to enforce what exists (something enemies of financial regulation occasionally toss out there). From the press release:

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement. "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party."

This seems to demonstrate the inherent information asymmetries involved with securitization as it was practiced during the bubble years. If it was rating agencies sleeping on the job, it was investment banks and hedge funds colluding to dupe and deceive outmatched institutional investors. The client in question here was ultimately hedge fund manager John Paulson, widely heralded in the business press for making a killing off the housing crash. Paulson got a company called ACA to put securities of his choosing into a CDO it was managing (Abacus) that Goldman helped put together and sell off to other clients. He then shorted the same CDO with default swaps. The results: The Dealbook rundown explains that "as the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars."

James Kwak and Felix Salmon have analyses that explain why Goldman and not Paulson is the entity being held legally accountable. Salmon:

Paulson and ACA are both culpable, but it’s Goldman which was clearly central to the plan of deceiving investors into believing that the CDO was being managed by people who wanted it to make money, when in fact it was being structured by the biggest short-seller in the entire subprime market. And although ACA should never have been so passive in terms of accepting the names given to it by Paulson, it did reasonably believe, because it was essentially lied to by Goldman Sachs, that Paulson was in the deal to make money on the long side.... The scandal here is not that Goldman was short the subprime market at the same time as marketing the Abacus deal. The scandal is that Goldman sold the contents of Abacus as being handpicked by managers at ACA when in fact it was handpicked by Paulson; and that it told ACA that Paulson had a long position in the deal when in fact he was entirely short.

In other words, Goldman enabled Paulson to make fools out of ACA and all the investors who bought a piece of Abacus, all while collecting the fees for the deal.

Kwak isolates the juiciest quote from the documents, from an email by Goldman trader Fabrice Tourre, who appears to have been the point man on the deal: "More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" Just another financial mastermind at work.

Magnetar (14 April 2010)

Magentar would be a decent name for a band (it refers to "the super-magnetic field created by the last moments of a dying star"), but it's the name of a Chicago area hedge fund that, according to this ProPublica article by Jesse Eisinger and Jake Bernstein, executed one of the more nefarious (and probably characteristic) trades of the housing bubble. (The story is also featured in this episode of This American Life.) It's complicated but well worth trying to understand. This is the general gist:

According to bankers and others involved, the Magnetar Trade worked this way: The hedge fund bought the riskiest portion of a kind of securities known as collateralized debt obligations -- CDOs. If housing prices kept rising, this would provide a solid return for many years. But that's not what hedge funds are after. They want outsized gains, the sooner the better, and Magnetar set itself up for a huge win: It placed bets that portions of its own deals would fail.

Along the way, it did something to enhance the chances of that happening, according to several people with direct knowledge of the deals. They say Magnetar pressed to include riskier assets in their CDOs that would make the investments more vulnerable to failure.

In short, investment banks needed equity investors to create new CDOs. Magnetar volunteered and then allegedly used its clout as investor to push the CDO managers into toxifying the securities in the structure so that it would fail. Magnetar wanted it to fail, despite owning the equity, because that loss would be made up many times over by the payout on the credit-default swaps (which essentially insure against default) that it had taken out on the crappified CDOs with earnings from the equity. As long as the CDOs paid out, Magnetar could buy the swaps. When the CDO failed, the swaps would give the big payday. It was magic, nearly miraculous -- kind of like magnets themselves. ("Fucking Magnetar, how do you work?")

Along with some useful elucidation, James Kwak explains the significance of this Magnetar business in a post aptly titled "The Cover Up":

The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them -- only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.

As Bernstein and Eisinger explain, "From what we've learned, there was nothing illegal in what Magnetar did; it was playing by the rules in place at the time." Obviously these "rules" are useless if they provide no safeguard against systematic abuses and unsustainable banking practices and apparently rampant rating-agency laxity. The whole point of having rules governing the financial sector, after all, is to allow it to function for the common good of the economy -- so that it can match savings with worthwhile investments like the apologists say it does. But instead we had legislation undoing Glass Steagall and forbidding regulation of derivatives, etc. -- establishing rules that made it seem as though the function of a financial system was to guarantee that bankers could make lots of money no matter what happened to the economy at large.

As for what to do about it now, Mike Konczal's useful paper (pdf) about the current state of financial reform is a start.

"Manufactured uncertainty" (15 March 2010)

This post at Farnam Street, a behavioral economics blog, raises a point that always rankles me about purposely confusing pricing schemes designed to generate asymmetrical information. This is their take on nickel-and-dime fees the airlines have begun to charge:

Airlines are unbundling fares. 'Airfares' are lower but there are now fees for luggage, pillows, meals, coffee, and even washrooms (if the CEO of Ryan Air gets his way). What's really happening though, is that airlines are making pricing less transparent to consumers.
The real purpose of separating costs (unbundling) is to make it harder for consumers to directly compare prices between airlines. It is now almost impossible to directly compare total prices for one airline to another without a lot of thought. Airlines are banking on consumers not doing this hard thinking and choose a flight based on something other than the lowest price.

Voilà: financial innovation. Sometimes this sort of strategy is a divide-and-conquer play, where the customers willing to do the work of figure out the real prices end up getting a better deal than their "lazier" comrades. But generally it is simple obfuscation to circumvent the norm of unambiguous posted prices.

This reminds me of an old HBR article from June 2007: "Companies and the Customers Who Hate Them" by Gail McGovern and Youngme Moon. "Companies have found that confused and ill-informed customers, who often end up making poor purchasing decisions, can be highly profitable indeed," they begin, and then detail how management gets addicted to the baffle-the-customer approach. It begins when a price-discrimination schemes go rogue and begin to become deliberately vague, masking the ways in which fees are assessed. And it is abetted when there are natural or contrived hurdles for consumers to jump over before being able to switch to a new service provider. The brains in management realize that their customers have become fish in a barrel and then they open fire.

They single out banks, gyms and cell-phone companies for particular opprobrium: They cite how banks, for example, encourage practices that they can then charge penalty fees for -- overdraft "protection" comes to mind, something Bank of America has surprisingly decided to partially suspend.

The article concludes with advice for how companies might regain the favor of the customers they have abused, but I had the feeling that it was more of a how-to article with an epilogue tacked on for ideological cover -- the way authors would attach some moralizing to their pornography in the 18th century to get it past the censors.

Regulation and cultivating ignorance (3 March 2010)

The Roosevelt Institute's Make Markets Be Markets conference I mentioned tin a previous post is taking place today. Felix Salmon directs attention toward Elizabeth Warren's talk, which presumably is based on this paper (pdf) from the report. Warren argues that because of the regulatory shambles, consumer-credit companies can use obfuscatory complexity to confuse and exploit their customers, who have next to no vanilla alternatives. Salmon summarizes:

In 1980, noted Warren, Bank of America’s credit card agreement was one page and 700 words long; today it’s 30 pages of dense legalese. Banks will never willingly return to a world of 700-word credit card agreements, not when their profits from consumer finance are almost entirely a function of forcing consumers into paying hidden fees they don’t understand at the outset.

From the point of view of ordinary consumers, financial innovation is so much disorienting and distracting flim-flam from snake oil salesmen. Its purpose is not efficiency so much as it is the manufacture of information asymmetries with a captive population. So the main goal of any financial consumer-protection regime would have to be simplification. As Warren explains in the paper, "Shorter, clearer contracts will empower consumers to begin making real comparisons among products and to protect themselves. Better transparency will mean a better functioning market, more competition, more efficiencies, and, ultimately, lower prices for the families that use them."

Banks would likely protest that without their "innovations" it won't be profitable for them to lend as much, and marginal borrowers would find themselves unable to get credit and unable "to pursue the American dream" etc., etc. But banks have seemed to count on marginal borrowers being ignorant borrowers; they seems to have designed their contracts precisely to give loan officers incentives to find ignorant borrowers. And ignorant borrowers, by definition, are riskier since they have no real understanding of the contract they are entering into. This played out as the explosion of subprime lending, which was lucrative upfront for banks but patently unsustainable over the long haul. When the refinancing merry-go-round ended, the whole edifice came crashing down.

Warren notes that consumer-protection regulation won't eliminate ignorance or cupidity, but it can curtail its deliberate cultivation: "Nothing will ever replace the role of personal responsibility. The FDA cannot prevent drug overdoses, and the CFPA cannot stop overspending. Instead, creating safer marketplaces is about making certain that the products themselves don’t become the source of trouble." She addressing the "moral hazard" critique of consumer protection regulation -- the idea that people won't take any responsibility for their decisions if they think the government is out there making sure they can't make any mistakes. But the goal is not to make it structurally impossible for people to make bad decisions; the goal is to allow for a level playing field on which informed decisions can be made, so that responsibility can be morally inferred. As it stands, it's hard to argue that borrowers be punished for being snared by predatory lending practices.

Salmon points out that the Fed can't be expected to enforce regulations that protect consumers:

prudential regulators, meanwhile, exist to make those banks healthier: they like anything which generates income and profits, and have historically not cared in the slightest if such products are only profitable because they rip off consumers with moderate financial literacy. If they end up housing the CFPA, the CFPA will never be allowed to force the banks into the world of simplicity and honesty that we financial consumers so desperately need.

The upshot is we seem to live in a society in which the health of banks seems to come at the expense of consumers, and the state is caught in the middle of that. It is supposed to mediate between the conflicting interests. But since the deregulatory wave hit in the 1970s and '80s, it has been inclined to do nothing and sell that to the people who get screwed as the "benefits of small government." Unless a credible check to the pro-banking forces is set up within the state, consumers will continue to have no way to balance their interests against those of banks and will continue to be prey.

Forcing Markets to Be Free (2 March 2010)

Via Mike Konczal, an omnibus package of essays about financial reform that have helped lift the sense of despair I felt after finishing John Lanchester's book about the financial meltdown. Lanchester's book is sort of a black-humor take on the financial malfeasance that brought on this recession; it won't tell you anything new if you were following the story all along, but it has some helpful analogies to illustrate how financial derivatives products work and it expresses the right sort of eloquent outrage. Still, the book paints a stark picture of how bankers are institutionally bred to greed and contempt for those outside their sphere, which all convinced me that we will probably remain doomed to repeat the boom-bust cycles and that we'll continue as a society to be held hostage by financial intermediaries. Lanchester quotes from Keynes's "Economic Possibilities for Our Grandchildren" (pdf), in which he predicts the material wealth of society will increase to the point where greed will cease to be socially necessary, as invisible-hand Mandevillian types have long argued. Keynes:

Thus for the first time since his creation man will be faced with his real, his permanent problem-how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well. The strenuous purposeful money-makers may carry all of us along with them into the lap of economic abundance. But it will be those peoples, who can keep alive, and cultivate into a fuller perfection, the art of life itself and do not sell themselves for the means of life, who will be able to enjoy the abundance when it comes....

When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals. We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues. We shall be able to afford to dare to assess the money-motive at its true value. The love of money as a possession -- as distinguished from the love of money as a means to the enjoyments and realities of life -- will be recognised for what it is, a somewhat disgusting morbidity, one of those semicriminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.

Lanchester's book is basically an extended meditation on how wrong Keynes was about this. Greed is not classified as a mental illness in our world of abundance; instead it is touted as an enlightened virtue and held to be best way to demonstrate ambition. Thus we have permitted those who dare to be greedy on the grandest scale to carve themselves a seemingly permanent niche in the power structure of our society.

(Keynes also makes a point about technological unemployment in that essay, which pertains to my latest post at Generation Bubble -- about the possibility that the kids graduating now may be able to look forward to have to "be themselves" as a job, which will either be utopia or the most subtle and soul-sucking form of alienation yet conceived. I also cite Black Flag's "Damaged II.")

The essays on financial reform are premised on the notion that the "greed is good" ideology is not synonymous with capitalism. Hence the title for the collection: Make Markets Be Markets. The basic idea is that financial reform should restore transparency and thus true competition to markets that have been corrupted by the bankers and plutocrats and the politicians they have bought and paid for. It's a retort to the idea that "free" markets are unregulated, when in fact unregulated markets aren't markets at all. Truly unregulated markets would represent a regression to a Hobbesean world of accumulation by the audacity of brute force. "Free" markets in practice have turned out to be selective enforcement of the rules beneficial to capitalists while dispensing with the fairness principles that may originally have given them their opportunities. And meanwhile the rest of us chumps uphold the social norms (respect for property and the sanctity of contracts) that make the charade possible. A recurring undertone in the "Make Markets Be Markets" essays is that those social norms are in jeopardy if the powers that be continue to flout them and take them for granted. I tend to see the Tea Party movement as an expression of how those norms are fraying.

From a purely theoretical viewpoint, I wonder whether financial reforms are inevitably efforts to valiant efforts to keep a ship that should be evacuated instead and allowed to sink. Less cryptically, capitalism in its ideal form still seems predicated on those character traits that Keynes singles out as semicriminal, so regulation within it will always be a losing battle, worth fighting only because (a) one believes that any other economic system will be worse or (b) one regards human suffering in the here and now more urgent than the theoretical happiness of posterity. But when I think more pragmatically, it seems obvious these reforms be fought for and enacted, even though they aim to preserve capitalism as we know it. Financial reform strikes at the heart of the ideological struggle within capitalism, trying to shift the basis for "freedom" away from the notion of untrammeled and unfettered ambition and toward the idea of respect for the social norms of mutual respect and a recognition of how precious and fragile they are.

But What About the Tract Homes? (2 Feb 2010)

Suburbia (not this one, alas) seems to be in the news, prompted by Joel "New Geography" Kotkin's essay claiming that the Obama administration (aka "the president’s cadres") is inveighing a "war against suburbia." This is so ridiculous it almost needs no comment. Atrios sums it up well: "This is completely idiotic for mostly obvious reasons, including the hundreds of billions devoted to propping up single family home prices." (I think Kotkin needs to watch Over the Edge is he wants to see what a war on suburbia really looks like.)

Mike Konczal puts some specific numbers behind some of the other obviousness, the idea that money for Obama's high-speed-rail initiatives threatens pro-suburban transportation policy.

From the ProPublica Stimulus Spending List:
Highway infrastructure investment $26,725,000,000
Highway infrastructure funds distributed by states $60,000,000
Highway infrastructure funds for the Indian Reservation Roads program $550,000,000
Highway infrastructure funds for surface transportation technology training $20,000,000
Highway infrastructure to fund oversight and management of projects $40,000,000
Additional capital investments in surface transportation including highways, bridges, and road repairs $1,298,500,000
Administrative costs for additional capital investments in surface transportation $200,000,000

High speed rail capital assistance $8,000,000,000
Check that out: Over $28 billion dollars allocated to highway spending, with over $26 billion allocated to “Highway infrastructure investment.” That’s over three times the amount spent on the $8 billion for “high speed rail capital assistance.”

Factor in all the ongoing support and tax breaks for mortgages and single-family homes, and it's safe to say that the suburban way of life is going to remain heavily subsidized and under no particular threat from the current regime. No one is planning to run rails in place of the highways. And as Amanda Marcotte points out "some of the biggest beneficiaries of public transit by rail are the very suburbanites in middle American cities that Kotkin claims to fiercely defend."

Kotkin goes to great lengths to sell his bill of goods: he quotes right-wing economics writer Robert Samuelson, he evokes Europe as a boogeyman, uses the "elitists hate it, so it must be okay" argument, and deploys insinuating rhetoric, as in this passage:

These efforts will be supported by an elaborate coalition of new urbanist and environmental groups. At the same time, a powerful urban land interest, including many close to the Democratic Party, would also support steps that thwart suburban growth and give them a near monopoly on future development over the coming decades.

Yes, there is a vast left-wing conspiracy implementing the urbanist agenda and unleash its "deep-seated desire to change the way Americans live" behind the backs of voters, who are nonetheless so outraged that they voted for Scott Brown.

Kevin Drum, who seems to think it is glib to remind suburbanites of their subsidies, argues that these suburban voters are waiting for some more explicit and unwarranted handouts, mainly because they are too myopic to see the ways existing policies already benefit them. Drum writes that "there's a real tension between good policy and good politics" and seems to imply that we must inevitably surrender the former to the latter. What has happened over the past few years gives us no reason to think about things less cynically, I suppose, but I would hope there is still something useful in arguing the merits of policy, in acknowledging that suburbanization is unsustainable in the form it has taken up to now. Why give respect to Kotkin for providing an ideological smoke-screen for suburban-voter selfishness? Marcotte also makes a good point about the ideological cover Kotkin provides for suburban racism of the sort that apparently animates a good portion of the Republican party: "You can really tell what the agenda behind this article is when author Joel Kotkin puts 'white flight' in square quotes, implying that liberals made it up because of our irrational hatred of the suburbs." (I always thought they were "scare quotes," though they are sort of for squares, as well.) It always seemed to me that suburbs are about the fantasy of escaping from the presence of poverty or any feelings of social responsibility over inequality. You move somewhere where "those people" don't exist. Then you can practice a me-first, NIMBY-style politics as if it's rational and "natural."

Of course suburbanites don't like the idea of having to change their lifestyle. Ideally economic, demographic and environmental realities will end up driving the change, not a government cabal. Incidentally, it's at least as plausible to argue that zoning restrictions, various state-funded incentives and the relative underinvestment in cities that forcibly "changed the way Americans live" in the past 60 years. Ultimately, ideology and habitus shape where and how people choose to live more than any explicit raft of social-engineering programs -- in a class-inflected society, residential spaces will mutate to continue to reflect and reproduce the various distinctions.