When I first tried to understand what the whole financial meltdown was about, it sounded to me like some kind of perpetual motion machine -- a black box that reversed the first law of thermodynamics ("econo-dynamics"?) to produce energy from nothing, or money from debt. Turns out the principles behind the "financial instruments" that caused the collapse were indeed crafted in part by physicists and mathematicians who designed complex formulas that defied real-world understanding, but that appeared to guarantee profits out of nothing.
Here's my quick take on the smoke-and-mirrors magic-of-the-marketplace that deregulation made possible at the turn of the last century (y'all remember Enron) and how it's manifesting itself in today's financial crises -- using clips from CBS's "60 Minutes" report, "Wall Street's Shadow Market", (10/6/08) and Alex Gibney's documentary, "Enron: The Smartest Guys in the Room" (2005).
The Enron-mentary made me sick to my stomach, most of all because of the fact that it's virtually impossible not to see Enron as the natural extension of capitalism run amok. You can call the people at the top monsters, but aren't they ones we (by supporting this system) created? There's no advantage to morality when you get high enough.
I find it interesting to hear about mathematicians and physicists working on a system to try to reduce risk--something so complex that no one else could understand it. As someone who is just at the beginning of a career in physics, I hope that I use my skills for something more constructive than a system designed, possibly, to obfuscate real risks and to put off having to pay for a few more years.
Jim, I just hope you have the chance to turn this into some kind of franchise. Although it does make one wonder how much Enron executive action figures would be worth today.
Frankly, I'm sick of all the anti-capitalist ignorance being spouted by the left. Kerry and Obama both lack even the most basic knowledge of economics, a.k.a knowledge that would be obtained in a freshman-level business course. I'm not saying that either you, Jim, or William, who is the only other poster at the time I'm writing this, is ignorant. I have no idea of your education in economics, but it would be helpful if someone pointed out that we wouldn't have much of an economy to crash without our wonderfully efficient capitalist market. Is capitalism the problem? No. Are there people and businesses who have abused the system? Of course. Should there have been regulation in financial markets that dealt in more money than all the stocks traded around the world? Of course. But how do we regulate things that the government simply doesn't understand. Yelling "Regulate!" when you don't understand what you're regulating is like yelling "Bomb them!" when you don't know who you're fighting. It's not really going to fix anything, and everyone's going to be worse off. That's my two cents, but since the economy's bad, you get it for free.
Adam Smith: (Now there's an economist for you.) Both the docs I quote from in this little video seem to do a pretty good job of explaining complex principles in ways laymen (like me) can understand. I know nothing of economics -- even less, I'm sure, than John McCain, who admits as much. But I do know something about human nature, and when you create financial incentives without accountability to anyone but insiders, you're providing an engraved invitation for abuse. I also understand the idea of checks and balances -- as in systems, not as in checking accounts and bank balances. (I don't think I understand the latter very well at all.) I'm amazed, though, at how willing supposedly sophisticated investors have been, to put money into schemes like Enron's, or these mortgage debt securities and "credit default swaps" that sound too good to be true because they are.
I think the trend toward deregulation has swung way too far and needs to come back toward the center again -- and that's not an "anti-capitalist" argument, or even a "liberal" one, as the last couple weeks have shown. All but the most adamant far-right free-marketeers have been saying that excessive deregulation has contributed substantially to the mess we're in. If the problem had just been selling bad mortgages, we wouldn't be in any serious trouble; as the "60 Minutes" piece reports, 94 percent of people are keeping up with their mortgage payments. But the investment banks inexplicably chose to place their bets on those least likely to pay. It was the incomprehensible "financial instruments" that built this house of cards. Still, I don't know who would have been responsible for noticing that these unregulated things called "credit default swaps" were actually "insurance policies" (and, as such, subject to regulation) -- with insufficient capital to back them up. That sounds like plain old fraud to me. And where there's money, there will always be crooks. (No, I'm not saying money causes crime -- just temptation.)
Here in Dallas, we can't even get the code inspectors to prevent a four-story building from being built in an area that has a zoning restriction limiting building height to three stories.
If government employees can be easily fooled on something as simple as where the ground is, how could we possibly hope to find regulators able to untangle these messy, complicated derivatives, etc. that are designed specifically to get around whatever regulations do exist (and, you know, there was a pretty massive package of regulations passed in the wake of Enron, so it's not like the Congress, etc. has been sitting on their hands since then).
Jim,
I agree with what you're saying about the opaque nature of these bank's practices, particularly the credit default swaps, which as I understand them were like insurance policies as you say, or like short selling but with the possibility (gamble) that the payment would never come due.
I've seen "Enron: The Smartest Guys in the Room" and was enraged by what their executives did. But the question asked in the video is "Is this the work of a few bad apples, or the dark side of the American Dream?" To me, the answer is simple: a few bad apples. It's too easy to point to all the people who lost their 401ks and call them victims of the free market when we all have benefited in unimagineable ways from that system. I remember an anecdote about a Soviet ambassador visiting an English Ambassador and asking the Englishman, "Who runs your bread market?" and the English Ambassador said, "Well, nobody." Imagine if we needed the government to tell us how much bread we would need this week. It's completely absurd. Overall, the market does it's duty amazingly, and sometimes (and I know this sounds cold) there are costs. Of course the government should regulated fraud. Fraud interferes with free markets. What the government shouldn't do is regulate the market itself. That is simply impossible.
Which brings me to Reagan's clips, which is what really frustrates me about this video. Government isn't the solution to a poor economy, which I believe is the issue Reagan is addressing in this clip, not fraudulent corporations or gambling banks. Carter's administration saw government regulation in areas such as gas prices, which had disastrous results, and the economy was in the toilet (I'm not saying it's because of the gas prices, obviously). If the problem is a poor economy, the solution was free markets. Free markets are simply more efficient. Reagan's "Trickle Down Economics" isn't crackpot economics, it's just... economics. When the government lowers taxes, government tax revenue generally increases. That gives an idea as to the incredible power of freedom in the marketplace.
What we have in our country today is a lesson by hard knocks. Now we know about these banking practices, and it smarts. Banks will think twice in the future, and we won't suffer another blow. That's the free market in a nutshell.
Imagine if we needed the government to tell us how much bread we would need this week. It's completely absurd.
But the government should regulate the conditions in which you bake the bread, no?
Banks will think twice in the future, and we won't suffer another blow.
Because, anything bad that's happened once in the entire history of mankind has never happened again.
Adam,
I was talking mostly of the Enron-mentary; basically, as Jim points out, the problem here is not "capitalism" but human nature. No one was watching the guys at the top (of Enron), and they did whatever they possibly could to get rich without any concern for human decency--which is capitalism unbounded by other concerns. Capitalism is mostly a good thing (compared to other systems) but it is basically an amoral system, as most systems are. My use of the phrase "capitalism run amok" is basically what it sounds like--capitalism without any other other factors reining it in. Anyway, basically my only economics education is, yes, a freshman level course, but I mean to learn about it more.
Adam: I see your point. By including that "dark side of the American Dream" quote at the end (just before "the magic of the marketplace") I simply wanted to emphasize that there IS a dark side. To EVERY dream. Like what I said in my previous comment (and William B elaborated below) -- unless there are checks and balances and regulations, the unchecked "market" can simply become a pyramid scheme. And people who may not even consider themselves criminals -- who may even be technically playing by "the rules" (by, for example, being careful not to call the credit default swaps "insurance") -- wind up inflicting terrible damage. Every system (heck, every person) has a "dark side." Maybe that's pessimistic, but I think it's realistic. The term I object to is not "marketplace," it's "magic." Markets should be transparent. To make informed decisions, people have to know what they're buying and selling.
I think we basically agree on the larger issues. There is definitely the potential for pain to be delivered by the free market, and I certainly don't think it's anything but realistic to see the potential dark side in people and in systems (both the market and government systems. We can't forget the corruption that plagues many governments worldwide).
What I wish we had was a free market without all the lobbyists. Our markets aren't really free when politicians are constantly giving huge breaks to industries in exchange for campaign contributions. The banking industry's lobbyists are strong enough to sway Congress regarding which TYPE of bailout plan they would get, one which gave the government would get control and one in which it wouldn't. Talk about looking a gift horse in the mouth. But I'm not sure how to fix that problem. I'd be favor of regulating the government there. Maybe we'd see better business practices as a result.
I am curious about what exactly you meant by the pyramid scheme analogy. Do you mean that corruption within the free market causes this (rather limited cases really)? Or that any free market system moves in this direction unless someone's keeping watch? The second is a common misconception, but certainly not true according to economic principles. But you don't have to look at those principles. It's just common sense. Our poor are people who have to scrimp on eating out and take the bus. Compare that to the poor of other countries and you get an idea what I'm talking about. If there's one idea that I think is often lost, and most crucial to understanding economics, is that a marketplace always results in both parites benefiting. One person making money doesn't mean that another loses it. I know this sounds overly simplistic, but it's amazing how many people believe--even argue--that this is false. This is why, Will, I don't necessarily think that capitalism is an amoral system, though I know what you're getting at. It's a system in which one can be rewarded for being amoral, and, as you said, that is true of virtually any system.
Markets should be, and for the most part are, transparent. The 60 minutes interview does a great job pointing out that these bankers didn't even really understand what they were getting into. That's scary, and I agree that if government workers can't get someone in those banks to explain these new securities, Congress should start paying attention.
Anyway, it's been fun discussing this, but I'll probably have to stop rambling now. I'm a USC Cinema MFA and have to start shooting a short this weekend. I suddenly feel grossly unprepared. Thanks for the post, Jim. Stimulating as always.
-Dan (a.k.a Adam Smith)
The pendulum may be about to swing again, and as a liberal I'll be closer to happy, but I'm also willing to bet that if it swings it will swing too far. One way to avoid it swinging so far the other way is for those on the free market side to take a bit of responsibility and make some suggestions as to how they will regulate their own damn selves in the future. One of the relatively simpler ideas would be to limit the number and variety of pies into which any one entity may stick its fingers. The *really* smart thing, of course, would be to do this when things are good. But like C. Montgomery Burns, the richest will trade it all for just a little more.
And, man, am I sick of the blame being doled out to average Joes for buying a house they can't afford. No one knows how much they can afford. They are *told* how much they can afford. If the entire world is on a spending spree and you have nothing but you are told that all you have to do is scrape up a few dollars and someone will give you a house, which will almost immediately become a source of cash for you and will continue, year after year, to increase in value, where is the risk? It's not at all (as the sales pitch goes) like buying a Lexus or Rolex or other fancy item with an x in it, that you can't afford. It's not an extravagance, it's an investment. This is the American Fantasy but it's touted in every direction as the American Dream. Skeptics like me might not have fallen for it, but such skepticism is, of course, un-American.
Adam/Dan: By pyramid schemes I meant any of these formulas and sales pitches and financial instruments (whatever somebody chooses to call them in any given instance) that appear to generate money from nothing -- like the ones described in the clips, from the way Enron manipulated so-called "mark to market accounting," to the chopped-up mortgage debt schemes. Undoubtedly there will always be ways to fool the market and cheat the odds, but I think we ought to eliminate as many loopholes as we can so that we taxpayers don't find ourselves suddenly saddled with billions and billions (thank you, Carl Sagan) of dollars in private debt. How does anybody explain why every person in the US is now stuck with an additional $2,000+ tax burden because of some bad investments made by unimaginably rich bankers at huge financial corporations? And those executives are still rich beyond imagination. (Remember Ken Lay's wife describing her family's nouveau poverty?) That's where my mind boggles. Thanks for the discussion -- and good luck on that short.
P.S. Regarding the definition of poverty: Yes, it's relative, as you no doubt know from attending USC, where you're not far from some very poor and hazardous streets. It's one thing to live without money in a remote rural community where your family and neighbors have lived for years or even centuries (where the idea of "bus money," for example, is irrelevant); but it's something else to be homeless in the streets/slums of a big city....