Author: ken

A Question on the Economy

from Ann D’Ercole

As I walk or drive around neighborhoods here and in Europe I’m still struck with how pleased I feel that everything, everywhere is clean, attractive and projects a sense of relative safety compared to the old days when many more decrepit buildings and neighborhoods blighted the world.
A couple of years ago I did start to wonder how it was all being financed. But I was willing to forget that question because I liked what I saw. So, my question to you is in our post 911 collective unconscious could it be that we were all happy to sign onto what appeared to be an equalizing egalitarian world where all neighborhoods were places where people would want to live? We accepted a sign of global prosperity because we wanted one rather than accept 911 as a sign of global disaster.

Dear Ann:

I think you are right that we were all happy to sign on to the evident signs of prosperity, the clean streets, the restored neighborhoods and new cultural buildings — and our increasing retirement portfolios as well.  Behind the facade was a good deal of social inequality less easy to see.  But your main point — and I agree very much — we were complicit.  We did not ask and we did not want to know how it was accomplished.

MORE ON RISK

OTHER BAD IDEAS

A number of other economists are speaking up about the ideologically driven economic theories that allowed our financial institutions to accept ballooning risk — and stave off the “danger” of regulation.

In Saturday’s New York Times, Joe Nocera cites Jeremy Grantham, “a respected market strategist with GMO, an institutional asset management company,” (Poking Holes in a Theory of Markets) who lays they blame on the efficient market hypothesis.

I think there is a lot more of this coming, and no shortage of bad ideas to blame. But the key is why was so much faith placed in such flimsy ideas?   How were the minds of financial managers, economic gurus, investors, regulators,  and the rest of us so easily swayed.  How did we allow it to get out of hand?

Here I think we have to look at a host of unconscious motives that powerfully shaped behavior without being available for critical scrutiny.  In my previous post I pointed to how the competitive race among financial firms seemed to pose a greater risk for them than the risk of default.  Eying each other so intently, they could not keep their eyes on the ball. But then, of course, there was also the pressure we all put on the system for greater and greater returns. And our government’s ideological commitment to “free markets” and deregulation,  and so on.

I think that instead of blaming specific ideas, it might be more useful to  look at how we use them and how we think?  Clearly we need regulation of markets more than we allowed ourselves to be persuaded we did, but we also need some intellectial and emotional self-regulation as well.  We have to pay more attention to the unconscious processes that drive collusive behavior.


ABSTRACT RISK

AND REAL DANGER

It is becoming increasingly clear that a major contributor to our economic meltdown was the cavilier way in which our financial institutions managed to get risk off their books — and out of their minds as well.  How did that happen?

Paul Wilmott has emerged as a vocal and active critic of the abstract economic models that lay behind this way of thinking — and  Nassim Taleb,  author of the bestseller The Black Swan, calls him the smartest quant in the world. “He’s the only one who truly understands what’s going on … the only quant who uses his own head and has any sense of ethics.”

Wilmott notes in Newsweek, Revenge of the Nerd:  “They built these things on false assumptions without testing them, and stuffed them full of trillions of dollars. How could anyone have thought that was a good idea?”  He adds, “We need to get back to testing models rather than revering them,” he says. “That’s hard work, but this idea that there are these great principles governing finance and that correlations can just be plucked out of the air is totally false.”

But what may be even more significant is Wilmott’s pessimism about change: “What I think is going to happen is that people will forget and we’ll just keep going on the way we have been with nothing really changing,” he says. Wilmott is encouraged by President Obama’s proposals to tighten regulation of derivatives; he thinks it’ll keep quants on a shorter leash. But he’s also stunned by the lack of outrage over the financial mess. The violence that erupted at this year’s G20 summit wasn’t anywhere near what he thought it should’ve been. “Where the hell was everybody? If people aren’t angry now, they’ll never be.”

So what explains the quants blindness to risk?  More importantly: why do the firms that employ them fail to learn from experience?  And, as Wilmott asks, “Where is the outrage?”  You might think that the battled scarred veterans of finance would be more skeptical about their clever quants, more tough-minded.  Why is it so hard to face  the reality of such risk?  What don’t they know they know?

I suspect it is about the immense competitive pressures that financial institutions feel to come up with investments yielding greater and greater returns.  In a society where all have become invested — through our  pensions, endowments, college funds, 401Ks, and savings —  finance has come to play the key role.   Financial returns from investments have become more important than productivity — or virtually anything else apart from national security.  The result is that the pressure within and between financial firms mounts.  Their competitive advantage  in the moment matters more than long range success, and risk of long term failure is downplayed.

To be sure, in the end the danger of financial collapse will spoil every other advantage, but the risk that the financial firms pay more attention to are the risks of failing to compete successfully with other firms to gain investments.  That risk casts all others into the shadows  — and makes it all too easy for investment managers to be seduced by the abstract reassurances of the quants.

And that is why Wilmott’s pessimism is justified.  People will forget because they will be intensely concentrated on the promise of gain and the competition with others.  In that situation, risk becomes a nuisance — and then it fades out of mind.

JUSTICE IS BLIND

BUT WHAT ABOUT THE JUSTICES?

Those who reacted with indignation to Sonia Sotomayor’s  comments on how her awareness of race inevitably influenced her judgment, may be hypocritical and they may be trying to manipulate public opinion — but it is even more important to grasp that they do not have reality on their side.  Senator Cornyn, a Texas Republican on the Judiciary Committee, opined that “The American ideal is that justice should be colorblind.”  Apart from the question of whether or not it has been our “ideal,” or even if it has ever been realized, is it even possible?

Adam Liptak makes a nice point in this Sunday’s New York Times, “The Waves Justices Make.” Supreme Court justices themselves have been deeply influenced by the racial identities of their fellow judges.  “Marshall could be a persuasive force just by sitting there,” Justice Antonin Scalia told Juan Williams in an interview for a biography of Justice Marshall, recalling the justices’ private conferences about cases. “He wouldn’t have to open his mouth to affect the nature of the conference and how seriously the conference would take matters of race.”

To some extent, we are all racists, as John Blow pointed out in his OpEd piece in Saturdays New York Times:  “On one end is the mere existence of racial bias. Harvard’s Project Implicit, an online laboratory, has demonstrated that most of us have this bias, whether we are conscious of it or not.  Somewhere in the middle of the spectrum are the conscious expressions of that bias in the form of prejudices. On the other end, at the extreme, are deliberate acts of racial discrimination based on those prejudices. That’s where the racists dwell.”

The universality of this bias is rooted in the unconsciously determined categories that our minds create to make sense of our experience.  We lump things together.  And it is demonstrated in the tragic shooting of off-duty police officers by their white colleagues.  Those “accidents” were almost certainly not consciously intended, but in the heat of the moment, with little time to reflect, like the rest of us, they relied on those categories, with disastrous consequences.

That cannot be said of Rush Limbaugh, Newt Gingrich, Tom Tancredo or the other Republicans who are clearly looking for an issue to block Obama’s nomination.  In terms of Blow’s categories of bias, that’s genuine “racism.”

CHANGING MINDS AND HEARTS

Liberals vs. Conservatives

On the OpEd page in Thursday’s New York Times, Nicholas Kristof notes that liberals and conservatives have different emotional profiles, not just different ideas.  They face the world with different stances. (See “Would You Slap Your Father? If So You’re A Liberal”)

“For liberals, morality derives mostly from fairness and prevention of harm. For conservatives, morality also involves upholding authority and loyalty — and revulsion at disgust..”  This is a good beginning at delineating the unconsciously held attitudes that underly conflicts over policy and politics.  Essentially, the arguement goes, we start with an underlying predisposition to think a certain way, a “moral intuition,” and then our brains find the arguments to support that position.

But the interesting question he goes on to raise is, given this fact, how can each camp learn from the other?  He tells us that he started out with the old fashioned idea that debate – the clash of viewpoints in the marketplace of ideas – was the right approach.  But now, he cites the work of Professor Jonathan Haidt, Psychology Professor at Virginia:  “Our minds were not designed by evolution to discover the truth; they were designed to play social games.”

There are other factors as well that keep us from changing our minds.  We tend to fight to preserve our predispositions, seeing other points of view as antagonistic, threatening to the beliefs that makes us comfortable.  We also strive to protect our identities as members of different ideological camps. We endanger our affiliations and support systems if we are too willing to change.  It is a complex and thorny array of factors that keep us tenaciously holding to our beliefs.  But I think Kristof is right to ask: How can we open our minds – and hearts – to different points of view?

His suggestion is that we reach out to moderates on the other side in order to break down the “us vs. them” battle lines.  That’s a good beginning, but just a start. When we get back to our own communities it is hard to hold on to the new ideas we picked up at lunch.  Moderates can play a crucial role, but, clearly, they are not the root of the problem.

As a psychotherapist, I know how hard it is for people to change ingrained patterns of behavior and established assumptions — even when they want to.  So I think we need an array of strategies and a consistent emphasis on the existence of the problem to make any progress at all.  And we need leadership that constantly reminds us that there are better ways to listen to each other and to talk.